A sole trader can deduct interest, bank charges and other finance costs to the extent the borrowing is used for the business. The test is the wholly and exclusively rule in section 34 ITTOIA 2005, applied to what the money is actually funding. Since 2024 to 2025 the old £500 cash basis cap has gone, but interest on borrowing that funds private drawings, including through an overdrawn capital account, is still restricted.

Which finance costs can a sole trader claim?

GOV.UK lists bank, overdraft and credit card charges, interest on bank and business loans, hire purchase interest, leasing payments and alternative finance payments such as Islamic finance as costs a self employed person can claim. Repayments of the loan itself are never deductible.

Section 29 ITTOIA 2005 says that, for calculating trading profits, interest is an item of a revenue nature whatever the nature of the loan, so interest on a loan to buy a van is not capital just because the van is. Section 58 allows a deduction for the incidental costs of obtaining loan finance, such as fees, commissions, advertising and printing, if the interest is itself deductible, and even where the finance is not in fact obtained. It excludes stamp duty, exchange losses and the cost of a premium or discount on repayment.

On the tax return, the SA103F notes put loan interest and hire purchase in box 25 and bank, overdraft, credit card and lease charges in box 26. Any non business part of a loan, overdraft or finance payment goes in the matching disallowable boxes, 40 and 41.

What decides whether interest is deductible?

HMRC’s Business Income Manual at BIM45665 says interest is allowable where the borrowed money buys business assets or provides working capital to pay trading costs. The crucial point is how the funds are used while the interest accrues. The use can change, so the original reason for the loan does not fix the answer forever.

  • Security is irrelevant. BIM45685 confirms that a loan secured on your home can still be a business loan if it pays for a business asset, and a loan secured on a business asset can be private if the money is spent privately.
  • Use can change. BIM45680 gives the example of a private car brought into a GP practice and used half for home visits, so half the interest becomes allowable.
  • Mixed use is apportioned. Where an asset is used partly privately, BIM45670 requires a reasonable apportionment of the interest.
  • Private loans stay private. BIM45675 says interest on a separate loan taken out to meet private expenditure is not deductible whenever it is paid.

This is the same test that governs every business cost; the wholly and exclusively rule page explains the case law behind it.

How do the accruals basis and cash basis differ?

Under traditional accounting, interest is deducted as it is charged in the accounts for the period. Under the cash basis, which became the default for sole traders and partnerships from 6 April 2024, HMRC’s guidance at BIM72030 says expenses are deducted when paid during the tax year. For the wider comparison see cash basis vs accruals accounting.

The old £500 cap

Before 2024 to 2025, section 51A ITTOIA 2005 stopped cash basis traders deducting interest on cash borrowing, except for up to £500 a year of interest and incidental finance costs. HMRC’s guidance at BIM70040 explains that the £500 applied without any apportionment for private use, and that interest on purchases, such as trade credit, hire purchase interest and credit card interest on allowable purchases, sat outside the cap.

Section 51A was omitted by Finance Act 2024 for 2024 to 2025 and later years. BIM72030 now says the cash basis does not usually change which expenses are allowable, apart from the rules on capital expenditure and car hire. So a cash basis trader with £3,000 of genuine business loan interest can now claim all of it, and must apportion interest on mixed purpose borrowing in the ordinary way.

What is the overdrawn capital account restriction?

A sole trader’s capital account is roughly the money introduced plus profits, less losses and drawings. If drawings exceed what the owner has put in and earned, the account goes overdrawn and the business has to be financed by borrowing. In effect the bank is funding the owner’s living costs, and interest on that part of the borrowing is not for the trade.

HMRC’s guidance at BIM45705 says an overdrawn capital account is no more than an indication; HMRC must show that private drawings caused it and that borrowings funded it. In Silk v Fletcher, summarised at BIM45725, an accountant’s drawings exceeded his profits for years. The Special Commissioner accepted that this pointed to the loans funding drawings, put the burden on the taxpayer to prove otherwise, and said that making book entries to put the account back in credit does not make the interest deductible; the question is the underlying reality.

The guidance also sets limits on the restriction:

  • Unrealised gains, such as a revaluation of property or goodwill, are ignored when deciding whether the account is overdrawn (BIM45710).
  • Accumulated depreciation is added back, because charging depreciation lowers the capital account without any cash leaving (BIM45715).
  • Where the account is overdrawn because of trading losses, the borrowing is treated as providing working capital and no restriction applies; only drawings taken on top cause a restriction (BIM45715).
  • BIM45700 confirms you can withdraw profits and capital you introduced, but swapping your own capital for a loan does not on its own make the new interest deductible.

HMRC’s own example

In the example at BIM45715, Mr A introduces £50,000, makes losses of £30,000 and takes drawings of £20,000 over two years, leaving his capital account at nil. He borrows £30,000. In year three he makes a further £5,000 loss and still draws £10,000, so the account ends £15,000 overdrawn. Interest on the loan is £3,000. The restriction is based on the £10,000 of drawings, not the £15,000 overdrawn balance, so £1,000 is disallowed (£3,000 x £10,000 / £30,000).

Cash basis traders often have no balance sheet, but the principle does not depend on one: borrowing that funds drawings still fails section 34. See drawings for sole traders for how drawings interact with tax more generally.

What about mixed and offset accounts?

Many sole traders run everything through one account. BIM45695 says that if a single overdraft account is used only for business, the interest is allowable. Where business and private transactions are mixed, or where an offset mortgage combines a home loan with business borrowing, a reasonable apportionment between identifiable business and private purposes is needed. Keeping a separate business account is the simplest way to avoid that argument.

Which interest is never deductible?

  • Interest on late paid Income Tax and Capital Gains Tax, and interest on late paid PAYE and National Insurance (BIM45740).
  • Interest on borrowing used for private purposes, however it is secured.
  • Residential landlords face a separate finance cost restriction; see landlord mortgage interest relief.

Companies follow the loan relationship rules rather than this guidance, which BIM45650 says applies only for Income Tax. If you lend to your own company, see interest on loans to your company; a partner borrowing to invest in a partnership may instead qualify for qualifying loan interest relief.

A worked example

Illustration only. Leon, a cash basis decorator, borrows £20,000. He spends £15,000 on a van used only in the business and £5,000 on a family holiday. Interest for the year is £1,200 and his business account charges are £180.

  • An identifiable three quarters of the loan funds the trade, so £900 of the interest is deductible under section 34(2).
  • The £300 relating to the holiday is disallowed.
  • The £180 of bank charges on the business account is deductible in full.

Before 2024 to 2025 his loan interest deduction would have been capped at £500 under the old cash basis rule; now he claims £900.

What mistakes come up most often?

  • Claiming loan repayments as well as interest.
  • Assuming interest is allowable because the loan is in the business name or secured on business assets.
  • Still applying the £500 cap after 2024 to 2025, or still relying on it to avoid apportioning private use.
  • Ignoring years of drawings above profit, then fixing the capital account with year end journals.
  • Claiming interest charged by HMRC on late tax.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.