HMRC starts the new tax year in a generous mood

It was only last week that we were speculating whether there was an ominous reason behind HMRC’s silence on the ‘official rate of interest’ (ORI), given it is usually announced weeks before the start of the tax year. As a result, RSM contacted the HMRC press office which mentioned it expected the ORI for the 2024/25 tax year to be published on 6 April 2024. 

That date was perhaps a surprising one to make the announcement given it was after the new tax year had begun but also because it fell on a Saturday, an uncommon day for HMRC announcements. 

Nevertheless, HMRC kept to its word and confirmed the ORI for the current 2024/25 tax year. There was, however, a surprise in store and many taxpayers might have expected a substantial increase in the ORI given the rise in the Bank of England (BoE) base rate in recent years. Instead, the ORI has remained at the eye-catchingly low rate of 2.25%.

Directors and employees with ‘cheap’ loans, where generally the interest rate charged by the employer on the loan is either nil or below the ORI, can now breathe easy for at least another tax year. This is because where a loan, in excess of £10,000, is provided by a company to an employee or director, a taxable benefit arises if the interest rate charged is less than the ORI. 

For example, if the director paid interest at a rate of 2.25% for the 2023/24 tax year on a £100,000 loan, no benefit or associated tax liability would ordinarily have arisen for that tax year. Where the loan is provided interest-free they would have a taxable benefit calculated as an annual tax charge on 2.25% of the loan for the 2023/24 tax year.  

For an additional rate taxpayer in England, Wales and Northern Ireland, that works out as an effective income tax rate of 1.0125% on the loan, or £1,012 income tax bill for the 2024/25 tax year on a £100,000 loan. For a top rate taxpayer in Scotland, it is a slightly higher rate of 1.08%, or a £1,080 income tax bill for the 2024/25 tax year on a £100,000 loan.

The BoE’s base rate is currently 5.25%, so those with outstanding beneficial loans may have been worried about a potential hike in HMRC’s official rate of interest from 6 April to match the base rate. As it turns out, they appear to have had nothing to worry about. It remains unclear why the ORI has not been increased in line with the BoE base rate and the boat may have been missed on two occasions in terms of increasing tax receipts. The Treasury could have either benefitted from larger tax receipts on benefits in kind with a higher ORI or potentially tax of up to 39.35% on dividends used to repay those loans. 

The ORI looks particularly peculiar when compared to what has happened in the past when the BoE base rate has been at a similar level. For example, when the BoE base rate fluctuated between a rate of 5.25% and 5.75% in the 2007/08 tax year, the ORI was set at a level of 6.25% in the same year and 6.1% in the subsequent tax year. We have asked HMRC to confirm the basis on which the ORI has been set at 2.25% and await their response. It may be that it is based on a historical average or using forecasts of future interest rates. 

Either way we end up with a slightly odd situation where the tax system could be seen as effectively incentivising employees and directors to take larger loans from their employers to then invest personally or replace third-party debt. Anyone thinking of exploring such a strategy should proceed with care and seek independent advice before doing so, but the current differential between the ORI and the BoE base rate could distort some taxpayers’ decision making. The contrast is perhaps best highlighted with the coupon being offered on government bonds. On one hand, the ORI has been set for the current tax year at 2.25%, on the other a UK Treasury Gilt, with a redemption date of 7 March 2027, was issued on 11 January 2024 with a coupon of 3.75%. It seems Easter has got mixed up with Christmas this year with HMRC in a surprisingly generous mood.