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Compensation payment was taxable | accountingweb
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Taxpayers didn’t bank on redress being taxable

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Two businessmen who failed to report the compensation payment they received from Barclays, lost their appeal after claiming they were prevented from obtaining proper advice.

21st Mar 2023
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In 2007, two shareholders, David Fox and Ian Barnett, took a loan from Barclays Bank to acquire a property to be used by their company, which conducted a telecoms business.

Between exchange and completion of that property transaction, Barclays encouraged them to enter into a swap relating to the interest rate on the loan.

By 2009, the relationship between Fox, Barnett and Barclays had declined, and the shareholders complained to Barclays about their treatment. In July 2012, Teacher Stern LLP, solicitors for the taxpayers, issued a pre-action letter to Barclays.

In August 2012, Fox and Barnett were invited to put their proceedings against Barclays on hold and participate in the independent review process regarding interest rate hedging product (IRHP) mis-selling. The taxpayers agreed and in May 2014, Barclays made an offer of £443,592.69, which they accepted. This figure comprised a redress payment (a sum of basic redress and applicable consequential losses) as well as compensatory interest thereon.

Fox and Barnett received the funds, after deduction of income tax from the interest element of the redress payment, during the 2014/15 tax year. While they reported the interest payments on their 2014/15 tax returns, they did not report the redress payment.

In August 2016, HMRC enquired into both returns and issued closure notices in October 2017, charging all the amounts listed as “basic redress” to income tax. HMRC also issued associated penalties for inaccuracies in those returns.

The taxpayers appealed against both the closure notices and the penalties [TC08704].

The litigation argument

The parties agreed that if the basic redress amount (which was £371,669.18) was to be treated as a payment to refund of all the amounts that would not have been paid by the taxpayers had they not entered into the mis-sold swap, then it was subject to income tax and should have been included on their self assessment returns.

However, the taxpayers advanced the argument that part of the basic redress was compensation for something other than the taxpayers’ liability to pay sums to Barclays under the swap, in other words that the settlement under the redress scheme was a settlement of a potential claim under litigation.

While there was no dispute regarding the principles of the chargeability of the redress payments as decided in Gadhavi vs HMRC [2018] UKFTT 600 (TC) and Wilkinson vs HMRC [2020] UKFTT 362 (TC), counsel for Fox and Barnett argued that the facts of this appeal were distinguishable from Wilkinson in particular, because the taxpayers had started litigation against Barclays, whereas there was none commenced or threatened in Wilkinson. 

The FTT accepted there was evidence of an increasingly poor relationship between Fox and Barnett on the one hand and Barclays on the other that, by 2012, had reached the point of pursuing a claim against Barclays in civil litigation. 

However, when Fox and Barnett decided to enter into the redress arrangement, the FTT noted that the taxpayers put that civil claim on hold. Both men knew that by accepting the redress offer, they were drawing a line under the civil claim option.

Dispute over legal fees

Another issue raised during this appeal was one concerning professional advice. Fox and Barnett argued that they had been excluded from obtaining professional advice regarding their redress scheme, pointing to the fact that their claim for legal fees of some £24,000 was refused, as the bank did not consider professional advice to be a necessary consequence of the mis-sale of an IRHP. Fox and Barnett argued that if they had received the relevant advice, they would have structured the settlement differently.

The FTT did not accept that argument; the taxpayers were not prevented from obtaining proper advice. While the redress scheme declined to refund legal and accounting fees, the FTT commented that taking a general position that professional advice is not necessary was not the same as preventing or excluding it.

Further, whether Fox and Barnett would have taken a different approach if they had received advice at the time on the tax treatment of their redress payments was speculation. They did not seek tax advice and they accepted the redress offer that was presented to them in its entirety.

As a result, the FTT found that the payment of the basic redress amount of £371,669.18 was to refund all the amounts that would not have been paid by the taxpayers had they not entered into the mis-sold swap.

The closure notices were upheld.

Penalties for inaccuracies

Turning to the penalties for inaccuracies, the FTT considered whether Fox and Barnett had taken reasonable care in completing and submitting their tax returns. 

The taxpayers argued they had a genuine belief that the tax to pay on the settlement had already been paid by deduction, as nothing in the redress scheme process alerted them to the need to include the redress payment in their returns.

They also argued that it would be unfair for them to be penalised for not taking advice on what to include in their returns, when they were (in their belief) precluded from doing so by the nature of the offer made under the redress scheme.

The FTT had already concluded that the taxpayers were not precluded from taking advice on the tax treatment of the redress payments.

Further, the FTT noted that Fox and Barnett were experienced businessmen. It was not reasonable for them to conclude that the footnote provided in the redress offer suggested that all tax had been paid on the whole sum received under the redress scheme, as that footnote only referred to the deduction of tax from interest.

Given that Fox and Barnett had used professional advisers to complete their returns, and had provided their accountants with the details of the interest paid to them (and tax deducted thereon), they had been unreasonable in not telling their accountants about the redress element of the payment.

As the taxpayers had not taken reasonable care, the FTT found that the penalties for the inaccuracies in their returns had been validly imposed.

The appeal was dismissed.

Replies (6)

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By Hugo Fair
21st Mar 2023 22:42

Showing just how naïve I can be, I thought the very definition of a "compensation payment" was that it put you back in the position you were in before the 'bad act' for which you are being compensated ... in which case none of it constitutes income (for something you've done), let alone a gain?
In which case, why is it taxable?

And I certainly have some sympathy for the supposition that IF it is taxable, then that should have been taken into account when calculating the amount of redress to be paid out.

Thanks (2)
Replying to Hugo Fair:
Donald MacKenzie
By Donald MacKenzie
22nd Mar 2023 10:08

The compensation is taxable because it reimburses expenditure that was tax deductable.
Eg
Would have made profit of £150k but bad bank charged extra £60k
Taxed on £90k profits
Later paid £60k compensation
Now back in position if had made £150k profits, so tax payable on compensation

Thanks (8)
Replying to Donald MacKenzie:
avatar
By Hugo Fair
22nd Mar 2023 12:49

Thanks ... helpful and makes sense (the two don't always go together)!

Basically it's probably easier not to think of compensation in it's colloquial sense, but as late payment of an amount previously written-off as a bad debt?

Thanks (1)
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By petestar1969
22nd Mar 2023 10:14

Does this mean that anyone who claimed compensation for mis-sold PPI should have paid tax on it?

Thanks (0)
Replying to petestar1969:
By Husbandofstinky
22nd Mar 2023 13:16

If PPI was claimed as a business expense, then yes I would.

However, I would not have deemed it as allowable in the first place, then no.

Possible policy check as the above is a bit of a generalistion for the average Joe Public (personal rather than business)

Thanks (0)
Replying to Husbandofstinky:
By Nick Graves
22nd Mar 2023 13:28

Yes, one must be a bit careful with that one.

I've noted cases where the PPI was built-into the loan repayments (even when the client ticked the box to say 'no' because it was a S/E loan!) and in that case (after the client went nuclear at the bank) the refund (it was clearly a refund of premium) had to be declared.

Thanks (1)