In the current difficult economic client, employees may need to approach their employer for financial assistance in the form of a loan. Under the strict letter of the law, 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, is 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, then the loans are ignored for the purposes of the rules on beneficial loans for both income tax and national insurance contributions purposes.
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, then the exception will not be available and the benefit-in-kind will be taxed in full.
In September 2020, Bridgette (a higher rate 40% taxpayer) asks her employer for a loan to help pay for her seasonal bus pass at a cost of £2,320. To pay for this out of her take-home pay she would need to receive gross pay of £4,000 (£4,000 less tax at 40% (£1,600) and Class 1 NICs at 2% (£80)).
If her employer gives her an interest-free loan of £4,000 to enable her to buy the season ticket, it only costs Bridgette the £4,000 she borrows and subsequently repays to her employer. Providing the total of all beneficial loans made to Bridgette 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, Bridgette’s employer will not have to pay secondary Class 1 NICs on the amount borrowed.
As a final point, it should be noted that loans to directors are prohibited under the Companies Act 2006, though loans not exceeding £10,000 are permitted and larger loans may now be made with approval of the members. It is always worth seeking professional advice before extracting money from a limited company.