is compensation taxable?
updated September 2008
This note describes our current approach on whether or not compensation is taxable.
The law requires us to decide each case on the basis of our existing powers and what is fair in the circumstances of that particular case. We take into account the law, regulators’ rules and guidance, relevant codes and good industry practice at the relevant time. We do not have power to make rules for financial businesses. Our current approach may develop in the light of circumstances disclosed by further cases we receive. We may decide that fairness requires a different approach in a particular case.
2. compensation in mortgage endowment cases
3. compensation for being deprived of money
4. compensation for investment loss
(a) ... where the consumer still has the investment/account
(b) ... where the consumer no longer has the investment/account
5. compensation where an account is reconstructed
1. what this note covers
This technical note explains, in broad terms, our understanding of some general principles relating to the tax treatment of compensation that we award.
The exact tax treatment of the compensation awarded to any individual consumer is likely to depend both on the circumstances of the case and on the consumer’s own wider financial and tax position.
This is not something the Financial Ombudsman Service can advise on. Ultimately it is a matter to be resolved between the individual consumer and HM Revenue and Customs.
2. compensation in mortgage endowment cases
Where we uphold mortgage endowment complaints, we usually require the financial business to put consumers in the position they would be in now if they had originally taken out a repayment mortgage instead of the endowment mortgage. Our approach to redress in these cases follows the guidance in the Financial Services Authority’s handbook (at DISP Appendix 1 – often still referred to by its previous name of "RU89" by some financial businesses).
Payment of compensation calculated in this way is unlikely to create any liability to income tax or capital gains tax. But:
- Where the endowment policy is surrendered or sold, this may trigger a "chargeable event gain" liable to income tax. However, the financial business will usually be liable to refund any tax (under DISP Appendix 1.5.9G) if the surrender or sale results from the compensation settlement.
- Where there is a delay between the calculation of compensation (in accordance with DISP Appendix 2) and payment, any interest payable on that compensation relating to the delay is potentially liable to income tax – as explained in section 3 below.
- Where the policy is cancelled from the outset and the premiums are returned with interest, instead of compensation under DISP appendix 1, the interest on the premiums is potentially liable to income tax – as explained in section 3 below.
3. compensation for being deprived of money
The following cases are examples of upheld complaints where we awarded the consumer compensation for being deprived of money.
- An insurance company wrongly refused to pay out on Mr A’s insurance claim. We required the insurance company to pay Mr A’s claim, plus interest on the claim from the date of the accident to the date of payment.
- A bank did not pay Mrs B the proceeds of her investment until June, even though the investment had matured in January. We required the bank to pay Mrs B interest on the proceeds from January to June.
- Mr C was not in a position to invest, but an investment company wrongly persuaded him to pay into one of its investment policies. We required the investment company to cancel the policy from the beginning and to refund Mr C’s contributions with interest.
In cases like these:
- The compensation we award is for being deprived of money which the consumer should have had. As in the examples above, the compensation is usually interest until the date the money is paid.
- This part of the compensation is potentially subject to income tax, even if it is not described as interest. The law requires a financial business to deduct income tax at the lower rate from such compensation – and to pay this to the Inland Revenue.
- If the consumer is not liable to income tax at the lower rate, they can reclaim the deducted income tax from the Inland Revenue. In order to help the consumer reclaiming the tax deducted, where relevant, the financial business is required to provide the consumer with a certificate of tax-deduction on request – though many financial businesses provide one automatically.
4. compensation for investment loss
Where we award compensation for an investment loss – typically because the consumer was put in the wrong investment or account – the tax position depends on whether the consumer still has the wrong investment or account.
(a) ... where the customer still has the investment/account
The following cases are examples of upheld complaints where we awarded the consumer compensation for being put in the wrong investment/account and the consumer still had the investment/account.
- Mrs D had money in her deposit account with a bank. The bank wrongly persuaded her to move the money into an unsuitable investment – which then lost money. We required the bank to pay Mrs D what her money would have been worth if it had been left in the deposit account, less the current value of the unsuitable investment.
- Mr E was planning to take out investment X, but a financial adviser wrongly persuaded him to take out an unsuitable alternative investment Y – which performed worse. We required the financial adviser to pay Mr E what investment X would have been worth, less the current value of unsuitable investment Y.
- Miss F was planning to invest but had no particular investment in mind. An investment company wrongly advised her to take out an unsuitable investment – which then lost money. As it was not possible to decide how Miss F would otherwise have invested her money, we required the investment company to pay Miss F what her investment would have been worth if the capital had grown at 1% a year above the Bank of England base rate, less the current value of the unsuitable investment.
In cases like these:
- The compensation we award is for investment loss. As in the examples above, this is usually based on what would otherwise have happened to the consumer’s money.
- This kind of compensation is not usually subject to income tax, even if it is calculated by reference to an interest rate. And the law does not require a financial business to deduct income tax.
- The consumer may be liable to pay capital gains tax on it. Whether or not capital gains tax is payable will depend on the consumer’s individual circumstances. The law does not require financial businesses to deduct capital gains tax from such compensation.
(b) ... where the consumer no longer has the investment/account
The following cases are examples of upheld complaints where we awarded the consumer compensation for being put in the wrong investment/account and the consumer no longer had the investment/account.
- Miss G was planning to invest but had no particular investment in mind. An investment company wrongly advised her to take out an unsuitable investment – which then lost money. To reduce her loss, Miss G cashed in the unsuitable investment a year ago. We required the investment company to pay Miss G:
- her loss (calculated as what her investment would have been worth a year ago if the capital had grown at 1% a year above the Bank of England base rate, less the sale price of the unsuitable investment); plus
- interest on that loss from the date the unsuitable investment was cashed in until the date the compensation was paid.
- Mr H was planning to take out investment X, but stockbrokers wrongly persuaded him to take out an unsuitable alternative investment Y – which performed worse. The unsuitable investment matured and paid out a year ago. We required the stockbrokers to pay Mr H:
- his loss (calculated as what investment X would have been worth a year ago, less the maturity value of the unsuitable investment Y); plus
- interest on that loss from the date the unsuitable investment matured until the date the compensation was paid.
In cases like these:
- The tax treatment of the two parts of the compensation is likely to be different.
- The compensation for the investment loss to the date the unsuitable investment was sold (or matured) is not usually subject to income tax – in the same way as explained in section 4A above.
- The compensation for being deprived of the investment loss from the date the unsuitable investment was sold (or matured) to the date the compensation was paid is potentially subject to income tax – in the same way as explained at section 3 above.
5. compensation where an account is reconstructed
The following cases are examples of upheld complaints where we required financial businesses to reconstruct an account.
- A building society temporarily mislaid two of the mortgage repayments that Mr and Mrs J had made. We required the building society to reconstruct Mr and Mrs J’s mortgage account, so that the interest was adjusted to what it would have been if the repayments had been credited at the right time.
- A bank agreed an increased overdraft for Mr K, but forgot to update its computer system. The computer system treated the increased overdraft as unauthorised, and applied charges plus a higher rate of interest. We required the bank to reconstruct Mr K’s account, removing the charges caused by its mistake and applying the correct rate of interest.
The tax position will be based on the account as reconstructed – and will be the same as if the financial business had never made the error.