Only the interest portion of a business loan repayment is tax deductible. The principal is a repayment of borrowed capital, not an expense of earning income, so it reduces your bank balance without reducing your taxable income. A $120,000 annual repayment split into $80,000 of principal and $40,000 of interest gives you a $40,000 deduction.
This catches out more established business owners than almost any other rule, because it feels wrong. You sent the bank $120,000. Your accountant claimed $40,000. It looks like something has been missed, and the conversation usually starts with a degree of suspicion.
I am Mina Baselyous, a Certified Practising Accountant (CPA) and Chartered Tax Advisor (CTA) in Melbourne. This article explains why the rule works this way, shows what it costs in real dollars, and sets out how to plan cash flow around it so June is not a shock.
The Rule, and Why It Exists
A deduction is allowed for a loss or outgoing incurred in gaining or producing assessable income. Interest qualifies: it is the cost of using someone else’s money to run your business. Principal does not: handing back money you borrowed is not a cost, it is the reversal of a transaction that never went through your profit and loss in the first place.
The symmetry is the key to understanding it. When the bank lent you $250,000, that money was not income and you were not taxed on it. It went straight onto your balance sheet as cash and a matching liability. When you hand it back, it comes off the balance sheet the same way. Nothing touches the profit and loss at either end.
Interest is different because it was never on your balance sheet. It is a genuine expense of the year, and the ATO lists it among general business operating expenses as interest on money borrowed for producing assessable income or purchasing income-producing assets, current as at September 2026.
What It Looks Like in Real Numbers
Take the Melbourne trade and services company we use throughout this series. It has $290,000 of bank and equipment loans and paid the bank $120,000 during the year. Here is what the tax return sees, and what the bank account sees.
| Loan repayments, year ended 30 June 2027 | Cash out | Tax deduction |
|---|---|---|
| Interest charged by the lender | $40,000 | $40,000 |
| Principal repaid | $80,000 | nil |
| Total paid to the bank | $120,000 | $40,000 |
The $80,000 gap is the whole issue. That money left the business, reduced the bank balance, made the balance sheet stronger by reducing debt, and did absolutely nothing for the tax bill. It is one of the seven reasons your profit and your bank balance never agree, which we cover in full in why your profit and your bank balance never agree.
The Part That Really Hurts: You Repay Principal With After-Tax Dollars
Because principal is not deductible, the business must earn the money, pay tax on it, and then repay the loan out of what is left. To repay $80,000 of principal, a company taxed at the 25 per cent base rate entity rate must generate roughly $106,667 of pre-tax profit. The extra $26,667 goes to the ATO on the way through.
That arithmetic is worth sitting with. Every dollar of debt you repay costs you more than a dollar of trading performance, and the higher the tax rate on the entity carrying the debt, the worse the ratio gets. For a sole trader on a higher marginal rate, the pre-tax profit required to repay the same $80,000 is substantially more again. Our guide to Australian income tax rates for 2026-27 sets out the relevant brackets.
In practice, says Mina Baselyous (CPA, CTA, Registered Tax Agent), this is why a business can be profitable, well run and still feel permanently short of money. It is servicing debt with after-tax dollars while its accountant reports a healthy profit. Nobody has told the owner that the two facts are perfectly consistent.
Carrying debt and wondering why the tax bill never moves?
At Pinnacle, we model debt repayments, tax and cash together so you know what the business actually has to earn to service its commitments. Book a consultation with Mina to find out where you stand.
Book a ConsultationWhat Is Deductible on a Business Loan
Plenty is deductible, just not the principal. The test throughout is purpose: the borrowing must be connected to producing assessable income. Where a loan is used partly for private purposes, the interest must be apportioned, and the ATO does look at this.
- Interest. Deductible to the extent the borrowed funds were used for income producing purposes.
- Loan establishment and borrowing costs. Application fees, valuation fees, mortgage stamp duty on the loan and similar costs, generally deducted over the shorter of the loan term or five years rather than immediately.
- Ongoing bank fees and charges. Account keeping and facility fees on a business account.
- Depreciation on the asset you financed. The asset is deducted through the depreciation rules regardless of how it was funded. Our guide to tax depreciation covers the mechanics.
That last point matters more than owners realise. If you borrow $140,000 to buy equipment, you do not deduct the $140,000 and you do not deduct the principal repayments. You deduct depreciation on the equipment plus the interest on the loan. Deducting the asset and the principal would be claiming the same thing twice, which is precisely why the rule exists.
