If you are considering taking a small business loan, then you may be wondering how it will affect your next year’s taxes.
The short answer is – business loans are tax-deductible. Receiving a lump sum of money in your account is different from earning money in your business. Hence, most business loans are tax exempted. But, then there are some rules to be followed.
Here, in this post, we walk you through the implications of business loan taxations, helping you get a clear idea of what you will owe the income tax department.
What does a Small Business Loan Do?
Businesses generally avail small business loans in need of immediate funds. The common reasons are – expanding the scope of the company, hiring new staff, increasing inventory, purchasing new equipment, shifting to a new office, renovating an existing office, and more.
Business loans are of two major types:
- Secured business loans – Here, the borrower has to submit collateral to avail the funding
- Unsecured business loans – These loans that are provided without any collateral
Business Loan Components
When you avail a business loan, the lender provides you with a lump sum amount. This is the principal. When you repay the loan, you have to pay an additional amount on top of the principal. This is the interest on your loan. The interest is the fee you pay to the lender for the usage of the funds. The interest rate plays a crucial role in determining the overall amount you repay the lender.
Apart from helping you meet your short-term capital needs, business loans also provide tax relief. You can enjoy a few tax benefits when you repay the business loan.
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Tax Benefits of Business Loans in India
- Interest Repaid on a Business Loan Is Tax-Deductible
The interest component of your business loan is tax-deductible. You can deduct this amount from your gross income while calculating the income tax of your business. Make sure to maintain the correct records of your business loan, so that you can submit proof if later requested by the income tax department.
- Principal on Business Loan is NOT Tax-Deductible
The principal amount you borrow in a business loan is not tax-deductible. You cannot deduct this sum from your gross business income while calculating the year’s taxes.
However, the principal amount is not money earned by your business. What you are doing is essentially borrowing money from a third-party and repaying it. Hence, it is not considered as income for your business.
This means you don’t have to include it in your gross income. You don’t have to pay income tax for this amount, nor can you deduct it from your gross income.
Now, that you are clear about the tax implications of business loans, you have to understand,
- Tax Deductible Expenses for Businesses
Tax-deductible expenses work in favour of your business. These are expenses that can be deducted from your gross revenue or profits, thereby helping you lower your taxable income. Simply put, these expenses are subtracted from your overall business revenues for the year, before you compute your tax liabilities.
As explained above,
The Interest component of your business loan is a Tax Deductible Expense
The Principal component of your business loan is not a Tax Deductible Expense
- Business Loans Taxation Rules: In a Nutshell
The loan interest amount is tax exempted, if you can show proof that it was used for a business-related expense like purchasing equipment, inventory, etc. The principal amount does not offer any tax benefits as it is not tax-deductible. However, it doesn’t increase the overall taxes you pay, as you don’t have to include it in your gross revenue.
Now, we come to another related question,
What if I have availed a personal loan but used it for business purposes? Will I enjoy tax benefits?
Yes. Let’s say you have borrowed a personal loan to meet your business needs – like boosting working capital, paying staff, etc.
Then, the taxation rules are the same as above. You can claim tax exemptions on the interest component of your personal loan as it is a tax-deductible expense. Again, the principal is not a tax-deductible expense; hence, you cannot enjoy tax deductions on this amount.
Deduct the overall interest paid from your gross profit before calculating your tax liabilities. This reduces the net taxable profit of your business, which, in turn, reduces the taxes you pay.
There is no upper limit on the interest amount that you can claim as a tax-deductible expense. However, remember that you have to show proof that you have used this amount for business purposes. So, make sure to store all bills and receipts carefully, so that you can avoid any discrepancies with the IT department later on.
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Avail Business Loans and Enjoy Double Benefits
Now, that you are clear of the taxation rules of your business loans, you can go ahead and avail the right small business loans and grow your business, without having to worry about tax implications. Make sure to compare the costs of business loans with different lenders and choose the right one that offers you the best deal.
Shivam is a passionate content writer with Masters in journalism. A mutiple-award-winning writer, he brings over a decade of experience as a BFSI writer. In fact, he himself is known in his circle for sound financial advice. A writer by day and a reader by night, Shivam enjoys researching and writing on various financial topics, including credit, stock market, crypto, taxes etc. When he is not spending his time penning down an informative article or opinion, he can be found playing with his kids or collecting stamps.
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