Simon Hackett and Edward Hackett v HMRC: Tax treatment of interest rate hedging product mis-selling compensation

The Upper Tribunal has dismissed an appeal by brothers Simon and Edward Hackett against a First-tier Tribunal decision that compensation payments received for mis-sold interest rate hedging products (IRHPs) were chargeable to income tax.

The Hacketts had purchased three IRHPs between 2006 and August 2006 from HSBC and RBS. Following the Financial Conduct Authority's review scheme for mis-sold IRHPs, they received basic redress payments. HMRC issued closure notices amending their tax returns for 2014-15 to include these payments as taxable income. The Hacketts appealed, arguing the compensation was for lost opportunity costs and therefore not taxable.

The appellants' validity argument

The Hacketts advanced a novel ground of appeal, contending that the FTT decision was invalid because it violated formal rules of inference and logic. Their representative, Mr Bowe, argued that if the FTT's findings at paragraphs 35 to 73 were assumed true, then by 'all valid rules of inference' the conclusions at paragraphs 178 to 188 must be false. He characterised this as a question of formal validity rather than substantive soundness.

The Upper Tribunal rejected this approach. Judges Ramshaw and Brannan held that the appeal either involved an Edwards v Bairstow challenge (whether no reasonable tribunal could have reached the conclusion) or an insufficiency of reasons challenge. The tribunal noted that describing a decision as 'invalid' because conclusions and findings cannot both be true is 'in substance, no different from an argument that the true and only reasonable conclusion contradicts the determination'.

Analysis of the compensation scheme

The tribunal conducted a detailed analysis of the FCA's basic redress scheme and HSBC's implementation. The FCA scheme provided three possible outcomes: a full refund for customers who would never have purchased a hedging product; no redress for those who would have chosen the same product; and adjusted redress for those who would have entered an alternative product.

The Hacketts fell into the third category. HSBC determined they would have purchased simpler 'base rate cap' products but for the mis-selling. The compensation was calculated as the difference between payments made under the mis-sold products and what would have been paid under the alternatives.

HSBC's letter stated the redress was 'in full and final settlement of any claim to recover part or all of the payments you made under the interest rate hedging products'. The tribunal found this was a clear indication that basic redress compensated for the liability to make payments arising under the mis-sold IRHP.

The lost opportunity argument

Mr Bowe argued that the compensation was for a lost opportunity to enter into alternative products—a theoretical economic cost not taxable as income. He relied on economic theories that any choice involves opportunity costs, being benefits foregone from alternatives not selected.

The tribunal rejected this analysis. It held that the alternative product was relevant only to calculating quantum, not to identifying what the compensation was for. The basic redress scheme made no reference to compensating for lost opportunities. Rather, it focused on putting customers back in the position they would have been in, calculated by reference to actual payments made under mis-sold products.

The tribunal noted that consequential loss claims under the FCA scheme specifically covered lost opportunity costs, requiring customers to 'demonstrate there were concrete opportunity costs that they were likely to have taken if it had not been for the mis-sale'. This separate treatment indicated that basic redress was not for opportunity costs.

Application of Attwooll principles

Following London & Thames Haven Oil Wharves Ltd v Attwooll, the tribunal addressed two questions. First, what was the compensation paid for? The tribunal concluded it was 'compensation for business expenditure that the Hacketts would not have otherwise incurred but for entering into the mis-sold IRHPs'.

The method of calculation assisted this conclusion. The quantum was determined by reference to payments actually made under the mis-sold products, adjusted to ensure customers were not put in a better position than they would have been. As the FTT stated: 'The compensation was paid for what occurred tempered by the bank's assessment that the Hacketts would have entered into alternative products'.

Second, would the money compensated for have been taxable as income if received? The tribunal had no doubt it would have been. The IRHPs were entered into as part of the property rental business, and the Hacketts had properly deducted payments made under the products against their profits. The compensation was therefore an income receipt chargeable to income tax under the Income Tax (Trading and Other Income) Act 2005.

Procedural matters

The tribunal refused a late application to introduce a new ground of appeal concerning Extra-Statutory Concession D33. The application was made towards the end of the hearing without prior notice to HMRC or the tribunal. Applying the principles from ADM International Sarl v Grain House International SA, the tribunal found the late application caused prejudice to HMRC and was not in accordance with the overriding objective.

The tribunal also dismissed a ground alleging the FTT failed to answer the question raised. Mr Bowe contended the Hacketts had asked whether HMRC's tax assessment was 'logically valid', not what the compensation was paid for. The tribunal held the FTT correctly identified its task under sections 31 and 50 of the Taxes Management Act 1970: to determine whether the appellants were overcharged by the closure notices.

In strong terms, the tribunal criticised Mr Bowe's approach: 'We have not found Mr Bowe's approach at all helpful. The FTT considered that the arguments obfuscate the facts of the case and the task of the Tribunal. We agree.' Much of the confusion arose from failing to understand that opportunity cost is an economic concept not used in accounting principles or when determining tax liabilities from compensation payments.

The tribunal endorsed fully the FTT's conclusions, finding them entirely consistent with its own analysis. The FTT had applied relevant statutory provisions and authorities correctly, and its findings of fact were entirely contrary to a conclusion that compensation was for lost opportunity as argued by the appellants.

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