Director's Loan interest to stay at 2.25%

This decision is quite surprising, especially considering that when the Bank of England’s interest rates were similar to the current rates in the mid-2000s, the HMRC’s ORI was adjustable in accordance with the base rates.

Given that the HMRC’s interest rate for overdue tax payments has been set at 7.75% since August 2023, the choice to keep the ORI steady is even more unexpected.

The reasons behind not aligning the ORI with the BoE base rate remain a mystery, and it appears that opportunities to increase tax revenues may have been overlooked twice.

The Treasury might have gained from increased tax revenues on benefits in kind with a raised ORI or possibly up to 39.35% tax on dividends used to clear those loans.

The current ORI is notably unusual when compared to historical instances when the BoE base rate was at a comparable level. For instance, during the 2007/08 tax year when the BoE base rate varied between 5.25% and 5.75%, the ORI was established at 6.25% for that year and 6.1% for the following year.

Therefore, directors are positioned to take advantage of a particularly favourable tax scenario if they choose director’s loans over dividends, especially since the tax-free allowance for dividends has been reduced to £500.

A director’s loan occurs when a company director (or their close family members) receives a loan from their company that isn’t classified as a salary, dividend, or expense reimbursement, or money that was previously invested or loaned to the company.

For loans under £10,000, as long as the interest rate charged by the employer is not below the ORI, there is no extra tax obligation.

Directors and employees with ‘inexpensive’ loans, typically where the interest rate charged by the employer is zero or less than the ORI, can now rest assured for at least one more tax year.

This is because when a loan exceeding £10,000 is given by a company to an employee or director, a taxable benefit is incurred if the interest rate is lower than the ORI.

For instance, if a director paid interest at a rate of 2.25% for the 2023/24 tax year on a loan of £100,000, there would typically be no benefit or related tax liability for that year. If the loan is provided without interest, the taxable benefit would be calculated as an annual tax charge on 2.25% of the loan amount for the 2023/24 tax year.

If the director’s loan is not settled within nine months and one day after the corporation tax accounting period ends, HMRC imposes an additional tax on the loan at a rate of 33.75%, or 32.5% if the loan was issued before 6 April 2022. This additional corporation tax is referred to as section 455 tax.

For director’s loans exceeding £10,000 in value, companies must classify them as a benefit in kind, and they must be declared on self-assessment tax returns; tax may be due on the loan at the ORI.