Tax sting on PPI claims

Question.

I have received a cheque from my bank for being mis-sold PPI on a number of loans over a long number of years. I am delighted and surprised by the amount I have received. Do I have to complete a tax return to notify HMRC of the refund I have received?

Answer.

The tax due will depend on the different components making up your cheque. Typically, it will consist of:

1. A refund of the PPI premiums themselves
2. Historic interest (interest paid on the PPI premium because it was added to a loan or credit card)
3. Simple interest at a rate of 8% per annum

The simple interest is to compensate you for being deprived during the term of the PPI policy and is taxable – like any normal bank interest is. While the principle is to return you to the position you would have been in if you had never taken out the policy, the 8% interest is taxable and must be declared to HMRC or included in a self-assessment tax return. The bank may deduct basic rate income tax of 20% before paying you the simple interest. As a result, if once you include the interest in the calculation of your total income you are still a basic rate taxpayer, you should not need to complete a tax return nor have any additional tax to pay on it.

Interest up to £1,000 (£500 for higher rate taxpayers) may be tax-free if it is covered by the personal savings allowance. If you think tax has been incorrectly deducted from your interest, you may be able to get a tax refund.

If the simple interest is not taxed and exceeds £10,000 or if you are not a basic rate taxpayer, then there could be tax implications and you should confirm with HM Revenue & Customs whether they require a tax return from you. Conversely, if your income is under the personal allowance, you may be due a tax refund.

PPI interest is a potential trap for the unwary at tax return deadline time as HMRC is very likely to have the information on who has received repayments and interest. Banks pass HMRC information on all interest paid on normal accounts. Given the number of claims being paid out and the accompanying interest, HMRC would be failing to collect tax on a major scale if it did not seek out the relevant information and match it to tax returns.

In practical terms, omitting PPI interest payments from the return by accident or design carries a risk that is not worth the repercussions. HMRC could open an aspect enquiry on one thing they know is wrong on a return is wrong, but use it as justification for opening a full enquiry which could go on for a number of years.

The advice above is specific to the facts surrounding the questions posed. Neither FPM nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.