At a glance: Who is affected?
- Any individual receiving interest of more than £1,000 who does not already complete a tax return.
- Any Interest in Possession (IIP) trust receiving any amount of investment income.
Following the 2015 summer budget, the changes in the taxation of dividends grabbed all the headlines, casting the equally unexpected changes in the taxation of interest into the shade. However, the introduction of the personal savings allowance (PSA) is one of the biggest changes to the way that interest is taxed to have happened in many years.
On a practical level, these changes are arguably more likely to affect people than the changes to dividends (but please take a look at our separate guidance note on dividends), as on the whole, more “ordinary” people receive interest each year than dividends. Admittedly, in comparison, the reliefs that taxpayers are now being offered may not have much of an impact on tax (most people will save a little bit), but from an administrative point of view, the changes really could cause some unexpected problems.
So what happened?
From 6 April 2016, the Chancellor introduced the PSA, which is available to most individuals – anyone who earns more than £150,000 will not be able to claim it, but everyone else who has interest income is likely to benefit from a small tax saving each year.
Anyone who has income that does not exceed the basic rate – currently £43,000 (including interest), will now be able to earn interest each tax year of up to £1,000 per annum before paying any tax on their interest. Everyone else who earns less than £150,000 can earn up to £500 interest tax free.
What’s the problem?
In the past, most interest payers (banks, building societies, companies) deducted 20% basic rate tax at source, and paid interest over to you “net”. For basic rate taxpayers this meant that there was no need to worry about paying any further tax on any amount of interest earned as it was all dealt with by the bank who then paid HMRC directly. Higher rate taxpayers would still need to pay the difference between the basic and higher rate of tax, but individuals in this situation were probably already completing a self assessment tax return, or had enough other earnings to ask for an estimate of the tax to be included in their PAYE code. Non-taxpayers who did not need to pay even the basic rate of tax could complete a form asking the bank to pay the interest gross instead – Simple!
As a result of the changes in the budget, the banks (in their wisdom) have decided that from April 2016, all interest will be paid over gross – that is, with no tax deducted at source.
For all those earning less interest than the permitted £1,000 (or £500), that is fine as there is no tax to pay, so no problem.
For individuals who already prepare a self assessment tax return, again no problem – if there is tax due, it will be collected that way – albeit that the January tax bill may seem a little higher than usual.
The problem comes for anyone who exceeds the PSA (£500 or £1000) and does not already complete a tax return– i.e. many “ordinary” basic rate taxpayers whose main source of income is from interest producing investments. Interest in Possession (IIP) trusts will also be affected by the changes.
Anyone in this position must now consider whether they are going to need to register for self assessment from 2016/17. In many cases, the answer is going to be “yes”.
The main group of people this is likely to affect is those individuals who have either a modest pension or salary, and receive income from interest bearing investments that will exceed the £500 or £1,000 PSA limit.
In some cases HMRC will agree to collect the tax via PAYE, but this will only happen where there is sufficient salary or pension income to allow for the expected tax on the interest to be mopped up. It is also going to mean that HMRC will need to guess how much tax is going to be due, and adjust it year-on-year, leading to unpredictable tax codes and potentially under or over paid tax.
For many people, inclusion in the PAYE code will simply not work and therefore inevitably, it will mean completing a tax return each year in order to report the amount of interest earned, and pay over any tax.
This is likely to bring many more people into the self assessment regime than before.
Are there any exceptions?
The good news is that there are some exceptions.
Total income less than £11,000
Most individuals (at least those whose total income is less than £100,000) still have access to the personal allowance (PA), currently £11,000 per annum. So, for all those whose total income (including interest over the PSA) is less than £11,000, there will be no tax to pay, irrespective of how much of the income is made up of interest.
Total income of more than £11,000, but “non savings” income below £16,000
For anyone who has relatively modest non-saving income (salary, pension, rental income), there is potentially up to a further £5,000 of interest that can be earned, tax free. This needs to be looked at on a case by case basis as it will depend on the make up of your total income, however some people will be entitled to the starting rate for interest (SRI) tax rate of 0%.
By combining the PA, SRI and PSA, it is possible to pay no tax on up to the first £17,000 of non-saving and saving income, but only if you have the right kind of income.
We therefore strongly advise everyone who does not already complete a tax return and who receives more than £500 per annum interest income to take professional advice as to whether you are now required to complete a self assessment tax return, even if you think that you might be covered by one of the exceptions.
Opportunities for owner managed companies
The availability of these reliefs does provide opportunities to save tax for those who can control the type of income they receive, for example, owner managed company shareholders have the opportunity to plan how they draw their income from the company in order to maximise the use of the reliefs and minimise their tax. By ensuring that the right combination of salary, dividends and now interest is drawn, some individuals may be able to draw up to £23,000 from their company without incurring income tax or National Insurance costs.
Each case is different, but if you would like further advice on how this can work, please call a member of the CBW tax team to discuss how this could work for you.
Interest in Possession (IIP) Trusts
IIP trusts are chargeable to income tax at the prevailing basic rate of income tax – currently 20% – no matter what their total income is. In effect, the income is eventually taxed on the person or persons who hold the IIP at their prevailing rate of tax when included on their own tax return.
In the past, where the trust received bank interest, basic rate income tax had already been withheld by the bank, and the IIP trust had no further tax liability to consider. The same worked for dividends, which were paid with a basic rate tax credit. Often, neither the trust or the beneficiary (if they were a basic rate tax payer) would need to file a tax return as all tax had been dealt with at source.
As for individuals, the rules have changed and the banks are no longer paying interest net of tax, and dividends no longer have a tax credit applied. Therefore, these kind of trusts will no longer have the option not to prepare a tax return each year, as tax will now be payable under self assessment, even though this will still only be at the basic rate.
This means that from 2016/17, all IIPs will be required to complete a full self assessment tax return and pay tax, if they have any income at all.