A guessing game - interest rates and employee loans
Buried in the 2024 Autumn Budget were small print changes to HMRC's 'official rate' of interest. The consequences of these are about to take effect. How might they affect you and your employees?
Increased rate
On 6 April 2025 the official rate of interest (ORI) will rise to 3.75% (from 2.25%), the first change for over six years. Any increase in the ORI means that employees and directors who have their employer more than £10,000 at any time during the tax year, even for one day, will need to pay more interest to avoid a taxable benefit being triggered.
Trap. Remember, the benefit in kind tax is separate from the so-called 'close company' charge that a company has to pay where it lends money to shareholders and others, e.g. directors, who control it.
Quarterly review
As well as the increased interest rate, the frequency at which HMRC will review whether to increase or decrease the ORI will change from annually to quarterly from now on. The review dates will be 6 April, 6 July, 6 October and 6 January. This means that you may need to undertake more complex calculations to work out the taxable benefit depending on how frequently the ORI changes.
Employer v bank loan
The ORI still compares favourably to the bank lending base rate, let alone the eye-watering rates that currently apply to unsecured loans from banks and other lenders. This makes employer loans an attractive and tax efficient benefit in kind, especially if the loan is for no more than £10,000.
Tax-efficient charges
Loans that exceed £10,000 which are either interest free or the rate of interest charged is less than the ORI, will result in a tax charge. Plus, as the employer you must pay Class 1A NI (at 15% for 2025/26) on the taxable amount.
Trap. The balance of all loans made to the same employee must be aggregated to determine if the £10,000 limit is exceeded. Where it is, the whole loan, not just the excess over the limit, counts as a taxable benefit for the full tax year or, if shorter, the period of the loan.
Consequences of a fluctuating ORI
The recent hike in the ORI will mean that loans that didn't result in a tax and Class 1A NI charge in 2023/24 and 2024/25 will become taxable from 6 April 2025. For example, if in 2024/25 a director owed his company £15,000 for the whole of 2024/25 but was required to pay interest at the ORI of 2.25%, i.e. £338, there's no taxable benefit. If the debt and the ORI remain the same throughout 2025/26, the company must charge interest of £563 (3.75%) to prevent a taxable benefit occurring.
Tip. The tax and NI consequences of changes to the ORI can be avoided if the interest rate payable is fixed at the ORI applicable at the time the loan is made and other conditions are met.
The official rate of interest (ORI) will be reviewed quarterly instead of annually. Plus the rate has increased from 2.25% to 3.75% from 6 April 2025. The ORI is used to work out the amount of taxable benefit on loans made from employers to employees and directors. Higher tax and NI charges can be avoided by using fixed interest loans.
Team #TaxSwag