Tax relief for interest on a loan to buy a company car or van is given according to the interest paid each year

How Does This Work?

The loan repayments made during the year need to be split into the repayment of the original amount borrowed and the interest charged.

This can be done on either a full actuarial basis by calculating the monthly or yearly interest, or by a simplified method known as the 'Rule of 78'.

The interest for the year is then normally tax deductible in full, subject to the tax status of the business.

Actuarial Basis

On the actuarial basis the loan interest is calculated for each year of the loan according to the repayment schedule, the amount of the original loan repaid during the year and the interest due on the outstanding balance of the loan.

Click here to see an example of how loan interest is calculated.

Rule of 78

Under the Rule of 78 the total interest charged on the loan is split to mathematically attribute the interest to each loan repayment.

The total interest is divided by the sum of the months of the term. For example, over a 36 month term the sum of the months of the term is 632, e.g. 36 + 35 + 34 + 33 etc.

The interest is then attributed backwards from the last month of the loan term, for example ¹/₆₃₂ in the last month, ²/₆₃₂ in the 2nd from last month and so on until ³⁶/₆₃₂ in the first month.

If the interest is £1000 over the life of the loan this then would be £1000 / 632 x 36 in month 1, £1,000 / 632 x 35 in month 2 etc, for example:

• £1000 / 632 x 36 in month 1 = £56.96
• £1,000 / 632 x 35 in month 2 = £55.38
• £1,000 / 632 x 34 in month 3 = £52.22

and so on to the 12^th month.

In this way the total interest attributed to the first 12 months would be £563.29, for the second year £332.28 and the third year £104.43, total £1000.

It doesn't matter whether or not the profile of the actual annual loan interest for the term of the loan matches the Rule of 78 result - the result gives an approximate amount of interest each year which is normally acceptable for accounting and tax purposes.