Savings Accounts: deterred from compounding?

Archibaldy

Re: Non-ISA savings accounts with a fixed term of more than 1 year and paying annual interest.

There are many different accounts available that match this description, but they can be broadly grouped into a small number of categories. Two of the larger categories, arbitrarily named for my purposes, are:

CATEGORY A: Perhaps the most popular type of fixed term account available. No facility for early withdrawal, with or without penalty. The account holder can choose where interest is sent: compound [back to account] or to a separate account. Often, this setting can be changed by the account holder throughout the term of the account.
*Interest is reported and taxed annually.

CATEGORY M: Offered by some banks and BSs, and sometimes called savings bonds. No facility for early withdrawal, with or without penalty. Interest is sometimes credited to the account annually, but it is always paid only at Maturity [there is no choice].
*Interest is reported and taxed at maturity only.

Various media articles are leading some readers to believe that for those CATEGORY A accounts where the holder has chosen for interest to be paid back to the account annually [compounding], interest is taxed at maturity only, and account holders should report accordingly. ie. as if they are CATEGORY M accounts. As a result, some alarmed account holders are [unnecessarily] changing their CATEGORY A account settings to pay out annual interest to a separate account, instead of compounding; solely in order to ensure interest is taxed annually, and so make efficient use of allowances. I believe HMRC have confirmed my interpretation when asked specifically about CATEGORY A accounts: 'If you can access the interest during the term, regardless of the reason, you declare the interest each year.' and 'Limited access is still access.' It seems having the choice of interest destination is important, not the actual destination you choose. Having the choice means the interest is seemingly deemed 'accessible', which is key according to HMRC rules. One bank has also confirmed this interpretation for their CATEGORY A account, in writing. Other banks I've approached have said they don't comment on matters of taxation, and either referred me to HMRC or offered to change my account settings.

Here are two examples of recent advice, taken from guides and tips on the moneysavingexpert site:

Interest paid into the fix itself or at maturity can be a tax trap. It's the moment you can access the interest that crystallises it for tax purposes, so it all counts as interest income for that tax year (so even interest paid annually into a fix, as you can't access it, means it's counted that you got it all at maturity).

These means [sic] if you opt for a fixed-rate savings account longer than a year, and choose for interest to be paid at maturity, then all that interest is counted towards the final year's PSA. The same is true if monthly or annual interest is paid by the bank into the fixed account, so you're unable to withdraw it until the date the fix matures.

It's well-intentioned advice, but in the absence of additional explanation and qualification, and perhaps a superhuman grasp of semantics, it's not difficult to imagine how it might be misinterpreted or misapplied. Of course, the authors may have different interpretations of the rules to mine? There are similar examples on other sites and in the media.

I've tracked several threads on this subject, slogged through SAIM2400, and spoken to several organisations. I'd be grateful for any thoughts or experiences, whether you agree with my interpretation or not.


Apologies if I've inadvertently misused terminology. Monthly interest scenarios are omitted for simplicity.

Albermarle

This subject is discussed reasonably regularly on the savings and investments forum, where this post would be better relocated to.
Savings & investments — MoneySavingExpert Forum

There are different opinions, with some convinced that longer than one year fix rate accounts will be taxed at maturity unless the interest is withdrawn each year. ( and others not) 

One point often made is that probably the defining factor is when the provider reports the interest, as HMRC are unlikely to have the time to start digging into exactly what type of account it is. There is some evidence of a grey area, where providers are reporting annual interest, even when it is not totally clear that they should be doing, and some posters base their tax returns on this.