Borrowing to pay IRD: can you claim the interest on the loan?

For most New Zealand companies, yes: interest on a loan used to pay IRD is normally deductible, because section DB 7 of the Income Tax Act lets an ordinary company claim interest without proving a link to income. Sole traders, partnerships, trusts and look-through companies are different. They need a connection between the borrowing and earning income, so the answer depends on which tax the loan pays.

That’s the short version. The longer one matters because owners often get told “interest is always deductible” or “you can’t claim tax-related interest”, and both are wrong for somebody. Here’s how it works by structure, what IRD’s own interest does, and why the tax answer rarely decides the bigger question on its own.

The short answer, by business structure

How you trade	Interest on a loan used to pay IRD	The rule behind it
Ordinary company	Usually deductible	s DB 7: most companies need no nexus with income
Look-through company (LTC)	Depends on use	s DB 6 plus the general permission in s DA 1
Sole trader	Depends on which tax	General permission: must connect to earning income
Partnership	Depends on which tax	Same as sole traders, applied through the partners
Trust	Depends on use	General permission

IRD’s guidance on look-through companies spells out the split neatly: “usually a company would be entitled to an automatic interest deduction under s DB 7”, but LTCs don’t qualify and must instead satisfy the general permission (IRD Tax Technical, QB 11/03).

Why do companies get the easy answer?

Parliament chose simplicity for companies. Under s DB 7, a company that isn’t excluded can deduct interest it incurs without showing the borrowed money was used to earn income. Whether the company borrowed to buy a forklift, fund a dividend or clear a GST balance, the interest is generally claimable.

There are exceptions worth a quick check with your accountant:

• Look-through companies are taxed through their owners, so the company rule doesn’t apply.
• Companies with certain exempt income, or in a wholly owned group where another company has it, can lose the automatic deduction.
• Interest relating to some land is governed by its own rules, which override s DB 7 where they apply.

For a typical trading company with an IRD balance, none of those bite. The interest on a loan used to pay GST, PAYE, provisional tax or terminal tax goes in the accounts as an expense like any other finance cost.

What about sole traders, partnerships and trusts?

Here the general permission does the work: interest is deductible if it’s incurred in deriving assessable income, or in carrying on a business for that purpose. So the question becomes, what did the borrowed money actually do?

GST and PAYE. These are liabilities that arise from running the business: GST from your sales, PAYE from paying your team. Borrowing to pay them looks a lot like borrowing to pay any other business creditor, and that’s the stronger end of the spectrum.

Income tax. This is harder. Income tax is a tax on profit you’ve already made, and paying it doesn’t, on its face, help you earn the next dollar. For sole traders and partners, interest on borrowing to pay their own income tax is generally difficult to claim.

The narrow exception. IRD’s interpretation statement on the 1938 Public Trustee case accepts that interest can be deductible where borrowing lets a taxpayer keep income-earning assets they’d otherwise have to sell, and the liability paid off was involuntary (IRD Tax Technical, IS0082). Tax is involuntary, and a sole trader who borrows rather than sells the excavator that earns their income may have an argument. It’s fact-specific, so it’s a conversation for your accountant, not a box to tick.

If you trade as a sole trader and IRD is pressing, our page on sole trader IRD debt covers the wider options.

Is IRD’s own interest deductible?

Yes, and for everyone. Since the 2011 law changes, use-of-money interest payable to IRD is deductible for all taxpayers, companies and individuals alike, and the deduction falls in the year the interest is paid. The same change made interest IRD pays you taxable in the year you receive it (IRD Tax Technical).

Two practical points follow:

1. Timing. Because the deduction is tied to payment, a large chunk of use-of-money interest sitting unpaid in myIR does nothing for your tax bill until it’s actually paid.
2. Penalties aren’t covered. The rule is specific to use-of-money interest. Late payment penalties, explained on IRD’s late payment penalties page, are a separate charge, and you shouldn’t assume they can be claimed. If a penalty arose from something outside your control, penalty remission is the better avenue.

Our page on use-of-money interest explains how IRD calculates it day by day.

