Personal savings allowance - interesting times

Personal savings allowance - interesting times

From 6 April 2016 the new personal savings allowance (PSA) will be introduced and the payment of tax on the interest from bank and building society accounts under the tax deduction scheme for interest (TDSI) will cease. Going forward, interest payments which had been paid net of the basic rate of tax will now be paid gross, that is, with no tax deduction.

That said, savings income such as interest will remain taxable (unless within an Isa or Sipp). However, basic-rate taxpayers will be able to receive £1,000 in savings income-tax-free on top of the personal allowance (which is £11,000 for 2016/17). Higher-rate taxpayers will be able to receive up to £500; additional-rate taxpayers will not qualify. Any tax due on savings income paid gross has to be met directly with HMRC via self-assessment.

The headlines from the announcement of the introduction of the PSA in the March Budget 2015 included that 95 per cent of taxpayers will no longer pay any tax on savings interest, rendering the TDSI and the R85 form redundant.

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However, interest payable on cash is not the only income which will fall within the definition of savings income and the new PSA. And of course this change should not be confused with the changes to dividend taxation and the introduction of the dividend allowance.

Savings income

Savings income is defined under section 18 of the Income Tax Act 2007 (ITA) and includes interest from all of the following:

• Credit union accounts

• Certain National Savings and Investments products, including the “pensioner bond”, the 65+ growth bond

• Interest distributions from authorised unit trusts, Oeics and investment trusts

• Income from gilts and corporate bonds

• The interest element of purchased life annuity payments

• Income which is equivalent to interest, for example the profit on government or company bonds which are issued at a discount or repayable at a premium

• Income from certain alternative finance arrangements such as peer-to-peer (P2P) investments (see below).

• Gains from certain types of life insurance contract.

Savings income paid to an individual is usually taxable, however, section 12 of the Income Tax Act applies a savings rate of tax (currently 0 per cent) in certain cases. This is known as the starting rate for savings and is applied to the first £5,000 of otherwise taxable savings income.

This starting rate for savings does not apply if total taxable income after allowances is greater than £5,000. The 0 per cent rate is applied after any personal savings allowance and personal allowance. In combination, the personal savings allowance, starting rate for savings and standard personal allowance can provide tax-free income of up to £17,000 (2016/17).

So will it be all change? Not quite. Savings income under TDSI will change from net paying (for the majority) to gross paying with no tax deduction. However, there is no compulsion for other income sources to change. The likelihood is that savings income will continue to be paid in the same way it currently is, for the short term at least. For example, corporate bond funds paying net will continue to do so, for now.

As an aside, industry representations to HMRC hope this position will change but at the time of writing, no decision has yet been made.