How Business Owners Can Use Debt More Tax Efficiently
If you are a business owner with a mortgage, it is worth asking: is your lending working as hard as you are? Many Kiwi business owners are paying down personal home loans while sitting on retained earnings in their company, or holding debt in a way that is not as efficient as it could be.
This is where tax-efficient debt structuring can come into play. It may help reduce your overall tax bill and better align your borrowing with your business goals.
What is Tax-Efficient Debt?
Most people are familiar with the concept of “good debt” and “bad debt”, but there is a third category that business owners should consider: tax-efficient debt.
This refers to lending that is structured in a way that may allow you to claim the interest as a tax deduction. For example, lending used for business or income-generating purposes may qualify as tax deductible, whereas lending used for personal reasons, such as a mortgage over your family home, generally does not.
An Opportunity We Often See
A common scenario looks like this:
A business owner has retained earnings or a large shareholder current account sitting in their company, while also holding a personal mortgage that is not tax deductible.
In this case, it may be possible to borrow within the company, using those funds to distribute money to shareholders (such as through a dividend or a repayment of current account). The shareholder may then use those funds to repay a portion of their home loan.
The benefit here is that interest on lending within the company, if it meets the purpose test under New Zealand tax law, may be tax deductible. The purpose test focuses on how the borrowed money is used, not just who borrows it.
By contrast, personal mortgage interest generally cannot be claimed unless the borrowed funds are used for investment or business purposes.
Important: The deductibility of interest depends on the purpose of the borrowing and how the funds are actually applied. It is not enough to simply move money between entities.
Why This Matters
At a time when interest rates are still relatively high, the ability to claim interest as a business expense can improve your cash flow and reduce the amount of tax you need to pay.
For business owners, this could mean:
Accelerating mortgage repayments on personal debt
Freeing up cash for business growth or investment
Structuring lending in a way that aligns with long-term wealth goals
But, as with anything involving tax and lending, there are risks if it is not done properly.
Key Things to Consider
Before exploring this option, it is essential to seek personalised advice. Here are a few things to think about:
Company structure: Is your business a company, trust, partnership, or sole trader? The tax treatment will differ in each case.
Shareholder loans and drawings: Are you withdrawing retained earnings, repaying a current account, or declaring dividends? Each has its own implications for tax and financial reporting.
Substance over form: IRD looks at the real purpose of the lending. Simply re-labelling a transaction will not make it deductible if the underlying use is personal.
FBT, GST, and other obligations: Depending on how funds are used, other tax rules could be triggered.
Legal and banking considerations: Lenders may require security, guarantees, or have conditions about how funds can be used.
This is Not a Loophole
This is not about tax avoidance. It is about understanding the rules, applying them correctly, and making informed decisions with the help of your accountant and adviser.
As financial advisers, we often work alongside proactive accountants who can assess the tax implications while we look at the lending structure and feasibility. That collaboration is where the magic happens.
Summary: What You Should Know
Interest on lending used for business or investment purposes may be tax deductible.
Personal mortgage interest is usually not deductible, unless used to fund an income-earning asset.
Structuring lending through your business may provide tax efficiency, but only if the purpose test is met.
Always get tailored tax and financial advice before proceeding.
If you do not have an accountant you trust, we are happy to recommend accountants who take a proactive and strategic approach.
Want to explore this further?
If you are wondering whether your lending is working for you, or you would like an introduction to a trusted accountant, we are here to help.
Get in touch for a chat. We work with time-poor but driven business owners every day, helping them make smarter financial decisions that align with their goals.
This article is for educational purposes only and is not personalised financial advice. Speak to an adviser about your own position.