Guidance

Additional guidance on Interest Rate Hedging Products (IRHP) redress payments

Updated 24 January 2017

1. Individuals

1.1 Details of a taxable receipt

The payment is taxable because the business would have previously claimed tax relief for the payments under the Interest Rate Hedging Products (IRHP) as an allowable business deduction against profits. When the redress payments are made to you they must therefore be treated as business income and reflected in your business accounts in accordance with applicable accounting standards.

1.2 When the redress payment is taxable

The redress payment is taxable in the year in which it’s recognised in the business’s profit and loss account (this will usually be when it’s paid by the bank). Although you may have deducted the costs in earlier years you didn’t become entitled to the redress payment until the year in which your bank agreed to pay it, so it isn’t taxable until then.

1.3 The bank has paid the redress payment in instalments

In this case the redress payment remains taxable in the year in which it’s recognised in the profit and loss account. If part is paid in one year and part in a later year, then the tax treatment should follow the accounting treatment.

1.4 Why the redress payments are taxable if the business has ceased to trade

If the receipt arises from the carrying-on of the business or trade before it ceased - which will usually be the case - and the trader was subject to formal insolvency action (such as a voluntary arrangement, personal bankruptcy or trust deed) then the redress payments amount to a pre-insolvency business income receipt taxable as such under normal accounting rules. The tax liability would constitute a pre-insolvency debt recoverable by HM Revenue and Customs (HMRC) by the submission of a proof of debt in the relevant insolvency.

If the business ceased without being subject to any formal insolvency action then the rules for post-cessation receipts will apply (see Chapter 18 of Part 2, Income Tax (Trading and Other Income) Act 2005. The person liable for any tax will be the person receiving or entitled to receive the payment.

1.5 The payment is taxable despite arising the bank’s misconduct

The tax treatment of the payment is determined by its nature in your business, and isn’t affected by its treatment in the hands of the bank as payer. IRHPs were sold in connection with loans taken out for the purposes of your business. The payments under the products were deducted for tax purposes in drawing up your accounts, and the compensation aims to ‘fill the hole’ in the profits which the business suffered, so the compensation is a taxable business receipt.

1.6 The tax treatment for IRHP Redress differ from that for Personal Protection Insurance (PPI) mis-selling

The redress payments are taxable because they arise from your trading operations, and so will be a business receipt. Although redress payments paid to individuals for PPI is in many cases not taxable, this is because those payments were made to individuals in their personal capacity. HMRC’s position is that the distinction is quite clear – IRHP redress payments are made to people in their business capacity so the payments represent business income.

1.7 Tax should be deducted only on the interest element in the redress paid to individuals

For individuals, tax should have been deducted from the interest element of the payment only. This is because rules introduced with effect from 1st October 2013 require banks to deduct income tax from payments of interest to individuals in respect of compensation (see section 874 of Income Tax Act 2007). The tax that has been deducted by the bank can be set against your tax liability for the year in which you receive the payment. No deduction of tax should be made if the payment is to a company.

1.8 This is a capital receipt and so should not be subject to income tax

The sum is a trading receipt, since these payments are being made to compensate businesses for recurring costs associated with business loans. Those costs were generally treated not as capital costs but as revenue costs, deductible in the business’s profit and loss account. The redress payments are made to put the business back in the position it would have been in had the product not been mis-sold and so are taxable as trading rather than capital receipts.

1.9 This receipt falls within Extra Statutory Concession (ESC) D33

First of all, a sum is only taxed under the regime for chargeable gains if it isn’t first taxable as income (see section 37(1) TCGA 1992) and these sums are of an income nature.

In the unlikely event that the sum in question was subject to the capital gains regime, paragraph 11 of ESC D33 would only apply if it wasn’t possible to identify an asset underlying the payment.

1.10 Where the loan was taken out in a personal rather than a business capacity

Our understanding is that the banks entered into IRHP contracts with business rather than personal customers. It would therefore be exceptional for the redress payment to be a personal rather than a business receipt. Provided you can establish that the loan and associated IRHP were taken out by you in a personal capacity, HMRC would agree that redress paid to you in a personal capacity would be a non-business receipt. In such a case, however, the payment itself may still fall within the chargeable gains regime. The interest element of the payment would still be taxable in your hands.

1.11 Where part of the payment is compensation for distress – and how it should be treated

HMRC accepts that there may be exceptional cases where an element of the compensation payment will relate to personal injury or distress. The element of any payment identified by the bank as having been made in compensation for personal injury or distress will not be a business receipt.

