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HMRC internal manual

Savings and Investment Manual

Interest: financial mis-selling: further examples

Further examples of compensation for financial mis-selling

Example 3

Jennifer incurred charges on her current account of £60 after her bank mistakenly paid a £500 direct debit twice. After an investigation the bank credited to Jennifer the second direct debt payment and the bank charges she incurred because the mistake meant she had been overdrawn. The bank also paid Jennifer interest of £45 on the incorrect debit and the £60 charges.

The £45 interest is taxable and, because Jennifer’s current account pays interest as part of its normal terms and conditions, the bank will deduct tax from the £45 interest on payment.

Example 4

Kevin had £5000 savings in an account paying 0.5% interest. He instructed his bank to transfer the money into an account paying interest of 2.5% in January 2012. The bank lost the instruction and did not move the money until May 2012. As compensation the bank paid Kevin the difference between the 0.5% interest and 2.5% interest for the period from January to May.

The interest paid by the bank is interest on his deposit and so tax will be deducted by the bank when the interest is paid, unless Kevin is a non-taxpayer and has completed form R85.

Example 5

Linda had £5000 to invest and her Independent Financial Adviser (IFA) recommended she place the money in a Personal Investment Plan (PIP) which provided some life cover with a view to keeping her money in the PIP for at least five years. Linda invested in the PIP in March 2011 but she only wanted to invest for two years. In March 2013 Linda tried to withdraw her money from the PIP and it was agreed that the PIP was not the right product for her.

At March 2013 the value of Linda’s investment in the PIP was £5100 and this amount was taken out and invested in an ISA bond. The IFA paid compensation calculated as the shortfall between the return on the PIP and the return on the ISA bond in which she would have invested.

If the PIP is not a life assurance policy then the compensation calculated as the shortfall is not taxable, nor will any return on the ISA bond be taxable because it is exempt.

If the PIP is a life assurance policy, and assuming there have been no previous withdrawals, the £100 growth in the PIP will be treated as a chargeable event gain and liable to income tax under the special regime for life insurance policies. If Linda is, or becomes as a result of this gain, a higher or additional rate taxpayer then she will need to include the gain in her self assessment return.

If Linda was required to surrender the policy, the compensation paid by the IFA would be added to the amount withdrawn from the PIP (and transferred to the ISA) in order to calculate the amount of any chargeable event gain liable to tax. If Linda did not have to surrender the policy but chose to do so anyway, the amount of the compensation would not be included in the calculation of any gain. In such a case there may still be impacts for capital gains tax purposes, in line with the principles set out in Redress Type 1 of the Insurance Policyholder Taxation Manual (IPTM2060).