Big idea: Inland Revenue allows an interest deduction when borrowed money is used to earn taxable income.

If your loans have funded private spending (owner drawings, overdrawn shareholder current accounts), that portion of interest isn’t deductible.

The good news: you can often restructure now so future interest becomes deductible.

Warning

Always seek professional advice from a Chartered Accountant as there are traps.

Step 1: Diagnose the problem

List every loan and overdraft and ask: What did these dollars actually pay for?

Tag each portion business (stock, wages, equipment, fit-out, premises) or private (drawings, personal bills, historic tidy-ups).

Blended facilities are common—split them on paper first.

Step 2: Clean up shareholder current accounts

An overdrawn shareholder current account (the shareholder owes the company) screams “private use”.

If bank debt is effectively covering that overdraft, interest on that slice is non-deductible. Two fixes:

1) Dividend set-off

Declare a fully imputed dividend and apply it to clear the overdrawn balance (legal set-off).

From that date, ensure all borrowing funds business purposes only.

Example: The company has a $60k overdrawn current account and a $180k term loan.

You declare a $60k fully imputed dividend and set it off, eliminating the private receivable.

You then split the facility into two sub-accounts: $120k business working capital and $60k capex.

Going forward, interest on both is deductible because the funds are clearly tied to income-earning use.

2) Shareholder cash injection

The shareholder repays the debit current account in cash.

From then on, bank debt finances only business activity.

Again, interest becomes deductible going forward.

Guardrails: Pass the Companies Act solvency test, check imputation credits, and brief shareholders on the personal tax impact of dividends.

Step 3: Refinance for clear tracing

Where possible, ask the bank for separate sub-accounts: one for working capital, one for each asset purchase.

If you refinance an existing business loan at a better rate, interest remains deductible because the underlying use hasn’t changed.

Example: Last year you advanced $80k personally to cover payroll and stock (the company owes you—current account in credit).

Draw an $80k business term loan and repay the shareholder.

This is a refinance of business funding, so interest is deductible.

Step 4: On-lend when the bank prefers the individual

If the bank will only lend to you personally, use an on-lend: you borrow, then on-lend to the company at a commercial rate under a simple loan agreement.

The company uses the funds for business; its interest is deductible.

You return interest income; your personal interest cost broadly offsets it.

Example: You borrow $120k at 8.2% and on-lend at 8.5%.

The company buys equipment and deducts the 8.5% interest.

You return 8.5% interest income and pay 8.2% interest expense—small spread, clean tracing.

Records that make IR happy

• Board minutes: purpose of each facility and, if relevant, that it replaces prior business funding.

• Dividend resolution (for set-off) with solvency statement and imputation disclosure.

• On-loan agreement with commercial terms; withhold RWT as required.

• Drawdown/repayment log tying dollars to invoices and uses.

• Vehicle logbooks or business-use % where relevant.

Bottom line

You can’t re-characterise yesterday’s spend, but with clean splits, proper resolutions and crisp tracing, you can ensure tomorrow’s interest is deductible.

At David Hooper Chartered Accountants, we help small businesses restructure debt and maximise tax deductibility. Contact us at [email protected] or call 09 421 1635.