Market News

BY  Szu Ping Chan

The car loan mis-selling scandal risks blowing a £5.5bn black hole in the public finances, posing a fresh challenge for Rachel Reeves as she scrambles to balance Britain’s books.

Treasury officials have warned the Chancellor that a string of major firms could use compensation payments to people who were mis-sold loans to legally cut their corporate tax bills – reducing revenue for the Treasury at a time when she is battling to meet her fiscal targets.

Analysts at RBC Capital have suggested that the Treasury could lose up to £5.5bn in corporation tax receipts as a result.

A potential hole in corporation tax receipts would make Ms Reeves’s challenge of balancing the books harder. The Chancellor has repeatedly refused to rule out cutting spending or raising taxes in March against a backdrop of weak growth and higher borrowing costs that has crushed her headroom.

It comes after the Supreme Court blocked Ms Reeves’s attempt to intervene in a landmark car finance case that found it was unlawful for lenders to pay commission to dealers without a customer’s consent.

If the Supreme Court ultimately upholds a previous decision by the Court of Appeal on the case, it is expected to pave the way for the biggest mis-selling payouts since the scandal over payment protection insurance (PPI).

Financial services companies including insurers and asset managers are currently able to treat compensation payments as deductible expenses for corporation tax purposes.

George Osborne, the former chancellor, stopped high street banks from deducting these payments from their tax bills in 2015 following an avalanche of claims related to mis-sold PPI.

The move helped stem a plunge in corporation tax receipts in the 2010s, with the total PPI compensation bill estimated at £50bn.

However, unlike PPI, which was usually attached to credit cards and loans offered directly by high street lenders, car finance products are offered by myriad institutions.

The restriction imposed by Mr Osborne applies to “banking companies”, which have traditionally been defined as deposit-taking institutions, although lawyers and corporate tax experts warned the legislation was complex. Even high street lenders mostly conduct their car finance businesses through subsidiaries.

Lloyds Bank, which analysts say is the most exposed to compensation claims, carries out car finance lending through a subsidiary called Black Horse.

Wayne Gibbard, of law firm Shoosmiths, said there was huge variety across the car finance market, from banks such as Lloyds to manufacturers, including Volkswagen, and subprime lenders. This meant lenders could face different outcomes on their compensation bill.

He said: “There is quite a significant difference in structure if you look across the market. They all have such different models and their route to market is different.

“Not everything is equivalent and frankly that’s why it’s taken so long to unpick because there isn’t just one model, there’s not just one commission, it’s not just one product. It’s quite a complex market.”

It is understood that Treasury officials believe car finance firms that are bank-owned will not be able to offset payments against their corporation tax bills.

However, this still leaves the Treasury exposed to a potentially significant reduction in tax revenues, with most of the 7m outstanding car loan agreements conducted by “non-bank” lenders.

RBC estimates a total compensation bill for the car finance industry of £33bn if the Court of Appeal’s ruling is upheld. This would lead to a £5bn loss for the Treasury, its analysts said.

Even if the ruling is overturned, RBC still estimates a potential hit of £17bn, which would result in a £3bn loss of corporation tax receipts.

The Treasury’s submission to the Supreme Court argued that opening the door to tens of billions of pounds in compensation payments would harm Britain’s reputation as a place to do business “with a consequent impact upon economic growth”.

It made no mention of the potential fiscal impact to the Treasury’s coffers, focusing instead on the potential impact on low-income families who rely on specialist lenders to secure a loan.

It is understood that officials are working on a potential solution, although blocking non-banks from offsetting compensation payments against their tax bills could also harm the economy and the ability for families to secure finance by reducing the amount of money they are able to lend.

It came as Lloyds Bank increased the amount of money earmarked for compensation to more than £1bn and warned possible compensation payouts would be at “odds with 30 years of regulation”.

On Thursday, the FTSE 100 bank set aside an extra £700m to cover the possible costs of paying compensation for mis-sold car loans.

The provision is in addition to £450m booked last year and means the bill for Lloyds, which lends through its Black Horse division, stands at £1.2bn.

Charlie Nunn, its chief executive, said the new provision was a “best estimate” based on a range of scenarios, which include the outcome of the courts and regulators.

The Court of Appeal ruled last year that banks had mis-sold drivers’ car loans because they paid “hidden” commissions to car dealers. The Supreme Court is expected to offer a final judgement on the matter in April.

Lloyds’s original £450m provision was linked to a review by the Financial Conduct Authority (FCA) over bonus payments made to car dealers.

The FCA has been investigating these, known as discretionary commission arrangements, for the past 12 months. It is awaiting the outcome of the Supreme Court before deciding how to set up a possible redress scheme.

A Treasury spokesman said: “We respect the court’s decision to not grant our application to intervene and it is now appropriate to let the appeals process to run its course.”