Beneficial loan arrangements (480: Chapter 17)
How to tax a beneficial loan arrangement for a director or employee.
Overview
17.1
Section 175(1)
A director or employee gets a benefit by reason of the employment when they, or any of their relatives, is given a cheap or interest-free loan. The employee is generally taxable on the difference between interest at the appropriate official rate and the interest, if any, actually paid. Such loans are called beneficial loans.
17.2
It’s not necessary for the loan to be advantageous to the recipient for a chargeable benefit to arise. It’s sufficient if the cheap or interest-free loan is made by reason of the employment.
17.3
Section 188(1)
The director or employee can also benefit if a loan made by reason of their employment is released or written off. The director or employee is then no longer obliged to repay the amount they was lent. A tax charge will arise irrespective of the terms of the loan which has been released or written off.
Amount chargeable
17.4
Section 175(3)
The amount chargeable is called the cash equivalent of the benefit of the loan. This is the difference between the:
- interest that would have been payable if the borrower needed to pay interest on the loan at the appropriate ‘official rate’ (or rates) for the tax year concerned, and
- amount of interest actually paid by the borrower for the same tax year
Section 181(1)
Official rates are prescribed by the Treasury by means of Statutory Instruments. There are tables of official rates in Appendix 4. Detailed information on how to calculate the cash equivalent is given in paragraphs 17.27 to 17.30.
For the treatment of belated interest payments, see paragraph 17.35.
Loans in foreign currencies
17.5
Section 181(2)
Treasury regulations may specify different rates for use with certain loans made in the currency of a country outside the UK.
The loans are those where the benefit is obtained by a person who:
- normally lives in the country or territory where the currency in which the loan is made
- has lived in that country or territory at some time in the period of 6 years ending with the year of assessment concerned
The phrases ‘normally lives’ and ‘has lived at some time’ are not defined in law and so have their ordinary common-sense meanings. A person normally lives in the place (if any) where, taking all the facts into account, you would normally expect them to be in the absence of some special reason to the contrary (such as a temporary period of employment elsewhere). ‘Has lived at some time’ implies continuity but not necessarily of permanence.
A table showing currencies for which official rates, different from that generally applicable have been prescribed, what those rates are and for which periods they apply, is in table 3 of Appendix 4.
Meaning of ‘loan’
17.6
Section 173(2)
Loan means more than lending money. It includes any form of credit. It follows that any kind of advance made by reason of the employment is covered. For example, any amount shown in the employer’s books or records as owed by a director or employee will count as a loan.
Identifying the loan
17.7
The identification of the loan or loans made is a crucial step in the process of dealing with beneficial loans. A loan (but not necessarily a debt consisting of some other form of credit (see paragraph 17.6)) is always created by an agreement between the borrower and the lender. It’s the agreement which sets out the scope of the loan.
The terms of an agreement for a loan may take any one of a variety of forms. For example, they may provide that the loan is effectively to be divided into segments for the purposes of:
- securing it on assets
- calculating interest payable
- accounting
A single loan may:
- be represented by 2 or more accounts
- bear interest on different segments at different rates
- be secured on 2 or more assets
If the agreement under which it’s made and accepted is an agreement for a single loan, it will remain a single loan and be treated as such for all the purposes of the beneficial loan rules unless and until it reaches the point where it may be aggregated with other loans in the calculation of the cash equivalent. (See paragraph 17.27).
Just as a single loan may involve 2 or more accounts, rates of interest and forms of security, so 2 or more separate loans may be:
- subject to the same terms as regards interest
- secured on the same asset
- held in the same account
The fact that 2 or more separate loans may be aggregated for a particular purpose of ITEPA 2003 does not make them a single loan or mean that they can be treated as such for any other purpose. Each form of credit other than a loan is a single loan for the purposes of the beneficial loan rules. So a series of similar forms of credit (for example, the provision of a monthly service on credit) is for those purposes a series of separate single loans.
An Alternative Finance Arrangement (Sections 46 to 57 Finance Act 2005) provided by an employer to an employee is taxed in the same manner as a beneficial loan. Such arrangements (for example, wakala or a diminishing musharaka) do not give rise to payment or receipt of interest, but they’re taxed in the same way as equivalent arrangements that do give rise to interest.
