It’s just one of the myriad of incentives employers can offer their staff; loans to help them buy a home, or car, or carry out energy upgrades on their property.
However, although the regime – which allows employees to potentially avoid benefit-in-kind (BIK) tax on such loans – has been in existence for quite some time it hasn’t been changed since 2013, which means it is now considerably out of line with market rates. As a result, its use is negligible.
But how do the loans work and what exactly are the issues with the current regime? And should the upcoming budget look to put such loans back on the table as a real incentive employers can offer?
What is the regime?
A preferential loan is a loan from an employer to an employee on which either no interest, or a rate of interest that is lower than the specified rate, is payable. Such a loan is taxable as BIK and it means PAYE, PRSI and USC must be paid on the benefit.
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But employees can avoid this BIK charge provided they borrow from their employer at rates at, or above, those set by the Department of Finance. Thus, such loans, where available, can be an added incentive for employees.
How are they used?
For example, Trinity College Dublin offers a home loan incentive, “the purpose of which is to provide support to Trinity staff in the purchase of their first home”.
It is aimed at helping “meet the difference between the proportion of the cost usually advanced by banks/mortgage providers and the total cost involved in house purchase”.
Through the scheme, you can borrow up to €20,000, or 25 per cent of your salary, whichever is lower, and it must be repaid over 10 years. It says the rate of interest that will apply is the “specified rate of interest determined by the Department of Finance for qualifying home loans as currently allowed by Revenue guidelines”.
Does it need to be changed?
The problem now is that the rates as set by the Department of Finance are out of whack with the market.
Take the qualifying home loan rate of 4 per cent. A first-time buyer can now get a rate of 3.1 per cent, fixed over four years, with Bank of Ireland if they’re buying a new A-rated home; or 3.2 per cent with AIB, fixed over three years.
This is some way away from the department’s rate of 4 per cent.
And what about 13.5 per cent for all other loans?
Well, you could get a car loan with AIB for €10,000 over five years at a rate of 6.4 per cent, or a €15,000 home energy upgrade loan at a rate of just 3 per cent with Bank of Ireland. Again, significantly lower than the rates set by the department.
In its pre-budget submission, professional services firm PwC argues that these rates have for many years been significantly higher than prevailing commercial interest rates.
“This misalignment has resulted in benefit-in-kind charges that do not reflect economic reality, particularly in a fluctuating interest rate environment,” PwC says.
Of course, an employer can offer to lend at a lower rate, but then BIK will kick in.
So what is the point of the regime in the current market?
Pat Mahon, a partner with PwC, says the rates have always been excessive.
The last time the rates were changed was in 2013, when the home loan rate was reduced from 5 per cent to 4 per cent, while for personal loans the rate increased to 13.5 per cent from 12.5 per cent in 2012. At the time, the European Central Bank rate was just 0.25 per cent. While market rates would have been some way north of this, it does show just how divergent the Department of Finance’s rates are with the market.
The department was asked to comment on why the rates haven’t been changed since 2013, but did not respond to this query.
As a result of such a sizeable gap, the loans “effectively don’t happen any more”.
“It isn’t an incentive at all. Tax has just killed it as an option that employers could even contemplate,” Mahon says, adding that it’s the kind of thing that could push an employee on to the higher rate of tax as well, therefore increasing their effective tax rate.
While there might be exemptions, “by and large, with big employers, you wouldn’t see it”.
With respect to non-home loans, for example, he says “it would be a lot cheaper and less hassle for everyone concerned to go to the bank and get a rate of 7 per cent”.
Consider the example of a €20,000 loan. If this is offered as an incentive to an employee at a rate of zero interest, the employee will have to pay BIK at a rate of 13.5 per cent on the value of the loan, minus any interest they pay. So that’s €2,700, but as no interest is charged, the amount subject to tax is also €2,700.
As Mahon notes, the employee could pay up to 52 per cent tax on this, or €1,404, and they will still have the €20,000 loan outstanding.
And this BIK bill has to be paid on an annual basis – although it will fall in line with the decreasing loan balance.
If they had borrowed from their employer and avoided tax, they would have had to do so at a rate of 13.5 per cent for a personal loan, so interest of €7,611 over five years.
If they had opted to borrow in the market, they could have borrowed at a rate of 6.9 per cent, for a total cost of credit of €3,704 – or half what the BIK-free employer rate would have been.
If they do pay interest, then their BIK charge will be lower. Take the example of a preferential loan of €40,000 from an employer at a rate of 3 per cent, with interest paid of €1,200 in the first year. This is €400 less than that which would have applied under the specified rate of 4 per cent (€1,600). So then, the employee will have to pay tax on that €400.
As a result, PwC is calling for the regime to be changed. It says a review of the rates is needed to ensure they are “fair, proportionate and reflective of market conditions”.
“The only way of allowing this to be something that employers would consider would be to bring those rates down to something at or below market rates,” says Mahon. “I don’t see the logic of having the rates as they are at the moment.”
While use of the regime, if enhanced, might still be limited and confined to smaller amounts – as Mahon notes, employers are unlikely to want to be in the business of unsecured home loans – it could be a good offering.
