Interest: lump sum receipts and compensation
Interest included in compensation or damages
HMRC may sometimes need to consider whether a lump sum awarded to a taxpayer by a court or tribunal as compensation or damages, or a similar sum received under an out-of-court settlement, contains an element of interest. It is essential in such cases to obtain a copy of the court judgement, or any exchange of correspondence surrounding a negotiated settlement, and all other relevant facts and documents, before trying to come to a conclusion.
The case of Westminster Bank Ltd v Riches (28TC159 - see SAIM2060) related to an award of damages. It was held by the House of Lords that interest on the damages, running from the time when the cause of action arose, was ‘interest of money’ - it was compensation for delay in receiving payment. The case established that it is the intrinsic nature of the receipt that is important, not the label attached to it. Lord Simonds said (p196)
“The question in each case is whether the receipt is of an income or capital nature: that is the test for Income Tax purposes, not whether it is called ‘interest’ or ‘damages’.”
But this cuts both ways: a calculation of interest may be used as a means of arriving at the amount of a sum for damages, but what is paid may be wholly a capital sum. The House of Lords, in the Westminster Bank case, offered no criticism of earlier cases, such as CIR v Ballantine (8TC595) and Glenboig Union Fireclay Co Ltd v CIR (12TC427), where amounts computed as interest and even - in the former case - described as interest, were nevertheless held to be capital.
Where an award is made by a court, or compensation is paid by a local authority or similar body (for example, a payment for compulsory purchase), it will in many cases be clear that there is an interest element. There might be a specific statute which directs interest to be paid, or it may be evident from the documents that an amount described as interest does represent compensation for delay in payment.
Lump sums paid under an out-of-court settlement may present more difficult problems, since they almost inevitably represent a compromise between the positions of the parties, and there may be little documentation on how the figure was arrived at. There is case law authority (for example, Perrin v Dickson, 14TC608) for dissecting a lump sum into capital and income elements. However, the question of whether the parties intended any part of the lump sum to represent compensation for delay in payment will be wholly one of fact in any particular case.
Interest on damages for personal injury or death is exempt from tax - see SAIM2330.
See SAIM9115 for changes to the rules on deduction of income tax from interest relating to compensation. The new rules apply to payments made on or after 17 July 2013.