Mark McLaughlin looks at the current tax provisions relating to compensation payable to subpostmasters arising from the Post Office scandal.
Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP is General Editor of the Tax Annuals 2023/24 and co-author of Tax Planning 2022/23.
There has been a public outcry regarding the plight of Post Office sub-postmasters affected by the Post Office scandal (commonly referred to as the ‘Horizon scandal’) since the first screening of a four-part series Mr Bates vs The Post Office on ITV in early January 2024. The series is a dramatisation of the Horizon scandal, a miscarriage of justice that resulted in hundreds of subpostmasters being wrongly accused and prosecuted for theft, false accounting or fraud between 1999 and 2015.
It would have been difficult to miss the furore following the drama series and subsequent media coverage. The Horizon scandal has been labelled the ‘biggest miscarriage of justice of our time’ in Britain. Briefly, ‘Horizon’ refers to the Post Office’s accounting computer software. In 1999, the Post Office commenced rolling out the new Horizon software to its branches and sub-post offices. Almost immediately, some subpostmasters noticed that the new system reported false shortfalls, sometimes for thousands of pounds. The Post Office insisted that the system was robust and, when shortfalls occurred, prosecuted many subpostmasters or forced them to make up the amounts that were incorrectly assumed to have been misappropriated.
As a result of pressure from campaigners and MPs, in 2012 an investigation of Horizon was conducted, which concluded that the system contained faults. However, the Post Office insisted that no systemic faults existed. In 2019, a group of 555 subpostmasters led by Alan Bates won a group legal action in the High Court against the Post Office. The High Court ruled that Horizon contained bugs, errors and defects.
Following this case, the Post Office have been paying compensation to postmasters under several different schemes, depending on how subpostmasters were affected:
The tax implications of compensation payments arising from the Horizon scandal are outlined below. The group legal action in 2019 resulted in an out-of-court settlement with the Post Office. The group that brought the legal action was awarded £57.75 million. Unfortunately, around £46 million was swallowed up in legal costs, leaving compensation of only around £20,000 for each subpostmaster.
Subsequently, the HSS (originally named the ‘Historic Shortfall Scheme’) was established on 1 May 2020, by agreement between the Post Office and the 555 subpostmasters in the group legal action. It was designed to compensate subpostmasters who lost money due to shortfalls caused by Horizon but had not participated in the group action and were not convicted. The HSS is administered by the Post Office (NB at the time of writing, the scheme has reportedly received more than 2,700 eligible applications). In September 2023, the government announced that subpostmasters who have had their convictions based on Horizon evidence overturned would be offered compensation of £600,000 in full and final settlement of their claim.
However, some victims are still fighting to have their convictions overturned and receive compensation. On 10 January 2024, Prime Minister Rishi Sunak announced new legislation to exonerate wrongly convicted subpostmasters and said there would be a "new upfront payment of £75,000 for some of those affected".
In the absence of specific legislation, any compensation awards arising from the Horizon scandal would be taxable receipts in subpostmasters’ hands.
At present, compensation payments under the HSS are liable to income tax (and National Insurance contributions (NICs)). However, in June 2023 the government announced that subpostmasters in the HSS would receive top-up payments to ensure that the compensation amounts they receive are not unduly reduced by tax. The top-up payments are exempt from income tax (as well as NICs, and capital gains tax (CGT); see below).
The various tax reliefs and exemptions in respect of compensation payments arising from the Horizon scandal introduced so far are summarised below.
Tax relief for payments under certain specific schemes not related to the Horizon scandal were introduced in FA 2020, s 102 and Sch 15, together with relief for ‘other compensation payments made by or on behalf of a government, public authority or local authority’. The legislation provides for ‘qualifying payments’ to be exempted from income tax and CGT. The legislation also provides for relief from inheritance tax (IHT) in respect of such payments.
The ‘other compensation payments’ provision allows for qualifying payments to be added by secondary legislation, including in relation to compensation payments arising because of the Horizon scandal.
