4. Calculating the Benefit: Averaging vs. Precise Method

A. Overview of Calculation Methods

HMRC permits two principal methods for calculating the taxable benefit arising from a beneficial loan: the “averaging method” and the “precise method”.3 The selection of method can influence the final BIK amount and is contingent on the specifics of the loan arrangement.

B. The “Precise Method”

The precise method requires a more detailed calculation. It involves determining the interest on the maximum outstanding loan balance on each day throughout the tax year, or for the specific period the loan was outstanding if shorter.3 The official rate of interest applicable to those specific days is used. The daily interest amounts are then aggregated to arrive at the total taxable benefit for the year.3

For the 2025-2026 tax year, the announced ORI of 3.75% will apply when using the precise method.3 This method must be used if the loan was not outstanding for the entirety of the tax year, or it can be elected by the taxpayer or employer if deemed more appropriate or beneficial.5 While generally providing a more accurate reflection of the benefit, particularly if loan balances fluctuate significantly or if multiple ORIs apply within the year due to quarterly reviews, it is administratively more demanding.

C. The “Averaging Method”

The averaging method is often the default approach, particularly if the loan was outstanding for the full tax year.3 This method calculates the average loan balance by taking the sum of the loan balance at the start of the tax year (or when the loan was initially made, if later) and the balance at the end of the tax year (or immediately before it was repaid, if sooner), and dividing this sum by two. This average balance is then multiplied by the relevant average official rate for the tax year.3

For the 2024-2025 tax year, the average official rate is 2.25%.5 However, a critical point of attention arises for the 2025-2026 tax year. As of March 2025, and reiterated in information available up to May 2025, the averaging method interest rate for 2025-2026 has not yet been officially confirmed by HMRC. Several sources indicate that it is, for the time being, still being referenced at the 2024-25 level of 2.25%.3 This creates a notable discrepancy, as the precise method rate for the same period is confirmed at 3.75%. If this averaging rate were to remain at 2.25% for 2025-26 while the precise rate is 3.75%, it could present a significant, albeit potentially temporary, tax planning consideration for loans that meet the criteria for the averaging method (i.e., outstanding for the full tax year). This uncertainty underscores the need for directors and companies to closely monitor HMRC communications for definitive guidance on the 2025-2026 averaging rate.

To use the published average official rates, the loan must have been outstanding throughout the entire Income Tax year.5

D. Choosing the Appropriate Method

The decision on which calculation method to use depends on several factors. These include the duration of the loan within the tax year, the stability of the loan balance, and any variations in the ORI that might occur, especially with the advent of quarterly reviews. The averaging method offers simplicity if its conditions are met.3 However, the precise method, despite its complexity, may be required or could prove more advantageous if loan balances fluctuate significantly or if multiple ORIs apply during the year. The introduction of quarterly ORI reviews from April 2025 might make the precise method a more accurate reflection of the benefit over a year if the loan balance changes or if the loan is taken out or repaid mid-quarter. While the averaging method is simpler, its utility could be affected in a volatile ORI environment if the single published “average rate” does not adequately capture multiple “actual rates” that may have been in force during the year.

5. Key Considerations for Directors and Companies

A. The £10,000 Exemption Threshold

A crucial provision within the beneficial loan rules is the de minimis exemption for small loans. If the total outstanding balance on all beneficial loans provided by a company to a director or employee does not exceed £10,000 at any point throughout the tax year, no taxable benefit is considered to arise from these loans.1 Consequently, no Income Tax is due from the director, and no Class 1A NICs are payable by the company in respect of this specific benefit.1

HMRC guidance (EIM26140) clarifies that this £10,000 limit applies to the aggregate balance of all beneficial loans to that individual and must be considered on a day-to-day basis.10 While the threshold itself has not changed, the financial implications of exceeding it will become more pronounced from April 2025 due to the higher ORI. The taxable benefit on a loan just marginally over £10,000 will be substantially greater under the 3.75% ORI compared to the previous 2.25% rate. This intensifies the strategic importance for both directors and companies to structure loan arrangements, where feasible and commercially appropriate, to remain below this £10,000 aggregate limit if the primary objective is to avoid BIK charges.4 Even for loans falling under this threshold, maintaining accurate and contemporaneous records of all loans and repayments is a matter of good practice.4

B. Tax Implications for Directors

Should a director receive a loan (or loans) from their company with a total outstanding balance exceeding £10,000, and this loan is provided interest-free or at an interest rate below the prevailing ORI, the director will be liable for Income Tax on the calculated BIK.1 This BIK amount is typically reported to HMRC via the director’s Self Assessment tax return, unless the tax is collected through the PAYE system by an adjustment to their tax code.

C. Tax Implications for Companies

Companies providing beneficial loans to directors also face specific tax obligations and reporting requirements.

• Class 1A National Insurance: The company is liable for Class 1A NICs on the full value of the BIK calculated for the director’s beneficial loan.1 A significant development from 6 April 2025 is the compounding effect of two separate changes: firstly, the BIK value itself will increase due to the higher ORI of 3.75%; secondly, this larger BIK amount will then be subject to an increased Class 1A NIC rate. One source indicates this rate is set to rise from 13.8% to 15% from 6 April 2025.1 This combination will substantially escalate the cost to the company of providing such loans, potentially making them a less attractive form of remuneration or financial support.

