Confusion over PPI compensation and tax liability

Individuals receiving compensation for mis-sold payment protection insurance (PPI) are unaware they may be liable to pay tax on awarded payments, after HMRC clarified its position on PPI and taxation.

HMRC confirmed that while no tax is due on the repayment element of PPI compensation, tax is however due on the additional interest.

PPI was designed to cover loan repayments, including mortgages and credit cards, should the policy holder fall ill or become unemployed. It has increasingly been revealed it was sold to those ineligible to make a claim and, in many instances, people were unaware that they had actually purchased the discretionary insurance.

Figures from the Financial Services Authority (FSA) show that banks and building societies are estimated to have paid out around £2.1 billion in PPI compensation claims to date.

According to the BBC, the average PPI pay-out is around £3,000, including 'a capital based sum - based on the original PPI premium paid - and interest that would have accrued if the individual still had never made these payments.' Only the latter interest part is taxable.

The clarification has led to some accountancy bodies calling on the Government to withdraw the tax. Speaking to the BBC, Roy-Chowdhury, head of taxation at the ACCA accountancy body, said that the law should be changed and added: "There is huge scope for people to be underpaying tax inadvertently."

HMRC has said that PPI compensation may or may not have had tax deducted by the company, bank or building society making the payment and that an individual's tax position regarding PPI compensation will depend on personal circumstances. In general, it said:

  • Non-taxpayers who have had tax deducted from their PPI compensation may be able to claim for tax to be repaid to them by HMRC.
  • Basic-rate taxpayers who have had tax deducted from their PPI compensation will not have to do anything further, unless they need to complete a tax return.
  • Higher-rate taxpayers who received interest with or without tax deducted, or basic-rate taxpayers who have received interest without tax deduction, should declare the interest to HMRC in the normal way.