Business Capital Withdrawals: What the 2026 HMRC Guidance Means for Interest Relief

If you run a sole trader business, partnership or property business, you may sometimes want to take money you previously put into the business back out for personal use.

But what happens if the business needs to borrow money to replace that withdrawn capital?

This question has attracted attention following changes to HMRC’s Business Income Manual in 2026. The updated guidance on funding a business and withdrawing capital provides more detail on when interest on borrowing can qualify for tax relief.

The key issue is the purpose of the borrowing and whether the interest satisfies the “wholly and exclusively” test.

What has HMRC changed?

HMRC revised its guidance covering business funding and the withdrawal of capital from an unincorporated business.

The relevant sections are BIM45690 – Funding the business and BIM45700 – Withdrawal of capital from a business. HMRC’s guidance applies to the calculation of trade profits and property income and does not directly apply to companies, which have separate loan relationship rules.

The updated wording makes an important point: simply replacing capital that has been withdrawn with loan finance does not, by itself, mean that the interest automatically qualifies as a business deduction.

This has raised questions about how interest relief should work where a business owner originally funded the business with personal money and later borrows to replace some of that capital.

The “wholly and exclusively” test

The starting point is the tax rule that business expenditure generally needs to be incurred wholly and exclusively for the purposes of the business to qualify as a deduction.

For borrowing, this means looking at the purpose for which the money was obtained.

If a loan is used to purchase business equipment, pay business expenses or fund other genuine business expenditure, the interest may be deductible, subject to the relevant rules.

However, if borrowing is used to finance private spending, the associated interest will generally not qualify as a deduction. Where a loan has clearly identifiable business and private elements, the business element may be deductible while the private element is not.

Why capital withdrawals can be complicated

Consider a business owner who originally put their own money into the business.

Later, they decide to withdraw some of that money for personal use. If the business does not have enough spare cash, the owner may arrange borrowing so that the business can continue operating with a similar level of funding.

This can look economically similar to replacing the owner’s capital with borrowed funds.

However, HMRC’s revised guidance places greater emphasis on the purpose of the borrowing rather than simply looking at where the borrowed money remains within the business.

HMRC specifically states that simply exchanging existing capital for loan finance does not, on its own, satisfy the wholly and exclusively test.

An example

Suppose Sarah puts £100,000 of her own money into her business.

After several years, she decides to withdraw £60,000 for personal use. The business then borrows £60,000 to maintain its funding.

The loan carries interest at 5% a year, resulting in annual interest of:

£60,000 × 5% = £3,000

The important question is whether the £3,000 interest expense qualifies as a deduction.

Under HMRC’s current guidance, the purpose of obtaining the loan needs to be considered. If the borrowing was obtained specifically to facilitate Sarah’s personal withdrawal, HMRC’s guidance indicates that the interest may fail the wholly and exclusively test.

This is different from a situation where the borrowing is clearly obtained to fund business expenditure, such as purchasing equipment, paying for repairs or meeting other business costs.

What if the borrowing funds business expenditure?

The position is clearer when the loan is taken out for a specific business purpose.

For example, suppose a landlord takes out a loan specifically to fund significant repairs to a rental property. Where the borrowing is genuinely used for the property business, the interest may be deductible, provided the relevant conditions are satisfied.

HMRC’s guidance confirms that borrowing used for genuine business expenditure can qualify for relief. It also says that where only part of a loan relates to business purposes, a reasonable apportionment may be required.

Keeping clear records of why the borrowing was taken out and how the money was used can therefore be particularly important.

What does an overdrawn capital account mean?

An overdrawn capital account can be an indication that borrowing is being used, directly or indirectly, to fund private expenditure.

This does not necessarily answer the tax question by itself. HMRC’s guidance indicates that the underlying circumstances and purpose of the borrowing need to be considered.

This means business owners should not assume that interest is deductible simply because the loan appears on the business’s accounts.

Equally, the existence of an overdrawn capital account should be considered alongside the wider facts rather than in isolation.

Is this actually a new tax law?

This is an important distinction.

The changes are to HMRC’s internal guidance, not necessarily a change to the underlying legislation.

The statutory starting point remains the requirement that relevant expenditure must satisfy the applicable “wholly and exclusively” test. HMRC’s Business Income Manual explains how its officers should apply the rules when reviewing business profit calculations.

So, the updated wording does not automatically mean that every capital replacement loan will have its interest disallowed.

Instead, the guidance gives HMRC’s interpretation of how the existing rules should be applied to these circumstances.

Does this affect limited companies?

The guidance discussed above relates to unincorporated businesses, including trades and property businesses.

HMRC expressly states that BIM45690 and BIM45700 do not apply for Corporation Tax purposes because companies are subject to separate rules under the loan relationships legislation.

Therefore, company owners should not automatically apply the treatment discussed here to a limited company.

What should business owners do?

If you are considering withdrawing capital from your business and replacing it with borrowing, it is worth reviewing the arrangement before taking out the loan.

Consider:

• Why is the borrowing being taken out?
• What will the borrowed funds actually be used for?
• Is the borrowing connected with a specific business expense or asset?
• Are any funds being used for personal expenditure?
• Is the business capital account overdrawn?
• Can the purpose and use of the borrowing be supported by clear records?
• Has the interest been calculated and apportioned correctly where necessary?

Good documentation can be particularly valuable if HMRC later asks why the borrowing was undertaken.

Final thoughts

The 2026 changes to HMRC’s guidance have highlighted an important area for sole traders, partnerships and property businesses.

The key issue is not simply whether money remains in the business. Instead, the purpose of the borrowing and how it relates to the business can determine whether the associated interest qualifies for tax relief.

If you have previously introduced personal funds into your business and are considering withdrawing them, it is sensible to review the tax treatment before arranging replacement borrowing.

As always, the correct treatment depends on the individual facts and circumstances.

This article provides general information and should not be treated as personalised tax advice.

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