Will I have to pay tax on my injury compensation?

In most cases, you do not have to pay tax on personal injury compensation, but there are a few exceptions. While specific legislation protects compensation awards from taxes like Capital Gains Tax (CGT), interest accrued on these payments can sometimes be taxable.

This article clears up any confusion around the tax situation for personal injury claimants, explaining when you might need to pay and how different scenarios, such as delayed payments or investing your award, could impact your tax obligations

Claimants do not pay tax on injury compensation

If you receive financial compensation following an injury, specific legislation ensures that you will not have to pay Capital Gains Tax (CGT), or any other tax on the award (sce. gov.uk). This is the case whether a compensation settlement is received as a lump sum or in staggered payments.

Whether the compensation is awarded by the court, or as an out-of-court settlement, you will be exempt from paying tax.

So why the confusion?

In 2014, HMRC revised its rules so that certain types of compensation became taxable.

Press reports suggesting that claimants have to pay tax on certain types of compensation created anxiety for people pursuing an injury claim. Many claimants were concerned that compensation calculated to meet treatment costs could be depleted after tax deductions.

The main focus of the reports in the media was compensation paid out for mis-sold payment protection insurance (PPI) on credit cards, loans, and other lending products. Successful claimants who received compensation for lost interest, in addition to the original PPI premiums, would have to pay tax on the interest component of their compensation.

As no tax was deducted at source, claimants would have to declare the compensation for lost interest as income on their tax returns.

Any interest received on your personal injury compensation may be taxable

Interest may be added to your compensation award. Interest would be calculated from the date of your accident or injury to the date of settlement of your claim (sce. gov.uk).

In most cases, tax will be deducted by the party (usually the defendant or their insurance company) paying the interest. Even if the tax is deducted before you receive the payment, you will still have to declare it to HMRC.

For example:

A claimant sustained an injury on 1 January 2013 and their claim settled on 14 July 2014.

An award of £20,650 was made, comprising of £20,000 for damages and £650 for interest lost between 1 January 2013 and 14 July 2014.

In this example, income tax would be payable on the £650 as the interest represents the amount that the claimant would have accrued had the £20,000 been paid on the day of the injury up until the date of settlement.

Some tax on interest may be payable if payment is further delayed.

Even though a claim has been settled and an amount awarded, there may still be delays before you receive your compensation being paid to the claimant.

Any interest that the payer adds to the compensation because of a delay in payment is taxable because the interest is likely to be paid gross (no tax deducted). It should, therefore, be declared on any tax return.

For example;

A claimant was awarded £20,650 on 14 July 2014, but the payment was not made until 14 January 2015.

In this case, a further £206.50 was added to represent the six months' interest. The £206.50 is the amount to declare on the tax return.

What if I invest my compensation award and earn interest on it?

If you invest your damages award, any interest generated would be liable for tax. This is usually taxed at source for basic rate taxpayers but would need to be declared on a self-assessment return or to HMRC.

See also:

No Win, No Fee injury claims

Why do all injury solicitors charge the same 25% success fee?

How will a personal injury claim affect my benefits?

How much does it cost to make a personal injury claim?

Should I set up a personal injury trust? Pros and cons

Can I get legal aid for a personal injury claim?

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Author:
Howard Willis, Personal injury solicitor

About the author

Howard Willis qualified as a solicitor in 1984 and has specialised in personal injury for over 25 years. He is a member of the Association of Personal Injury Lawyers (APIL) and is a recognised Law Society Personal Injury Panel expert.