In a decision that has caught the attention of many, the UK’s HM Revenue and Customs (HMRC) has announced that it will maintain the Official Rate of Interest (ORI) for director’s loans at 2.25% for the upcoming 2024/25 tax year. This decision marks the second consecutive year that the rate has remained unchanged, despite fluctuations in the broader economic landscape, specifically the base interest rate currently sitting at 5.25%.
The ORI is a critical figure used to calculate the taxable benefits on loans provided to directors under beneficial loan arrangements. Such arrangements are common among company directors who may borrow funds from their businesses for personal use. The rate’s stability is particularly notable given the contrasting movements in related financial metrics, such as the Bank of England’s base rate and the HMRC’s interest rate on late tax payments, which has been elevated to 7.75% since August 2023.
The decision to hold the ORI steady comes as a relief to many directors and employees benefiting from what are termed ‘cheap’ loans—where the interest rate charged by the company is below the ORI. This scenario is especially pertinent for loans exceeding £10,000, where a lower interest rate would typically trigger a taxable benefit. By keeping the ORI at 2.25%, directors using this financial tool will face no additional tax liability, assuming they match or exceed this interest rate in their repayment terms.
For context, the HMRC’s ORI is not always directly aligned with the Bank of England’s base rate. Historical data reveals that during periods of similar base rates in the mid-2000s, the ORI was adjusted more consistently in proportion to those base rates. For example, during the 2007/08 tax year when the base rate hovered between 5.25% and 5.75%, the ORI was adjusted to 6.25% and then to 6.1% in the subsequent year. The current decision to maintain the ORI at a comparatively low level despite a higher base rate is therefore somewhat unusual and signals a potential strategic consideration by HMRC aimed at stabilizing economic transactions amidst varying economic conditions.
From a practical standpoint, the implications for directors are significant. Opting for a director’s loan could now be more attractive than other forms of income extraction like dividends, particularly since the tax-free threshold for dividends has recently been reduced to just £500. Director’s loans are beneficial not only for their potential tax efficiencies but also for the simplicity and flexibility they offer in managing personal and business finances.
Furthermore, directors must be mindful of the conditions surrounding such loans. If a director’s loan exceeds £10,000 and is not repaid within nine months and one day of the company’s financial year-end, a hefty tax rate of 33.75% (or 32.5% for loans issued before 6 April 2022) could be levied under section 455 of the Corporation Tax Act. This tax is designed to discourage companies from providing long-term, low-interest, or interest-free loans to directors without appropriate tax penalties.
In summary, HMRC’s decision to hold the ORI steady at 2.25% presents both opportunities and challenges. Directors and their advisors need to carefully consider the financial and tax implications of director loans, ensuring compliance and optimal tax planning. The unchanged rate could represent a tactical advantage for financial management within companies, aligning directors’ personal financial goals with corporate objectives while navigating the complexities of tax legislation.
If you have any questions on how this topic affects you, get in touch on 01902 711370 or email enquiries@uklandlordtax.co.uk.