• Section 455 Tax (Loans to Participators in Close Companies): For “close companies” (typically smaller, owner-managed businesses), an additional tax consideration arises under Section 455 of the Corporation Tax Act 2010. If a close company makes a loan to a “participator” (which includes directors who are also shareholders) and this loan remains outstanding more than nine months after the end of the company’s accounting period in which it was made, the company must pay Section 455 tax to HMRC.1 The current rate for this tax is 33.75% of the outstanding loan balance 1, a rate that mirrors the higher rate of dividend tax. This tax is essentially a temporary levy; it is refundable to the company once the loan is repaid, credited, or written off. It is important to note that the increase in the ORI does not directly alter the Section 455 tax rate itself.1 However, the overall increased tax cost associated with beneficial loans (due to higher ORI leading to higher BIK and Class 1A NICs) might indirectly influence company policy. Companies may become more stringent in ensuring S455 loans are repaid within the stipulated nine-month window to avoid tying up cash in the S455 charge, especially when the loan is already generating a higher ongoing BIK cost.

• Reporting Obligations (P11D): Employers are required to report details of beneficial loans (i.e., those where a taxable benefit arises, typically because they exceed the £10,000 threshold and are below ORI) to HMRC. This is done annually on form P11D, which details benefits and expenses provided to directors and employees. The deadline for submitting form P11D is 6 July following the end of the tax year.4

6. Concluding Remarks and Strategic Outlook

A. Summary of Key Changes

The landscape for director loans in UK companies is undergoing a significant transformation. The headline change is the substantial increase in HMRC’s Official Rate of Interest from 2.25% to 3.75%, effective from 6 April 2025.2. Accompanying this is a new policy allowing for potential quarterly reviews and adjustments to the ORI, introducing an element of dynamism not previously seen.2 A notable point of current uncertainty is the official rate for the averaging method of BIK calculation for the 2025-2026 tax year, which, as of early 2025, had not been confirmed to align with the new 3.75% precise method rate.3

B. Strategic Implications for Directors and Companies

These changes necessitate a proactive response from both companies and their directors. Existing loan arrangements should be urgently reviewed to assess the impact of the higher ORI on potential BIKs and associated tax liabilities. Companies must factor the increased Class 1A NIC costs into their financial planning and budgeting processes, particularly given the concurrent rise in the ORI and the Class 1A NIC rate itself.1 Internal policies governing the provision of loans to directors may require updating to reflect the new regulatory environment and manage the increased costs. Crucially, diligent monitoring of HMRC announcements will be essential to ascertain the confirmed averaging method rate for 2025-2026 and to stay abreast of any subsequent quarterly ORI changes. The combination of a higher ORI, potential quarterly variability, and the current ambiguity surrounding the averaging rate for 2025-26 moves the management of director loans from a routine compliance task to an area requiring active financial planning and risk assessment.

C. Long-Term Trends

The recent adjustments suggest a potential long-term trend where HMRC seeks to maintain the ORI in closer alignment with prevailing market interest rates. If the ORI remains relatively high and subject to more frequent fluctuations, the attractiveness of beneficial loans as a consistently low-cost method of director remuneration or financing may diminish. This could prompt companies and directors to re-evaluate their overall remuneration and profit extraction strategies. The increased cost and complexity might lead to a shift towards other forms of reward or funding, depending on their comparative tax efficiency in light of the new ORI regime. Decisions regarding new loans, repayment schedules for existing ones, or the interest rates to be charged will now carry greater financial weight, making informed, proactive decision-making and professional advice more critical than ever.

Works cited

1. HMRC’s Official Rate of Interest rises to 3.75%: what this means for you – StarBox, accessed May 9, 2025, https://starbox.co.uk/hmrcs-official-rate-of-interest-rises-to-3-75-what-this-means-for-you/
2. HMRC to increase the official rate of interest from 6 April 2025 – Macfarlanes, accessed May 9, 2025, https://www.macfarlanes.com/what-we-think/102eli5/hmrc-to-increase-the-official-rate-of-interest-from-6-april-2025-102k608/
3. HMRC increases beneficial loan rate to 3.75% – SPA, accessed May 9, 2025, https://spa.org.uk/hmrc-increases-beneficial-loan-rate-to-3-75/
4. Beneficial Loan Arrangements | A Comprehensive Guide – Pro Tax Accountant, accessed May 9, 2025, https://www.protaxaccountant.co.uk/post/beneficial-loan-arrangements
5. Beneficial loan arrangements — HMRC official rates – GOV.UK, accessed May 9, 2025, https://www.gov.uk/government/publications/rates-and-allowances-beneficial-loan-arrangements-hmrc-official-rates/beneficial-loan-arrangements-hmrc-official-rates
6. www.legislation.gov.uk, accessed May 9, 2025, https://www.legislation.gov.uk/uksi/2025/270/pdfs/uksiem_20250270_en_001.pdf
7. HMRC increases beneficial loan rate to 3.75% | Business …, accessed May 9, 2025, https://www.accountancydaily.co/hmrc-increases-beneficial-loan-rate-375
8. HMRC official rate of interest to increase to 3.75% from 6 April 2025 | Herbert Smith Freehills, accessed May 9, 2025, https://www.herbertsmithfreehills.com/notes/remuneration-and-incentives/2025-posts/hmrc-official-rate-of-interest-to-increase-to-3.75–from-6-April-2025.
9. The tax traps of director’s loans – How to avoid unnecessary charges – Seymour Taylor, accessed May 9, 2025, https://stca.co.uk/blog-news/the-tax-traps-of-directors-loans-how-to-avoid-unnecessary-charges/
10. EIM26140 – The benefits code: beneficial loans: exemptions from charge: small loans – HMRC internal manual – GOV.UK, accessed May 9, 2025, https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim26140