You need to borrow money to pay for home improvements. Your company will advance you the cash if you pay it interest at HMRC’s official rate to prevent a benefit in kind. How can a little-known tax break protect you from interest rate rises?
Tax and company or employer loans
If you’re a director and borrow money from your company at a rate lower than HMRC’s “official rate”, currently just 2% (simple) per annum, you’re taxed on a benefit in kind. This can be avoided if you pay interest to your company at or above the official rate. The rate has remained unchanged since April 2021 but if it increases, you’ll have to pay more interest to avoid a taxable benefit being triggered.
Maintaining zero tax cost
At the current official interest rate a loan of, say, £40,000 from your company, repaid by equal instalments over five years would require you to pay total interest of £2,027 to prevent being taxed on a benefit in kind. If, as seems likely, HMRC’s official rate is raised to track increases in the Bank of England lending rate it would go up by 2% to 4% (predictions are that further increases are likely). Your interest payments would therefore need to more than double to £4,199 to prevent you being liable to a taxable benefit and your company a corresponding Class 1A NI bill (see The next step ). The good news is this extra interest can be avoided without any financial, tax or NI consequences for you or your company.
Tip. If you fix the repayment period and the rate of interest on borrowing from your company, any future rises in the official rate won’t affect your tax position. The rule is that if the official rate of interest increases in a tax year after the one in which a fixed-term and rate loan is made you can avoid a taxable benefit by continuing to pay interest at the original rate you fixed.
Example. In October 2022 Andrew’s company, Acom Ltd, makes a loan to him repayable over five years at an interest rate of 2% (simple) without either party being entitled to vary the terms and conditions. Andrew pays the interest accumulated on the loan for the 2022/23 tax year in May 2023. This interest matches that due at the official rate which means there’s no benefit in kind. In April 2023 HMRC sets its official rate increases at 4% for the 203/24 tax year. Andrew continues to pay interest at 2% for 2023/24 and later years, despite it falling short of that payable at the official rate.
HMRC policy on interest
Theoretically, HMRC could raise its official rate before the start of next tax year, which would make the Tip above ineffective, but it’s unlikely to do so. HMRC’s policy is to “… confirm the official rate of interest in advance of the new tax year” . The rate for 2022/23 is already set at 2% and any increase should therefore not take effect until 2023/24.
Tip. If you have an overdrawn director’s or other loan account with your company on which you pay interest at the official rate, to prevent a taxable benefit consider converting it to a fixed-term and rate loan before the start of the 2023/24 tax year. This will mean that you can continue paying interest at the current low rate of 2% (simple) and not be taxed on a benefit in kind even if the official interest rate rises.
If the interest you pay on a company loan is at least equal to HMRC’s official rate there’s no taxable benefit. What’s more, if you fix the interest rate and repayment period at the current official rate, increases in subsequent tax years are ignored. This means that you can continue to pay interest at the original rate (currently 2% simple) for the term of the loan regardless of any change in HMRC’s official rate.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.