Pension compensation and tax.

ASB1960

I am not sure whether this is the best forum, but I will try here first.

As a result of maladministration delaying a pension transfer I am seeking compensation for the difference in value as a result of market movements.

Ideally any amount would be paid to my new provider, however this is probably not possible as it was crystallised funds that were transferred.

How will a lump sum payment (possibly in the region of 15,000) be treated for taxation. Some elements of the compensation will be for inconvenience and the loss of a mortgage offer.

https://www.gov.uk/hmrc-internal-manuals/savings-and-investment-manual/saim2070

The manual above seems to suggest that it would possibly be non taxable. There is no element of interest, the claim is for the loss of investment growth as a result of the delay.

If it is taxable and is treated as a pension payment that is a big problem for me because it will presumably trigger the MPAA 

The ombudsman guidance isn't particularly helpful. Merely saying it is complex with no indications of what thos complexities may be.

Thank you for any guidance.

Albermarle

As a result of maladministration delaying a pension transfer I am seeking compensation for the difference in value as a result of market movements.

Now of course we do not know the details of what happened, who the provider is etc, so difficult to be sure about the likely outcome of any compensation claim. However from what I vaguely remember in past threads on a similar subject, any compensation is likely only to cover a fraction of any perceived losses, and/or just be a good will gesture of some sort.

So possibly worrying about tax implications may be a bit premature.

ASB1960

If it is treated as drawdown income of as much as £0.01 that has forward consequences of a substantial amount of tax due to loss of relief as a result of MPAA being triggered. :-(

Albermarle

ASB1960 said:

If it is treated as drawdown income of as much as £0.01 that has forward consequences of a substantial amount of tax due to loss of relief as a result of MPAA being triggered. :-(

I have had a couple of small goodwill payments, following unacceptable delays. They just sent me a cheque.

Jeremy535897

Some advice here:
"A compensation payment may be due to a pension scheme member because of poor advice, bad administration or a failed or poorly performing investment. The aim of compensation is to put the client back in the position they should have been in, but because of how Her Majesty’s Revenue and Customs (HMRC) view compensation payments, this isn’t always straightforward.

The current guidance from HMRC states that where compensation is awarded to the member and paid into a pension, this payment is deemed to be a third-party contribution, which would attract tax relief. This is because HMRC deem the complainant to be the member and the resulting compensation to be due to the member personally.

Whilst receiving tax relief on top of compensation payments seems advantageous on the surface, this can cause problems for successful complainants, as the payment counts towards their annual allowance (or the tapered or money purchase allowances, where applicable). It could also have Lifetime Allowance implications as a contribution will cause the loss of any enhanced or fixed lifetime allowance protection that might be held.

For pension schemes which apply tax relief at source automatically, the scheme rules will generally state any personal member contributions they receive must be eligible for tax relief. This relies on the member having sufficient UK earnings to allow for the gross contribution amount – not always possible for those with only investment or pension income, or those on lower salaries.

Because of the potential complications providers may request that any compensation payment is paid directly to the member. In other circumstances the rules on which payments can be made from a pension scheme are typically very strict. Yet a compensation payment due to the member in respect of a pension can be paid to the member directly, and it is not an unauthorised payment. Paying the member directly means the funds would then be outside the tax-advantaged pension wrapper, so the member isn’t truly back in the position they should have been in.

It’s clear that clients who have already suffered a loss risk additional poor outcomes because of the treatment of pension compensation payments. It’s also bad for taxpayers in general, as compensation amounts can be subject to a reduction to reflect the fact taxpayer-funded basic rate relief will automatically be reclaimed by a pension provider to uplift the amount that ends up in the scheme."

From https://www.investcentre.co.uk/articles/compensation-payment-complications

It is hard to see how compensation paid directly to a member could be regarded as drawdown, as nothing has left the pension scheme, and it wouldn't be a payment of income.

ASB1960

Sadly that doesn't say much as to taxation. I should be getting a callback from HMRC in due course. My research, and reading of the HMRC savings and gains manuals suggest:-

a) It may be a capital gain. The argument being the asset disposed of was the right to take action. There is a case on this and an extra statutory concession which could apply. This could expose me to CGT that would not otherwise have applied.

b) Ombudsman decision have tended to reduce an award to 85%. This being based on the idea that had it run its course it would have eventually been 25% tax free and 75% taxable. It is not clear whether this is an actual deduction and a certificate provided or purely nominal (ie the payment is tax free in the members hands. If it were not tax free then not accounting for the members marginal rate looks unfair).

c) Some articles similar to that you posted talk about a members marginal tax rate increasing as a result of compensation and a resultant tax bill. This can only occur if it is actual income. This would also be unfair.

I will update after I have heard from HMRC. It may be a curiosity to some. I shall also try the pensions forum.

Jeremy535897

I think this is a difficult question. If you owned a chargeable asset (say shares in a company) personally, and it declined in value due to the negligence of an adviser, and you received compensation, then you would be treated for capital gains tax purposes as if you had received a capital sum derived from the asset, and that would be a capital gain, calculated according to the detailed rules.

This is not what happens, though. If the pension scheme itself is restored to where it should have been, in which case you have received nothing, as the pension scheme is exempt from capital gains tax and income tax on interest, there can be no tax liability.

If you personally receive compensation for a reduction in the size of your pension pot, the pension pot is not a chargeable asset in your hands. You then look to see whether section 51(2) TCGA 1992 exempts the gain. Unfortunately it does not in this case, but that is where ESC D33 can apply. See:
https://www.bkl.co.uk/insights/compensation-damages-income-tax-cgt/
https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg13030

There is no income, unless there was an interest component to the payment.

When an Ombudsman reduces compensation to take account of a potential future tax liability, that is an adjustment of the capital sum to be paid, and not something for which any tax credit is available.

ASB1960

I have also just (maybe prematurely) posted in the pension forum. I will check the links and also comment below.

It seems reasonable that it ought to be non taxable (reason and tax rules seldom align). The basis of this is that the approach taken by the ombudsman tends to reduce the award to account for basic rate tax. If it were further taxable this would reduce the value.

Thanks again.

ASB1960

I got a callback with HMRC. She told me (barring any interest element) it is not taxable.