The tax rules for compensation payments are inconsistent and, in the context of pensions, fundamentally flawed, commentators believe. Without change, there is a risk they will be exploited by claims management companies, and ordinary taxpayers may be left to pick up the tab. For Isas, a compensation payment for an investment can be made to the account as a “defaulted investment subscription”.
Money can be paid back into the Isa and not use any of the investor’s annual subscription limit. However, compensation in relation to a service or advice provided to a member of a pension is – in the eyes of HM Revenue & Customs – personally due to that member. This means if compensation in relation to advice upon or investments held within a Sipp is made back to a Sipp – for example, to put the fund back in the position it should be – HMRC says we must treat it as a tax-relievable contribution.
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 will also cause the loss of any enhanced or fixed lifetime allowance protection that might be held.