While the current interest rate environment continues to provide promising GIC opportunities, the cost of borrowing remains high.
If you’re a business owner on a variable rate, or in the market for new financing, you’ve no doubt felt the impact – particularly as this growing expense joins a rise in the cost of goods sold, fuel, and the overall effects of inflation.
When it comes to tax time, however, there is a silver lining, says Tyler Carson, Senior Relationship Manager, Commercial. That’s because the cost of borrowed money is tax deductible if it’s used to produce income.
“Higher interest rates make the cost of borrowing ultimately more expensive in the grand scheme of things because there’s a higher monthly payment,” he says. “But the potential for a lower income tax offers somewhat of a bright side.”
Interest expense can include costs for operating lines of credit or equipment loans that are income-generating for your business.
Carson is based in CWB’s Kamloops Banking Centre. Here he gives a quick 101 on claiming interest expense – and why it’s important for business owners to take action, particularly in today’s economic environment.
The difference a year can make
What effect has rising interest rates had on borrowing costs? For illustrative purposes, he gives the example of a $1,000,000 loan taken out on Jan. 1, 2022 in a scenario where interest is tied to prime.
“If you look at the difference in interest expense over a 12-month period, it’s significant,” he says. “In this case, the interest payment would have increased by $17,500 compared to what it would have been if the rate stayed the same. Deducting this from taxable income will help to alleviate the burden of this increase to some extent.”
Claiming interest expense
“You need to be able to prove the loan was used for an income-producing purpose and be able to trace the amount,” says Carson who advises consulting with your accountant as well as the Canada Revenue Agency’s Income Tax Folio S3-F6-C1, Interest Deductibility. “Once you’ve confirmed what’s eligible, there are some key documents that can provide the information that will help you to claim the deduction.”
Here’s a rundown of what you (and your accountant) will need:
Borrowing documents: “Beyond just tax purposes, you should have these organized and accessible so you understand the complete picture of everything you’re borrowing,” says Carson.
Loan agreements: “This lays out what each loan is for – whether that’s real estate, equipment, or other – and also the amortization schedule. The amortization schedule breaks down your monthly payment and what’s being applied to your principal vs what’s being applied to the interest. This gives you an idea of the loan’s interest expense for the year.”
Principal and interest statement: You can request this simplified document from your lender. “On the bank side, the client can always ask us to provide a principal and interest statement for a certain period. For example, if their fiscal year end is June, we can give them a statement that shows in plain language how much interest and principal they’ve spent over the year,” he says.
Carson adds this is one of the most frequently requested statements from clients, especially during tax time. He advises asking your lender for the statement a month or two in advance of your fiscal year end. This allows your accountant some breathing room ahead of preparing your financial statements.
In the business of cash flow
Business expenses are naturally taxing on cash flow and that makes money-saving strategies like claiming borrowing costs important to retaining more of your hard-earned dollars. CWB banking centres like Carson and Mutagirova’s have teams with specific expertise in cash management to help your business grow. Call or visit a location to start a conversation.