Tax on interest not received because of early closure penalty

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  • @IanManc so you agree with my post made at 3:10 pm?  
    Reed
  • Olinda99
    Olinda99 Posts: 1,240 Forumite
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    you would treat the penalty as a capital loss for cgt purposes (can be carried forward)
  • IanManc
    IanManc Posts: 2,079 Forumite
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    Suppose you have an account that pays interest annually on 1st November but is subject to a 6 month interest penalty for early closure.  It almost looks as if:
    1. You close your account on 31st October.  You pay tax on half a year's worth of interest credited to your account on closure
    2. You close your account on 2nd November.  A full year's interest was credited to your account the previous day.  You lose half of that as a penalty but, if what others say is true, you are taxed on all of it.
    This seems grossly unfair but if you are taxed on interest when it arises and penalties are not tax deductible then this is what would happen.
    In answer to your question, you are still under the misapprehension that there is an "interest penalty" and that you are paid interest and then "you lose half of that as a penalty". Neither is true.

    You are paid interest. It is taxable.

    You suffer a penalty for early withdrawal which is equivalent to X number of days interest. That is how the penalty is calculated. It doesn't reduce the interest you have been paid.

    Has the penny dropped yet?
  • IanManc
    IanManc Posts: 2,079 Forumite
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    Olinda99 said:
    you would treat the penalty as a capital loss for cgt purposes (can be carried forward)
    No you wouldn't. There isn't a loss arising on the disposal of a capital asset here that you can set against CGT.
  • ColdIron
    ColdIron Posts: 9,000 Forumite
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    edited 13 November 2023 at 4:54PM
    Olinda99 said:
    you would treat the penalty as a capital loss for cgt purposes (can be carried forward)
    I think you have to dispose or change an asset class for CGT. E.g sell shares or property for cash etc. Cash for cash is neither
  • IanManc said:
    Suppose you have an account that pays interest annually on 1st November but is subject to a 6 month interest penalty for early closure.  It almost looks as if:
    1. You close your account on 31st October.  You pay tax on half a year's worth of interest credited to your account on closure
    2. You close your account on 2nd November.  A full year's interest was credited to your account the previous day.  You lose half of that as a penalty but, if what others say is true, you are taxed on all of it.
    This seems grossly unfair but if you are taxed on interest when it arises and penalties are not tax deductible then this is what would happen.
    In answer to your question, you are still under the misapprehension that there is an "interest penalty" and that you are paid interest and then "you lose half of that as a penalty". Neither is true.

    You are paid interest. It is taxable.

    You suffer a penalty for early withdrawal which is equivalent to X number of days interest. That is how the penalty is calculated. It doesn't reduce the interest you have been paid.

    Has the penny dropped yet?
    Penny still in the air.  I understand what you are confidently asserting but I'm still finding it hard to believe.  The nearest worked example I could find is here: https://www.gov.uk/hmrc-internal-manuals/savings-and-investment-manual/saim2440

    Example 2
    Sam entered into a five year fixed-term bond on 6 April 2017. The bond credits interest to Sam’s account annually on the 31 December. Sam can only gain access to both the annual interest and the principal in advance of 5 April 2022 if a penalty is paid for early access.
    Since the terms and conditions of the bond allow Sam to draw on the funds, although with a penalty, the interest arises and is taxable each year as it is credited.
    If the terms and conditions of the bond did not allow access until maturity, the interest would arise and be taxed at that point.  

    This was an ideal opportunity to mention how the penalty is treated for tax purposes, but they don't.

    Reed
  • eskbanker
    eskbanker Posts: 30,859 Forumite
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    edited 13 November 2023 at 5:15PM
    Suppose you have an account that pays interest annually on 1st November but is subject to a 6 month interest penalty for early closure.
    If you feel that such accounts exist (that penalise early access via an 'interest penalty'), can you post some links to them, as the standard is very much that the penalty is a charge equivalent to a specified amount of interest....
  • I have found the same debate here: https://www.accountingweb.co.uk/any-answers/bank-interest-and-tax-deducted

    The issue is not resolved but Ernest N Dever thinks that, in effect, the penalty is tax deductible.
    Reed
  • eskbanker
    eskbanker Posts: 30,859 Forumite
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    I have found the same debate here: https://www.accountingweb.co.uk/any-answers/bank-interest-and-tax-deducted

    The issue is not resolved but Ernest N Dever thinks that, in effect, the penalty is tax deductible.
    But that's based on the same false premise, in that the start of that thread posited that: "He withdrew some money before the end of the term and lost some interest."

    That's not what actually happens in the real world, so further hypothesising about that is invalid....
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