VAT on interest income
Posted on 2nd July 2022
Rising rates mean that your business can now earn interest income on surplus funds in a savings or deposit account. Does this money have potential VAT implications that you will need to consider?
Exempt income
The starting point is that interest income you earn is exempt from VAT. This is different to dividend income, which is outside the scope of VAT. So, there is no output tax liability on any interest that you earn from any source. However, because the income is exempt, it is still included in Box 6 of your VAT returns each period.
Tip. If you have always excluded bank interest income from Box 6 on past returns, then don’t worry unless you trade as an investment business. The income will be small and not concern HMRC, so you can just correct the error moving forward.
Qualifying cars
The starting point is that interest income you earn is exempt from VAT. This is different to dividend income, which is outside the scope of VAT. So, there is no output tax liability on any interest that you earn from any source. However, because the income is exempt, it is still included in Box 6 of your VAT returns each period.
Tip. If you have always excluded bank interest income from Box 6 on past returns, then don’t worry unless you trade as an investment business. The income will be small and not concern HMRC, so you can just correct the error moving forward.
Flat rate scheme (FRS)
You can use the FRS if you have annual taxable sales of £150,000 or less, excluding VAT. A specific flat rate percentage is applied to your gross business income in a period; the percentage depends on your relevant trade category. The turnover figure includes both exempt and zero-rated sales but excludes sales or income that is outside the scope of VAT.
However, you do not pay FRS tax on your bank interest income, even though it is exempt from VAT, because it is classed as incidental to your business.
Tip. If you use the cash-based turnover method to work out your FRS sales figure and just add up the credit entries in your business bank account, make sure you leave out all entries for bank interest, capital introduced, dividend income, loans received, etc.
Trap. The exception to the FRS exclusion is if you trade as an investment business where interest is a core source of income rather than being incidental to your main activity.
Partial exemption
If your business is partially exempt, with an input tax restriction on costs that directly relate to your exempt activities, you are likely to be using the standard method of calculation. This means that you apportion the input tax on your mixed costs and general overheads by applying the fraction of the taxable sales to the total taxable plus exempt sales.
However, you will exclude your interest income from the denominator part of the fraction, as long as it is incidental to your business, i.e. not part of your main trading activity. This will increase your input tax recovery.
What about interest paid?
Include bank and loan interest paid by your business in the Box 7 inputs figure of your returns, i.e. as a business expense. Bank charges and overdraft fees are also included. However, there will be no input tax to claim on these costs because they are all exempt from VAT as a financial service.
Tip. If you have incorrectly claimed input tax on past returns, this will need to be corrected going back four years in accordance with the usual error correction rules.
Exclude interest income from your flat rate scheme turnover figure. You can also exclude it from your partial exemption calculations with the standard method unless you trade as an investment-related business where the income is not incidental. Errors must be corrected for the last four years.
Questions or queries?
Please do let us know if you have any questions or if you need any further help understanding the rules. – please call us on 01252 877477 or message us here.
Information correct at time of publication
This article was produced in July 2022 – please always check with Fuller Spurling that information is current, up to date and applicable to your situation.
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