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HMRC internal manual

Savings and Investment Manual

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Deduction of tax: yearly interest: interest relating to compensation payments

Deduction of income tax from interest relating to compensation

Finance Act 2013 amended the legislation in ITA07/S874 by inserting new rules on the deduction of income tax from interest relating to compensation. ITA07/S874(5A) provides that interest that is payable to an individual in respect of compensation is to be treated as a payment of yearly interest. As a consequence, the person paying the interest will be required to deduct income tax at source from it. This is subject to a regulation-making power to allow this requirement to be disapplied if necessary.

The legislation applies to interest paid on any form of compensation. A common example is likely to be interest relating to compensation paid for financial mis-selling, in particular compensation paid by banks, building societies and other financial institutions (SAIM9116).

The legislation does not change the character of a compensation payment or deem such a payment to be interest where, on first principles it is not. HMRC’s approach to this is explained in more detail at SAIM2070. Note in particular the guidance on interest on compensation for payment protection insurance (PPI) at SAIM2105.

The changes do not, for example, affect the treatment of the compensation element in Periodical Payment Orders for personal injuries, which is exempt by virtue of ITTOIA05/S751 (SAIM2330).

However, it does mean that income tax is deductible from interest relating to compensation regardless of whether that interest is ‘short’ or ‘yearly’.

See SAIM9116 for the commencement provisions for the legislation.