Tax on interest not received because of early closure penalty

masonic

Reed_Richards said:

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.

Reed_Richards

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_Richards

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?  

eskbanker

Reed_Richards said:

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

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.

ColdIron

But as you have detailed in your own post, you have not paid tax on money you never received

It's a penalty taken from capital

eskbanker

talexuser said:

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.

But you did receive that interest income (added to your capital), even though an amount equivalent to some (or even all) of it was then used to pay the stated penalty, so basically Coventry BS, FOS and HMRC are all on the same page as most on this thread but you're aligning with OP?

ColdIron

talexuser said:
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

You (or they) are not bound by natural justice (what ever that is) you are bound by the terms and conditions of the contract you entered into

I should not be paying tax on an amount I never received.

You did receive it. I am sure that if you calculate the interest paid you would agree that it is correct to the penny. Your issue is not the amount of interest received but the mechanism of the penalty

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 

The mechanism of the penalty was to deduct it from the capital so clearly you had received full interest

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.

Correct. This applies to every contract. If you choose to ignore the terms of the contract you own the consequences of that inaction

Just before you submitted your application you would have confirmed that you had read and understood the T&Cs

You had not

This is clearly a case of caveat emptor

• The principle that the buyer alone is responsible for checking the quality and suitability of goods before a purchase is made.

jimjames

eskbanker said:

talexuser said:

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.

But you did receive that interest income (added to your capital), even though an amount equivalent to some (or even all) of it was then used to pay the stated penalty, so basically Coventry BS, FOS and HMRC are all on the same page as most on this thread but you're aligning with OP?

Difficulty is that if you have £10,000 in account, earn £500 interest but then incur a £250 penalty so receive £10250 when you close it.

You don't know that the £10250 is actually made up of £500 interest plus £9750 of capital where the £250 has been deducted. To the person receiving they might (and as per OP do think) that the payment is £10000 plus £250 interest.

eskbanker

jimjames said:

eskbanker said:

talexuser said:

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.

But you did receive that interest income (added to your capital), even though an amount equivalent to some (or even all) of it was then used to pay the stated penalty, so basically Coventry BS, FOS and HMRC are all on the same page as most on this thread but you're aligning with OP?

Difficulty is that if you have £10,000 in account, earn £500 interest but then incur a £250 penalty so receive £10250 when you close it.

You don't know that the £10250 is actually made up of £500 interest plus £9750 of capital where the £250 has been deducted. To the person receiving they might (and as per OP do think) that the payment is £10000 plus £250 interest.

I agree that it's incumbent on providers to make available clear closure statements illustrating both interest paid and penalty deducted, as two separate transactions....