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HMRC internal manual

Savings and Investment Manual

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HM Revenue & Customs
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Deduction of tax: yearly interest: interest relating to compensation payments: amounts paid by financial institutions

Banks and building societies

SAIM9070 explains that there are a number of exemptions from the duty to deduct income tax from yearly interest. These exemptions include yearly interest paid by building societies (ITA07/S875), and by banks in the ordinary course of their business. However, these exemptions do not apply to interest relating to compensation which is treated as yearly interest by ITA07/S874(5A) (SAIM9115), where this is paid on or after 1 September 2013 (for building societies) or 1 October 2013 (for banks). These dates relate to the first return periods for the purposes of the CT61 return beginning on or after the date of Royal Assent for Finance Act 2013.

These payments of interest are not made within the Tax Deduction Scheme for Interest (see SAIM9030), so banks and building societies must deduct tax from this interest even where they hold a completed form R85 for the recipient.

Other financial institutions

Other financial institutions, such as insurers, are not exempt from the requirement to deduct income tax from payments of yearly interest. With effect from payments made on or after 1 October 2013, any interest relating to compensation is treated as yearly interest, and all interest on such payments will accordingly be subject to deduction of tax at source.

In order to determine whether deduction of tax is required it is necessary to analyse the nature of the payment. This does not mean that every payment of interest by such institutions will necessarily require deduction at source. In particular, payments made by insurers to make an immediate correction for administrative errors are unlikely to fall within these rules.

Example 1: interest paid on late annuity payment

An annual annuity of £5200 is paid by an insurer on a monthly basis (£433.33 per month). The payment was missed for one month, and the insurer paid compensation of £12.50 to the customer, reflecting an interest rate of 3% p.a.

The payment is interest but it is not interest relating to a compensation payment. The insurer has merely paid interest on the late annuity payment, and the normal rules for determining whether the interest is ‘yearly’ or ‘short’ will apply. In this case, there is no doubt that the interest is short, and there is no requirement to deduct income tax from it.

Example 2: compensation for capital or income loss

An insurer may operate a ‘platform’ for individuals to ‘self-trade’ within an ISA, SIPP or a Share Account. The platform may receive payments and buy/sell instructions on a daily basis and from time to time administrative errors will occur. Often the insurer will compensate the customer by, for example, making an additional pension contribution or an additional or enhanced annuity payment. Such amounts are not interest and will not be subject to deduction of tax under ITA07/S874(5A). Any interest on such a payment will be subject to deduction at source.