Everything you always wanted to know about tax but were afraid to ask
THE UK tax code is reportedly 12 times the size of the King James Bible at more than 10 million words, and while not all is relevant to peer-to-peer platforms and investors, there is plenty that baffles the sector.
Tax on P2P is paid in a similar way to savings or investments. Income tax is due on interest payments and capital gains tax (CGT) may be due on the sale of loans for example on the secondary market. This is typically reported at the end of the tax year by filing a self-assessment return or – where less than £3,000 tax is paid overall – by altering the tax code so anything owed is effectively taken from an employee’s monthly payslip. Corporate investors would report any interest in their accounts and company tax return.
HMRC clarified in March last year that investors can offset losses from defaulted loans or those in arrears against interest from others. But Neil Faulkner, founder of P2P analysis firm 4th Way, believes more clarity is needed on how this works for loans purchased on secondary markets.
“If interest has been accrued and not yet paid – such as with loans that roll all the interest to the end of the loan – lenders will be liable for tax on all the accrued interest,” he says. “If the loan is repaid early, the lender could end up with a tax loss.
“Lenders could factor that into their calculations when deciding what price to pay for existing loan parts and should spread their money across lots of loans so that you don’t get unlucky on just one loan.”
When it comes to CGT, very few people are likely to be impacted as the profit would need to be above the current allowance of £11,300, and many platforms cap the premiums on loan sales. However, Faulkner adds that it would be useful to have specific guidance on CGT and P2P rather than the generic tax rules.
How tax is taken
Since the introduction of the personal savings allowance in April 2016, tax is no longer deducted automatically for savings and investments, including P2P loans. This is because basic rate taxpayers can now earn up to £1,000 in savings income tax-free, while higher-rate taxpayers get a £500 allowance, which can be hard to earn in a whole tax year. But tax is still taken automatically for deb-tbased securities, so those investing in crowd bonds on platforms such as Downing and Abundance face having to reclaim their money from HMRC.
“There are still some inconsistencies in the way HMRC administers tax between very similar models of P2P investment,” Bruce Davis, managing director of Abundance, explains. “Abundance has been working hard with officials at HMRC to try to iron out these differences which we believe cause unnecessary bureaucracy and confusion for our small investors.
“For example, the difference in treatment between loans and debentures for withholding tax at source means that thousands of our small investors will have to reclaim small amounts of tax themselves from HMRC using their online or postal forms.”
P2P may be seen as an alternative form of lending, but it can still be used in mainstream tax-free savings products such as self-invested personal pensions (SIPPs) and Innovative Finance ISAs. However, there is confusion over how the rules are applied.
SIPPs are a popular way for people to maximise their retirement savings by providing tax-free earnings on their investments. While P2P loans are technically allowed in SIPPs, connected parties rules stipulate that there must be no connection between the lender and borrower. This provides a challenge for SIPP providers if a P2P loan is allocated to a large number of borrowers. Anyone found to be lending to connected parties faces a tax charge of up to 55 per cent and the pension provider could also face a fine.
As a result, investors are left using smaller, niche SIPP providers that can be more expensive. Loans within SIPPs typically have to be secured, which affects the eligibility of some P2P loans, but Simon Laight, partner at law firm Pinsent Masons, says there should still be scope to include them.
“This is a complex definition but it covers obvious things like being married, civil partner, same company,” he explains. “You have to ensure a SIPP member doesn’t accidentally lend to a borrower on a P2P platform he is somehow connected to. In many cases the investor wouldn’t necessarily know the identity of the individual whom the proposed loan is being made to.
“A lot of SIPP operators say it is impossible and decide not to play in the P2P market.”
But Laight says these interpretations are unfair as the tax charges only arise if there is an actual connection between the two parties – mere possibility is not enough. He highlights that a SIPP scheme administrator should not intentionally allow unauthorised payments and should report them if they arise, but argues that should not equate to refusing all investments that have the potential of triggering unauthorised payments.
