When you hold client money, you're essentially looking after someone else's cash. That money could be earning interest in their own bank account, so the rules say you need to compensate them for this. It's about fairness - clients shouldn't lose out because their money is sitting in your client account.
If you hold client money for a certain period, you generally need to pay interest to that client. The SRA Accounts Rules set out when this applies, how to calculate it, and what exceptions exist. Not paying interest when you should is a breach - so get this right.
Think of interest on client money as compensating the client for the time their money is in your hands. It's not profit for you - it belongs to the client.
You must pay interest on client money if you hold it for a qualifying period. The money must be in a designated client account or a general client account, and it must be held long enough to trigger the interest obligation. This isn't about every single pound - there are thresholds and exceptions we'll cover.
For interest purposes, we're talking about the same client money definition we covered in Topic 2. This includes money held for clients, trustees, beneficiaries, or as stakeholder. If it's client money that sits in your client account, the interest rules potentially apply.
When calculating whether thresholds are met, you look at the gross amount before any deductions. This means you don't deduct tax, fees, or costs first. If a client receives £10,000 (gross) that needs to go through your client account, you calculate interest based on that full amount.
Don't try to avoid paying interest by splitting money into smaller amounts or spreading it across multiple accounts. The rules look at the substance of the transaction, not just the form.
Interest on client money is calculated using a base rate set by the SRA. This isn't the Bank of England base rate - it's a specific rate set out in the SRA Accounts Rules. The rate can change, so you need to check the current rules. Historically, this has been quite low, often below high street bank rates.
Interest is calculated on a daily basis and typically compounded. You're essentially calculating what interest the money would have earned if it had been in an interest-bearing account for the client. The exact formula is set out in the rules, but most firms use software to handle the calculations automatically.
You need to track how long the money is held. The clock starts when the money hits your client account and stops when it leaves. Some periods don't count (like when money is between accounts), and certain transactions might pause or reset the calculation. Keep accurate records - you'll need them if a client queries their interest.
Use your accounts software to calculate interest automatically. Manual calculations are error-prone, and getting it wrong means either underpaying (client complaint) or overpaying (firm loses money).
Not every penny triggers an interest payment. There are practical thresholds - called de minimis rules - below which you don't need to pay interest. This makes sense administratively. Imagine calculating and paying interest on every £5 that sits in a client account for a few weeks. The admin cost would exceed the interest itself!
The SRA sets specific monetary thresholds below which interest doesn't apply. These thresholds can change, so always check the current SRA Accounts Rules. The idea is that below a certain amount, the administrative burden of calculating and paying interest outweighs the benefit to the client.
If the amount held is below the de minimis threshold, you simply don't need to calculate or pay interest. However, you still need to keep records of the client money and follow all other client account rules. The de minimis exemption only relates to the interest payment obligation.
De minimis applies per holding, not as a firm-wide total. You can't aggregate multiple small amounts to avoid the threshold - each client's money is assessed separately.
There are specific situations where, even if you're holding client money, you don't need to pay interest. These exceptions are built into the rules and reflect practical scenarios where requiring interest would be unreasonable or unnecessary. Let's go through the main ones.
If the client withdraws their money before the qualifying period for interest is reached, no interest is due. This makes sense - the money wasn't held long enough to trigger the obligation. The client gets their money back promptly, which is what the rules are ultimately trying to ensure.
Money that passes through your client account very quickly - for example, received and paid out within days - may not generate an interest obligation. There are minimum holding periods in the rules. If the money doesn't stay long enough, no interest calculation is needed.
This is an important exception for residential property transactions. Deposits of up to £10,000 in residential conveyancing matters don't attract interest. Above this threshold, interest may apply. This exception recognises the high volume of conveyancing transactions and the administrative burden that would result from calculating interest on every standard deposit.
For residential deposits, track the £10,000 threshold carefully. A £10,500 deposit would potentially trigger interest on the excess £500, depending on how long it's held.
Some statutes provide their own rules for how money should be handled, and these override the general interest rules. For example, court deposits might have specific rules about how interest is calculated and paid. When a statute says something different, the statute takes precedence.
Don't assume an exception applies without checking. The rules are specific, and getting it wrong is a breach. When in doubt, calculate the interest - it's better to pay when you didn't have to than vice versa.
When you calculate that interest is due to a client, you need to record this properly in your books. Interest is a liability to your client until you pay it out. The accounting entries ensure your ledgers reflect what you owe, and they provide an audit trail showing you've complied with your obligations.
