The Government has confirmed that millions of victims of payment protection insurance (PPI) mis-selling will have to pay tax on their payout. Anyone who receives interest on top of the compensation capital is liable. An estimated three million people could be due compensation, ensuring a windfall for the taxman. Don't panic though - only the interest is taxable, so any money you owe will only be a small proportion of the overall payout.

The government would be due a significant sum in tax as the compensation will accrue interest at a fairly high rate of 8%. This will be taxable, and the government will expect to raise several hundred million pounds from this. However, of all the major banks, only RBS and Natwest deduct tax from the interest on PPI Claims. Barclays (including Barclaycard), Halifax, HSBC, Lloyds TSB and Santander do not deduct tax in this way. If tax is deducted at 20%, then the higher rate payers will need to pay a top-up.

Some providers deduct basic rate tax at source, but you'll need to check. If they don't, or if you owe more than they deduct, you'll have to organise a payment yourself. Interest on PPI compensation is treated in the same way as savings, so all taxpayers who are paid additional interest will owe tax.

Nobody should be worse off though, as had you not purchased PPI - and kept any money in an interest-bearing account instead - the interest received would have been taxable anyway. Remember that if you complete a self assessment form, you must declare any interest as savings interest, and pay money owed as part of your total tax bill.

However, it's still worth trying to claim through a company like iSmart Solutions, against mis-sold PPI if you're entitled to money back, as you only pay tax on the additional interest on top of the actual compensation. What's more, any tax you're required to pay back will only be a small proportion of the overall redress.

Barclays HSBC