Savings within Personal Savings Allowance not actually as free

AndrewMB

the MoneySavingsExpert website states “Basic-rate (20%) taxpayers: can earn £1,000 in savings interest per year with no tax; Higher-rate (40%) taxpayers: can earn £500 in savings interest per year with no tax”. And indeed this is the information on the HMRC website and on every other guidance website. But I’ve discovered it’s not entirely true.

In a situation where there is a capital gain charged partly at the higher rate and partly at the lower rate, the amount at the lower rate is calculated by deducting income less allowances from the basic rate threshold. It turns out that when doing this, savings income is deducted, but the Personal Savings Allowance (£500 or £1000) is ignored. The effect of this is that the total tax bill is higher than if there were no savings interest, and the amount it is higher is the savings interest multiplied by the difference between the two rates of capital gains tax.

So, even though this is collected through capital gains tax, one is in effect paying tax on savings interest as the tax bill is increased compared with what it would have been if the savings interest did not exist. In this situation I see no way that the savings interest could possibly be described as having “no tax”.

I discovered this from a tax calculation done on the HMRC self assessment website. I queried it with HMRC who assured me the calculation was correct.

I suspect that the intention when the Personal Savings Allowance was introduced was that savings below this really should be tax free, so the HMRC shouldn’t be doing what they are doing here. Alternatively, there needs to be a warning on this (and every other) guide to tax on savings interest that in these circumstances the interest isn’t actually tax free.

eskbanker

It's regularly pointed out on here that the PSA isn't an allowance in the usual sense, but a nil rate band, i.e. savings interest income is taxable income but is taxed at 0%, rather than being "tax-free" as such.

For most this is a semantic distinction of no consequence, but for some, such as those with non-savings earnings close to a threshold, it can and does matter, and likewise, your CGT calculation will be based on your actual taxable income, even if some of that is at 0%....

Dazed_and_C0nfused

AndrewMB said:

the MoneySavingsExpert website states “Basic-rate (20%) taxpayers: can earn £1,000 in savings interest per year with no tax; Higher-rate (40%) taxpayers: can earn £500 in savings interest per year with no tax”. And indeed this is the information on the HMRC website and on every other guidance website. But I’ve discovered it’s not entirely true.

In a situation where there is a capital gain charged partly at the higher rate and partly at the lower rate, the amount at the lower rate is calculated by deducting income less allowances from the basic rate threshold. It turns out that when doing this, savings income is deducted, but the Personal Savings Allowance (£500 or £1000) is ignored. The effect of this is that the total tax bill is higher than if there were no savings interest, and the amount it is higher is the savings interest multiplied by the difference between the two rates of capital gains tax.

So, even though this is collected through capital gains tax, one is in effect paying tax on savings interest as the tax bill is increased compared with what it would have been if the savings interest did not exist. In this situation I see no way that the savings interest could possibly be described as having “no tax”.

I discovered this from a tax calculation done on the HMRC self assessment website. I queried it with HMRC who assured me the calculation was correct.

I suspect that the intention when the Personal Savings Allowance was introduced was that savings below this really should be tax free, so the HMRC shouldn’t be doing what they are doing here. Alternatively, there needs to be a warning on this (and every other) guide to tax on savings interest that in these circumstances the interest isn’t actually tax free.

There are a number of situations where this type of impact is seen.  Tapered Personal Allowance and HICBC being a couple of the more common ones.

If you want genuinely tax free interest you need to opt for cash ISA's.

HMRC certainly aren't going to change anything, they simply do what the legislation says.  It is your MP who has the power here, not HMRC.

EvaKatz

Thanks AndrewMB - your post was very helpful as I was looking for some clarity on this.