Car Loan Mis-Selling Scandal Poses £5.5bn Fiscal Headache for UK Chancellor

Chancellor Rachel Reeves faces a new challenge in balancing the UK economy as the car loan mis-selling scandal threatens to create a £5.5bn black hole in public finances.

Treasury officials have warned that major firms could utilize compensation payments for mis-sold loans to reduce their corporate tax bills, eroding revenue at a time when the Chancellor is striving to meet fiscal targets.

Revenue Loss from Corporation Tax

RBC Capital analysts estimate the Treasury could lose up to £5.5bn in corporation tax receipts as companies claim compensation payments as deductible expenses. This potential revenue loss compounds the Chancellor's challenge of balancing the books.

Reeves has repeatedly declined to rule out spending cuts or tax increases amidst weak growth and increased borrowing costs that have constrained her fiscal flexibility.

Landmark Supreme Court Case

The Supreme Court has dismissed Reeves' attempt to intervene in a landmark car finance case that deemed lender commissions paid to dealers without customer consent unlawful. If the Supreme Court upholds the Court of Appeal's previous decision, it could lead to substantial compensation payouts, similar to the payment protection insurance (PPI) scandal.

Complex Market Challenges

Unlike PPI, which was primarily associated with high street lenders, car finance products are offered by a wider range of institutions. The definition of "banking companies" subject to the tax restriction imposed by former Chancellor George Osborne is complex, leaving many car finance firms outside its scope.

Varied Impact on Lenders

Legal and tax experts warn of a diverse landscape in the car finance market, with lenders facing varying outcomes in their compensation bills.

Treasury's Response

Treasury officials believe bank-owned car finance firms will be unable to offset payments against corporation tax. However, non-bank lenders account for the majority of outstanding car loan agreements, leaving the Treasury vulnerable to a significant reduction in tax revenue.

RBC estimates a potential compensation bill of £33bn for the car finance industry, resulting in a £5bn loss for the Treasury. Even if the Supreme Court overturns the ruling, RBC predicts a potential hit of £17bn and a £3bn loss in corporation tax receipts.

Alternative Solutions

The Treasury argues that allowing billion-pound compensation payments could harm the UK's business environment and economic growth. However, officials are considering alternative solutions, as blocking non-banks from offsetting compensation payments could also hinder the economy and limit families' access to finance.

Lloyds Bank's Provision

Lloyds Bank has recently increased its provision for compensation to over £1bn, acknowledging that potential payouts would conflict with "30 years of regulation." The bank has set aside an additional £700m to cover car loan compensation costs, bringing the total provision to £1.2bn.

Supreme Court Ruling Expected

The Supreme Court is expected to issue its final judgment in April, potentially paving the way for the next phase in the mis-selling scandal.