2. Companies

2.1 How to treat the payment to the company

In most cases the swap would have been taken out for the purposes of the company’s trade. In this case, the redress payment should be treated as a trading receipt and included in the profits of the company’s trade for tax purposes.

2.2 What to do if the company has ceased trading when the payment is made

If the swap was taken out for the purposes of the company’s trade, but the company has since ceased trading, and was subject to formal insolvency action (such as a winding up, administration order or company voluntary arrangement), then the redress payments amount to a pre-insolvency business income receipt taxable as such under normal accounting rules. Any consequential corporation tax liability would constitute a pre-insolvency debt (see Rules 13.12(1)(b) and 13.12(3) Insolvency Rules 1986) recoverable by HMRC by the submission of a proof of debt in the relevant insolvency.

If the swap was taken out for the purposes of the company’s trade, but the company has since ceased trading and wasn’t subject to any formal insolvency action, then the receipt will normally be a taxable post-cessation receipt in the hands of the person receiving or entitled to receive the payment.

2.3 What to do if the company has been dissolved and the redress payment is paid to one of its creditors

Where a company has been dissolved the post-cessation receipts regime will continue to apply to any redress payments made. The person who receives the redress payment will be taxable on the full amount of the payment. There is no requirement in the legislation that the person who receives the post-cessation receipt is the one who carried on the trade in question.

2.4 What to do if the company is an investment company which doesn’t carry on a trade

Where the company is an investment company, or the swap was otherwise taken out for non-trading purposes, it’s expected that the redress payment would be treated as non-trading income under the derivative contract rules and would be taxable in the company’s hands. However, if the company has ceased to be party to the swap, the redress payment would be taxed as ‘other miscellaneous income’.

2.5 What to do if the IRHP was taken out for a mixture of trade and non-trade purposes

If it can be established that this was the case then the redress payment received on the trading proportion will be taxable as a trading receipt, while the balance will be taxable as non-trading income. Similarly, if the IRHP was for trade purposes for part of its existence and for non-trade purposes for the rest, then the redress payment received relating to the trading part will be taxable as a trading receipt and the balance relating to the non-trade period will be taxable as non-trading income.

2.6 The year in which the redress payment is taxable

The redress is taxable in the accounting period in which it’s recognised in the company accounts.

2.7 The basis on which the interest on the company’s redress payment is taxable

The interest is taxable because it arises from a deemed loan relationship within Part 6 of CTA 2009. The redress payment is a money debt and the interest arises on that debt, and is therefore treated as a taxable loan relationship credit.

2.8 Tax should not be deducted from the interest element of the payment to companies

For companies, the interest will be paid without deduction of tax, so the full amount of the interest will be taxable as a loan relationship credit.

3. General

3.1 How to claim for tax relief to compensate for the fact that the redress payment has pushed me into a higher tax bracket

The tax rules apply to the amount of redress that you receive in the year, and there is no special tax relief if the payment pushes you into a higher tax bracket. However, if you believe your tax bill is higher than it would be because you received tax relief on the costs relating to the IRHP at a lower rate of tax than that applied to the redress payment then this is something to take up with your bank. The advice of the Financial Conduct Authority is that any additional tax you’ve to pay as a result of mis-selling would be a consequential loss. You should receive fair and reasonable redress from your bank, which should put you back in the position you would have been in had there been no regulatory breach.

3.2 What to do if the bank pays a sum to compensate for the additional tax that has already been paid

Any element of the payment that relates to additional tax incurred by you as a result of the compensation being paid to you would not of itself be taxable. This is because when the tax was originally paid it wasn’t deducted as an expense of the trade.

3.3 The tax position for trustees

If the receipt relates to a trade that continues to be carried on by the trustees then the receipt will be taxable under the general principles - see Individuals and Companies. If the trade has ceased then the redress payment will be treated as a taxable post-cessation receipt in the hands of the trustees.

3.4 The tax position for personal representatives

Personal representatives of a deceased estate will also be taxable on the redress payment. It will be treated either as a trading receipt (of a continuing trade) or as a post-cessation receipt, in each case taxable in the hands of the personal representatives acting in that capacity.

3.5 The tax position for partners

Where redress payment is paid to a partnership, the partnership as a trading entity receives the compensation, which is a trade receipt in its hands. Profits are then allocated to the partners in accordance with their profit sharing arrangements. This doesn’t alter the nature of the redress payment as a taxable payment.

3.6 How to enter the redress payment separately on a tax return

HMRC routinely checks tax returns to make sure that they’re correct and complete, and it may be helpful for you to draw attention to the redress payment when you submit your tax return.