Tax may be payable on compensation you receive.
Tax may be payable on compensation you receive. It depends on:
- the type of compensation you’ve been awarded
- your financial position
We can give a general overview on how compensation may be treated for tax purposes. But any tax due will depend on your individual circumstances, so you should talk to HM Revenue and Customs (HMRC) if you’re unsure what you need to pay.
Compensation for investment loss
You might have to pay tax on compensation you get for being mis-sold an investment. It depends on the type of investment, your individual circumstances and whether you still hold the investment or not.
If you still have the investment
In this scenario, you won’t normally pay income tax on any compensation you received. However you might need to pay capital gains tax on it (depending on your own financial position). You’d need to talk to HMRC to determine this and pay any amount due via a self-assessment tax return – the business won’t deduct capital gains tax for you.
If you’ve sold your investment
You’re likely to get two different parts to your compensation and they are treated differently for tax purposes.
- You may get compensation for any loss you experienced up until the date you sold the investment. You won’t usually need to pay income tax on this part, but you might need to pay capital gains tax. You should check with HMRC.
- If you get interest on top of compensation for the period since you sold the investment (or it matured), you usually need to pay income tax on this part. The business would usually deduct this on your behalf and give you a tax deduction certificate. If you’re not a taxpayer, you can reclaim any tax you paid from HMRC.
If you were mis-sold PPI
You’ll only need to pay income tax on any interest we tell the bank to pay you. You won’t need to pay it on the rest of your compensation.
As an example, let’s say you were mis-sold PPI, and the PPI repayments were added to your loan. We’ll tell the bank to pay back any repayments you shouldn’t have been asked to make. The compensation you get for this part will not be subject to income tax.
The business should let you know if they will deduct income tax from it at the basic rate before they pay it to you.
HMRC has published more detailed guidance on PPI compensation.
If you’re given compensation for an endowment mortgage complaint
If we agree you shouldn’t have been sold an endowment mortgage, we usually tell the business to work out how much you’d have saved if you’d originally taken out a repayment mortgage instead of the endowment mortgage and compensate you for this amount.
This compensation is unlikely to be subject to income tax or capital gains tax. But there are some exceptions you may wish to check.
If you’ve since sold the endowment policy
This may trigger a gain that you might need to pay income tax on. However, the business will usually need to pay you back for any tax you incur, if the surrender or sale is a result of the compensation settlement.
If there were delays between the calculation of compensation and the date you were paid
You may get interest on top of your compensation and if so, this is potentially subject to income tax.
If a policy was cancelled from the outset and the premiums were returned with interest
The interest on the premiums is potentially liable to income tax.
The tax treatment of compensation in pension cases can be complex. Generally, we aim to place the consumer in the position that they would be in if the business hadn't made the error.
If a business has made a mistake on your pension or given you poor pension advice, we might recommend that your pension arrangement is ‘topped up’. This means that it will be the value it should have been, without the business’ mistake. This will take account of any tax relief you might be entitled to. However, payment into the pension isn’t always possible, so it might need to be paid to you directly.
How to pay tax on compensation
They should pay it directly to HMRC and give you a tax deduction certificate. If they haven’t given you one, you’ll need to ask for it.
The basic rate of tax may or may not be the correct rate for you to pay. It depends on your earnings and tax position:
If you don’t earn enough to pay income tax
You can usually claim back the tax the business has deducted for you. You’ll need to contact HMRC to do this.
If you pay income tax at the basic rate
The business has already deducted the correct amount for you. You’ll usually need to mention the compensation amounts and deducted tax if you fill in a self-assessment tax return.
If you pay income tax at the higher rate
You need to tell HMRC about your compensation so that it can be taxed correctly. You can declare the compensation to them or include it on a self-assessment tax return.
If you’re liable to pay capital gains tax on your compensation
You need to tell HMRC or declare it on a self-assessment tax return. The business won’t deduct capital gains tax on your behalf.