In the case of Chester Lettings Ltd v HMRC [2026] UKFTT 614 (TC), the FTT has dismissed an appeal against a closure notice charging corporation tax on a compensation payment made in respect of the mis-selling of a financial derivative known as an interest rate hedging product (IRHP).
CORPORATION TAX – closure notice issued pursuant to paragraph 32(1A) of Schedule 18 to the Finance Act 1998 – contractual settlement entered into and sum paid for mis-sold Interest Rate Hedging Products (‘IRHPs’) – Financial Conduct Authority’s (‘FCA’) standard basis for compensation under the FCA process – redress payment and interest – whether the basic redress is ‘income’ or ‘capital’ in nature – the nature of the loss for which compensation was paid –the predominant feature or characterisation of the payment– whether the money in respect of which the sum has been paid would have been taxable as an income receipt had it been received – the two stage process set out by Diplock LJ in London & Thames Haven Oil Wharves v Attwooll – whether the payment or interest is chargeable to tax – Appeal dismissed
The company claimed that “where someone has been overcharged under a finance arrangement, and is compensated for the difference between the amount they actually paid and the amount they would have paid had they been sold a more appropriate financial product, this is not ‘income’ but is compensation for a “lost opportunity”, which is a ‘capital’ sum.” The company claimed that these “capital” sums were not taxable under ESC D33. The FTT did not agree, noting that the company’s submissions were “misconceived, and completely miss the mark.”
Despite independently reaching a settlement agreement, the company agreed that the compensation received from the out of court settlement was on all fours with compensation that would have been received under the Financial Conduct Authority’s (FCA) redress scheme. Compensation under this scheme consisted of three elements: a basic redress to compensate the recipient for the difference between the actual payments they had made and the payments they would have made if the the breaches of relevant regulatory requirements had not occurred; interest, being the opportunity cost (loss of profits or interest) of being deprived of the money awarded as basic redress; and consequential losses, which included bank charges and legal expenses. The FTT held that all these elements were chargeable to corporation tax under the loan relationship rules.
“While one can certainly say that the compensation was paid ‘for’ the mis-selling, in Diplock LJ’s two-stage test, this simply establishes the ‘source of the legal right’ which entitles the Appellant to compensation. It does not resolve the issue of the nature of the payment. Consequently, the solution to the ‘first problem’ identified by Diplock LJ, and further explained by Lord Hoffman, is that the compensation was paid for the Appellant’s liability to pay a sum of money which it had to pay because the instruments had been mis-sold to it. The ‘second problem’ is whether the liability in respect of which the compensation is paid was a liability to pay money which was a revenue expense. The answer can only be that it was. The payments were properly deductible from the profits of the business. They were revenue expenses. It follows that the compensation paid by reference to those expenses must be a revenue receipt, and must constitute taxable income in the hands of the Appellant.
Despite the matters urged upon me by Mr Bowe, I am satisfied that while a taxpayer who has paid excessive amounts under a hedging product because they have been sold the wrong hedging product has lost the opportunity of acquiring a more suitable product, the compensation for the excessive payments is in the nature of revenue – for tax purposes – because the payments, when made, were expenses for tax purposes. Put plainly, the payment was not made to compensate for a ‘missed opportunity’ …
… I am satisfied that the costs involved in a mis-sold loan relationship unequivocally arise from that loan relationship, and amount to compensation to remedy those costs arising from it.”
