The cut in the Bank of England’s base rate has garnered much attention in the press this week, but some keen observers (or employment tax aficionados!) may have noticed another rate change taking effect from April. Regulations amending the HMRC official rate of interest from 2.5% to 2.25% have been laid before the House of Commons and will come into force on 6 April 2020.
The official rate is relevant for the purposes of Chapter 7 of Part 3 of the Income Tax (Earnings and Pensions) Act 2003, which provides that tax is generally chargeable on an employment-related loan to the extent it is interest-free or carries a rate of interest rate lower than the official rate (a so-called “taxable cheap loan”). The cash equivalent of the benefit of the loan – being the difference between the amount of interest that would have been payable at the official rate and the amount of interest (if any) actually paid – is generally treated as earnings from the employment, and is subject to tax at the individual’s marginal income tax rate as well as Class 1A (employer only) National Insurance contributions. The official rate is also relevant to notional loans arising from the acquisition of securities by an employee for less than their market value.
As an example** of how the taxable cheap loan provisions and official rate may apply, if an interest-free loan of £100,000 was advanced to an employee (an additional rate taxpayer) by their employer on 6 April 2019 and outstanding for the whole of the tax year, the employee’s income tax liability in respect of the loan for the tax year in question would equate to £1,125 (the loan amount x 2.5% (being the official rate of interest for the 2019/2020 tax year) x 45% (being the additional rate of income tax)). On the same basic set of facts, but assuming the loan is advanced on 6 April 2020 (when the new official rate takes effect, and assuming that rate remains unchanged for the whole of the tax year) and outstanding for the whole of the 2020/2021 tax year, the income tax liability should equate to £1,012.50. The income tax is collected through self-assessment, rather than through the Pay As You Earn (PAYE) system.
Aside from the change to the official rate, we would like to take this opportunity to remind readers that loans to employees and directors are fertile ground for traps and pitfalls for the unwary; employment-related loans from third parties (that is, a person other than the employer or a member of its group of companies), in particular, can give rise to unintended – and very expensive! – consequences for employees and their employers. Please contact a member of the Weil tax team if you have any questions.
**This example is intended to be illustrative of the basic principle only.