Officially interesting: a drop in the official interest rate of HMRC
Regulations were recently introduced to reduce HMRC’s “official interest rate” (ORI) from 2.5% to an all-time high of 2.25% as of April 6, 2020. A photo of a curious cat could be a better click bait than a headline. on interest rates, but stick with us: there is more to do here than you might initially think.
ORI was introduced to calculate the notional benefit conferred by “employment-related loans”. An “employment-related loan” is essentially a loan made to an individual by an employer or a related entity. When the interest rate payable on such a loan is lower than the ORI, the difference is treated as a benefit for the employee, subject to income tax. But the ORI is now used in various other parts of the UK tax code, particularly in relation to non-UK resident trusts.
In April 2017, the taxation of non-resident trusts in the United Kingdom was radically overhauled, in connection with the extension of the concept of “deemed domicile”. As a result of these changes, overseas residents who have established non-resident trusts and have since become deemed domiciled in the UK must be careful not to ‘taint’ those trusts, in order to avoid tax consequences. potentially catastrophic.
Loans made between a trust and its settlor (or another trust of which the settlor is a beneficiary or settlor) can result in “contamination” unless interest is charged and paid on the loan to ORI. As a result, many loan agreements have been put in place with interest rates following the ORI. As the interest owed on the loan must indeed be paid annually to avoid taint, it is important that the parties to such loan agreements are informed of the development of the rate and ensure that the correct amount of interest is paid. It is debatable whether an inadvertent interest overpayment under such a loan agreement, due to lack of awareness of a change in ORI, would necessarily result in a stain, but it is clearly better to avoid the risk.
Statutory rules regarding the valuation of the benefits of non-resident trusts were also introduced in April 2017. Under these rules, the ORI determines the value of the benefits conferred by interest-free or low-interest loans and by updating disposal of movable property such as works of art. The reduction in ORI means that the presumed value of these benefits will decrease accordingly in 2020/21. As a result, the tax payable by the beneficiaries on these benefits will decrease and, when a taxable benefit is avoided by the beneficiary by paying an appropriate interest rate on the loan / appropriate license fee for the use of movable property , the amount of interest or license fees payable will decrease. Again, loan agreements and license agreements may have been put in place reflecting these rules and will need to be checked to ensure that any reduction in interest or license fees payable is met.
The changes to the ORI are supposed to reflect the evolution of commercial interest rates – the ORI has fallen from 6.25% in 2007/08 to 2.5% currently, a decrease which is very much correlated with a reduction the base rate of the Bank of England from 5.75% to 0.25% over the same period. But the ORI clearly hasn’t come down as low as the BoE’s base rate, so the relationship between the two looks pretty loose. Based on this, and given the bureaucracy generated by any change to the ORI, reducing the rate of a single mustache just doesn’t sound appealing.