Where This Bites Hardest
The squeeze is worst where repayments are large relative to the deduction available: short loan terms, fast principal reduction, and assets whose depreciation is capped or slow. Three situations account for most of the pain we see on client files.
- Short term equipment finance. A three year term on a five year asset means principal is repaid far faster than depreciation is claimed, so cash goes out well ahead of the deduction.
- Cars above the car limit. Depreciation is capped at the car limit no matter how much you financed, so a $150,000 vehicle on a five year loan produces large non-deductible repayments against a capped deduction. We work through the numbers in selling a car above the car limit.
- Loans in the wrong entity. Interest is only deductible where the borrowing is connected to producing assessable income in that entity. Debt sitting in the entity that does not earn the income is a structuring problem, not a lending one.
One more to watch: a loan from your own company to you personally is not an ordinary business loan at all. It sits under Division 7A, requires a written agreement, a minimum yearly repayment and interest at the ATO benchmark rate, which is 8.77 per cent for the 2026-27 income year according to the ATO’s Division 7A benchmark interest rate. Get it wrong and the balance becomes a deemed unfranked dividend.
How to Plan for It
You cannot make principal deductible, so the work is in forecasting and structuring. The aim is that the cash needed for principal repayments is identified before the year starts, and that the debt sits in the entity where the interest is deductible against the income it helped produce.
- Split every repayment in your accounts. If the whole repayment is coded to interest, your profit is understated and your loan balance is wrong. This is one of the most common coding errors we correct on new client files.
- Forecast principal separately from tax. Both are non-negotiable cash commitments and neither appears as an expense. Put them side by side in the budget and cash flow forecast.
- Match the loan term to the asset life. Financing a ten year asset over three years guarantees a cash squeeze even if the investment is sound.
- Review where the debt sits. Before refinancing or restructuring, check the interest is deductible in the entity carrying it. This belongs in tax planning, ideally before the facility is signed.
- Watch the balance sheet, not just the profit. Repaying principal makes the business stronger even though it does nothing for tax. That improvement shows up as rising net assets, which is why we read the balance sheet monthly.
What to Do Next
Pull your loan statements for the last financial year and split the total paid into principal and interest. Then take the principal figure and divide it by one minus your entity’s tax rate. That is the pre-tax profit your business had to generate simply to stand still on debt.
Most owners have never calculated that number, and it usually reframes how they think about both borrowing and pricing. If the result is uncomfortable, the conversation to have is about loan terms, entity structure and working capital rather than about finding more deductions. Our guides to the cash flow statement and working capital are the natural next reads.
Frequently Asked Questions
Are business loan repayments tax deductible in Australia?
Only partly. The interest component is deductible where the borrowed money was used to produce assessable income. The principal component is not, because repaying borrowed capital is not an expense of earning income. So a $120,000 annual repayment made up of $80,000 principal and $40,000 interest gives a $40,000 deduction.
Why is loan principal not tax deductible?
Because the loan was never taxed as income when you received it. Borrowing puts cash and a matching liability on your balance sheet without touching the profit and loss. Repaying it reverses that entry the same way. Allowing a deduction would give you a tax benefit for money that was never assessed.
How much profit do I need to make to repay $80,000 of loan principal?
Divide the principal by one minus your entity’s tax rate. For a company taxed at the 25 per cent base rate entity rate, repaying $80,000 requires about $106,667 of pre-tax profit. The higher the tax rate on the entity carrying the debt, the more pre-tax profit each dollar of repayment consumes.
If I borrow to buy equipment, what can I actually claim?
You claim depreciation on the equipment and interest on the loan. You do not claim the purchase price as an immediate deduction unless a write-off concession applies, and you never claim the principal repayments. Claiming both the asset and the principal would be deducting the same cost twice.
What happens if I code the whole loan repayment to interest?
Your profit is understated, your deduction is overstated and your loan balance on the balance sheet is wrong. It is one of the most common bookkeeping errors we find, and it usually surfaces when the reported loan balance will not reconcile to the lender’s statement at year end.
Is interest deductible if I used part of the loan privately?
Only the portion relating to income producing use. Where a loan is used partly for business and partly for private purposes, the interest must be apportioned on a reasonable basis and you need records to support the split. Mixing private and business borrowing in one facility makes this much harder to defend.
General Advice Disclaimer: The information in this article is general in nature and does not constitute personal financial, tax, or legal advice. It has been prepared without taking into account your personal objectives, financial situation, or needs. Before acting on anything in this article, consider its appropriateness to your circumstances and seek advice from a registered tax adviser or CPA. Liability limited by a scheme approved under Professional Standards Legislation.
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