Meaning of ‘making a loan’
17.8
Section 173(2)(b)
Making a loan includes:
- arranging a loan
- guaranteeing a loan
- in any way facilitating a loan
- taking over a loan from another person
Loans taken over from another person
17.9
Section 174(4)(a)
If the rights over an existing loan are taken over by another person the loan will remain within the charge if it was within the charge when it was first made. A loan within the scope of the charge cannot be removed from it by the original lender transferring their rights to another person. But a loan which was not within the charge when it was first made can be brought within it if it’s taken over by a person mentioned in paragraph 17.11.
Meaning of ‘relative’
17.10
Section 174(6)
Relative is given a special meaning for the purposes of the charge on beneficial loans or their release or writing off.
Persons defined as relatives include:
- the employee’s spouse
- the parents, children, and brothers and sisters of both spouses
- remote ancestors or descendants of both spouses, for example, grandparents and grandchildren
- the spouses of all the persons mentioned above
This definition is much wider than that used for other benefits of directors and employees within the benefits code (see chapter 1 paragraph 1.22).
Meaning of ‘loan obtained by reason of the employment’
17.11
Sections 174(1) and (2)
The phrase ‘by reason of the person’s employment’ is given a special meaning in connection with the charge on beneficial loans or their release or writing off. The benefit of a loan or its release or writing off is obtained by reason of a person’s employment if the loan is made by:
- the employer or a prospective employer – there’s an exception to this rule at 17.12
-
a company or partnership:
- controlled by the employer
- controlling the employer
- under the same control as the employer
-
a person having a material interest in a close company or in another company or partnership controlling that close company and the employee’s employer:
- is that close company
- controls it
- is controlled by it
There is an exception to this rule which is explained in paragraph 17.13 below. The extended meaning of ‘making a loan’ in paragraph 17.8 applies for the purpose of these rules
A loan made by a person other than the employer may in some cases fall within the rules on employment income through third parties – see chapter 1 paragraphs 1.16 to 1.23.
Exception for loans made by an employer who’s an individual
17.12
Section 174(5)
There’s an exception to the rule in paragraph 17.11 that the benefit of a loan is obtained by reason of a person’s employment if it’s made by their employer or prospective employer. No charge arises if it’s shown that a loan has been made by an employer who’s an individual, in the normal course of domestic, family or personal relationships.
Loans by persons with a material interest in a close company
17.13
The exception explained in paragraph 17.12 applies to loans made by a person within the third bullet of paragraph 17.11 as well as to loans made by a person within the first bullet. A loan made by an individual who has a material interest in a close company or in another company or partnership which controls such a company, is not a loan the benefit of which is obtained by reason of a person’s employment if it can be shown that the loan was made in the normal course of the lender’s domestic, family or personal relationships.
Qualifying loans
17.14
Sections 180(4) and (5)
The rules set up a special category of loans called qualifying loans. A summary of loans which are ‘qualifying’ is set out in Appendix 5. Loans which are not qualifying are referred to in what follows as non-qualifying loans. Loans used to buy land are not qualifying loans. The distinction between qualifying and non-qualifying loans is relevant in relation to:
- the exemption for qualifying loans on which the whole of any interest would be eligible for relief (see paragraph 17.15)
- the exemptions for small loans (see paragraphs 17.16 and 17.17)
- aggregation and non-aggregation of loans (see paragraph 17.27)
Exemptions for some qualifying loans
17.15
Section 178(5)
There’s no chargeable benefit on some qualifying loans. Exemption applies if the whole of any interest on the loan (or any interest which would be payable if the loan were interest-bearing) qualifies for tax relief under any of the categories in Appendix 5. Do not report such loans on form P11D.
The exemption does not apply if only part of the interest on the loan qualifies for tax relief. In that case the full cash equivalent of the loan should be reported on form P11D. Any tax relief due to the employee should be claimed by the employee, usually on his or her Self Assessment tax return.
Example
Mr A had 2 interest-free loans from their employer as follows:
| Nature of loan | Amount of loan |
|---|---|
| Loan to purchase an interest in a partnership | £60,000 |
| Loan to buy land | £20,000 |
The loan to purchase the interest in the partnership is exempt (if it were interest-bearing all the interest would qualify for relief) and should not be reported on form P11D. The loan to buy the land is not exempt. The full cash equivalent of the land loan must be reported on form P11D.
Exemptions for small loans
17.16
Section 180(1)
No tax is chargeable if the total balance outstanding on all beneficial loans does not exceed £10,000 throughout the year of assessment in question. This exemption does not apply where the loan is given through optional remuneration arrangements (see Appendix 12).
This means that, in strictness, where this exemption could be applicable it will be necessary to calculate and consider the total balance outstanding on all an individual’s beneficial loans on a day-to-day basis. However, in practice, many loans will decrease steadily from the time they’re taken out.
