When do savers need to file a tax return?

I was listening to the latest This is Money podcast tonight and it sparked a thought (and a slight panic) about the tax I owe on some of my non-Isa savings for the fiscal year ending April 2023.

What should I do if I know I am liable? Reading online I understand that banks and building societies are now digitally connected to HMRC, and so HMRC will automatically calculate the tax due and adjust my tax code.

However, others suggest that I should fill out a tax return.

I’m an ex-accountant (I left the industry over a decade ago) and I’m aware that the world has moved on, as has the tax-free savings deduction.

Do I have to go through the pain of a tax return, or does HMRC have all the information it needs to calculate my tax liability on my savings via the digital link with my savings providers? Via email

Ed Magnus of This is Money replies: This is an excellent question. I wonder if HMRC’s own rules might need to be changed, and how on earth the UK tax authorities go to the police to see who is and who is not following the rules.

More than six million savers are expected to face tax bills on their interest for the first time in seven years – and many could be forced to pay hundreds of pounds.

Since 2016, most savers receive a personal allowance every year with which they can earn a certain amount of interest tax-free, without an ISA.

Base rate taxpayers are eligible for a £1,000 PSA. This means that they can receive up to € 1,000 per year tax-free in savings interest.

Higher rate taxpayers have a PSA of £500 each year and higher rate taxpayers do not receive a PSA.

The higher savings rate now threatens to drag many savers above these thresholds.

For example, there are currently 10 savings providers that pay 6 percent or more on a 1-year fixed-interest savings account.

Someone who uses an account and pays 6 per cent exceeds their annual allowance by a pot of £16,700 as a base rate payer, or just £8,350 as a higher rate.

When must savers file a return?

The good news is that not everyone who owes tax on their savings needs to file a return.

Under HMRC’s rules, anyone making less than £10,000 from savings and investments will not need to file a tax return, which will make up the vast majority of people.

In cases where savers earn more than their PSA but have less than £10,000 in income from savings and investments during the year, HMRC says their tax liability is calculated and paid automatically.

Those who already file a self-declaration, for example if they are self-employed, must state the interest earned from savings on their form.

If someone is employed or receiving a pension, in most cases HMRC will automatically update their tax code and withhold tax from their earnings.

To determine their tax code, HMRC estimates how much interest they will earn in the current year by looking at how much they received in the previous year.

If a saver is unemployed, not receiving a pension and not filing a tax return, HMRC uses information provided directly by banks and building societies about any savings interest they receive. It will use that to inform people if they have to pay taxes and how to pay them.

We spoke with John McCafferyhead of tax affairs and tax partner at Alexander & Co Chartered Accountants and Tax Advisers, and Neela Chauhana private client tax partner at UHY Hacker Young, on how this will work in practice.

How does HMRC calculate someone’s undeclared savings interest?

John McCaffery replies: This is an area where many taxpayers get confused and it can lead to unexpected tax bills. It is also an area where HMRC may be missing out on revenue.

If you are employed or receiving a pension, HMRC should automatically adjust your tax code so that tax on savings and investments is paid automatically.

This is calculated from the previous year’s earnings, which banks should automatically forward to HMRC.

An individual’s tax code is then adjusted for the following year when taxes are levied, allowing up to 50 percent of gross pay to be withheld from each pay period.

However, we note that this does not always happen and that deviations occur regularly.

In addition, as this is based on the previous year’s income, changes in an individual’s circumstances may result in incorrect tax codes and HMRC demanding a significant amount of tax in the short term, at the end of a tax year.

Who must fill in tax returns on savings?

John McCaffery replies: If a person has not yet completed a self-assessment tax return, they will usually only need to file one if their savings and investment income exceeds £10,000 per tax year.

Anyone who already completes a self-assessment tax return must declare the interest earned from these sources on their return.

Another consideration is that the investment market today is very diverse, with people owning many different forms of alternative investments.

These may not be automatically reported to HMRC. It always pays to regularly check that these are included in your annual tax statement.

If that is not the case, the principle of self-evaluation applies and private individuals are advised to file a report.

Are people aware of possible tax liabilities?

John McCaffery replies: As many taxpayers are unsure or even unaware of their obligation to pay tax on savings and investment income, HMRC may be missing a trick to educate taxpayers about this gray area.

Many people assume they already pay taxes on their income, and others are completely unaware of the requirements.

Clear communication on this subject would help all concerned and generate additional revenue for HMRC.

Making the self-assessment applicable to everyone with a tax liability on their annual compensation would simplify the situation for everyone.

While this may be seen by many as an additional administrative burden, it is a fairly simple process, with professional advice being sought.

People’s tax liabilities would then be accurately calculated and in many cases could be lower than originally estimated.

Neela Chauhan adds: There will certainly be savers on modest incomes who find themselves receiving a nasty letter informing them of tax dues that they have no previous experience or knowledge of.

What happens if I don’t pay tax on my savings?

Neela Chauhan replies: Undeclared income in UK bank accounts is an area HMRC has all but ignored in recent years [as savings rates were low]but rising interest rates have put it firmly back on the watchlist.

HMRC staff surveying this area will have quite a bit of work on their hands.

HMRC receives a huge amount of data from the banks and will have to spend a lot of time and resources on it. However, it has invested heavily in AI and machine learning to do that faster.

That technology enables HMRC to send tens of thousands of aggressive nudge letters to taxpayers at once.

Of course, the personal savings tax only affects those who have not filed accurate tax returns, and anyone who filed their tax returns correctly can rest easy.

John McCaffery adds: HMRC has the power to open inquiries and investigate an individual’s tax status. Failure to disclose may result in fines, interest on late payment or, in case of deliberate evasion, criminal investigation.

Recently HMRC has allocated significant resources to send ‘nudge letters’ to taxpayers.

It shares data with a wide variety of sources, including banks abroad and in the UK, overseas governments, crypto exchanges, and the Land Registry.

It also receives data from landlords’ rent guarantee schemes. This data has resulted in many investigations by HMRC into second home ownership, rental income taxation, foreign assets and investment income.

All income over £300 coming from abroad must be declared on a self-assessment tax return.

In these circumstances, the fact that an individual was unaware of their tax obligations is not a valid excuse.

Should the personal allowance be abolished?

Neela Chauhan replies: It really is in the interest of the government to allow the personal allowance to rise in line with the rising interest rate, that would have saved it a lot of suffering.

The real income it gets from that extra bank interest is actually negative if you include inflation.

An additional concern is that some people might be deterred from saving, which would hardly help to quell inflation.