BKM208300 - Bank compensation restriction: qualifying company: arm’s length arrangements with profit element

In most cases, an arm’s length arrangement will involve a profit element. By way of illustration, a Treasury company might be expected to make a small profit on its activities and a claims handling company might equally expect to make a small margin on its costs.

As the recharge to the banking company is likely to include a fee for providing a service, at first sight it appears that the disallowed amount will be higher than the actual compensation payments made to customers. However this is not the case as illustrated by the following example.

Example

BCD has two banking companies, B and C. They contract the handling of compensation claims to D, under an arm’s length arrangement where D charges them the cost of handling their respective claims (in year X, £100m and £200m respectively) plus a 5% “handling fee”.

The amount of compensation and interest actually paid to customers by D is £80m and £180m respectively.

At face value, the legislation would appear to deny relief to B and C on the amounts paid to D (being £105m and £210m respectively). However, the companies need to identify which elements of what they pay to D are in fact for compensation to customers, rather than for administrative or other costs. In this case, they are actually only paying £80m and £180m respectively to D for the direct costs of compensation, and it is this which they should disallow. The profit element earned by D is not considered to be a direct cost of compensation, but is more akin to a handling, processing, or administrative cost.

This ensures that banks which choose to process their claims in-house rather than externally are not penalised for this choice.

Administrative costs are picked up through the proxy introduced by CTA09/S133B (see BKM205100), which effectively uplifts compensation costs by 10% to account for administrative costs. B and C would therefore need to include a deemed receipt of £8m and £18m respectively. In the above case, this would result in B being effectively denied a deduction on £88m and C being effectively denied a deduction on £198m.