The Personal Savings Allowance and car finance compensation

The Personal Savings Allowance is the reason most people are owed money back on their car finance compensation. The interest added to compensation is taxed as savings income, and the lender deducts basic-rate income tax (22% from 6 April 2027) from it before paying you (HMRC SAIM9115). But the lender doesn’t know your income or your allowances. If the interest falls within your Personal Savings Allowance, or the starting rate for savings, the tax it took off should not have been paid.

What the Personal Savings Allowance is

The Personal Savings Allowance (PSA) is the amount of savings interest you can receive in a tax year without paying tax on it. How much you get depends on your income tax band (GOV.UK):

Your income tax band	Personal Savings Allowance
Basic rate	£1,000
Higher rate	£500
Additional rate	£0

To work out your band, GOV.UK says to add all the interest you’ve earned to your other income. So a large amount of interest can, in rare cases, move you into a higher band.

What the starting rate for savings is

The starting rate for savings is a second allowance for people on lower incomes. If your other taxable income (not counting savings interest or dividends) is less than £17,570, you can receive up to £5,000 of interest tax-free. Every £1 of other income above your Personal Allowance of £12,570 reduces it by £1 (GOV.UK).

You can have the starting rate and the Personal Savings Allowance at the same time. For example, someone with £15,000 of pension income has £2,430 of other income above their Personal Allowance. Their starting rate is £5,000 minus £2,430, which is £2,570. On top of that they have a £1,000 Personal Savings Allowance, so up to £3,570 of interest could be tax-free. Our guide to the starting rate for savings explains the band in more detail.

Why it applies to car finance compensation

Car finance compensation has two parts. The part that refunds what you overpaid isn’t income. The interest added for the time you were without that money is taxed as savings income (HMRC SAIM2115). That is the same treatment as interest from a bank account, which is why the same allowances apply.

Under the FCA’s motor finance scheme, compensation includes simple interest at the Bank of England base rate plus 1% a year, with a minimum of 3% (FCA). Your lender’s payment letter or tax statement should show three figures: the gross interest, the tax deducted and the net interest paid to you. Those are the figures that matter for a tax rebate.

Worked examples

These examples use the rates from 6 April 2027, when scheme payouts are expected: the lender deducts 22% from the interest, and interest above your allowance is taxed at 22% (basic rate) or 42% (higher rate). The figures are illustrations, not estimates for any real payout.

Situation	Compensation interest	Tax deducted	Other savings interest	Tax actually due	Tax to reclaim
Non-taxpayer, £11,000 pension	£300	£66	None	£0	£66
Basic-rate, £30,000 salary	£300	£66	None	£0	£66
Basic-rate, £30,000 salary	£300	£66	£900	£44	£22
Higher-rate, £60,000 salary	£300	£66	None	£0	£66
Higher-rate, £60,000 salary	£800	£176	None	£126	£50

In the third row, the £900 of bank interest uses up most of the £1,000 allowance, so £200 of the compensation interest is taxable at 22%, which is £44. In the last row, £500 of the £800 is covered by the higher-rate allowance and the other £300 is taxed at 42%, which is £126. The lender took £176, so £50 is owed back. Our guide for higher-rate taxpayers explains why larger payouts can leave a higher-rate taxpayer with nothing to reclaim, or a small amount to pay.

Your allowance covers all your interest in the year

The Personal Savings Allowance isn’t given separately for each payout. It covers all the savings interest you receive in a tax year (6 April to 5 April) from every source: bank and building society accounts, other compensation and car finance compensation from every lender.

That matters if you had more than one car finance agreement. Two payouts in the same tax year share one allowance. Two payouts in different tax years get an allowance each. Our guide to multiple PCP or HP payouts covers this in more detail.

Interest from ISAs doesn’t count towards the allowance, because ISA interest is tax-free anyway.

What changes from April 2027

Finance Act 2026 raises tax on savings income by 2 percentage points across all bands from 6 April 2027: 22% for basic-rate taxpayers, 42% for higher-rate and 47% for additional-rate. The Personal Savings Allowance and the starting rate for savings are not changing (GOV.UK).

That matters because the FCA’s scheme is not now expected to pay out before a court hearing in February 2027 (see our car finance compensation scheme latest update). Payouts after 5 April 2027 fall in the 2027/28 tax year. If your compensation interest is within your allowances, nothing changes: no tax is due on it, so whatever the lender deducted should be repaid. The lender will deduct 22% rather than 20%, because tax withheld from interest moves to the new savings basic rate, so there is slightly more to reclaim. The higher rates only matter for interest above your allowances.

How the tax is reclaimed

If you’re not in Self Assessment, tax deducted from savings interest is reclaimed on form R40, one claim per tax year. Claims can be made up to four years after the end of the tax year you were paid (GOV.UK). If you file a Self Assessment tax return, the interest and the tax deducted go on your return instead.

For the full picture of which parts of compensation are taxed, see is car finance compensation taxable?. To see roughly what you could get back, use our car finance tax rebate calculator. If you claim with us, we work out the right tax year and allowances, submit the claim to HMRC as your agent and pay you the balance after our fees. You can also claim from HMRC yourself.