HMRC Crackdown on Savings Interest: What Savers Need to Know

As interest rates continue to rise in the UK, savers are facing a new challenge: ensuring they comply with HMRC’s tightened scrutiny on savings interest. With over 2 million people expected to pay tax on their savings this year, it is crucial for savers to understand the implications and take proactive steps to avoid unnecessary penalties.

Understanding the Personal Savings Allowance

The Personal Savings Allowance (PSA) is a key factor in determining whether you owe tax on your savings interest. This allowance varies based on your income tax band:

Basic-rate taxpayers can earn up to £1,000 in savings interest tax-free.

Higher-rate taxpayers can earn up to £500 in savings interest tax-free.

Those earning above £125,140 have no PSA, meaning all savings interest is taxable.

With rising interest rates, many savers are inadvertently crossing these thresholds, making them liable for tax on their savings interest. For instance, a £50,000 salary plus £1,000 in savings interest could push you into the higher-rate tax bracket, reducing your PSA to £500 and making £500 of the interest taxable at 40 percent.

HMRC’s Compliance Process

HMRC is enhancing its monitoring capabilities to ensure compliance. Here is how they are doing it:

Reporting by Banks and Financial Institutions

Banks and financial institutions are required to report interest earned on savings accounts directly to HMRC under the Common Reporting Standard (CRS) and the Automatic Exchange of Information (AEOI) agreements. This includes total interest earned, the accounts where the interest was generated, and whether the account holder has reported this interest correctly.

Cross-Checking Tax Returns

HMRC cross-references the reported interest data with your tax records. If discrepancies are found, such as interest earned but not declared, your account may be flagged for further review.

Tax Code Adjustments

For those paying tax through PAYE (Pay As You Earn), HMRC may adjust your tax code to account for additional tax owed on savings interest. This allows HMRC to collect the tax directly from your salary without requiring a self-assessment return.

Consequences of Non-Compliance

Failing to report taxable savings interest can lead to significant penalties:

Penalties start at 15 percent of the unpaid tax for careless errors and can go up to 100 percent for deliberate omissions.

You could face backdated tax bills for previous years, plus interest on the overdue amounts.

Proactive Steps for Savers

To avoid the pitfalls of HMRC’s crackdown, here are some actionable steps:

Use ISAs to Shelter Savings

Consider using Individual Savings Accounts (ISAs) to keep your savings interest tax-free. ISAs offer a tax-efficient way to save, especially for those with significant savings.

Optimise Your Savings Structure

If you have a joint account, ensure the interest earned is split in a way that maximises your combined Personal Savings Allowance. For example, if one partner earns less, it may be tax-efficient to move savings into their name.

Manage Children’s Savings

Parents should be aware that if a child earns more than £100 in interest on gifted money, the entire interest is taxed as the parent’s income. Using a Junior ISA or splitting contributions between parents can help spread the tax hit.

Choose the Right Savings Accounts

Be cautious with fixed-rate accounts, as the interest is only taxed when the money becomes accessible. This can lead to a significant tax liability in the final year. Opting for accounts that pay interest monthly or annually, or using a fixed-term ISA, can help avoid this issue.

HMRC’s New Powers and Concerns

HMRC has been granted new powers to automatically seize unpaid taxes from bank accounts, a move that has raised concerns among MPs and tax professionals. This strategy, aimed at bridging the tax deficit, has been criticised for potentially jeopardising savers and risking mistakes that could lead to wrongful confiscation of funds.

Conclusion

The rising interest rates and HMRC’s increased scrutiny on savings interest make it imperative for savers to be vigilant. By understanding the Personal Savings Allowance, ensuring compliance with HMRC’s reporting requirements, and taking proactive steps to optimise your savings structure, you can avoid unnecessary tax liabilities and penalties.

At Cutts and Co Accountancy, we are committed to helping our clients navigate the complexities of tax regulations. If you are unsure about how the new HMRC rules affect your savings, our expert advisers are here to provide guidance and ensure you are fully compliant with all tax obligations.