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Taxing compensation payments

A fairly common question is “If you win a compensation claim, is it taxable?” The answer is “well, it depends”.

Over 73 paragraphs in Wilkinson https://www.bailii.org/uk/cases/UKFTT/TC/2020/TC07861.html the Judge explains that interest rate swap compensation for a property business is taxable as income. Paragraphs 24, 31 and 48(1) explain why. A key point is: what is the compensation replacing (eg business profit) and how would that have been taxed?

In paragraph 39 the Judge notes that the tax position can be described as “simple”, even though the taxpayer arguments are quite complex. Perhaps it is simple, and after victory against a big bank (rightly so) the taxpayer (now wrongly) feels they are on a winning streak and can beat HMRC by having the compensation tax free.

The case is similar to the HMRC victory in Gadhavi https://www.bailii.org/uk/cases/UKFTT/TC/2018/TC06762.pdf which is also an unbinding First Tier Tribunal case. Repeated cases may be a hint that one will head to the higher courts for a binding view, although both cases seem correctly decided.

Not all compensation is taxable. Some is exempt as a matter of policy (TCGA 1992, s51) or may be subject to relief, if used to restore the asset (TCGA 1992, s23) and some is subject to capital gains tax (based on the right to make the claim – but often effectively exempt under ESC D33).

Tax rules may differ for the actual compensation sum and interest paid on that amount.

Compensation offers should be checked, to see what is included, how it is described and any tax treatment noted in the offer. Note that there is a difference between tax formally deducted and the tax treatment taken into account under the Gourley principle but not an actual tax credit.

Tax advice, detailed and in writing, should be taken at the time of the offer and, despite the Judge’s comment in Wilkinson the analysis may not be simple. If there is any doubt the “white space” disclosure in a self-assessment tax return may provide an opportunity to provide protection from penalty risk should HMRC disagree.