The other major stumbling block with SIPPs and P2P is the treatment of residential property. SIPPs generally cannot invest in residential property, which could catch P2P investors out if they do not know who they are lending to. Similar to the connected parties rule, a SIPP that invests in residential property faces unauthorised tax charges which could be up to 55 per cent. Laight believes this should be manageable. “Any SIPP considering P2P lending should include declarations by the borrower as to use of the money; and insist on including a term in the loan that the loan must not be used to purchase residential property,” he says.
The Tax Incentivised Savings Association (TISA) has been lobbying HMRC to clarify rules around using P2P inside a SIPP. Technical policy director Jeffrey Mushens says the lobby group has met with government officials about changing the system to remove these obstacles.
“The mood music from the Treasury has been positive, we will continue to push for change,” he says. “Making it easier to put P2P in SIPPS should also make the asset more popular with financial advisers which will also provide a boost.”
P2P is associated with fast-paced technology but the ISA market drags it back into the dark ages due to the way that transfers work. All transfer authority forms, for any form of ISA including IFISAs, require ‘wet’ signatures and they all require the applicants to return the forms by post. This will hit transfer speeds, according to 4th Way’s Faulkner. “The system is still paper, manual, and costly, which is why several platforms are charging extra for their IFISA wrapper,” he says. “In addition, some traditional ISA providers do the transfer by posting a cheque. In this day and age, cheque transfers should be prohibited.
“Costs and frustration are not the only issue with slow transfer speeds. While I personally think investing is best done in a slow and steady way, an awful lot of investors get quite upset if they miss out on opportunities, and they don’t want bureaucracy to be the cause.”
Transferring P2P loans
HMRC is clear that P2P loans held outside a tax wrapper can only be sold and repurchased into an IFISA if they have been made available for purchase by more than one prospective purchaser. This means P2P investors effectively have to take their chances on the secondary market, which could mean sale fees and the possibility of income tax if they want to move existing loans into an IFISA.
But Stewart Cazier, head of retail at business lending platform ThinCats, says there doesn’t seem to be a clear reason for HMRC’s ban on transfers of existing P2P assets into an IFISA.
“This process is fine for ordinary exchange-traded assets, for example if you sell BP shares in your general account and buy some more in your ISA account,” he says. “You might just have some market movement in the price. It is not clear why HMRC prevents P2P assets being directly transferred into the IFISA other than the question of establishing their market value by public auction.
“However, it seems a more simple approach would be to say that the transferred loans are worth par plus accrued interest, and restrict the prohibition on transfer to any loans in default where the market value might not be clear.”
Flexible ISA Savers have been able to access flexible ISAs since the start of the 2016-2017 tax year. This lets someone take money out of a cash ISA and put money back in during the same year without losing their allowance, which they would have done previously. This rule also applies to IFISAs, but Cazier questions its appropriateness.
“It seems strange to encourage investors to treat IFISAs as a short-term savings vehicle by offering flexible IFISAs,” he says. “P2P investments are best reserved for money which a client is unlikely to need to access unexpectedly. Why then offer withdrawals from the current tax year without affecting the subscription? This isn’t a cash ISA, and we should be making sure that it isn’t thought of as being at all similar.”
Recent data on IFISAs provided by HMRC has been fiercely contested by the industry. HMRC said there were £17m subscriptions and 2,000 accounts in the 2016-17 tax year, but Crowdstacker and Abundance alone say they took in almost £18m of new subscriptions in total. HMRC has said its data is based on ISA returns submitted by the platforms but is open to hearing feedback.
Chris Barnard, senior accountancy manager at software provider Crunch, says investors can consult their P2P provider to find out what tax needs to be paid.
“P2P lenders generally provide a year-end tax statement which makes it clear that they need to report this with HMRC,” he says.
It may be easy for HMRC to use its popular phrase that tax doesn’t have to be taxing, but it can clearly still be confusing. It is best for investors to check with their platform or an accountant if they are not sure so they don’t get caught out.
This article featured in the February print edition of Peer2Peer Finance News. Read the magazine online here.