When you calculate interest, you're essentially saying "we owe the client this amount." In the client ledger, this appears as a credit - money that will flow out to the client. In your accounts, you're building up a liability that will eventually be paid. The exact entry depends on your accounting system, but the principle is the same: record what you owe.
When you actually pay the interest to the client, you're reducing that liability. The client ledger is credited (money going out), and the bank account is debited. The entry shows the interest payment being made, completing the cycle. The client receives their interest, and your books show the transaction has been completed.
In some situations, interest on client money can become firm income rather than being paid to the client. This might happen if the client can't be traced, or if the rules specifically allow it. When this occurs, the interest is transferred from the client account to the office account and recorded as firm income. This is the exception, not the rule - most interest belongs to the client.
Interest that earns interest - that's compound interest. If money is held for a long time, you might need to calculate interest on the accumulated interest. Your accounting software should handle this, but you need to understand the principle. Compound interest increases what you owe the client over time, so accurate records of when money was received are essential.
Always keep your interest calculations with the client file. If a client questions their interest, you need to show how you calculated it. This is your defence against disputes.
Paying interest isn't just about calculating the right amount. There's a process to follow: identify when interest is due, calculate it correctly, record it in your books, notify the client, and make the payment. Each step matters, and missing one can cause problems down the line.
Most firms use specialised accounts software to calculate interest. Manual calculations are possible for simple cases, but they're time-consuming and error-prone. The software tracks when money came in, applies the correct rate, accounts for thresholds and exceptions, and produces the final figure. You still need to understand the process to verify the software is doing it right.
Interest should be paid promptly once it becomes due. Don't sit on it - it's the client's money. The rules don't specify an exact number of days, but "promptly" is the standard. Best practice is to pay interest as part of the normal client account reconciliation process, ensuring regular, timely payments.
Clients should be told when they're receiving interest. It doesn't need to be a formal document, but they should know it's happening. This could be a note on their statement, a line item in a bill, or a separate communication. Transparency prevents disputes and shows you're following the rules properly.
Every interest payment must be recorded in your ledgers. The client ledger shows the transaction, the cash book shows the bank payment, and your records show the complete picture. This is essential for reconciliation and for demonstrating compliance if anyone checks your books. Incomplete record-keeping in this area is a red flag for auditors and regulators.
Make interest payments part of your monthly reconciliation process. It ensures nothing gets missed and spreads the administrative workload rather than creating periodic large tasks.
You receive £25,000 in compensation for a personal injury client. The money sits in your client account while you arrange the settlement and pay any disbursements. After deducting your costs and expenses, £20,000 remains. If this money is held for more than the qualifying period, interest would be calculated on the gross amounts held and paid to the client along with their settlement.
You receive a £8,000 deposit for a residential property purchase. The money is held in your client account for three weeks before completion. Because this is a residential conveyancing deposit under £10,000, no interest is payable. This is the specific exception we covered earlier. The £8,000 is simply held and then paid out without interest calculation.
You receive a £15,000 deposit for a commercial property transaction. This exceeds the residential conveyancing threshold (and it's commercial anyway). The money is held for two months before completion. Interest would be calculated on this amount for the holding period and paid to the client at completion, unless an applicable exception applies.
You receive £5,000 for a client and pay it out to a third party just four days later. Because the money was held for such a short period (below the minimum qualifying period), no interest is due. The money came in and went out too quickly to trigger the interest obligation.
| Scenario | Amount | Holding Period | Interest Due? |
|---|---|---|---|
| Personal injury settlement | £25,000 | 6 weeks | Yes (if no exception applies) |
| Residential deposit | £8,000 | 3 weeks | No (conveyancing exception) |
| Commercial deposit | £15,000 | 2 months | Yes |
| Short-term holding | £5,000 | 4 days | No (below minimum period) |
For SQE1, know the main exceptions (conveyancing under £10k, short holding periods) and the principle that interest belongs to the client. You don't need to memorise exact rates, but understand when interest applies and when it doesn't.
Don't confuse "no interest due" with "no record-keeping needed." Even when interest isn't payable, you still need proper client account records and to follow all other SRA Accounts Rules.
Interest on client money is about fairness. Clients entrust you with their money, and the rules ensure they're compensated for that. Get it right, and you're demonstrating good practice and protecting both your clients and your firm.