Presumably there's a flaw here somewhere...

I was thinking last night about tax on savings. I'm not sure why. But I was.

In the UK, one can add £3000 per year into a special tax-free savings account (an ISA). (I'm only considering cash ISAs in this post).

I thought of a cunning way to get tax free interest on more than £3000 each year and I wonder if it would work.

Here's the scenario.

Imagine you have £6000 to invest in a savings account (pretend you're saving for an imminent purchase so investing in stocks is not suitable, etc, etc). Let's assume the annual rate is 5%. Before anybody tries to get too clever, let's keep this simple: if you put £1000 into the ISA, you'd get £50 in interest after a year. Let's also assume we pay UK higher rate tax (40%), that we're honest people and we inform the Inland Revenue of any taxable interest income - meaning that we're liable for 40% tax on non-ISA interest.

So, of the £6000, you would put £3000 into an ISA and £3000 into a regular savings account (which we also assume pays 5% but is liable for tax)

At the end of the year, you'd get £150 tax free from the ISA account and £90 after tax from the other account - a total of £240.

Here's the clever bit.

What's to stop a bank launching the following offer?

"Our cash ISA pays 10% interest tax free (but you must also invest £3000 with us in a 0% regular account".

So... you'd still be saving £6000 and the bank would still be paying the same amount in interest. The only difference is that the 10% interest on the £3000 (£300) would be given to you tax free since it was paid from the ISA.

In other words, you'd save £60 in tax.

This idea obviously scales up to the frankly amazing "our ISA pays 100% interest! (but you need to save £57000 in a 0% account to qualify" offer - which would save somebody with £60,000 £1,140 in tax. Superb!

There must be a flaw in this somewhere...