Employment-Related Loans – An Improving Tax-Free Perk?

Employment-Related Loans – An Improving Tax-Free Perk?

Employers will be able to help staff with tax-free loans of up to £10,000 for items such as travel season tickets, after the Chancellor announced in the 2013 Budget that the exemption limit on benefit-in-kind loans would be doubled from April 2014.


Currently, no taxable benefit-in-kind arises on interest-free loans where:


·         the loan has been made on commercial terms by employers who lend to the general public; or

·         the total of all beneficial loans made to an employee does not exceed £5,000 at any time in the tax year.


From 6 April 2014, the £5,000 exemption will rise to £10,000.


Cheap loans

Cheap loans provided by employers, which do not involve the payment of interest, are taxed in the same way as conventional employee loans, i.e. on the difference between the interest (or its equivalent) payable by the employee and the amount of interest that would be payable at the ‘official rate’. For 2013/14, the official rate is 4%.


There are two ways of calculating the taxable benefit:


•             the averaging method; and

•             the alternative method.


The averaging method will usually apply unless the taxpayer elects for, or HMRC specifically require, the alternative method to be used. Where the loan is not at the same level throughout the tax year, it may make a significant difference if one or other method is used.


Averaging method

To calculate any tax charge using the normal method, the following steps should be followed:


Step 1

Find the balance of the loan outstanding on 5 April, or on the day on which the loan was made.

Step 2

Find the balance on 5 April at the end of the tax year. If the loan was fully repaid during the year, it is necessary to look at the balance on the day of repayment.

Step 3

Calculate the average of the two figures from Steps 1 and 2 above.

Step 4

Calculate the average official rate of interest (if the official rate of interest was unchanged for the whole year, or for the part of the year during which the loan was outstanding, this step can be ignored).

Step 5

Apply this average loan figure to the average ‘official rate of interest’ in force during the period for which the loan was outstanding during the year using the formula:

A x I x M/12

A = average loan as calculated above;

I = average interest rate as calculated above;

M = number of whole months during which the loan was outstanding in the year.

Step 6

Deduct any interest paid by the employee.


Alternative method

This precise method considers the amount of loan outstanding each day and is calculated as follows:

Step 1

For each day in the tax year, multiply the maximum outstanding amount of the loan by the official rate of interest in force on that day.

Step 2

Add together those daily amounts.

Step 3

Divide the result by the number of days in the tax year.

Step 4

Deduct any interest paid by the employee.


Practical Tip :

Employers can offer employees a tax-free cheap loan of up to £5,000 per year. Provided the full amount of the loan is repaid to the employer and total loans outstanding do not exceed £5,000 at any time, no tax or NIC will be payable. This limit is due to rise to £10,000 in April 2014.


Sarah Laing