For income tax purposes, no income tax liability arises in respect of a qualifying payment, and the payment is ignored for all other income tax purposes. For CGT purposes, gains on certain disposals are not chargeable gains (i.e., gains on: disposals resulting from the forfeiture of rights, or from refraining to exercise rights, for a qualifying payment; a disposal of the right to receive all or part of a qualifying payment; or a disposal of an interest in any such right).
The IHT relief is available to subpostmasters or their personal representatives, to whom a qualifying payment has been made. It should be noted that the provision is a relief, not an exemption. It operates by reducing the IHT liability on an individual’s death estate by the lower of the ‘relevant percentage’ (i.e., the 40% IHT ‘death’ rate) of the payment, or the IHT that would otherwise be chargeable on the individual’s death estate.
These regulations extend the income tax and CGT exemptions for qualifying payments in FA 2020, Sch 15 to payments made by the Post Office arising from the OHC scheme where a conviction was quashed because it involved evidence from the Horizon system.
There is also an income tax exemption for compensation payments under the GLO, which were made by the Department for Business, Energy and Industrial Strategy or the Department for Business and Trade to those who were party to the claim.
The IHT relief in FA 2020, Sch 15 is also extended to IHT compensation payments by these regulations (but not to GLO compensation payments).
The regulations came into force on 16 March 2023, but were introduced with retrospective effect from 22 July 2021 and 1 August 2022 in relation to compensation payments under the OHC and GLO respectively.
These regulations (which came into force on 1 August 2023) extend the income tax and CGT exemption for qualifying payments in FA 2020, Sch 15 in respect of top-up payments made by the Post Office to the recipients of HSS compensation payments for the purpose of topping-up that compensation payment to account for sums lost to tax.
A further extension to the list of qualifying payments in FA 2020, Sch 15 was introduced (in SI 2023/1009), with effect from 9 October 2023.
These provisions (which are backdated to 1 May 2020 in relation to HSS compensation payments, and to 1 August 2022 in relation to GLO compensation payments) add compensation payments under the HSS and GLO to the list of qualifying payments for IHT relief purposes.
For subpostmasters who operated through a company, further legislation was published in Finance Bill 2024 (Clause 24) to ensure that tax relief for a relevant compensation payment (in FA 2020, Sch 15) is extended to corporation tax.
A ‘relevant compensation payment’ for these purposes means a payment under the GLO or HSS, as well as under the Suspension Remuneration Review (i.e., a review established by the Post Office to provide redress to postmasters suspended before March 2019 who did not receive remuneration during their suspension period), Post Office Process Review Scheme (i.e., a Post Office review to provide redress to subpostmasters financially impacted by processes or policies in respect of balance discrepancies unrelated to the Horizon system) and any other scheme specified in Treasury regulations that provides for compensation payments by a government, local or other public authority including for the purposes of compensating those affected by the Horizon system.
In addition to the corporation tax exemption for relevant compensation payments, the Finance Bill 2024 provisions include an exemption from income tax and CGT for ‘relevant onward payments’. These broadly arise to the extent that a relevant compensation payment is made to a company, which subsequently makes a payment to a director or employee of the company, or the payment is made to the company’s shareholders, and it is reasonable to conclude that the company’s payment is made to the individual for the purpose of passing all or part of the compensation payment to the individual. However, where the relevant compensation payment to the company was made under the HSS, or under the Suspension Remuneration Review before 1 January 2024, a payment to an individual is only a relevant onward payment to the extent that it was made to top-up the compensation paid to account for sums lost to tax.
The strength of public opinion about the plight of affected subpostmasters could potentially result in further tax measures. Given the unprecedented nature of the Horizon scandal, most people would probably not object to the introduction of a blanket tax exemption (i.e., regardless of the category of compensation scheme) with retrospective effect to when the first settlements were made. This is notwithstanding that the tax cost of such an exemption would effectively be borne by taxpayers out of the public purse.
The long running Horizon scandal saga still has some distance to run; only time will tell what the final tax treatment of compensation payments will look like.
