Interest-free or cheap loans

An interest-free loan to an employee is chargeable to tax if it exceeds £5,000 at any time during the tax year. The amount chargeable is the rate of interest set as the ‘official rate’. Since 5 April 2010, this has been 4% and is charged on the average amount outstanding during the fiscal year.

Any amount written off is chargeable as a payment of emoluments.

The de minimis exemption of £5,000 (above) does not apply to a loan to a participator in a close company. If such a person has a loan or advance nine months after the end of the accounting period in which the advance or loan was made, a charge will arise under section 455 Corporation Tax Act 2010 (CTA 2010).

The benefit in kind charge will not be made if:

• the loan or advance does not exceed £15,000, and
• the borrower works full time for the company or one of its associated companies, and
• the borrower does not have a material interest (5%) in the close company or any of its associated companies.

For the purposes of establishing whether a taxable benefit arises, it is necessary to aggregate all loans and advances. As well as straightforward loans, the following are also regarded as loans:

• overdrawn director’s loan account; and
• advances on account of expenses payments (although in practice HMRC disregard advances not exceeding £1,000 provided that the amounts are spent within six months and the employee accounts to the employer at regular intervals for the expenses).  (ITEPA 2003, sections 174 - 190).

A civil servant was required by his employers to move to London from Wigan. He received an advance of salary which was interest-free and repayable on demand in certain circumstances. It was repaid by monthly instalments over ten years and he was assessed on it. He appealed, contending that he received no benefit from it. This was rejected by the court, holding that the true nature of the advance was a loan from the employer. Williams v Todd, [Ch D 1988, 60TC 727]. Find out more here.

There are two methods of calculating beneficial loan interest:

• average basis (based on the opening and closing balances of the loan) and
• alternative method - calculated on the day to day outstanding balance of the loan.

When completing return P11d for an employee the first of the two methods must be used. Find out more here.