If you’re a higher-rate taxpayer, you may still be able to reclaim from HMRC some of the 20% tax your lender deducted from the interest in your car finance compensation, but usually less than a basic-rate taxpayer. It depends on how much interest you received. Smaller payouts can often be reclaimed in full. Larger ones may give a partial repayment or none.
Why the answer is different for you
The interest in car finance compensation is savings income. The lender usually deducts 20% income tax from it before paying you. Our overview of whether car finance compensation is taxable explains the rules for every tax band.
Your Personal Savings Allowance sets how much savings interest you can receive tax-free each year. GOV.UK sets it at:
- £1,000 for basic-rate taxpayers
- £500 for higher-rate taxpayers
- £0 for additional-rate taxpayers
Above your allowance, a higher-rate taxpayer owes 40% on savings interest. The lender has only deducted 20%. So on larger amounts of interest, the 20% already taken may not cover what you owe.
The general rule
Call the tax the lender deducted T. Because the lender takes 20%, T is one fifth of the gross interest.
- If T is £100 or less, the interest is £500 or less. It fits inside your allowance, so no tax was due. You can usually get all of T back.
- If T is more than £100, the repayment is usually £200 minus T.
- If T is £200 or more, the interest is £1,000 or more, and there is usually nothing to reclaim.
This assumes the compensation is your only savings income that year. Bank or building society interest uses up the same £500 allowance, which reduces what you can reclaim.
Worked examples
Example 1: tax deducted £80. The gross interest was £400. That is within the £500 allowance, so no tax was due. You can usually reclaim the full £80.
Example 2: tax deducted £150. The gross interest was £750. The first £500 is tax-free. The remaining £250 is taxed at 40%, which is £100. The lender took £150, so you’ve overpaid by £50. That matches the rule: £200 minus £150 is £50.
Example 3: tax deducted £240. The gross interest was £1,200. The first £500 is tax-free. The other £700 is taxed at 40%, which is £280. The lender only took £240. There is nothing to reclaim, and you may owe a further £40.
HMRC may collect extra tax on savings interest through your tax code or your Self Assessment return. If the figures suggest you owe more, it’s worth checking your tax position for that year.
Additional-rate taxpayers
If your income is over the additional-rate threshold, you have no Personal Savings Allowance. All your compensation interest is taxable at 45%. The 20% deducted by the lender won’t cover it, so there’s no repayment. You may owe more tax.
When your tax band is borderline
Your band depends on your total income for the tax year in which the compensation was paid. The interest itself counts towards that total. A payout can push someone just over the higher-rate threshold, or a year with lower earnings might leave you a basic-rate taxpayer.
So check the tax year the money was actually paid, not the year you took out the finance. Our guide to multiple payouts explains how tax years work if you had more than one.
If you live in Scotland, savings income uses the UK bands and allowances, not the Scottish income tax bands.
Getting the tax back
Many higher-rate taxpayers file Self Assessment returns. If you do, the interest and the tax deducted go on your return for that year. If you don’t, the repayment is claimed from HMRC on an R40. Our guide to what an R40 form is explains what it is.
The figures that matter are on the lender’s letter: the gross interest, the tax deducted and the net interest paid.
For higher-rate taxpayers the margin can be small, so the calculation matters. When you use our service, we check your income and other savings interest for the year, work out whether a repayment is due, prepare and submit the R40 as your agent, and deal with any HMRC queries. Our how it works page explains the process.
Next step
Find the tax deducted on your lender’s letter and try our eligibility calculator. The rules above are general, and HMRC works out the final figure from your full income for the year.