Weighing up a loan to clear the balance? See what’s possible in 60 seconds, with no credit check when you first enquire.

Does it matter if the loan is secured against my house?

What secures a loan doesn’t decide whether the interest is deductible. What matters is who borrows and what the money is used for.

That distinction catches out a lot of directors. Take a property-secured loan to clear company tax:

• The company borrows, with a director’s home or a family trust’s property as security and a guarantee from the owner. The company uses the money to pay its IRD debt, and under s DB 7 the company generally deducts the interest. The home is just security.
• The director borrows personally against the home, then puts the money into the company. Now the director is paying the interest, and the director isn’t a company, so s DB 7 doesn’t help. Whether the director can claim depends on how the money went in, for example as an interest-bearing loan to the company, and on the general rules.

Same house, same IRD debt, two quite different tax results. Settle the structure with your accountant before the loan documents are drawn up, not after. Our page on property-secured tax debt loans explains how the security side works.

A worked example: what the deduction is really worth

Illustrative only. Not a real client, and the figures are round numbers chosen for clarity.

A Hamilton joinery company owes IRD $80,000: two GST periods and some overdue PAYE. Its directors borrow to clear it in one payment, and over the first year the loan’s interest and fees come to $9,000.

• The company is an ordinary company, so under s DB 7 the $9,000 is a deductible expense.
• At the company tax rate of 28%, the deduction reduces the company’s tax by $2,520.
• The after-tax cost of the loan for that year is $6,480.

Now flip it. Suppose the same company had stayed on an instalment arrangement instead. The use-of-money interest it paid during the year would also be deductible when paid, so the tax deduction would shave the cost of that route too. What wouldn’t be deductible is any late payment penalty that had already been charged.

The lesson: a deduction lowers the cost of borrowing, but it usually lowers the cost of the alternative as well. It’s a factor, not a tiebreaker.

Had the same owner been a sole trader borrowing to pay last year’s income tax, the deduction might not be available at all, and the after-tax cost would be the full $9,000.

Should the tax treatment change whether you borrow?

Rarely on its own. When owners compare a loan with an instalment arrangement, the things that usually decide it are:

• Total dollars, after tax, over the life of each option, including fees and any penalties.
• How long the debt hangs around. An arrangement can run for months or years; a loan clears IRD on day one.
• Enforcement risk. A broken arrangement can lead straight back to deduction notices. A cleared balance can’t.
• What it does to your next application. Lenders, landlords and suppliers read a cleared IRD balance very differently from a live one.

Our arrangement vs loan cost check lays the two side by side in dollars and risk. Run it with your after-tax numbers once your accountant has confirmed what’s deductible for your structure.

What records should you keep?

Deductions are only as good as the paperwork behind them. Keep:

• the loan agreement, showing the borrower’s legal name (the company, not you, if the company is meant to claim);
• proof of where the money went, ideally a payment straight from the loan account to IRD, with the myIR receipt;
• annual interest statements from the lender;
• a short file note of what each part of the loan paid for, if it covered more than one thing; and
• your accountant’s advice on treatment, especially for sole traders, partnerships and trusts.

Mixing loan money with general funds before paying IRD makes it harder to show what it was used for. Pay IRD directly where you can.

Clearing IRD with a loan you understand from day one

Tax debt is the work we do every day, and we’re one of the few business funders who see an IRD balance as a reason to talk rather than a reason to decline. Knowing how the interest will land in your accounts is part of choosing well, and so is knowing whether you can borrow at all.

Our loans run from $5,000 to $5,000,000 for business purposes, with property-secured options from $20,000 and funding possible in as little as 24 hours on those. You’ll find more on how it works on our loans to clear IRD debt page.

The enquiry takes about 60 seconds and there’s no credit check when you first enquire. Your details stay with us: we don’t send them to a pile of lenders, so your phone won’t start ringing off the hook. A real person who understands IRD’s process reads your enquiry and calls you. Please fill the form in accurately, including your business structure, the IRD balance and any property you could offer, so we can match you to the right option the first time.

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