02 May 2023

Providing Support to Employees

Q: One of our employees has asked if the business can provide a loan to help clear a personal debt which arose when making improvements to their home. They financed the work using short-term credit cards with high interest rates. If the company provides support to employees with a short-term loan, to help relieve some of the pressure they are under from credit card companies, are there any tax implications? Also, is it necessary to have a formal loan agreement drawn up?

A: A taxable benefit arises on an employee or officer of a company, under the employment-related loan legislation, where the total loans made to the employee exceeds £10,000 at any time in the tax year. Such employee loans are often interest-free or if interest is charged by the lending company it is usually below the official interest rate (which is currently 2.25%). If this is the case and the borrower pays less than the current market rate of interest, a taxable benefit arises.

Providing Support to Employees | Charges

The taxable benefit charged on the employee is equivalent to the amount of interest that would have been paid if the employee had paid the official rate of interest, less any interest actually paid by the employee. Although the official interest rate is currently 2.25% it is subject to change and should be rechecked before employee loans are authorised.

For the employee, the taxable benefit will be made at their marginal rate and collected via their self-assessment tax return (if they prepare one) or via their PAYE code changed to collect in later tax years.

The company will incur Class 1A National Insurance Contribution @ 13.8% of the taxable benefit and be required to prepare and file P11d return by 6^th July following the tax year in which the benefit arose.

For any interest payments made by an employee to be allowed as a deduction, several conditions must be fulfilled. Firstly, the interest must have been paid by the employee to benefit from a deduction. Therefore, the interest cannot be owed, and it must have been paid ‘for’ the year of assessment, but not necessarily ‘in’ the year of assessment.

HMRC have also stated that they require there to be a formal obligation on the employee to pay the interest for the tax year relating to the loan. HMRC’s view is that interest cannot arise except under an obligation. Thus, a voluntary payment made by an employee will not be treated as deductible interest. On this basis, it is usually recommended that a formal loan agreement be put in place in order to prove that an obligation exists. It is also important to note that interest cannot be backdated and therefore the obligation to pay interest must be in place throughout the period of the loan.

If the loan made to an employee (when added to all loans made to that employee at any time during the relevant tax year) does not exceed £10,000 there is no taxable benefit or Class 1A charge. Providing support to employees in the form of small loans should therefore benefit from exemption.

Finally, if an employee receiving a loan is also a director or shareholder the company may incur a tax charge @ 33.75%, which is repayable once the loan is cleared. It is advisable therefore to obtain specific legal and tax advice before making substantial loans to an officer or employee of a company.