The bank paid you back. One country calls part of it income

Figures relate to tax year 2025-26 (UK) · 2025 (US)

A letter arrives from a bank, a pension provider or an adviser you used years ago. Something was mis-sold, a review has taken place, and money is coming back to you.

The payment is rarely one thing. Part of it returns what you lost, and part compensates you for being without that money in the meantime. Redress payments split into pieces, and the two tax systems treat those pieces differently.

Key takeaways

• The capital part of redress payments is usually not income in either country.
• The interest element added on top is taxable in both.
• Britain often deducts basic rate tax from that interest at source.
• America taxes the interest as ordinary income with a credit for UK tax.
• A payment into a pension is treated differently from cash in hand.
• The letter rarely sets out the split clearly enough to file from.

What is a redress payment?

Redress payments are sums a financial firm pays to put a customer back where they would have been without the problem. According to HMRC guidance, how each element is taxed depends on what it actually replaces rather than what the firm calls it.

Mis-sold policies, poor pension advice and unsuitable investments all produce redress payments.

The ombudsman and the regulator drive many of these schemes.

Which part is actually taxable?

The interest element of redress payments, almost always. The capital element restores your own money and is not income, while the interest compensates you for the time you were without it and behaves exactly like interest from any other source.

Britain generally taxes that interest and often deducts tax before paying you.

America taxes the same interest and gives credit for the British tax.

Why does the split matter so much?

Because reporting the whole payment as income overstates your tax considerably, while reporting none of it understates it. Neither country will accept a figure plucked from the total without the calculation behind it.

The letter is the only evidence of the split you are likely to get.

Keep it with your tax papers rather than filing it away.

A worked example

The figures below are illustrative and use round numbers to show the mechanics.

Claire is American and lives in Edinburgh. She receives £24,000 from a pension provider after a review of advice she took in 2012.

The letter shows £20,000 restoring her loss and £4,000 of interest, with £800 of basic rate tax already deducted from the interest.

Her American return shows roughly $5,000 of interest income, with a credit for the British tax taken. The £20,000 of capital is not income on either side.

How the elements are treated

What about a distress award?

Britain generally does not tax a modest sum paid for distress and inconvenience. America has no matching exclusion unless the payment compensates for physical injury or sickness, so it usually counts as income there.

The amounts are small, which keeps the stakes low.

Note the amount separately so it does not get folded into the interest.

But the divergence is real and worth getting right.

Does a pension redress work differently?

Considerably. Where the firm pays money into your pension to restore the position, nothing reaches your hands and the pension rules take over from that point. That is often the better outcome.

Americans need to think about the pension itself as well.

Check whether the payment counts against your annual allowance as well.

Our guide to employer pension contributions covers the American treatment.

Can you reclaim the tax deducted?

Often, where your allowances cover the interest. Firms deduct basic rate tax by default, and a saver whose personal savings allowance absorbs the amount can reclaim it from HMRC through a repayment claim.

That reclaim reduces the credit available on your American return.

Make the claim and the American return in the same sitting, so the figures agree.

So the two sides have to be worked together rather than separately.

What if the money arrives years late?

You report it in the year you receive it, not the year the problem occurred. A payment covering a decade of loss still lands in a single tax year, which can push your rate up sharply.

Neither country spreads it back across the earlier years.

Check whether spreading the payment across two years is possible before accepting it.

That bunching is the main unfairness people notice.

How to handle a payment

1. Keep the letter setting out how the payment was calculated.
2. Identify the capital element and the interest element separately.
3. Note any tax the firm deducted before paying you.
4. Convert the interest to dollars at the rate on the payment date.
5. Report the interest on both returns and claim the credit.
6. Check whether a repayment claim to HMRC is worth making.
7. Leave the capital element out of income on both sides.

What if the letter gives no breakdown?

Ask the firm for one in writing, because they calculated it that way even if the letter does not show it. Most will provide a breakdown on request within a few weeks.

Filing without it means guessing at a figure you cannot support.

Ask specifically for the capital and interest split in writing.

A written breakdown is worth waiting for.

Does it affect your estimated payments?

