HMRC's July 2026 Business Income Manual amendments cast doubt on interest deductibility for borrowing used to fund capital withdrawals, marking a significant departure from longstanding guidance.
HMRC's Interest Relief U-Turn on Capital Withdrawals: What Accountants Must Know
On 1 July 2026, HMRC amended several pages of its Business Income Manual dealing with interest relief, including BIM45690 'Funding the business' and BIM45700 'Withdrawal of capital from a business'. Although this change occurred in early July, it is now coming to practitioners' attention as a significant departure from longstanding guidance—one that could fundamentally alter tax planning for unincorporated businesses and landlords.
The Change
The update appears to cast doubt on the deductibility of interest incurred on borrowing used to fund capital withdrawals from a business, even where the proprietor's capital account remains in credit.
A credit balance on a proprietor's capital account is no longer viewed by HMRC as sufficient, by itself, to support an interest deduction. Instead, HMRC now states that simply exchanging existing capital for loan finance does not on its own satisfy the wholly and exclusively test provided by section 34 ITTOIA 2005, and the interest payable is only allowable where the borrowing is used for business expenditure.
This is a marked reversal. Before the July 2026 amendments, BIM45700 expressly recognised that a proprietor could withdraw profits and capital introduced into a business even where substitute funding then had to be provided through interest-bearing borrowing.
Why This Matters
These pages apply not only to trading businesses but also to property businesses and are directly relevant to individual landlords and property partnerships whose businesses are financed partly by capital introduced by the proprietors and partly by external borrowing. Many unincorporated proprietors have relied on the flexibility to refinance their personal capital investment at any time and claim relief on the resulting interest. This change threatens that position.
The change affects interest incurred when borrowing funds to finance the withdrawal of capital from a business and represents a notable departure from HMRC's previous guidance and may have real consequences for many unincorporated business owners, as HMRC might increasingly seek to restrict relief.
The Practical Impact
Consider a sole trader who introduced £300,000 personal capital into a trading business and has built up retained profits. If the proprietor now wishes to withdraw that capital (say £100,000) and refinance the shortfall through a business loan, interest on that loan may no longer be deductible under the new guidance, provided HMRC concludes the withdrawn funds were not used for business purposes. This creates both compliance risk and cash-flow planning problems: proprietors may now find themselves unable to withdraw their own capital without losing interest relief.
The revision is particularly sharp because HMRC's published update record describes the amendments as providing clearer context and removing unnecessary numerical calculations, but the description does not adequately convey the practical significance of the changes.
What Advisers Should Do Now
The guidance only reflects HMRC's interpretation of the law and can be challenged; nevertheless, taxpayers considering refinancing arrangements or funding private expenditure through additional business borrowing should proceed with caution until HMRC provide further clarification or the issue is tested before the courts.
Practitioners should:
- Review existing client files where interest relief has been claimed on borrowed funds used to replace withdrawn capital. Document the position taken and assess audit risk.
- Advise clients on current refinancing plans to consider the new HMRC stance and the timing of any transactions.
- Monitor tribunal cases and any ICAEW, CIOT, or professional body challenge to the revised guidance, which will likely emerge shortly.
- Flag this issue in client newsletters to ensure unincorporated proprietors understand the changed landscape before taking action.
The door may not be permanently closed—HMRC's interpretation can be challenged—but practitioners must treat any such arrangements as higher-risk until clarity is restored. If HMRC intends this as a permanent hardening of the rules, legislative or judicial clarification is essential.