How are employee loans treated for tax and NI purposes?
An employer may offer a cheap or interest-free loan to an employee, for example to cover the purchase of a season ticket, to meet welfare expenses or in the case of financial hardship. An employee loan (which for taxable benefit purposes includes any form of credit) is given to an employee with the expectation that the amount is to be repaid in full to the employer, often via a pre-agreed deduction from the employee's net salary. Employee loans are not liable to PAYE tax, but may be taxable as a benefit under part 3, chapter 7 of the Income Tax (Earnings and Pensions) Act 2003 if they exceed a certain limit during the tax year.
An employee loan (or loans) is not treated as taxable earnings of the employee if the total balance outstanding on all the loans does not exceed £10,000 during the tax year.
If an employee loan is liable to tax because it exceeds the limit, the taxable benefit and associated employer-only class 1A national insurance contributions (NICs) liability is calculated on the basis of the difference between the interest that would have been payable had the borrower paid interest on the loan at the official rate for the tax year concerned and the amount of interest actually paid. There are two alternative ways of calculating the taxable benefit, either using an averaging method taken over the tax year (or duration of the loan, if a shorter period) or treating the loan on a daily basis.
If the employer no longer requires an employee loan to be repaid, a PAYE tax and class 1 NIC liability arises on the amount released or written off at the time this occurs, irrespective of the terms of the loan that has been released or written off, unless the release or write-off takes effect on or after the death of the employee.
A loan is treated differently from an advance of salary, which is effectively a prepayment of net salary. A salary advance is treated by HM Revenue and Customs as a payment on account of earnings, and PAYE tax and class 1 NICs must be applied on the amount advanced at the point of payment.