It can where the interest is substantial. Money arriving without any American withholding often creates an underpayment charge, even though the British firm already deducted tax from the interest before paying you.

Our guide to estimated tax payments from the UK covers the dates.

One payment in the right quarter usually removes the charge.

What about an investment compensation scheme?

Redress payments from a statutory compensation scheme follow the same logic, splitting between restoring the loss and compensating for the delay. The source of the money does not change the analysis.

Keep the scheme correspondence alongside the payment advice.

Those letters usually set the split out more clearly than a firm would.

Does it change your capital gains position?

It can, where redress payments relate to an investment you still hold or sold at a loss. Compensation for a loss on an asset may need setting against the base cost rather than treating as separate income.

That analysis differs between the two countries.

Flag any payment connected to an asset you owned.

What if the payment goes to a joint account?

The split follows who held the original product rather than whose account received the money. A policy in one name produces income for that person alone, however the bank transfer was addressed.

Joint products split according to the ownership.

Say so in the records if the division is uneven.

Does it matter who sold you the product?

Not for the tax analysis. A bank, an adviser, an insurer or a compensation scheme all produce the same split between capital and interest, and both countries look through to what each part replaces.

The identity of the payer changes nothing.

What matters is what the money is actually for.

How long should you keep the paperwork?

At least six years, and longer where the payment touched an asset you still own. The calculation letter is the only document proving the split, and firms rarely reissue them years afterwards.

Scan it as soon as it arrives.

Paper letters about decade-old products go missing easily.

What if you have moved since the mis-selling?

Your residence when the payment arrives drives the British position, while the American obligation follows your citizenship throughout. Someone who left Britain years ago can still receive a payment taxed here.

Tell the firm your current address and tax position.

A wrong assumption about residence changes what they deduct.

Does an ombudsman award work the same way?

Broadly yes. An award from the ombudsman service splits between restoring the loss and compensating for the delay in exactly the same manner, and the decision letter usually sets the parts out clearly.

Ombudsman decisions tend to be better documented than firm offers.

Keep the decision alongside the payment advice.

What about interest on a late payment?

Interest added because the firm was slow to pay is taxable in the same way as the main interest element. It compensates you for time rather than restoring a loss.

Firms sometimes label it separately on the advice.

Add it to the interest total rather than the capital one.

Is the payment ever a capital gain?

Occasionally, where it relates to an asset rather than to advice. Compensation connected to a specific investment can reduce your base cost or produce a gain instead of ordinary income.

The two countries take different routes to that answer.

Raise it where a holding is involved rather than assuming interest treatment.

Do you need to tell HMRC separately?

Only through your return. The firm reports the interest and the tax deducted to HMRC, so the information arrives without you doing anything extra, but the figures still belong on your self assessment.

A repayment claim is a separate step if you want the tax back.

Our guide to registering for self assessment covers the filing.

Does it affect your account reporting?

It can, because a large payment landing in a British account lifts the balance, and the foreign account reporting looks at the highest figure reached during the year rather than the closing one.

A single payment can push you over the threshold for one year only.

Our guide to FBAR deadlines and penalties covers the test.

What if the firm has gone out of business?

A statutory scheme usually steps in, and the payment follows the same split between capital and interest. The scheme letter generally explains the calculation more clearly than a firm would have done.

Limits apply to how much the scheme will pay.

Those limits do not change how the tax works on what you receive.

Mistakes and penalties we see with redress payments

The first is reporting the whole of redress payments as income. That overstates the tax, sometimes by thousands.

The second is reporting none of it, which leaves taxable interest off both returns.

The third is claiming an American credit for tax that was later reclaimed from HMRC.

The fourth is discarding the letter. Without it, nobody can evidence the split later.

How US UK Tax Accountants helps

We read the calculation letter behind your redress payments, separate the elements properly, and report only what is genuinely income on each side. Then we work the British reclaim and the American credit together so they match.

Where a payment went into a pension, we look at the American treatment separately. Our US federal return service covers the filing.

If a redress letter has landed, get in touch before you spend it. The split decides the tax, and the letter is the only proof you will have.

Last reviewed 3 October 2026. This article is general information and not personal tax advice. Every payment turns on its own facts, so take advice on yours before filing.