An article published in March 1992 (see [1992] Gazette, 4 march, 34), the contents of which had been agreed between the Law Society's revenue law committee and the Inland Revenue, set out the tax treatment of interest arising on solicitors' deposit accounts.

The text of the article subsequently appeared in the Guide to the Professional Conduct of Solicitors, up until 1995.In summary, for most designated client accounts, tax will be deducted at source by the bank or building society and the solicitor will pass it on net to the client.

Where money is held on a general (undesignated) client deposit account, deduction at source will not apply and interest will be received gross by the solicitor, who will then make payment gross to the client.

The position remains unchanged as far as interest arising on designated deposit accounts is concerned.

There has, however, been an important change in the treatment of interest arising on undesignated accounts which is then paid on to clients.Since April 1996, savings income received by an individual, the estate of a deceased person or an interest in possession trust has been taxable at the lower rate (20%), unless in the case of an individual his or her total income makes him or her liable to higher rate tax, rather than the basic rate of tax (s 73 the Finance Act 1996 inserting a new s 1A into the ICTA 1988).

Interest from designated deposit accounts is clearly taxable as savings income.

However, there had been some uncertainty about whether payments made by solicitors to clients in respect of interest earned on undesignated client accounts would be savings income for the purposes of s 1A.

In the March 1992 article, it was stated that payment from an undesignated deposit account was of compensation in lieu of interest, and not itself interest.

The Revenue's initial view was that such payments would be taxable in the client's hands under case VI of schedule D, and would not therefore fall within s 1A.

Following correspondence between the Revenue and the revenue law committee, the Revenue has reviewed the position and has concluded that such payments may in future be treated as payment by time for the use of money representing interest within case III of schedule D, and, with effect from 6 April 1998, should be treated as within case III.

consequently, the lower rate of tax on savings income can apply where appropriate.

The Revenue proposes that, for 1996-1997 and 1997-1998, such payments should continue to be treated as within case VI of schedule D.The Revenue has published an article in its bi-monthly periodical, Tax Bulletin (February 1998 edition), which sets out its view.

In the article, it has drawn solicitors' attention to the provisions of s 349 ICTA 1988, which directs that under certain circumstances, where 'yearly interest' is paid, the person by, or through whom, the payment is made must deduct income tax from the payment at the lower rate of income tax.

For solicitors, this is most likely to occur when making payments to a person whose usual place of abode is outside the United Kingdom, in what the Revenue acknowledges is the 'relatively unusual' case where payments in respect of money held on undesignated client account comprise 'yearly interest'.The revenue law committee's view is that s 349 would normally only be in point when, at the time of placing money on deposit, the solicitor and the client contemplated that it would be likely to remain on deposit for a year or more (in which circumstances it would be unusual for the money to be placed on an undesignated account).