HM Revenue and Customs' (HMRC's) new 0% rate of interest on overpaid tax means that there is nothing to gain for taxpayers.

Now that HMRC has reduced its rate of interest on overpaid tax to 0%, what recompense is there for those individuals who have paid too much tax?

What are the interest rates?

Following the reduction in the Bank of England base rate to 1.5%, although not specifically linked, the rate of interest paid by HMRC on unpaid and overpaid tax has now changed, in most cases from 27 January 2009. This is the fourth cut in HMRC's interest rates in three months.

For income tax, capital gains tax, national insurance contributions, stamp duty, stamp duty reserve tax and stamp duty land tax, the interest rate for unpaid tax has reduced from 4.5% to 3.5%, welcome news in the light of falling commercial interest rates. However, the interest rate on overpaid tax has also dropped from its previous level of 0.75% to 0%. These new rates also apply to many indirect taxes.

The rates of interest for corporation tax, including instalment payments, differ slightly.

Why are there two different rates?

HMRC has always had two different interest rates - the higher one, for unpaid tax is for those who are behind on their payments and is set to encourage taxpayers to pay their tax promptly, and to compensate HMRC for the loss of the use of the money. The lower one, for overpaid tax is to provide commercial restitution for those taxpayers for the period in which HMRC has had use of the money.

Now that the interest rate for underpaid tax is reduced to 0% there is not only no recompense for these individuals, but there is also, arguably, no incentive for HMRC to process repayments promptly.

Who is most likely to be affected?

The reduction in the rate of the interest for overpaid tax is likely to have the greatest impact on those with low and/or fixed income levels, such as teenagers and pensioners.

Many pensioners can reclaim tax paid on savings interest where their liability ends up less than the 20% normally deducted at source. However, if their total taxable income falls below their annual tax-free entitlement, they can apply for interest to be paid without deduction of tax instead using form R85 to avoid suffering the tax and then having to reclaim it from HMRC.

Parents can also apply on behalf of their children for interest on their child's account to be paid without deduction of tax. However, this authority will expire on 5 April following the child's 16th birthday. Those who do not notice this may then potentially be overpaying tax on this income, which could be reclaimed at a later date.

In the past, any overpayments such as these would be repaid along with a repayment supplement, which will now be at 0% - hardly providing recompense for the loss of the use of the money, hitting those who need it hardest.

What about the future of interest payments?

HMRC is not currently permitted to allow the interest rate to fall below zero. In addition, it is continuing to look at ways of providing a simplified and harmonised regime, focusing on recompense, fairness and simplicity, for both HMRC and the taxpayer.

There are currently vast discrepancies in the way interest is charged in respect of different taxes and HMRC is planning to address this situation. One specific area of focus is the late payment of PAYE and NIC by employers.

Currently, although businesses are required to pay over PAYE and NIC monthly, interest due on late payments is not calculated until the end of the year when the full annual liability has been calculated. This is a vast contrast to most taxes where interest is chargeable as soon as the liability is overdue. HMRC is also gathering views on other factors including whether to adopt the Bank of England base rate as a starting point for calculating interest rates and whether the differential in rates for charging and paying interest should be maintained.

Francesca Lagerberg, head of the National Tax Office at Grant Thornton says: "The reduction in the rate of interest for unpaid tax is welcome news, when you consider the rate of interest for other borrowings. The rate that is paid to taxpayers has, in comparison, always rated poorly, owing to HMRC not wanting to be used as a bank by errant taxpayers. However, the reduction in the rate of interest on overpaid tax to 0%, even with interest rates at an all time low, is certainly not commercially competitive. Many taxpayers will be surprised by the change."

Please contact us if you would like further advice on any of the above.