Taxpayers relying on HMRC to sort out the tax due on interest are given a warning.
As had often been noted over the last few years, one of the strategies adopted by successive governments to increase tax revenue is the freezing of tax allowances and bands. As inflation increases income, the net result is generally to:
- bring more people into the tax system; and
- make existing taxpayers pay more tax, both in absolute terms and as a proportion of their income.
One frozen allowance causing growing problems is the personal savings allowance (PSA), unchanged since its introduction in 2016:
- For basic rate taxpayers, the PSA is £1,000 per tax year, which means they have no tax to pay on their first £1,000 of interest income.
- For higher rate taxpayers, their tax-free interest under the PSA is £500.
- Additional rate taxpayers do not qualify for a PSA.
Until 2022, a sub-1% Bank of England Bank Rate meant that the PSA covered interest on a substantial five-figure deposit, meaning most savers had no tax to pay on their interest earnings. However, the effects of rising inflation dramatically changed the picture with higher interest rates. In the 2023/24 tax year, Bank Rate averaged about 5%. Consequently, savers earned much more interest to set against their frozen PSA.
HMRC is now struggling to collect all the income tax due on interest for 2023/24. To prevent a flood of tax returns, HMRC has previously told taxpayers that it would use the personal interest information sent directly by banks and building societies to calculate tax due on interest, and then issue a Simple Assessment or adjust their tax code. However, the volume of computations needed for 2023/24 was so great that HMRC did not complete the task of issuing assessments until March 2025. This was over a month after the normal online filing deadline for 2023/24 tax returns.
To make matters worse, HMRC was unable to match about one in five of the 130 million account reports it received to taxpayer records. HMRC is now reminding savers that the taxpayer is ultimately responsible for paying tax on interest received and that they should do so urgently if they have not heard from HMRC.
A similar problem seems certain to occur for the tax year just ended, but do not expect Rachel Reeves to increase the PSA in response. The current focus on potentially placing restrictions on cash ISAs could end up making things worse.
Tax treatment varies according to individual circumstances and is subject to change.
The Financial Conduct Authority does not regulate tax advice.
Content correct at time of writing.