Rachel Reeves at risk of creating £5bn black hole through failed car finance intervention

Rachel Reeves has faced a fresh blow after reports found that her failed intervention in the car finance scandal could risk creating a £5.5billion black hole in the UK’s public finances.

The warning comes as car finance companies prepare to put aside millions of pounds in compensation payments following a crucial Supreme Court ruling.

The potential shortfall would hit the Treasury hardest and comes at the same time as Reeves battles to meet her fiscal targets due to weak growth and rising borrowing costs.

Officials from the Treasury have now raised concerns that firms could legally reduce their corporation tax bills by offsetting compensation payments to customers who were mis-sold car loans between 2007 and 2021.

The warning comes as major lenders prepare for what could become Britain’s biggest mis-selling payout since the payment protection insurance (PPI) scandal, according to experts.

Financial services companies, including insurers and asset managers, can currently treat compensation payments as deductible expenses when calculating corporation tax.

This practice was restricted to high street banks in 2015 when former Chancellor George Osborne blocked them from deducting PPI compensation payments from their tax bills.

But the move helped prevent a significant drop in corporation tax receipts during the 2010s when PPI compensation reached an estimated £50billion.

However, the restriction only applies to “banking companies” defined as deposit-taking institutions, with lawyers warning the legislation is “complex”.

Even high street banks typically conduct their car finance operations through subsidiaries, such as Lloyds Bank’s Black Horse division. But unlike PPI, which was primarily linked to credit cards and loans from high street lenders, car finance products are offered by a wide range of institutions.

Wayne Gibbard, of law firm Shoosmiths, told the Telegraph: “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.”

The market includes traditional banks, manufacturers like Volkswagen, and subprime lenders, each potentially facing different outcomes on their compensation bills.

Treasury officials now believe bank-owned car finance firms will not be able to offset payments against corporation tax with most outstanding car loan agreements in place with “non-bank” lenders.

Ahead of the Court of Appeal ruling in April, Lloyds Banking Group has nearly tripled its provisions for the car finance scandal to £1.2billion, setting aside an additional £700million on top of the £450million already earmarked.

Charlie Nunn, the bank’s chief executive, told the BBC this was their “best guess at this stage” of potential compensation costs. The increased provision has impacted Lloyds’ profits, which fell to £5.97billion from £7.5billion the previous year.

Other banks have also made provisions, with Barclays setting aside £90million and Santander £295million. Nunn emphasised that the car finance issues were not comparable to the PPI scandal, which cost the bank £21.9billion in 2019.

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RBC Capital estimated that the total compensation bill for the car finance industry could reach £33billion if the Court of Appeal’s ruling is upheld.

The bank calculated that two-thirds of car finance loans are issued by non-banks, suggesting a potential £5billion loss for the Treasury if all losses are offset against tax. Even if the ruling is overturned, RBC still forecasts a possible £17billion compensation bill, which could result in a £3billion reduction in corporation tax receipts.

The Treasury’s attempt to intervene in the landmark car finance case was blocked by the Supreme Court earlier this month. But in response to the rejection, a Treasury spokesperson said: “We respect the court’s decision to not grant our application to intervene and it is now appropriate to let the appeals process run its course.”