Al Rayan Bank customers mistakenly hit with HMRC tax bills on cash Isas

More than 250 customers holding cash Isas with Al Rayan Bank have been hit with HMRC tax bills, despite their savings supposedly being held tax-free.

Cash Isa savings interest should be exempt from tax, no matter how much you're earning. But an issue between Al Rayan and HMRC has led to some customers being wrongly charged.

Here's what the issue is, and what to do if you've been affected.

What is Al Rayan Bank?

While you might not have spotted it on your local high street, Al Rayan Bank offers some of the most competitive rates in the market, including a table-topping three-year fixed-term savings account.

As Al Rayan products are Sharia-compliant, savers are offers an Expected Profit Rate (EPR) rather than an interest rate. But so far, Al Rayan has always paid out its EPR, so for customers, it works much in the same way as any other bank.

In the Isa market, Al Rayan Bank currently offers a 12-month and 24-month fixed-term cash Isa, with a 1.6% EPR and 1.8% EPR respectively, and an instant-access Isa with an EPR of 1.35%.

Cash Isa customers charged tax

A Which? member received a letter from HMRC claiming he owed tax on his savings interest. HMRC said his tax code would be changed for the 2019-20 tax year to recoup the money each month, effectively reducing his take-home pay.

Yet the bill was in relation to his cash Isa with Al Rayan Bank, which should be tax-free. After contacting the bank, he was told it was aware of the problem and had received similar complaints from other savers.

According to the member, the bank didn't tell him what the problem was, only that there had been a 'misunderstanding' with HMRC.

The Which? member wrote to HMRC for more information, and has been left waiting for a response. At the time of writing, Al Rayan Bank hadn't contacted him either.

Why has it happened?

An Al Rayan Bank spokesperson told Which? 252 of its cash Isa customers have been affected by the cash Isa issue.

It said: 'We have written to everybody impacted by the issue to clarify the steps HMRC and Al Rayan Bank are taking to rectify the situation, and to apologise for any inconvenience caused.'

However, they refused to go into any detail about how or why the issue occurred.

While HMRC couldn't comment on the Al Rayan case specifically, it did explain how errors can happen.

A spokesperson for HMRC said: 'Isas should not be included with savings reports provided to HMRC [by savings providers] as they are not taxable.

'Where a provider has done so, we will work with them to identify and rectify any customer tax accounts affected.'

HMRC has confirmed it will correct the tax codes and tax calculations of all affected Al Rayan customers, and that customers don't need to take any action themselves.

Find out more:understand your tax code

Will HMRC ever charge you tax on Isa savings?

All money held within an Isa 'wrapper' is tax-free, which means that you don't have to pay tax on any interest earned.

The only times when tax may be charged is if you exceed your annual Isa allowance, which is the amount you're able to deposit into Isa accounts each year. In the 2018-19 tax year, and continuing to 2019-20, the Isa allowance is £20,000.

You can deposit this into one cash Isa, one stocks & shares Isa, one innovative finance Isa, or you can mix and match. You can also deposit smaller amounts into a lifetime Isa and Help to Buy Isa if you're eligible to open them.

If you pay in more than £20,000, it's good practice to report the error to HMRC. If you don't, it will be flagged in the Isa reports HMRC receives from Isa providers.

HMRC will identify which payment breached your allowance limit and will begin a process called 'repairing the Isa'.

This involves HMRC returning any money deposited following the limit being exceeded. Any interest earned will be put towards your personal savings allowance and you may have to pay tax.

Find out more:cash Isa rules and allowances

Are other savings taxable?

Interest earned in savings accounts is liable to tax, although you may be able to earn a set amount tax-free. This is known as your personal savings allowance.

The amount of personal savings allowance you're eligible for depends on your income.

If you're a basic-rate taxpayer, you can earn up to £1,000 in savings interest during each tax year before paying tax. Higher-rate taxpayers can earn up to £500, while additional-rate taxpayers don't receive a personal savings allowance.

Find out more: tax on savings and investments