Sarah Laing looks at how employers can help employees by offering a tax-free cheap or interest-free loan.
The tax legislation provides that a tax charge will arise where a director or employee obtains a benefit by reason of their employment when they, or any of their relatives, are given a cheap or interest-free loan.
The tax charge generally arises on the difference between interest at the appropriate ‘official rate’ (currently 2.25%) and the interest (if any) actually paid. Such loans are called ‘beneficial loans’.
However, subject to satisfying a few conditions, as long as the total amount outstanding on all loans from an employer to an employee does not exceed £10,000 at any time in the tax year, the loans are ignored for the purposes of the rules on beneficial loans for both income tax and National Insurance contributions (NICs) purposes.
What are the conditions?
No taxable benefit-in-kind will arise where:
- the loan has been made on commercial terms by employers who lend to the general public; or
- the total of all loans made to an employee does not exceed £10,000 at any time in the tax year.
It is important to remember that this is an ‘all or nothing’ exception. If (however briefly) the loan balance rises above £10,000 at any time in the tax year, the exception will not be available and the benefit-in-kind will be taxed in full.
Example: Loan for travel season ticket renewal
In July 2020, Brenda (a 40% taxpayer) needs to renew her train travel season ticket at a cost of £5,510. To pay for this out of her take-home pay she would need to receive gross pay of £9,500 (i.e. £9,500 less tax at 40% (£3,800) and Class 1 NICs at 2% (£190)).
If Brenda’s employer gives her an interest-free loan of £5,510 to enable her to buy the season ticket, it only costs Brenda the £5,510 she borrows and subsequently repays to her employer. Provided the total of all beneficial loans made to Brenda by her employer is less than £10,000, no taxable benefit arises, so the cost of the benefit is nil.
In addition, since the loan is not salary, Brenda’s employer will not have to pay secondary Class 1 NICs on the amount borrowed.
Loans made by individuals
No taxable benefit arises in respect of loans (however large) if the loan is made by an individual and it can be shown that it was made in the normal course of his/her domestic, family or personal relationships (e.g. where the owners of a business make a loan to a son or daughter). However, HMRC are likely to take a close look at cases where such a claim is made.
Tax staff dealing with the tax affairs of an employer should liaise with staff dealing with the business accounts of that employer before agreeing that this exemption applies. If the loan is shown as an asset in the accounts of the employer’s business, HMRC will be less inclined to accept that this was made in the course of a private relationship.
This exemption can only apply where the lender is an individual. It cannot, therefore, apply where a loan is made by a company, even where that company is controlled by somebody with the relevant personal relationship. However, certain loans can be chargeable under the employment-related loan rules where they are made by an individual having a material interest in a close company. In these cases, where the loan is made by the individual with the material interest, the exemption for loans made in the course of personal relationships can still be available.
Similarly, no tax charge can arise if an employee is able to demonstrate that he has derived no benefit from a loan made to a relative of his. This exemption applies to the charge in respect of a loan and also applies where a debt is released or written off.
Loans to directors are generally prohibited under the Companies Act 2006, although loans not exceeding £10,000 are permitted and larger loans may now be made with the approval of the members.