HM Revenue and Customs (HMRC) are stepping up efforts to reduce the tax gap, this time the target being interest earned on savings. They are proactively scanning bank accounts and directly contacting individuals who have possibly exceeded the various tax-free allowances and could now owe tax on the interest paid by their bank/building society.
Interest people earn from savings can lead to a tax liability if it exceeds the various allowances. It gets complicated.
Firstly, you have the regular personal tax-free allowance (currently £12,570).
Low-income individuals who have less than £5,000 earned from sources other than there savings (non-savings incomes) have the Starting Rate for Savings tax band. This allows them to earn up to £5,000 in interest on their savings totally tax-free. However, this tax band is reduced by £1 for every pound in non-savings income earned over the £5,000 limit.
On top of regular tax-free allowances and savings allowances there's also a Personal Savings Allowance (PSA). For basic rate taxpayers, this allowance stands at up to £1,000 a year, meaning that if you earn more than that amount from interest, the excess is subject to income tax at 20 percent. For those in the higher rate bracket, earning between £50,271 and £125,140, the PSA falls to £500, with any surplus taxed at 40 percent. Additional/Top rate taxpayers don't get a PSA.
Looking at the allowances above it becomes clear that the target for HMRC will be people who are likely higher rate taxpayers with a good chunk of savings earning interest not from ISAs. These people likely have used their personal allowance already against other income, are not eligible for the starting rate for savings and only have the fallback of the £500 personal savings allowance. £10,000 at a 5 percent interest rate would hit that limit in a single year.
Most savings accounts deposit the accumulated interest at the end of the term, so a scenario where a lump of money is popped in a three-year fixed deposit at a 5 percent interest rate could trigger a tax demand.
On top of proactively looking at savings accounts, HMRC has also received more powers like the Direct Recovery of Debts (DRD) power. Under this legislation, if you owe more than £1,000 in unpaid taxes, HMRC can directly grab funds from your bank account—provided that a minimum balance of £5,000 will remain after the seizure. Pretty controversial.
Bnks are required to report interest earnings to HMRC, allowing the agency to make real-time adjustments to tax codes. This means that for many employed or pensioned individuals, taxes on savings are collected automatically through the PAYE system, reducing the need for annual Self Assessment tax returns.
The people outside of this group will need to look at their savings interest, as it looks like HMRC is no longer waiting for discrepancies and has started sending letters. These letters target those who, according to the data supplied by banks, have accumulated taxable savings interest that exceeds their PSA. The letters serve as both a notification and an early warning, urging taxpayers to either reconcile their accounts or prepare for an unexpected tax bill.