Client Deposit Interest: Tax and Accounting for UK Professional Services Firms

First, Who Owns the Interest? The Client or Your Business?

The fundamental question of who is liable for tax on interest earned from client deposits in the UK hinges on one thing: ownership. The tax liability follows the owner of the interest income. Determining ownership is a two-step process that involves reviewing your client agreements and any relevant professional regulations that govern your industry.

The starting point is always your client contract or terms of service. This document must explicitly state what happens to any interest accrued on client funds. If the contract specifies the business retains the interest, then it is your company's income. If it states the interest belongs to the client, or is silent on the matter, the default legal position is that the interest belongs to the client. As HMRC note, interest on designated client accounts is treated as belonging to clients unless held under an agreement saying otherwise.

Secondly, certain regulated industries have specific obligations. Professional services firms in sectors like law or property must adhere to overriding rules from their governing bodies. For instance, the SRA client account rules are very clear that law firms must account to clients for interest earned. If your firm operates in a regulated sector, you must follow your professional body's guidance, which supersedes your client contract. In practice, we see that a well-drafted contract aligned with regulatory requirements is the most effective way to avoid ambiguity.

The Tax Treatment: How HMRC Views Client Fund Interest

Once ownership is established, the tax treatment becomes clear. The principle is straightforward: if your business does not own the interest, it has no tax liability on it. If it does own the interest, it must be reported as taxable income.

Scenario A: Interest Belongs to the Client

If your contract or professional rules mandate that interest is paid to the client, the situation is simple from a tax perspective. The client funds are held as a liability on your balance sheet, and any interest earned simply increases that liability. The interest never touches your Profit & Loss account and is not considered your income. Therefore, your business has no UK Corporation Tax to pay on these amounts.

Scenario B: Interest Belongs to Your Business

When your client agreement explicitly allows your business to keep the interest, it becomes taxable income. For tax purposes, this is treated as a ‘non-trading loan relationship credit’ under the loan relationships regime (CTA 2009). For a startup founder, this simply means it is taxable income that is not part of your main trade, like selling software or consulting services. It is, however, taxed at the same Corporation Tax rate. All Corporation Tax liabilities are reported on the CT600 tax return, and this interest must be included in your calculations.

Putting It Into Practice: Systems for Client Account Interest Reporting

Knowing the rules is one thing; implementing them in your day-to-day finance operations is another. For early-stage businesses using Xero and spreadsheets, setting up a robust system is key to accurate client account interest reporting and avoiding compliance headaches. This process addresses the common difficulty of segregating deposits and maintaining audit-ready records.

Step 1: Segregate the Funds

Client money should never be mixed with your company's operational cash. We recommend opening a separate client deposit account once the funds you hold exceed approximately £10,000 or are held for more than one month. This physical separation in your banking simplifies tracking, reduces risk, and demonstrates good governance.

Step 2: Structure Your Chart of Accounts

Next, you must reflect this separation in your accounting software. For most pre-seed to Series B startups, a clean chart of accounts is your best defence against inaccurate reporting. In a system like Xero, you can create the following accounts to manage client funds and interest correctly:

• Current Asset (Bank): 801 Client Deposit Bank Account. This account mirrors the actual cash held in your separate bank account.
• Current Liability: 950 Client Deposits Held. This account represents the principal amount you owe back to your clients.
• Current Liability: 951 Client Interest Payable. Use this account to track interest accrued that belongs to the client, increasing the total amount you owe them.
• Other Income: 350 Interest Income - Client Deposits. This Profit & Loss account should be used only if your business is entitled to keep the interest.

Step 3: Record Journal Entries Correctly

A consistent workflow for recording transactions ensures accuracy. Consider a services firm that holds a £20,000 deposit for a client and is contractually entitled to keep any interest earned.

1. Receiving the Deposit: When the £20,000 arrives, you record the increase in cash and the corresponding liability to your client.Debit: 801 Client Deposit Bank Account £20,000
Credit: 950 Client Deposits Held £20,000
2. Accruing Interest (Monthly): The bank pays £50 of interest into the client account. Since the business keeps the interest, this is recorded as income.Debit: 801 Client Deposit Bank Account £50
Credit: 350 Interest Income - Client Deposits £50
3. Returning the Deposit: At the end of the project, you return the original deposit to the client, clearing the liability.Debit: 950 Client Deposits Held £20,000
Credit: 801 Client Deposit Bank Account £20,000

This structure ensures client funds never appear as company revenue and that any interest you earn is correctly categorised for your CT600 tax return. For more detail, see our guide on client deposit accounting under UK GAAP.

Key Actions for Managing Client Deposit Interest

For a founder or operations manager handling the finances, managing the tax on interest earned from client deposits in the UK boils down to three key actions. Getting this process right from the start provides clarity and minimises compliance risk as your business scales.

1. Review Your Client Agreements. Your contract is the primary document that determines interest ownership. Ensure it is explicit about whether your business retains the interest or passes it to the client. If you operate in a regulated industry, check the rules from bodies like the SRA or RICS and ensure your contracts comply.
2. Implement Physical and Accounting Segregation. If you hold significant client funds (£10,000+) or hold them for extended periods (over a month), open a dedicated client bank account. This is non-negotiable for good governance. Mirror this setup in your accounting system by creating distinct balance sheet accounts and perform monthly reconciliations to ensure balances match.
3. Book Transactions Correctly. When you earn interest that your business is entitled to, record it as ‘Other Income’ to ensure it is captured for your Corporation Tax calculations. When interest belongs to the client, treat it as an increase in the liability you owe them. You can use a simple burn-down process to track retainer usage against the deposit.

Following these steps will provide a clear audit trail and help you file an accurate CT600 return with HMRC. For more resources, visit our hub on Client Deposits & Retainer Accounting.

Frequently Asked Questions

Q: What happens if my client agreement is silent on who keeps the interest?
A: If your contract is silent, the default legal position in the UK is that the interest belongs to the client. HMRC guidance supports this, noting that interest on client accounts is treated as the client's unless an agreement says otherwise. To avoid ambiguity, your terms should always address this explicitly.

Q: Do I need a specific type of 'client account' from my bank?
A: While banks offer formal "client accounts," any separate, designated bank account for client money serves the purpose of segregation. The key is keeping client funds physically separate from your operational cash. For regulated firms, your professional body may require a specific type of statutory client account.

Q: Is there a minimum amount of interest I must pay to a client?
A: Some professional bodies, like the SRA for solicitors, have rules allowing firms to retain small "de minimis" amounts of interest if it is fair and reasonable and the client is informed. For most non-regulated firms, however, this depends entirely on the specific wording of your client agreement.