For these loans the maximum balance in any year cannot exceed the balance at the beginning of that year (or in the case of a loan taken out in the year at the time when it was taken out). It will be possible in such cases to know whether the exemption applies without knowing the maximum total balance outstanding day by day. Interest accrued is not added to the balance of a loan outstanding until the interest falls due for payment.
17.17
Section 180(3)
Where exemption under paragraph 17.16 is not due but would have been but for the existence of one or more qualifying loans (see paragraph 17.14) only the qualifying loans are taken into account for the purposes of the beneficial loan rules.
Example
Ms B had 3 interest-free loans from her employer as follows.
| Nature of loan | Maximum outstanding balance |
|---|---|
| Qualifying | £50,000 |
| Non-qualifying | £6,000 |
| Non-qualifying | £4,000 |
| Total | £60,000 |
Since the maximum total balance outstanding in the year exceeds £10,000, exemption under Section 180(1) is not due. Apart from the qualifying loan the maximum total balance outstanding in the year would be £10,000. Since this does not exceed £10,000, exemption under Section 180(3) is due for the non-qualifying loans. The qualifying loan will be charged as if it were the only beneficial loan.
Exemption where no benefit is derived from a loan to a relative
17.18
Section 174(5)
There’s no chargeable benefit if a director or employee who’s not in an excluded employment shows they had no benefit from a loan made to a relative of theirs. This exemption protects an employee from a charge where there’s a genuine arm’s length transaction between the employer and the employee’s relative. It also applies where a debt is released or written off.
Exemption for loans for fixed periods at a fixed rate of interest
17.19
Section 177
There’s no chargeable benefit in any year of assessment on a loan made to a director or employee if the loan:
- is for a fixed and invariable period
- is at a fixed and invariable rate of interest
- when the loan was first made, the interest paid on it in the year it was made was not less than the interest calculated at the appropriate official rate for that year
The tests to be satisfied for this exemption are stringent. The loan must be for a specific period which cannot be varied under any circumstances and the rate of interest must be fixed and incapable of alteration.
Exemption for ‘commercial loans’
17.20
Section 176
There’s no chargeable benefit on a loan made to a director or employee if:
- the loan was made by a person in the ordinary course of a business carried on by that person which includes the lending of money
- at the time when the employee loan was made the lender was making comparable loans (see paragraph 17.21) available to all their potential borrowers
- the comparable loans made by the lender at or about the time (see paragraph 17.23) as the employee loan was made, a substantial proportion (see paragraph 17.22) was made to members of the public at large with whom the lender was trading at arm’s length (see paragraph 17.24)
- the same terms apply to all comparable loans (including the employee loan)
- where the terms of the comparable loans (including the employee loan) are different from the original terms, the new terms were imposed in the ordinary course of the lender’s business
The exemption is due only if all those conditions are satisfied.
This exemption also applies, on the same conditions about the giving of credit for making a loan, to the giving of credit to a director or employee by a person whose business includes the supply of goods or services on credit.
Comparable loans
17.21
Sections 176(3) and (4)
A loan is comparable with another if both are made:
- for the same or similar purposes
- on the same terms and conditions
The words ‘the same or similar purposes’ have their ordinary common-sense meaning. A loan to buy shares in one company is made for a similar purpose to a loan to buy shares in another company. A loan to buy a holiday is not made for a similar purpose to a loan to buy a house
The words ‘on the same terms and conditions’ mean just what they say.
They’re not made on the same terms and conditions if 2 loans are:
- made on the basis of different lending criteria
- carry interest at different rates
- have different terms as to repayment or security
Similarly, since any fees charged in connection with the making of a loan (for example, valuation fees, administration or arrangement fees, reservation or booking fees) are part of the terms and conditions of the loan, a loan where no such fees are charged cannot, by definition, have been made on the same terms and conditions as one where such fees are charged.
Substantial proportion
17.22
The substantial proportion test operates by reference to numbers of loans and not by reference to total amounts lent. If 50% or more of the comparable loans made at, or about, the same time when the employee loan was made, were made to members of the public at large, this test will be satisfied. Whether a proportion below 50% would be enough will be a matter of fact or degree.
At or about the time the employee loan was made
17.23
The law does not specify the period within which the loans to be taken into account in applying the substantial proportion test have to be made. This allows the application of common sense. If a public offer for loans for the same or similar purposes and on particular terms and conditions is open from 1 April to 31 December all such loans made in that period will have been made at or about the same time for the purposes of the substantial proportion test.
