Why interest on director loans matters
When a limited company lends money to one of its directors, it does not legally have to charge interest. However, HMRC sets a statutory benchmark known as the 'official rate of interest'. If the company charges no interest, or charges interest below this benchmark on loans exceeding 10,000 pounds, the difference is taxed as employment income under Section 175 of ITEPA 2003.
By charging and collecting interest at or above the official rate, the company eliminates the Benefit in Kind entirely, meaning the director incurs zero personal income tax and the business avoids Class 1A National Insurance.
HMRC's Official Rate of Interest
HMRC's official rate of interest is currently 3.75% per annum (effective from 6 April 2023). This rate is reviewed periodically by the Treasury to reflect prevailing market borrowing rates.
The official rate represents the minimum commercial interest rate a company must charge a director to avoid creating a taxable perk. If you borrow 25,000 pounds for a full year, benchmark interest at 3.75% equals 937.50 pounds.
How the interest shortfall is taxed
The taxable Benefit in Kind is simply the 'interest shortfall' - the difference between benchmark interest at 3.75% and the actual interest paid by the director to the company. If you pay 2% interest on a 25,000 pound loan, you pay 500.00 pounds to the company, leaving an interest shortfall of 437.50 pounds.
The director pays personal income tax on this 437.50 pound shortfall at their marginal tax rate (20%, 40%, or 45%), and the company pays 13.8% Class 1A National Insurance on the same figure.
Company tax treatment of interest received
Any interest paid by the director to the company represents taxable trading or non-trading loan relationship income for the business. The company must declare this interest income on its CT600 return, where it is subject to standard UK Corporation Tax (between 19% and 25%).
Even though the company pays Corporation Tax on the interest received, charging interest is often more tax-efficient than paying higher rate personal income tax (40%) and Class 1A NIC (13.8%) on the BIK.
Worked example: 0% vs 2% vs 3.75% interest
Consider a higher rate (40%) director borrowing 25,000 pounds for a full 12-month tax year:
1. At 0% interest: Benchmark interest is 937.50 pounds. The director pays 375.00 pounds in personal tax, and the company pays 129.38 pounds in Class 1A NIC. Combined tax is 504.38 pounds.
2. At 2.0% interest: Director pays 500.00 pounds interest to the company. Shortfall is 437.50 pounds. Director pays 175.00 pounds tax, and company pays 60.38 pounds NIC.
3. At 3.75% interest: Director pays 937.50 pounds interest to the company. Shortfall is zero. Director pays 0.00 pounds tax, company pays 0.00 pounds NIC, and no P11D reporting is required.
Inputs for the director's loan interest calculator
Director's loan amount
The total overdrawn principal balance borrowed from the company.
Interest rate charged by company
The annual interest rate the director actually pays to the company (enter 0% if interest-free).
Borrower's income tax rate
The director's marginal personal tax rate (20% basic, 40% higher, or 45% additional rate).
Tax year
The UK tax year, defining HMRC's official interest rate and statutory rates.
Months loan was held in tax year
The number of months the loan was outstanding during the tax year, used to pro-rate interest.
CALCULATOR QUESTIONS
Directors loan interest calculator questions
What is the official rate of interest for director loans?
HMRC's official rate of interest is currently 3.75% per year (effective since 6 April 2023). It is the benchmark rate used to calculate interest shortfalls on director loans.
When must the director pay the interest to the company?
Under HMRC rules, the interest must actually be paid to the company before 6 July following the end of the relevant tax year. Accruing interest in the company books without actual payment does not satisfy the requirement.
Does my company pay tax on the interest I pay it?
Yes. Interest received by the company from a director is treated as taxable income under the UK loan relationship rules and is subject to Corporation Tax at between 19% and 25%.
Can the company charge interest above the official rate?
Yes, a company can charge any commercially reasonable rate. As long as the rate equals or exceeds HMRC's official rate (3.75%), no Benefit in Kind arises.
Does charging interest stop Section 455 tax?
No. Charging interest only eliminates the Benefit in Kind and personal tax. If the principal loan itself is not repaid within 9 months and 1 day of the company year-end, Section 455 Corporation Tax at 33.75% remains payable.
Is interest charged on loans below 10,000 pounds?
Loans of 10,000 pounds or less are exempt from Benefit in Kind rules under Section 180 ITEPA 2003, so no interest needs to be charged to avoid personal tax.