TAX IS a fragmented issue in the peer-to-peer space. It is investors’ own responsibility to declare earnings with HMRC – which could appear as a fairly common scenario within the financial sector.
However, the vast diversity of P2P business models, along with the recent introduction of the Innovative Finance ISA (IFISA) further fragmenting platforms’ approaches, have turned such a simple premise into a multitude of scenarios, and an equal number of exploitable loopholes, according to a number of sources.
One grey area stems from the tax regulator’s relatively flexible wording on when a loan becomes irrecoverable – and therefore when losses on that asset can be offset against interest gained on other P2P loans.
HMRC clarified in March last year that, provided relief conditions are met, “investors may [not only claim tax relief] but also set these bad debts against interest received on other P2P loans.”
It also added that, starting from 6 April 2016, tax relief for defaulted P2P loans against income from other P2P loans on the same platform will be given automatically, so investors do not need to make a claim in a tax return.
If investors are not due interest from loans on the same platform, they have the option to offset losses against loans bought through other platforms, it added.
With these clarifications, the tax regulator helped dissipate some ambiguity, but the definition it provided around a loan becoming irrecoverable “when there is no reasonable prospect of the recovery of the loan” could engender different behaviours among investors.
HMRC states that whether a loan has become irrecoverable should be judged on a case-by-case basis. While a platform would usually decide when a loan has become irrecoverable, the regulator conceded that the lender can step in with its own judgment if information is lacking.
In certain cases, the investor could get even greater leeway, based on HMRC wording: “When the borrower has entered legal recovery procedures such as liquidation, administration, receivership or bankruptcy, the loan may be treated as becoming irrecoverable as if such action was not available.”
Investors could then claim relief that same tax year, but would have to declare any future credit recovery as interest in future tax years.
“The main point goes back to the fact that declaring interest income comes down to the individual P2P investor,” says Andrew Holgate, chief credit officer and co-founder of Assetz Capital.
“Is there a loophole here that could enable tax evasion to take place? There is an element that HMRC could be missing out.”
There could be a disparity between investors who have put funds into secured loans and those holding unsecured loan investments, as HMRC allows the former to treat their loans “as becoming irrecoverable as if the security did not exist.”
But what further complicates the picture is the fact that platforms are, strictly speaking, barred from providing tax advice to their customers, according to Proplend’s chief executive Brian Bartaby.
“Platforms can certainly help by providing clear tax statements and links to impartial, authoritative sources of tax information like HMRC,” Bartaby says. “But it’s equally important to reinforce the point that we aren’t authorised to offer advice.”
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Platforms are still required to report to HMRC on their investors’ regular accounts once a year, and within 60 days from the end of the tax year on IFISA accounts.
Last year, discrepancies between such information and clients’ own tax return filings resulted in the regulator sending out interest ‘nudge’ letters to P2P investors “who appeared to have under-declared untaxed interest”.
“Obligations for platforms are currently quite limited,” explains Holgate. “But from our point of view, there has always been, and always will be, a need to engage with HMRC, and there should be an effort to work with them to ensure no client is evading taxes.”
CapitalStackers’ managing director Steve Robson adds that at present, platforms’ obligations are more centred around the Financial Conduct Authority’s ‘treating customers fairly’ rules, which include making it clear to investors where they stand on tax.
Neil Faulkner from P2P analysis firm 4th Way agrees that platforms should go the extra mile to boost tax awareness.
“It would be good customer service for platforms to go above and beyond by giving a clear set of instructions on how to declare taxable income to the taxman,” Faulkner says.
However, a platform’s spokesperson warned that some P2P providers went too far with advising investors, potentially swaying their decisions and stretching the interpretation of regulatory wording.
That risk has become more evident since platforms began to roll out IFISA products, providing different guidelines on their websites’ dedicated ISA sections. According to Treasury rules, invested funds cannot be transferred directly from a client’s regular account into the tax-free wrapper.
Moreover, HMRC states that an investor is not allowed to sell a loan contract to themselves, by selling it on a secondary exchange and then buying it back, the platform’s spokesperson pointed out.
However, the lack of further specifications has enabled platforms to adopt diverging approaches. This in turn risks creating a competitive advantage for those that allow investors to “re-qualify” their investments through the secondary market, the source warned.
“That risks creating a bed and breakfast type of account, and in the real world there is not enough liquidity in the P2P market to create that.”
Platforms such a Zopa and Landbay have said that investors can sell their loan parts through the secondary market and then deposit money into their new ISA account. However, Proplend took a different approach and did not spell out such instructions.
“We do still get questions from customers about whether they can transfer existing P2P loans into the ISA to earn the income completely tax free – we feel comfortably within our rights to confirm no,” says Bartaby.
“HMRC is quite clear on this point too: you can’t transfer any P2P loans you’ve already made or crowdfunding debentures you already hold into a IFISA.
“We have taken steps to stop individuals buying loans into their ISA that they already hold outside of their ISA.”
Overall, the novelty of IFISAs and the flexibility engrained in current regulatory guidelines have generated a number of approaches that may need to be streamlined in the future.
“The rules for IFISAs are straightforward for most people, most of the time, but there are an awful lot of ‘long-tail’ situations that can trip customers up,” comments Faulkner.
“Get it wrong and customers could be in breach of the rules or lose their allowances.”
“Subtleties exist in the rules around new contributions, transfers of existing contributions, or opening new accounts in the same or different tax years,” Faulkner adds.
“There’s definitely some uncertainty around the restriction on only being allowed to subscribe to one ISA of each type each tax year,” asserts Bartaby. “Clarification on this point is a little ‘buried’ and the fact that people are having to go look for it suggests it could be clearer.”
“If investors get this wrong, there could be tax implications where limits have been exceeded.”
Faulkner also thinks that rules are still unclear on capital gains or losses on P2P secondary markets, and on how secondary market buyers are required to compensate original lenders for unpaid due interest. And the downsides of such ambiguity may ultimately backfire against investors.
“I probably wouldn’t try to be so clever in trying to find a loophole,” says the platform’s spokesperson.
“HMRC might not allow ignorance as a defence, even if the ignorance is caused by a lack of its own guidance,” adds Faulkner.