Background
Where a loan is provided to a director or an employee by their company, interest free or below the official rate of interest, then a Benefit In Kind (BIK) can arise on loans above £10,000. The BIK is calculated on the loan at the ‘beneficial rate’, less any actual interest paid by the individual.
HM Revenue & Customs (HMRC) has increased the official rate of interest for beneficial loan arrangements from 2.25% to 3.75% with effect from 6 April 2025, when calculating interest under the ‘precise method’. However, the rate when using the ‘averaging method’ for the current 2025/26 tax year has not yet been confirmed. For the 2024/25 tax year under the average method the rate remained at 2.25%. These relatively cheap interest rates offer an opportunity for a low cost of borrowing for a director from their company and/or a relatively low BIK tax charge when compared to the current base rate of 4.25% or most commercial loans from banks.
HMRC have also confirmed that the beneficial loan rate will now be reviewed each quarter and if necessary adjusted accordingly.
Detail
A company may wish to make funds available for the use of a director, employee or shareholder by means of a loan. This will have tax implications for the company and for the individual.
A director’s loan arises when a company director (or other close family members) is lent money by their company that is not a salary, dividend or expense repayment, or money previously paid into or lent to the company. In general where interest is charged on that loan by the company at the official rate of interest or higher then no additional tax liability arises on the director.
In most circumstances, there will be no tax consequences when the loan is made. However, care should be taken where the loan is made in anticipation of the payment of salary or a bonus. In this case, the amount advanced may be treated as earnings with the result that PAYE must be applied at the time the funds are made available to the director.
There are benefit-in-kind (BIK) implications where the loan is provided interest-free or if the interest charged is less than that which would be payable at the official rate, which HMRC has increased to 3.75% for the 2025/26 tax year when using the precise method. However, there is an exemption for small loans. This means that, provided the total loan balance is less than £10,000, no benefit-in-kind tax charge arises even if the loan is interest free or at a rate below the official rate.
There are two methods of calculating the interest:
- The averaging method, which is the default method for beneficial loans, uses the balance of the loan at the start of the tax year (or when the loan was made if this is later), plus the balance of the loan at the end of the tax year (or immediately before it was paid off if this is sooner) then divides the total by two and multiplies by the official rate of interest.
- The precise method which involves calculating the interest on a beneficial loan using the official rate of interest on a daily basis against the maximum outstanding balance of the loan on each day.
For director’s or employee’s loans over £10,000 a BIK will arise if interest is not paid on the loan at least equal to the official rate of interest. The BIK will be equal to the notional interest on the loan calculated at the ‘beneficial rate’, less any actual interest paid by the employee. The director will then have to report the BIK on their self-assessment tax return and tax may be payable on the benefit.
If a ‘close’ company (broadly a company which is controlled by 5 or fewer shareholders) makes a loan to a ‘participator’ (broadly a shareholder) a tax charge also arises for the company if the loan is not repaid with 9 months of the end of the company’s accounting period. The aim of the rules is to prevent the individual having the benefit of the funds without tax being paid.
The tax charge on the company, often referred to as s.455 tax, is currently 33.75% of the amount of the loan outstanding at the end of the company’s accounting period. The deadline for paying s.455 tax to HMRC is 9 months and 1 day after the end of the period.
Various anti-avoidance provisions apply to prevent the ‘bed and breakfasting’ of a loan, i.e. where a loan is repaid in order to avoid a s.455 charge, only for another loan to be made shortly afterwards.
The rules surrounding shareholder loans can be complex so if you require more information on any aspect of these or any of the points raised above please contact our Tax Director, Jenny Marks.
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