Michael Adebolajo claimed he had been assaulted by five officers at the high-security Belmarsh Prison.
The officers involved were suspended from work after the incident but were later told they had no case to answer.
A Ministry of Justice (MoJ) spokesman said it will "robustly" defend the compensation claim.
He said: "The public will be rightly outraged at the thought of this man receiving compensation from the taxpayer and we robustly defend claims made against the Prison Service."
The MoJ said it has successfully defended two thirds of prisoner claims over the last three years.
Adebolajo was convicted last year, alongside Michael Adebowale, of murdering the 22-year-old soldier who was run over and hacked to death near Woolwich barracks in May 2013.
Adebolajo was condemned to die in prison with a whole-life term for the murder, while Adebowale was sentenced to life with a minimum 45 years.
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