HMRC increases beneficial loan rate to 3.75%

HMRC has increased the ‘actual official rate’ for beneficial loan arrangements from 2.25% to 3.75% from 6 April 2025, the highest rate since 2014, when interest is calculated using the ‘precise method’.

However, the rate for loans repaid using the ‘averaging method’ for 2025-26 tax year has not been confirmed, currently at only 2.25%, making these loans very favourable when compared to Bank of England base rate of 4.5% and cost of commercial loans from banks.

Where a director is also a shareholder, companies can use a loan instead of a dividend, which would be taxed at up to 39.35%, allowing the director to benefit from the low interest rate.

One of the main arrangements affected will be directors’ loans, a benefit for directors of companies which often lend themselves money from the business, often as part of their remuneration. These particular loans have to be paid back within no more than nine months after the end of the company’s accounting period, otherwise the company incurs a tax liability of 33.75% of the loan balance.

This affects loans given to directors or employees who receive a benefit as a result of their 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.

HMRC guidance stressed that ‘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’.

Under the rules in section 188(1), Income Tax (Earnings and Pensions) Act 2003 (ITEPA), the director or employee can also benefit if a loan made due to their employment is released or written off.

The director or employee is then no longer obliged to repay the amount they were lent. A tax charge will arise irrespective of the terms of the loan which has been released or written off.

The amount chargeable is 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.

It is also important to note that an alternative finance arrangement (sections 46 to 57 Finance Act 2005) such as a beneficial loan falling under Islamic finance framework, and 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 have interest charges, but they are taxed in the same way as equivalent arrangements that do give rise to interest.

There are two methods of calculating the interest: the averaging method (which is the default) and the precise method.

Having calculated the official interest by the appropriate method, subtract any interest actually paid by the employee. Any amount remaining is the cash equivalent of the loan.

To use the averaging method, take the balance of the loan at the start of the tax year (or when the loan was made if this is later), plus the balance of the loan at the end of the tax year (or immediately before it was paid off if this is sooner) then divide the total by two and multiply by the official rate of interest.

To use the precise method, calculate the interest by multiplying the maximum outstanding balance of the loan on each day by the official rate of interest and divide by the number of days in the tax year. Add together all the daily interest amounts to get the total interest for the tax year.

HMRC guidance, Beneficial loan arrangements — HMRC official rates