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On 6 April 2016 a new personal savings allowance is being introduced. HMRC has released updated guidance on how this will work in practice. What do you need to know?

Personal savings allowance. For the 2016/17 tax year, a personal savings allowance is being introduced which will allow basic rate taxpayers to earn £1,000 in savings interest tax free, while the limit for higher rate taxpayers is £500. For example, to exceed the limit a basic rate taxpayer would need a savings pot of £50,000 earning interest at a rate of at least 2% p.a.

Note. Additional (45%) rate taxpayers are not entitled to any savings allowance.

Interest to be received gross. At the moment, banks and building societies deduct tax before the interest is paid to the customer unless the customer has a low income and has applied using Form R85 for the interest to be paid gross. When the new savings allowance starts in April, tax will stop automatically being deducted by banks so all interest will be received gross and the R85 will be discontinued.

Income under £17,000 in 2016/17. HMRC’s guidance states that, in this case, taxpayers won’t pay any tax on their savings income. This is because the personal allowance for 2016/17 is £11,000, then there’s a £5,000 0% savings band and the £1,000 personal savings allowance on top of that.

Limited guidance. HMRC’s guidance provides very basic examples, but does not adequately explain how the personal savings allowance will interact with the new £5,000 dividend allowance. For example, if someone receives a salary of £38,000, dividends of £5,000 and interest of £1,000, will they be entitled to a personal savings allowance of £1,000 or £500 given that their total income is over the £43,000 basic rate threshold? The guidance states that if your adjusted net income is over £43,000 (as is the case in this example as the dividend allowance does not reduce your total income for tax purposes) then you will only receive a £500 personal savings allowance. So in our example, even though the taxpayer will not pay any higher rate tax, they will still have to pay 20% tax on £500 of the £1,000 interest they received.

From April, banks will no longer deduct tax from interest and basic rate taxpayers can receive up to £1,000 of interest a year tax free. This means that if a client’s total income is under £17,000, they’ll have no tax to pay on their savings income.