Manage your DLA to counter HMRC’s interest rate rise

Interest-free or cheap rate loans

You’re probably aware that if your director’s loan account (DLA) is in the red by more than £10,000 at any time during a tax year it can count as a taxable benefit in kind. The amount on which you’ll pay tax and your company Class 1A NI depends on two factors: HMRC’s official interest rate and how much interest, if any, you pay on what you owe.

Example. Naomi is the majority shareholder and director of Acom Ltd. Her DLA is usually in the red by less than £10,000. However, on 10 April 2023 she borrows an additional £30,000 separate from her DLA. She pays no interest on either loan. The taxable benefit is calculated by applying the official interest rate to the average balance of each loan. This average is the amount she owes on 6 April 2023 (or the start of the loan if later) and the amount she owes at midnight on 5 April 2024. Assuming the average balances for her DLA and other loan are £6,000 and £25,000 respectively, the taxable benefit at the current interest rate (2%) would be £120 plus £500 (actually, slightly less as the loan was not for the whole of 2023/24).

If the interest rate rises in April 2023 to, say, 4.5%, which seems likely, the total taxable benefit would more than double to just less than £1,390.

Acom can elect to treat the loans as a single debt and calculate the benefit on the aggregate balance at the start and end of the tax year. This could save Naomi tax and Acom NI.

Example - with loan aggregation. In our previous example, Naomi’s DLA was in the red by £8,000 at 6 April 2023 and £4,000 at 5 April 2024, giving an average of £6,000. The balances of her other loan were zero on 6 April 2023, £30,000 on 10 April and £20,000 on 5 April 2024, giving an average of £25,000. By aggregating the loans it’s only the combined balance on 6 April 2023 and 5 April 2024 that counts; that’s £16,000 (£8,000 + £24,000)/2). If the official interest rate is 4.5%, the taxable benefit would be £720. That’s about £670 less than if the loans were not aggregated.

Further savings possible

As our second example shows, the taxable benefit can be reduced by lowering the opening or closing balances of the debt. Naomi could achieve a reduction by bringing forward salary or a dividend. For example, instead of Acom paying her a dividend of, say, £10,000 the end of June 2024, it credits it against her loan on or before 5 April. That would reduce the average balance on the loan by £5,000 and in turn cut the tax benefit by £225. So, by aggregating the loans and accelerating a dividend the taxable benefit can be reduced by almost £900 (£670 + £225).

A word of caution

HMRC can elect to use an alternative method of calculating the benefit which would negate some or all of the tax savings. However, the onus is on HMRC to know when the alternative method might work to its advantage. In practice that’s a rare event.