Car finance tax loophole could cost UK taxpayers billions

Ministers are under pressure to address a loophole that could see UK banks and specialist lenders avoid paying £2 billion in tax on compensation payouts linked to a major car finance mis selling scandal. The current law allows non banking entities to deduct compensation payments from profits before calculating corporation tax resulting in a reduced tax bill.

This loophole is significant because although banks have been blocked from claiming such relief since 2015 the motor finance divisions of major institutions including Barclays Santander UK and Lloyds Banking Group are categorised as non bank entities. Lending arms of car manufacturers such as Honda and Ford also qualify. The Office for Budget Responsibility OBR has confirmed that this could result in a £2 billion loss in corporation tax revenue across 2025 and 2026.

The government originally barred banks from deducting compensation payouts following instances of past misconduct such as the payment protection insurance scandal to protect state revenues. Bobby Dean a Liberal Democrat MP serving on the Treasury committee is calling for ministers to intervene and ensure the same rules apply to car loan mis selling cases to prevent taxpayers funding compensation for lender misconduct.

Documents from the OBR made public with the autumn budget confirm that the FCA’s proposed car finance compensation scheme would trigger a reduction in corporation tax receipts because these payouts are expected to be tax deductible for non bank entities. The compensation scheme itself is under consultation and aims to provide redress for borrowers overcharged due to unfair commission arrangements between lenders and car dealers.

The potential for banks to benefit from what is effectively a tax break for their own previous misconduct has sparked discontent. Darren Smith managing director of claims law firm Courmacs Legal voiced frustration with the government’s reluctance to close the loophole. These comments come amid growing scrutiny of government decisions following recent tax increases affecting millions of people.

The lending industry has pushed back against the size and scope of the proposed compensation scheme, arguing that it could overcompensate customers who suffered no loss. The Financing and Leasing Association has contended that a narrower scheme would lower costs and ensure lenders contribute more through corporation tax. The Treasury has not directly commented on whether it will act but maintains the importance of access to motor finance in the UK economy.