Members of the public at large
17.24
The public at large means, in this context, the public in general as distinct from a particular section of the public. The essential difference is between ordinary customers with whom the lender deals on an arm’s length basis and other borrowers with whom the lender has a special relationship – for example, employees, former employees or suppliers. This does not mean that loans made by specialised lenders such as merchant banks which do not lend to the general public are automatically excluded from the exemption.
The criterion is not whether a substantial proportion of the comparable loans was made to all and sundry but whether such a proportion of those loans was made to ordinary customers with whom the lender was dealing at arm’s length.
Exemption for loans varied onto ‘commercial’ terms
17.25
Section 176(5)
There’s no chargeable benefit on a loan, made to a director or employee, which has been varied onto the same terms as apply to loans made to members of the public, if:
- a substantial proportion of relevant loans (see paragraph 17.26) is held by members of the public (see paragraph 17.24)
- at the time of variation of the employee loan, members of the public with existing loans from the lender had a right to vary their loans on the same terms and conditions as applied to the variation of the employee loan
- any such loans to members of the public so varied are held on the same terms as the employee loan
- where the terms of the relevant loans (including the employee loan) are different from those immediately after the time of variation, the new terms were imposed in the ordinary course of the lender’s business
In deciding whether rights to vary loans are on the same terms and conditions, and whether loans are held on the same terms, disregard:
- penalties, interest and similar amounts incurred by the borrower as a result of varying the loan
- fees, commission or other incidental expenses incurred by the borrower for the purpose of obtaining the loan
Relevant loans
17.26
Section 187
For the purpose of the exemption for varied loans, the relevant loans are:
- the employee loan in question
- any existing loans which were varied at, or about, the time of the variation of the employee loan, so as to be held on the same terms as the employee loan
- any new loans made by the lender at, or about, the time of the employee loans which are held on the same terms as the employee loan
Calculation of chargeable benefit from a beneficial loan
Aggregation of loans between the same borrower and lender
17.27
Where there’s more than one loan owing to a close company by one of its directors, the company may elect to treat certain loans as a single loan for the purposes of calculating the chargeable benefit for a year.
The loans which can be dealt with in this way (aggregated) are those which are:
- not qualifying loans (see paragraph 17.14)
- in the same currency
- beneficial (see paragraph 17.1)
Loans which are exempt from charge cannot be aggregated. They include:
- commercial loans (see paragraph 17.20)
- loans falling within any of the exemptions mentioned in paragraphs 17.12 and 17.16 to 17.19
The fact that a particular director has one or more loans which cannot be aggregated does not mean that his or her other loans cannot be aggregated but an election must cover all loans which can be aggregated.
Example
A director of a close company has 5 cheap loans in sterling from his employer outstanding on a given day in a tax year. One of these loans is a qualifying loan which is not exempt because the interest only partly qualifies for relief. The other 4 loans are non-qualifying loans but one of them is a ‘commercial’ loan.
The company may elect to aggregate the 3 remaining loans for the year but it cannot elect to aggregate 2 of them and deal with the third separately.
The company election cannot be reversed by the director.
An election is effective only if the company gives HMRC written notice of it within 91 days of the end of the tax year concerned. An election is effective only for one tax year.
Calculation of the chargeable benefit – ‘the cash equivalent’
17.28
There are 2 alternative ways of working out the chargeable benefit from a cheap or interest-free loan or loans.
The normal averaging method (see paragraph 17.29) applies automatically unless:
- the director or employee elects for the other (the ‘alternative precise method’), or
- HMRC gives notice that it intends to use the ‘alternative precise method’
17.29
Section 182
The normal averaging method of calculation is based on the average:
- amount of the loan (or aggregated loan – paragraph 17.27) calculated by reference to its maximum opening and closing balances at the beginning and end of the tax year – if the loan was not in existence throughout the whole year, the average is based on the maximum balances on the dates the loan was made or discharged
- appropriate ‘official rate’ of interest for the tax year – or for such shorter period as the loan was in existence
The step-by-step calculation is as follows:
1 . Find the maximum amount of the loan outstanding on:
- 5 April preceding the year of assessment, or
- if the loan was made during the year, the date on which it was made
2 . Find the maximum amount of the loan outstanding on:
- 5 April within the year of assessment, or
- if the loan was discharged during the year, the date on which it was discharged
3 . Add together the maximum amounts found at Steps 1 and 2, and divide the result by 2. This is the average loan.
