Interest: taxation of interest: when interest arises
When does interest arise?
ITTOIA05/S370 provides that tax is charged on the full amount of interest arising in the tax year. This means that a person receiving interest cannot set off any interest payable, bank charges or similar amounts against sums chargeable under ITTOIA05/S369.
Interest ‘arises’ when it is received or made available to the recipient. Interest has been made available if it is credited to an account on which the account holder is free to draw.
Jonathan has a building society account, on which interest is credited every 31 December. He is free to make withdrawals from the account, at 30 days’ notice, but has not withdrawn money for many years. On 31 December 2017 he receives interest of £524, he should return the interest as income of year ended 5 April 2018, even though he has not withdrawn it.
Interest can in practice often be treated as arising when it becomes due and payable. However, if a taxpayer does not actually receive interest (or have it credited to an account) until a later date, it does not normally form part of his or her taxable income until it is received.
Sam entered into a five year fixed-term bond on 6 April 2017. The bond credits interest to Sam’s account annually on the 31 December. Sam can only gain access to both the annual interest and the principal in advance of 5 April 2022 if a penalty is paid for early access.
Since the terms and conditions of the bond allow Sam to draw on the funds, although with a penalty, the interest arises and is taxable each year as it is credited.
If the terms and conditions of the bond did not allow access until maturity, the interest would arise and be taxed at that point.
In January 2017, Jennifer makes a loan of £5,000 to her cousin to help him set up a business. They agree that interest will be payable quarterly in arrears at a rate of 5% per annum. But the business initially struggles, and Jennifer does not receive any interest until June 2018 when, after she threatens legal action, her cousin repays the debt along with interest arrears of £875. Jennifer is not required to pay any tax on the interest until 2018/19 when it arises. However, the whole £875 is taxable when she receives it. She cannot spread the arrears of interest over the years in which it accrued.
Interest on a judicial award should normally be regarded as arising on the date on which it is paid.
Decided cases which embody these general principles include Dewar v CIR (19TC561), Dunmore v McGowan (52TC307), Parkside Leasing Ltd v Smith (58TC282), and Peracha v Miley (63TC444).
Cases where there is the potential for a Ponzi (and Ponzi-type) schemes to be involved in the return of interest contact Financial Products team at BAI for advice.