Welcome clarification on tax treatment of interest arising from the McCloud remedy

On 23 February 2024, HMRC clarified how interest that arises from the McCloud public sector pensions remedy should be taxed. 

The McCloud remedy is a topic that we have already provided extensive commentary on (see here).

Taxation of Interest

HMRC have now confirmed that the first step is to calculate separately the interest on:

• compensation paid under the Public Service Pensions and Judicial Offices Act 2022 (the “2022 Act”); 
• authorised pensions;
• authorised top-up lump sums; and
• unauthorised payments, 

Once this has been done, schemes should, broadly speaking, apply the following principles to calculate the interest connected to each category (before it can be combined into one payment):

• Compensation – under the 2022 Act (this interest will not be taxable). 
• Authorised pensions (i.e. arrears) – broadly speaking, this will be taxable under PAYE. The same principles that apply in relation to guaranteed minimum pensions will apply (see here). 
• Authorised Top-Up Lump Sums – differing tax treatment will apply depending on whether the (a) interest is paid together with the lump sum or separately, and (b) combined amount of the lump sum and interest exceeds the maximum limits for authorised lump sums. 
• Unauthorised payments – “interest on unauthorised payments is itself an unauthorised payment”, meaning that interest will be subject to taxation under the unauthorised payments tax regime and should therefore  be reported to HMRC under the usual processes.

The above highlights that the tax treatment of interest relating to the public service pensions remedy depends on the reason it is being paid. 

Comment 

We view this development as a useful clarification for schemes as to how any interest on McCloud remedies (which is generally set at 8%) is taxed – especially considering the complexity in understanding how historic legislation and more recent legislation interact. 

In particular, it is useful to have confirmation that interest on unauthorised payments is itself an unauthorised payment (resulting in reporting obligations and a potential 40% taxation charge for the recipient). 

This article was co-written by Callum Duckmanton and Hannah Taylor.