Employee loans – tax considerations for employers

We often have directors asking what tax implications they need to be aware of when making a loan to an employee, and what considerations they should make before doing so. 

What is an employee loan?An employee loan is a loan made from the company to the employee. It is not offered by all companies, and these loans can be done in different forms. They may be cheaper than other loans available as the interest rates are more desirable (based on current rates).

What considerations should the company make before deciding to loan money to an employee?Before rushing into  agreeing to provide a loan, the company should take some time to consider some key factors:

• Has the company got the cash available to make the loan?
• How long will it take for the loan to be repaid?
• Are you confident that the loan will be repaid in full and not be defaulted upon? 
• How will the repayments be made; will this be deducted from payroll?
• Are the company and the employee clear on the income tax implications of an interest-free or low-interest loan?
• Are there criteria the employees must meet to be eligible for a loan?
• Have you got a loan agreement in place? 

What are the tax implications of an employee loan?Loans of up to £10,000 are tax-free from the company to the employee. There is no reporting required, and no tax or national insurance to pay. However, employers can still choose to charge interest on loans under £10,000 if they wish to do so. 

Loans of anything above £10,000 won’t be tax-free and will be considered as a taxable benefit in kind, therefore it must be declared on a P11D form. The employee will be liable to pay UK income tax and National Insurance Contributions on the difference between any interest paid, and interest calculated at the official rate of 2.25%.

• If the loan is interest-free, then the employee is taxed on a benefit in kind based on the official HMRC interest rate (2.25%) and the employer pays Class 1A NIC (13.8%) on this benefit.
• The official HMRC interest rate is currently 2.25%.  The company could charge employees interest at this rate - which is substantially lower than anywhere else - and that would mean that no benefit in kind is due, and consequently also no further tax cost to the company.
• If the loan is charged at an interest rate somewhere between the HMRC official rate (2.25%) and interest-free (0%), then the employee is taxed on this as a benefit in kind on the difference between the HMRC official rate and the actual rate charged.

Example – Tax implications of an interest-free employee loan of £20,000

Let’s say the company was giving an employee an interest-free loan of £20,000. If there was a regular payback over 4 years of equal instalments, let's say, and you gave it to the employee interest-free - then how it would work from a benefit in kind perspective is as follows:

Year 1

Average loan of £17,500 (£20,000 at start and £15,000 at the end of the tax year) - Benefit in kind (BIK) amount would be 2.25% x £17,500 = £394.  Employee pays tax on the £394 - if a 20% taxpayer the employee would pay £79 tax, or for a 40% taxpayer the employee would pay £158.  The company would pay Class 1A NIC at 13.8% on the £394 BIK - £54

Year 2

Average loan of £12,500 (£15,000 at start and £10,000 at the end of the tax year) - Benefit in kind (BIK) amount would be 2.25% x £17,500 = £281.  Employee pays tax on the £281 - if a 20% taxpayer the employee would pay £56 tax, or for a 40% taxpayer the employee would pay £112.  The company would pay Class 1A NIC at 13.8% on the £281 BIK - £39

Etc.

So overall, it is not a massive tax burden on the employee at that level of loan but does cost the company a small amount to provide. Whereas, if an employee were to borrow this money from a high street lender they could be looking at anywhere from 6% to 25% interest on a loan for £20,000.

Overall as long as the right considerations and agreements are in place, providing loans to employees can be a great incentive to employees and also a great retention strategy.

Structuring an employee loan:

Setting appropriate interest rates 

Loans can be provided either interest-free or at an appropriate interest rate.  It is down to the employer to set this. If charging interest, it is often done at a rate equal to the HMRC official rate to save any tax cost to the employee. Further details on HMRC official rates can be found here.

One practical question that is sometimes is asked – ‘Is it possible to provide multiple loans of £10,000 or under to the same employee to avoid the Benefit in Kind?’  The answer is no.  For this purpose, loan amounts are aggregated and if the total amount of loans exceeds £10,000, then the full amount of these loans is taxed in entirety.

Clear documentation and agreements

The company needs to take precautions when deciding to loan an employee an amount of money. We have seen plenty of situations where someone has had a loan and then left the company, never to be contacted or seen again! This results in no loan being repaid which is a cost to the business – usually it is when precautions haven’t been taken and there was no loan agreement in place. We always recommend and advise employers to ensure, when loaning to employees, that:

• A proper loan agreement is in place.
• You ensure that the loan is conditional on the employee remaining an employee of the business. This is also a good staff retention strategy.
• You have a loan repayment plan in place - we recommend keeping a simple loan schedule.  The repayment plan could be deductions from payroll, or it might be standalone repayments.

However, if you will be deducting from payroll you must get clear authority from the employee to make these deductions.   

What should be reported to HMRC?

• So long as the balance of the loan stays under £10,000 for the whole of the tax year (6th April to 5th April) nothing would need to be reported to HMRC. 
• Anything above £10,000 needs to be reported on a P11D form.

For more detail and information on employee loans, we recommend reading the guidance available from HMRC here and as always we recommend seeking professional advice. If you require any further assistance feel free to reach out to us via info@oldfieldadvisory.com or call 02476673160 and we will be happy to help.

Please note: This article is provided for information only and was correct as at time of writing (11/07/24). Any lists and details provided above are not exhaustive and are not intended to be full and complete guidance.  No action should be taken without consulting detailed legislation or seeking independent professional advice. Therefore, no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this article can be accepted.