Employers can provide a benefit to employees by providing a tax-free and cheap loan. These loans are often given to employees for travel season tickets or to buy electronic equipment such as laptops or phones. The rules, however, apply to all loans.
A tax charge is incurred when a director or employee gets a benefit due to their employment by receiving a cheap or interest-free loan. The tax charge also arises when a relative of the employee receives the cheap or interest-free loan. The tax is charged on the difference between the interest charged on the loan (if any) and the official rate.
A tax charge will also arise if the loan is written off or the director or employee is no longer obliged to repay the amount lent. Tax is chargeable on the amount written off. This charge arises irrespective of the terms of the loan — that is, whether the loan was exempt or not.
A loan means more than lending money. It includes arranging a loan, guaranteeing a loan, facilitating a loan or taking over a loan from another person. It includes any form of credit or advance made by reason of the employment. Any amount shown in the employer’s books or records will be treated as a loan. It is not necessary for the loan to be advantageous for the employee for a benefit to arise. It is a taxable benefit where the loan is for less than the official rate and it is made by reason of the employment.
The following table shows the official rate for recent years, from 6 April each year to 5 April the following year.
Although the official rate is usually held for the whole tax year, it can be altered during the year if interest rates vary significantly.
A £20,000 interest-free loan is provided to an employee in the year 2021/22. The loan is available for the whole year. The official rate is 2%. Interest that would be charged at the official rate is £400. As no interest has been charged, the benefit is £400 and tax is chargeable on this amount at the employee’s highest marginal rate. National Insurance (NI) is also due.
Loans provided by third parties
Sometimes loans are made by third parties, such as an employee benefit trust (EBT). It has been suggested that this is not an employment-related loan as this is a loan from a third party. However, HMRC does not accept that this is the case, because making a loan includes facilitating a loan. Consequently, if the employer provides the money to fund the EBT, the employer is regarded as making the loan.
Furthermore, new rules were introduced on 6 April 2011 to tax third-party arrangements that are used to provide a reward, recognition or a loan in connection with the employee’s current, former or future employment. These rules will apply and take priority over the normal employment-related loan rules.
A “relative” includes:
- the employee’s spouse
- the parents, children, brothers and sisters of both spouses
- remoter ancestors or descendants of both spouses such as grandparents or grandchildren
- spouses of all the persons mentioned above.
Calculating the benefit
The average value of the loan is calculated by adding the balances of loans outstanding at the start of the year and the end of the year and dividing by two. If the loan is £30,000 at the start of the year, and £10,000 at the end of the tax year, the average loan is £20,000.
For new or repaid loans, the average loan value is multiplied by the number of complete income tax months that the loan was outstanding and divided by 12.
These amounts are multiplied by the average official rate for the period of the loan and the amount of interest paid is deducted. The resulting cash equivalent is then reported to HMRC.
The employee or HMRC can elect a precise method of calculating the benefit, rather than using the averaging method.
The benefit can be calculated using commercial accounting software or using HMRC’s PAYE Online system.
Where a taxable loan is provided under “optional remuneration rules”, also known as salary sacrifice, and the amount of salary foregone by the employee is larger than the interest that would be payable on the loan at the official rate of interest, the amount to be treated as earnings is the salary or pay foregone, less any interest paid on the loan in the tax year. Where the amount foregone is less than the interest payable at the official rate of interest, the normal rules apply.
Reporting and paying tax
Where the business provides a beneficial loan, it needs to be reported on form P11D, which will impact the tax paid by the employee, and Class 1A NI contributions (NICs) paid on the value of the benefit.
Non-taxable benefit in kind
Non-taxable benefit in kind arises when either of the following conditions applies.
- The loan is made on commercial terms by the employer who lends to the general public.
- The total of all the loans made to an employee does not exceed £10,000.
For example, where the employer is a bank or building society, and the loan given to the employee is at the same rate as loans provided to the general public, there will be no benefit in kind, even if the rate of interest charged is less than the official rate.
The £10,000 limit is an “all or nothing” limit. If the £10,000 threshold is exceeded for even one day in the tax year, then a benefit in kind tax charge applies to the whole loan for the whole year.
Loans by individuals are not taxable (see below). Loans that are equal to or higher than the official interest rate are not taxed. Qualifying loans are not taxable — a qualifying loan is a loan where all of the interest qualifies for tax relief, such as a loan to buy an interest in a partnership. Loans using a director’s loan account are not taxed as long as the loan account is not overdrawn at any time during the tax year.
Example of exempt benefit
Ranjit (a 40% taxpayer) is to renew his travel season ticket at a cost of £4640 in March 2023. If Ranjit was to pay for this out of his normal salary, he would need to receive £8000 in gross pay: £8000 less 40% tax of £3200 and Class 1 NICs at 2% of £160. If the employee provides an interest-free loan of £4640 to enable Ranjit to buy the season ticket, it only costs Ranjit £4640, the amount he borrows and subsequently repays. On the assumption that the total of all beneficial loans made to Ranjit is less than the £10,000 limit, no taxable benefit arises and there is no extra tax to pay. Furthermore, as the loan is not salary, the employer does not have to pay secondary Class 1 NICs on the amount borrowed.
Loans by individuals
There is no taxable benefit where a loan is made by an individual and it can be demonstrated that it was made due to his or her domestic, family or personal relationships. For example, a loan made by a business owner to a son or daughter. HMRC will undoubtedly look closely at any instances where it is claimed that the loan is for domestic, family or personal reasons.
Whilst this exemption is for loans made by an individual rather than by a company, the exemption may be available where the loan is made by an individual with a material interest. Specific advice should be taken in these circumstances.
Loans to directors are normally prohibited under the Companies Act 2006. Loans not exceeding £10,000 are permitted and larger loans can be made with the approval of members. Loans to directors can be complicated and specific advice should be sought.