Employers can offer employees a tax-free cheap or interest-free loan of up to £10,000 per year.
Subject to 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 March 2020, Jim (a higher-rate- 40% taxpayer) needs to renew his annual season ticket to travel to work, which costs £8,200. To pay for this out of his take-home pay he would need to earn gross pay of £14,138 (£14,138 less tax at 40% (£5,655) and Class 1 NICs at 2% (£283)).
If his employer gives him an interest-free loan of £8,200 to enable him to buy the season ticket, it only costs Jim the £8,200 he borrows and subsequently repays to his employer. Providing the total of all beneficial loans made to Jim by his 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, his employer will not have to pay secondary Class 1 NICs on the amount borrowed.
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 (for example, where the owners of a business make a loan to a son or daughter). HMRC are however, likely to take a close look at cases where such a claim is made.
Tax staff dealing with the tax affairs of an employer will 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
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.