4 . Multiply the average loan found at Step 3 by the number of whole months for which the loan was outstanding in the year and divide the result by 12. For the purpose of this calculation months begin on the sixth day of the calendar month.
5 . Multiply the result by the appropriate average official rate of interest in force during the period that the loan was outstanding in the year.
6 . Deduct any interest which was paid by the director or employee for the loan for that year.
For an example, see Appendix 6.
‘Alternative precise method’ of calculating the chargeable benefit
17.30
Section 183
Broadly, the alternative method of calculation involves:
- dividing the appropriate official rate by 365
- applying that to the total of the maximum amounts of the loan (or loans) outstanding on each day in the tax year
In effect the total amounts of the maximum balances on the loan (or aggregated loan) for each day are converted into the equivalent balance for one day to which one day’s interest charge at the appropriate official rate is then applied.
Any interest paid on the loan for the tax year is then deducted to arrive at the chargeable benefit for that year. For an example, see Appendix 6.
Election for the alternative precise method of calculating the benefit
17.31
Either the employee or the officer of HMRC can elect for the alternative precise method of calculating the cash equivalent. An election covers all beneficial loans which the director or employee has outstanding at any time in the year of assessment concerned. It’s not possible to elect to have some dealt with by the alternative precise method and others by the normal averaging method.
Time limit for elections made by directors and employees for the alternative precise method of calculating the benefit
17.32
Section 183(2)
The time limit for making an election for the alternative method of calculation is 31 January in the next tax year but one after the relevant year of assessment. An election for 2012 to 2013 must be made by 31 January 2015 if it’s to be valid.
Interest paid is to be taken into account in calculating the chargeable benefit
17.33
Section 175(3)
When calculating the chargeable benefit from a beneficial loan for any year it’s necessary to deduct interest paid on it which satisfies the following conditions it must have:
- actually been paid
- been paid for the year of assessment
It does not have to be paid in the year of assessment to qualify.
Meaning of ‘interest’
17.34
Interest has a special technical meaning. In particular, a payment which a person makes voluntarily or agrees voluntarily to make cannot be interest. A payment cannot be interest for a year unless an obligation to pay interest existed in that year.
Recalculation of the chargeable benefit where interest is due but not paid until after the assessment has become final
17.35
Section 191
When interest, which a director or employee has to pay for a particular year, is paid after the assessment on the benefit for that year has become final, the law allows him or her to make a claim for the assessment to be recalculated to take the belated interest payment into account.
A claim to this relief can be made at any time up to the end of the general time limits that are applicable to individuals making claims for repayment of Income Tax.
‘Cash equivalent’ to be treated as interest paid
17.36
An amount equal to the cash equivalent of the benefit of any loan will be treated as paid by the director or employee as interest for that loan.
Treatment of notional interest paid
17.37
The amount treated under the beneficial loan rules as interest paid is so treated for all the purposes of ITEPA 2003 (other than those rules themselves). The notional interest is treated as accruing during the year and paid on 5 April in the year unless the director or employee ceases to be in employment to which the benefits code applies, in which case the interest is treated as paid on the last day in the year on which the employee is in such employment. (See Appendix 6).
Directors’ current or loan accounts with a close company
17.38
If the directors own all the share capital of the company and either formally or informally decide that sums withdrawn by them from the company are remuneration, or on account of remuneration, the withdrawals are not loans. PAYE should be applied at the time of each withdrawal. If the directors make withdrawals which are not remuneration or on account of remuneration, the withdrawals may put the directors in debt to the company.
If they do, charges on beneficial loans may arise unless they fall within one of the exemptions (see paragraphs 17.12 and 17.16 to 17.20). Interest paid on a debt incurred by overdrawing an account, or under similar arrangements, does not qualify for relief under the interest relief rules.
Whilst this restriction is more commonly applied to bank overdrafts, it applies equally to a director’s overdrawn current account with his or her company. It follows that no part of the interest or notional interest on an overdrawn current account will be eligible for relief irrespective of the use to which the money is put.
Joint and several loans
17.39
Section 185
If a loan is made jointly and severally to 2 or more directors or employees who are chargeable to tax for the loan, the cash equivalent of the benefit of the loan is apportioned between them in a just and reasonable way.
Optional remuneration arrangements
17.40
Section 175A
From 6 April 2017 where a taxable cheap loan is given as part of optional remuneration arrangements the amount of the benefit which is treated as earnings from the employment is the amount of any salary or cash pay foregone less any interest paid on the loan for the tax year. There’s further guidance about optional remuneration arrangements in Appendix 12.