Cast your mind back to the days when the news wasn’t full of pandemics and Brexit and you may remember countless adverts encouraging individuals to claim compensation for mis-sold payment protection insurance (PPI).
PPI can be a valuable form of protection, covering loan repayments if the borrower becomes unable to make them through redundancy or illness. In the 20 years to 2010, it was regularly sold in respect of all kinds of borrowing including store cards, car loans and unsecured overdrafts. However, PPI was often mis-sold to those who could never benefit from it such as the self-employed or those who already had a disqualifying medical condition. Other cases which have resulted in compensation pay-outs involved non-disclosure of commission paid by the insurer to the lender and the introducer.
This article looks at the tax consequences for those individuals who have received compensation for mis-sold PPI.
Settlement offers will typically be made up of several elements and we are seeing an increasing number of cases in which taxable items have been overlooked because of the baffling way in which these elements are described. A typical settlement offer would use the following descriptions:
Element 1: Refund of PPI commission/premium
Element 2: Interest on refunded commission
Element 3: Statutory compensation or payment for loss of interest
Element 1, the substantive refund, is not taxable. Element 2, confusingly referred to as “interest” is not, in fact, taxable. This actually represents the extra interest charged over the years if the premium was added to the original borrowing and so is simply a refund of monies which the borrower has incorrectly paid.
It is item 3 which is taxable, being the interest lost to the claimant by virtue of not having elements 1 and 2 in their bank account for all those years. This can be a substantial sum because many of these claims go back to the days when interest rates were way higher than they are today. This third element will usually have had income tax deducted at source at a flat rate of 20%. Depending on the claimant’s overall income profile, this tax paid at source may be too little or too much. For example, a higher rate taxpayer will have an additional 20% tax to pay on this interest and so should declare it on their self-assessment tax return. The receipt may in some cases require an individual to register for self-assessment when previously they have not needed to complete an annual tax return.
This “element 3” interest is all taxable in the year it is received, even though it may have accrued over many years.
If you have received a PPI settlement in recent years and are concerned that you may not have paid the correct amount of tax on the interest element, please get in touch. If tax is owed to HMRC, it helps to minimise penalties if you come forward and pay this voluntarily rather than as a result of an HMRC enquiry into your tax return.