A benefit arises if the employer lends money to their employees and charges interest at less than the official interest rate.
There are two main methods of calculation. Employers would normally use the averaging method unless requested by HMRC to use the alternative precise method.
Calculate the average official rate of interest for the period covered in step 1. If the rate changed during the period of the loan:
Multiply the average loan (step 1) by the average official rate of interest (step 2) and multiply by the number of whole months (a tax month runs from 6th day of one month to the 5th day of the following month) for which the loan was outstanding in the year, then divide the result by twelve.
The normal averaging method works well for steadily decreasing loans over a period of time. However if there is a fluctuating loan (e.g. a director’s loan accounts where the loan balance can increase sharply part way through the year and is brought back down before the end of the year), HMRC or the employer can elect for the alternative precise method of calculation. In this circumstance the actual balance on each day is multiplied by the official interest rate in force on that day. This is the reason why you have to report the maximum balance of each loan on the P11D form.
If the combined balance of all loans made available to an employee does not exceed £10,000 (£5,000 for 2013/14 and earlier tax years), there is no need to report a benefit.