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Thursday, 18th April 2024 |
| The Minister for Finance rejected Opposition suggestions to reform tax law in this area. By coincidence, points being made by the Opposition were echoed by a UK Judge in a recent case. |
At present an employee who receives a loan from his employer may be liable to tax on any saving he has achieved where the employer charges no interest on the loan, or an interest rate which is one lower than one specified in the Tax Acts. In principle that may seem fair enough. If such a tax charge did not exist one might expect that employers might be pressured into granting employees interest free loans, rather than having the employees pay interest on loans from commercial sources out of after tax income.
The rate specified in the Tax Acts is currently (save for housing loans) 10%. That rate was fixed by the Finance Act 1999, and represented a reduction from the previous year's rate, of 1%. If the loan is one which would entitle the employee to mortgage interest relief if he paid interest on the loan, then the specified rate is 6% (a reduction of 1% also from that in the previous year). The effect of the legislation is that if an employee receives an interest free loan from his employer, he will be treated as having taxable income equivalent to 10% or, in the case of a housing loan, of 6% of the amount of the loan. Had he been charged an interest rate of 5% by his employer, he would be treated as having taxable income of 5% in most instances, or a taxable income of only 1%, in the case of a housing loan, based on the amount of the loan.
During the course of the debate on the Finance Act provision which reduced the specified rates by 1%, it was suggested by the Opposition that greater flexibility was required. They urged the Minister to take the power to vary the specified rates by Ministerial Order, rather than doing it at best annually and sometimes less frequently, in Finance Acts. The Minister rejected this suggestion.
The Minister's rejection of this suggestion was unfortunate in the light of comments in a recent UK case on equivalent UK legislation. There the judge expressed the view that when the UK equivalent legislation was enacted, the intention behind it was that the specified rate in the legislation would equate with a market rate of interest. The judge doubted that the rate fixed, and relatively infrequently adjusted, any longer equated with market rates of interest and felt that the legislation was not working as intended by Parliament. This was exactly the point which Opposition deputies made to the Minister in the Finance Act debates here in Ireland. It is to be hoped that the Minister, who has shown himself to have an open mind as regards suggestions put by the Opposition or others, will review this matter before the next Finance Act. Ideally, the rate would not be fixed as a specific rate, but rather would be determined by a formula which would constantly adjust itself as interest rates adjust in the market place.
The UK case highlighted another area of injustice in the legislation. There is a relief provided in the legislation to the effect that where the interest rate charged on a loan to an employee is the same rate as is charged by the employer in making loans to members of the public, then the employee will not be treated as having taxable income by reason only that the interest rate in question is less than the specified rate. It is obvious that this section was intended particularly for banks and building societies. The UK case had concerned a financial institution which had made loans to employees at an interest rate which was less than the UK specified rate. Subsequent to the granting of the loans, the rate of interest and terms of the loans was adjusted to bring it into line with that applying to loans by the financial institution to third parties generally. It was hoped that by doing this the charge to tax on the difference between that interest rate and the specified rate would be avoided. Unfortunately, this did not turn out to be the case.
The court held that the adjustment of the rates and terms of the loan subsequent to it being made did not affect the matter. Because the loan when made was at an interest rate which was less than that applying to third parties generally, and less than the specified rate in the legislation, then, the charge to tax would apply for as long as the loan lasted, and notwithstanding that the interest rate had been adjusted to bring it into line with that being charged to third parties. The judge noted that the rate being charged to third parties was less than the specified rate (it was this which gave rise to the continuing tax charge) and this led the judge to criticise the failure to keep the specified rate in line with market rates. |
Brian Thornton is a tax director in KPMG's Galway office and a member of the Council of the Institute of Taxation in Ireland.
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| Article appeared in the May 1999 issue.
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