FSCS payments representing interest

Question proposed, That the clause stand part of the Bill.

I have a quick question. I understand the clause’s intentions; the Minister and I have discussed the Financial Services Compensation Scheme in other arenas on more occasions than I care to remember.

The clause centres on the tax treatment of interest and assumes that a depositor will get back their funds in full from the FSCS, which is the way in which the scheme has operated during the current financial crisis; in effect, the Government have issued an unlimited guarantee where the scheme has been called upon for retail depositors. However, the scheme’s rules, as outlined in the Financial Services Authority’s handbook, actually limit compensation to £50,000. If we return to a more stable financial climate and the £50,000 rule applies, a depositor with a deposit of £60,000 will only get £50,000 back, but will earn some interest on that money from the date that the scheme comes into force, in respect of their institution, and the date that the money is paid to the depositor. Will the interest they receive be treated as compensation, and therefore free of tax, or as interest and be taxable?

This clause deals with one aftermath of the default of a number of banks. Because of these bank failures the Financial Services Compensation Scheme has paid out more than £3 billion of compensation to bank customers. The hon. Gentleman is correct. We have discussed a number of the general principles surrounding this on many occasions. The compensation paid included not only the principal on the accounts but also a sum representing interest that the customers would have received had the bank not defaulted. The sum representing interest is the subject of this clause.

To ensure that customers are in the same position as they would have been in had the bank not defaulted, it is necessary to tax the sum representing interest as if it were interest for tax purposes. Without this clause the  sum representing interest paid by the FSCS would not be taxed in the same way as interest paid by the banks is taxed. This would lead to unfairness between those customers of the defaulted bank whose accounts had been transferred to another bank or building society and those who receive FSCS compensation. The customers whose accounts were transferred would still be taxed on interest received from their new bank or building society but the customers receiving compensation from the FSCS would not be taxed on the sum relating to interest.

The FSCS has rightly calculated the compensation it has paid by taking into account whether or not the customer was a taxpayer. If they were, then it deducted from the amount equivalent to interest, a sum equivalent to income tax, just as tax is deducted from interest paid by the bank. Without this clause non-taxpayers will not be able to claim repayment of the amount deducted by the FSCS, and customers of the defaulted bank, who are liable to higher rate tax, cannot be charged that higher rate tax. That is why the clause is needed.

The hon. Member for Fareham asked whether, if an FSCS payment is less than the original capital, any part of that payment will be treated as interest. Whether the original capital has been repaid is an issue that falls outside the scope of the clause. The amount and nature of the compensation paid by the FSCS is a matter for the rules of the FSCS. He will be well aware of that.

The clause affects the tax treatment of payments made by the FSCS. While the amount of compensation is a matter for the FSCS, where the payment received by the depositor is less than the amount they originally deposited, is it possible to treat the interest payable as being effectively not subject to tax because they have lost so much money? Should not the interest be seen as a form of compensation rather than a receipt to be taxed?

Our aim in the clause is to put depositors back in the situation that they would have been in, had the bank not defaulted. There is obviously a technical definition of compensation and how it applies. It is right to say that when the FSCS pays interest it is taxable, just as interest is. We are simply trying to bring people back to the circumstances that they would have been in. It is for the FSCS to determine the rules of its own compensation scheme and whether there should be a £50,000 limit or a higher one, as the hon. Gentleman understands.

Question put and agreed to.

Clause 33 accordingly ordered to stand part of the Bill.