Deducting Interest on Business Loans and Credit in Canada

Interest is one of the most overlooked deductions for self-employed Canadians. If you borrow money for business purposes -- whether through a bank loan, line of credit, credit card, or vehicle financing -- the interest you pay is generally deductible. But the CRA applies a strict "purpose test" and the rules for mixed-use borrowing can be tricky.

The Purpose Test

The fundamental rule for interest deductibility in Canada comes from paragraph 20(1)(c) of the Income Tax Act. Interest is deductible when:

1. The borrowed money is used to earn income from a business or property
2. There is a legal obligation to pay the interest
3. The interest rate is reasonable

The critical factor is the purpose of the borrowing, not the type of loan. A personal line of credit used entirely for business expenses qualifies. A business loan used to buy a personal boat does not.

The Supreme Court of Canada confirmed this in Ludco Enterprises v. Canada (2001): what matters is whether there was a reasonable expectation of earning income from the borrowed funds at the time of borrowing. You do not need to actually earn a profit -- just a reasonable expectation of income.

What Qualifies

Business Loans

The most straightforward case. A bank loan taken to fund business operations -- purchasing inventory, equipment, covering cash flow gaps -- produces fully deductible interest.

Example: You take a $50,000 business loan at 7% to purchase equipment for your consulting practice. The annual interest of $3,500 is fully deductible on your T2125.

Lines of Credit

A business line of credit used for business purposes generates deductible interest. If you have a personal line of credit that you use partly for business, only the interest attributable to the business portion is deductible (see mixed-use rules below).

Credit Card Interest

Business purchases on a credit card generate deductible interest when you carry a balance. If you use a personal credit card for both business and personal purchases, you must calculate the business portion of the interest.

Practical tip: Using a separate credit card exclusively for business makes this calculation straightforward and dramatically simplifies your records if the CRA asks questions.

Vehicle Loan Interest

If you financed a vehicle used for business, you can deduct the business-use percentage of the interest. However, the CRA caps the deductible interest on passenger vehicles.

For 2025, the limit is $300 per month ($3,600 per year) for vehicles in Class 10.1 (luxury vehicles exceeding the prescribed cost limit of $37,000 before tax). For vehicles under the cost threshold, the actual interest is deductible with no monthly cap, subject to your business-use percentage.

Example: You finance a vehicle with $250/month in interest. You drive 60% for business. Deductible interest: $250 x 12 x 60% = $1,800 per year.

Mortgage Interest (Home Office)

If you are self-employed and work from home, the business-use portion of your mortgage interest is deductible as part of your home office expenses on the T2125. This is separate from the general interest deduction and is calculated through your business-use-of-home percentage.

Mixed-Use Borrowing

Many self-employed Canadians use a single line of credit or credit card for both business and personal purposes. The CRA requires you to trace the use of borrowed funds and only deduct interest on the business portion.

How to Calculate

The CRA's preferred method is direct tracing: follow each dollar borrowed to its end use. If you borrowed $30,000 on a line of credit and used $20,000 for business equipment and $10,000 for a vacation, two-thirds of the ongoing interest is deductible.

The Complications

Mixed-use accounts become messy when you make ongoing draws and repayments. The CRA's administrative position, based on the Singleton v. Canada (2001) Supreme Court decision, is that repayments are applied to the personal portion first when possible. This means as you pay down a mixed-use line of credit, the remaining balance is increasingly attributable to business use.

Best Practice

The simplest approach is to keep business borrowing completely separate from personal borrowing:

• Use a dedicated business line of credit
• Use a separate business credit card
• If you need to borrow for business, draw from the business account and keep records

This avoids the tracing headaches entirely and makes your deduction bulletproof on audit.

Capitalized vs. Expensed Interest

In most cases, you expense interest in the year you pay it -- it flows directly to your T2125 as a current-year deduction. However, in some situations, interest is capitalized (added to the cost of an asset) rather than expensed.

When Interest Is Capitalized

• Construction period interest. If you borrow to construct a building or major asset, the CRA may require you to capitalize the interest incurred during the construction period and add it to the cost of the asset. This is then recovered through CCA (capital cost allowance) over the life of the asset.
• Vacant land. Interest on money borrowed to acquire vacant land is generally capitalized and added to the cost of the land rather than deducted currently. The exception is land used in an active farming business.

When Interest Is Expensed

For most self-employed Canadians, interest on business borrowing is a current expense deducted in the year it is paid or accrued:

• Working capital loans
• Equipment financing
• Vehicle loans
• Credit card balances
• Lines of credit for operating expenses

Interest on Refinancing

If you refinance a business loan, the interest on the new loan remains deductible as long as the original borrowing was for a business purpose. The CRA traces back to the original use of funds.

However: If you refinance and take out additional funds for personal use, only the interest attributable to the original business portion is deductible. The interest on the personal portion is not.

Compound Interest and Fees

Compound Interest

Under ITA 20(1)(d), compound interest -- interest charged on unpaid interest -- is also deductible in the year it is paid, as long as the underlying loan was for a deductible purpose.

Loan Fees

Certain fees associated with business borrowing are deductible, though not always in the year incurred:

Fee Type	Treatment
Loan application/origination fees	Deductible over 5 years (ITA 20(1)(e))
Annual credit card fees (business card)	Fully deductible in the year paid
Loan guarantee fees	Deductible in the year paid
Loan insurance premiums	Deductible in the year paid
Mortgage broker fees	Deductible over 5 years

Note that upfront financing fees (arrangement fees, standby charges) are amortized over five years or the term of the loan, whichever is shorter, under paragraph 20(1)(e).

Documentation Requirements

The CRA expects you to maintain:

• Loan agreements showing the terms, interest rate, and purpose
• Bank or lender statements showing interest charged
• Records tracing borrowed funds to their business use (especially for mixed-use accounts)
• Business-use calculations for vehicles and home offices
• A log showing how you determined the business percentage of mixed-use borrowing

Common Mistakes

1. Deducting personal loan interest. Interest on a personal mortgage, car loan, or credit card balance used for personal expenses is never deductible. Only the business portion qualifies.
2. Not tracking credit card interest separately. If you use one card for everything, you need to calculate the business percentage of interest each month. Most people do not, and the CRA can deny the entire claim if you cannot support it.
3. Exceeding the vehicle interest cap. For Class 10.1 vehicles, the deductible interest is capped at $300/month regardless of the actual amount. Many people miss this.
4. Forgetting loan fees. Application fees, broker fees, and other financing charges are often overlooked. They are deductible but may need to be amortized over five years.
5. Deducting principal repayments. Only interest is deductible. Principal repayments are not a business expense.

Sources

1. CRA Business Expenses - Interest and Bank Charges
2. Income Tax Act, Paragraph 20(1)(c) - Interest Deduction
3. CRA Income Tax Folio S3-F6-C1 - Interest Deductibility
4. CRA Motor Vehicle Expenses - Allowable Interest
5. Income Tax Act, Paragraph 20(1)(e) - Financing Fees
6. Supreme Court of Canada - Ludco Enterprises v. Canada