Tax on interest not received because of early closure penalty

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Comments

  • Reed_Richards said:
    Penny still in the air.  I understand what you are confidently asserting but I'm still finding it hard to believe.
    Per deposit, the penalty value is the same regardless of the gross interest amount received. The penalty is paid from your net capital, so it's not an interest penalty.
  • Reed_Richards
    Reed_Richards Posts: 4,163 Forumite
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    edited 13 November 2023 at 6:32PM
    I understand what I am being told, this is a pure penalty and is not tax deductible (from the interest being paid).  Now prove it; all I want is a good reference that supports these assertions. 

    Edit:  Incidentally, I have tried Googling this but I keep finding US advice where the penalty IS tax deductible, it seems 
    Reed
  • Thank you for all the comments; it has been quite an eye-opener.  It does seem very unfair.  To clarify, it was a fixed rate bond, not an ISA.  I closed it halfway through the year, with the redemption amount being capital plus interest minus the penalty.  The money was transferred to a higher paying account where I will obviously be incurring tax for the next six months' interest.  That means that HMRC are getting tax twice over if I declare the amount that the building society says.
  • IanManc
    IanManc Posts: 2,083 Forumite
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    edited 13 November 2023 at 7:42PM
    I understand what I am being told, this is a pure penalty and is not tax deductible (from the interest being paid).  Now prove it; all I want is a good reference that supports these assertions. 

    Edit:  Incidentally, I have tried Googling this but I keep finding US advice where the penalty IS tax deductible, it seems 
    You are asserting it is tax deductible. You prove it.

    @spider42 has provided you with chapter and verse that it isn't.
  • eskbanker
    eskbanker Posts: 30,995 Forumite
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    Oldhag2 said:
    Thank you for all the comments; it has been quite an eye-opener.  It does seem very unfair.  To clarify, it was a fixed rate bond, not an ISA.  I closed it halfway through the year, with the redemption amount being capital plus interest minus the penalty.  The money was transferred to a higher paying account where I will obviously be incurring tax for the next six months' interest.  That means that HMRC are getting tax twice over if I declare the amount that the building society says.
    HMRC won't be getting tax twice over!

    You'll have been paid interest for every day that the money was in the old account, and not a day more.

    You'll be paid interest for every day that the money is in the new account, and not a day more.

    There won't be any days that the money is earning interest from two accounts.

    Therefore no double-dipping....
  • masonic
    masonic Posts: 23,271 Forumite
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    edited 13 November 2023 at 10:02PM
    I understand what I am being told, this is a pure penalty and is not tax deductible (from the interest being paid).  Now prove it; all I want is a good reference that supports these assertions. 

    Edit:  Incidentally, I have tried Googling this but I keep finding US advice where the penalty IS tax deductible, it seems 
    As proof this is how it works, I submit the OP:
    Oldhag2 said:
    I've just joined MSE and this is my first post.  I am doing my tax return and have seen that a building society (on the end of year statement) showed the interest that I WOULD have received had I not closed the account and paid the early closure loss of interest penalty.  If I declare this number I will end up paying tax on interest that I have not received!  Has anyone experienced this?
    My emphasis and striking out of incorrect terminology. I also submit Dunmore v McGowan (1978), where it was ruled that in set-off situations, interest arises when the recipient benefits from it, even when they had no immediate right of access. In the OP's case the interest was used to set off a penalty that would have been charged whether or not any interest had accrued on the account in question. The BS has complied with HMRC rules on interest declarations and included it in the tax voucher. This is entirely correct and expected.
    Had the OP not earned any interest and been charged the penalty, they would not be entitled to deduct the penalty from their other income. Same goes for other sorts of bank charges, overdraft interest etc. The fact that the interest and penalty were applied to the same account makes no difference.
    That said, there are scenarios in which interest previously accrued would not arise. For example, if you close a First Direct regular saver early, an alternative interest rate is used for the whole period, rather than application of a penalty. This means the interest arising is that which is paid at the alternative rate.
  • I trust @masonic, who knows their stuff so I will accept that they are correct.  I was never confident that I was correct in my opinions, just frustrated that nobody could cite any HMRC guidance one way or the other.  


      
    Reed
  • Incidentally, is the penalty usually calculated forwards or backwards.  For example, if you pay a penalty equivalent to 90 days interest, is that the interest you earned for the previous 90 days or the interest you would have earned for the 90 days after you closed the account?  
    Reed
  • eskbanker
    eskbanker Posts: 30,995 Forumite
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    Incidentally, is the penalty usually calculated forwards or backwards.  For example, if you pay a penalty equivalent to 90 days interest, is that the interest you earned for the previous 90 days or the interest you would have earned for the 90 days after you closed the account?  
    Not sure it's either forwards or backwards as such, I believe it'll just be a straight calculation of 90/365 of the interest rate multiplied by the closing balance, although whether or not that balance is before or after addition of accrued interest isn't immediately obvious to me - maybe that'll depend on the specific Ts & Cs per account.
  • talexuser
    talexuser Posts: 3,499 Forumite
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    I do have the answer and it depends if the penalty was taken from capital. I had a fixed with Coventry Building Soc  which I closed early because calculated the penalty was worth paying to move to a higher payer as rates increased.

    They sent an interest statement showing the full interest without the penalty subtracted, which is what HMRC would eventually see. I went through their complaints procedure on the basis of natural justice I should not be paying tax on an amount I never received. They refused to budge because the penalty was taken from capital so in their eyes I had received full interest, which obviously I had not as a total amount returned. I went through the Financial Ombudsman on the same principle and he came down on the side of the building society saying it was perverse I should pay tax on money I never got but that is the situation, because the terms and conditions stated penalty from capital and it is buyer beware to scan though the reams of small print every time you undertake a contract.

    So if the penalty is interest reduction you are ok, if capital reduction you have been done and a full interest statement will be sent to HMRC. I am self assessment and will enter the amount I actually received and if HMRC want an explanation I will say this is the income I actually got. The difference is only a handful of pounds but I think an important principle is at stake - you should not be forced to pay tax on "theoretical" money you never received.
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