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The Chancellor has introduced a measure affecting individuals who have received or will receive compensation from the Financial Services Compensation Scheme because of the default of a financial institution, such as a bank, where the compensation includes a payment in respect of accrued interest.
Compensation paid by the FSCS to the customers of defaulting institutions has included an amount representing accrued interest from the last date interest was paid to the customer by the institution to the date that it defaulted (or for a fixed term deposit to the date of maturity if this is later than the date of default).
Income tax-payers will be charged to income tax on the amount representing accrued interest paid by the FSCS to them as part of the compensation.
Legislation will be introduced in Finance Bill 2009 to ensure that customers are in the same position as if the accrued interest were paid by the defaulting financial institution.
The measure applies to payments made by the FSCS on or after 6 October 2008.
Part of the compensation payment is described as interest by the FSCS and calculated as if the tax deduction rules on interest apply.
However, the legal nature of this part of the compensation paid by the FSCS is unclear and, without legislation treating this payment as interest for income tax purposes, the normal tax rules cannot apply.
Two new pieces of legislation have therefore been introduced. The first, ITTOIA 2005, new s 380A, brings payments made by the FSCS that represent accrued interest within the charge to income tax.
Where the FSCS has calculated the amount representing accrued interest as if it were subject to deduction of tax, the amount brought into charge is the total of the amount representing the accrued interest plus the amount calculated as if it were the tax deducted.
The second new piece of legislation is ITA 2007, s 979A which applies where the FSCS has calculated the amount representing accrued interest as if tax had been deducted from it.
The amount treated as if it were the tax deducted is taken into account under TMA 1970, s 59B in determining the amount of income tax payable on the accrued interest.
This ensures that non-taxpayers can make a repayment claim, or that the amount of notional tax deducted can be treated as if it were basic rate tax when calculating any liability to higher rate tax on the accrued interest.
