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The rate on a private loan is higher than a bank’s, so the after-tax cost matters. For most business borrowers the interest is deductible, and that changes the comparison with non-deductible costs such as ATO interest.
The use test
Tax law looks at what the borrowed money was used for. The security is irrelevant.
| Borrowed funds used for | Interest generally |
|---|---|
| Working capital, wages, stock, rent | Deductible |
| Paying business tax debts, such as GST, PAYG withholding and company income tax | Deductible |
| Buying income producing property or a business | Deductible |
| A development held for sale | Deductible, or included in the cost of trading stock, depending on the taxpayer |
| A director’s private expenses | Not deductible |
| An individual’s personal income tax bill | Generally not deductible |
Where funds are used for mixed purposes, interest is apportioned. Keep the business part clean by paying it directly to business creditors or into the business account.
Borrowing costs
Establishment fees, lender legal fees, valuation fees, mortgage registration and broker fees are borrowing expenses. Where they total more than $100, they are generally deducted over the shorter of the loan term and five years. On a six month loan, that usually means the whole amount falls within one or two income years. If the loan is repaid early, the undeducted balance is generally deductible in that year.
Prepaid interest
Many private loans take interest up front for the term. Prepayment rules limit when prepaid expenses can be deducted. Small business entities can usually deduct a prepayment immediately where the period covered is 12 months or less and ends by the close of the next income year. Larger taxpayers generally spread it over the period. See capitalised and prepaid interest for how these structures work.
Why this matters for ATO debt
General interest charge and shortfall interest charge stopped being deductible from 1 July 2025. A company paying 11.43% GIC bears all of it. The same company paying deductible loan interest bears 75% of it on a 25% tax rate. The numbers are set out in is a loan cheaper than ATO interest.
Records to keep
- The loan agreement and settlement statement, showing where every dollar went.
- The business purpose declaration.
- Invoices for fees.
- Bank statements showing the use of funds.
Entities matter
If a trust or an individual borrows and passes the money to a related company, deductibility depends on the terms of that on-lending. An interest free loan to a related company can break the link to assessable income. Structure it with your accountant before settlement.
This is general information, not tax advice. Rates and fees on this site are listed on the rates and fees page.
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Get matched with a funderFAQ
Is default interest deductible?
It is generally treated the same way as ordinary interest on the same loan, so deductible if the loan's purpose was income producing. Confirm with your accountant.
Is interest on a loan used to pay the ATO deductible?
For a business paying business tax debts, generally yes. The ATO's own general interest charge has not been deductible since 1 July 2025, which is why the comparison matters.
Can I deduct interest that is capitalised?
Interest that is capitalised is generally still incurred when it is charged. Timing can differ between taxpayers, so check the treatment for your entity.