The maze of UK tax legislation can be tricky for peer-to-peer investors to navigate, but Andrew Saunders is here to guide you…
IT’S UNLIKELY THAT Benjamin Franklin – 18th century polymath and one of the founding fathers of the USA – had ISA season in mind when he wrote “In this world nothing can be said to be certain, except death and taxes” way back in 1789. But all the same, the question of how certain peer-to-peer investors are about their taxes remains a pertinent one, especially as we head towards the end of the tax year in April.
Tax – especially the labyrinthine UK tax code – is renowned for its complexity, which can lead to anxiety and inertia amongst smaller investors, for fear of breaking the rules. It’s a reputation which derives, says Jake Wombwell-Povey, chief executive of direct lending investment manager Goji, from the way in which the government uses tax not only to raise revenue for public spending, but also to influence the way taxpayers act. “Tax is used by the government to incentivise and to change behaviours,” he asserts. “That’s completely understandable but when you start doing that, it does add complexity.”
Wombwell-Povey, who is also a committee chair for industry body the Tax Incentivised Savings Association, would like to see the system simplified but appreciates the conflicting agendas involved. “It would be great to remove complexity but we also recognise that tax is a key means of implementing government policy,” he adds.
But despite the reputation, investors shouldn’t let tax concerns put them off. The good(ish) news is that, for tax purposes, HMRC treats P2P in a broadly similar way to more conventional savings and investment products. Just as with those other products, the general principle is that – whatever its source – any interest earned is regarded as income and taxed at the income tax rate paid by the individual.
So if you are a basic rate taxpayer earning between £11,861 and £46,350 this year, you pay tax on interest at 20 per cent. If you are a higher rate taxpayer earning between £46,351 and £150,000 it’s 40 per cent, and for those earning over £150,000 it’s 45 per cent. (If you earn less than £11,860 then you pay no income tax at all, but there can’t be many P2P investors in this bracket).
However, one of the ways that the government uses tax to incentivise is by encouraging citizens to save and invest, so those tax rates don’t kick in until you have used up your Personal Savings Allowance.
Introduced by HMRC in 2016, the Personal Savings Allowance is an amount of interest that can be earned tax free from savings and investments – including P2P holdings. Basic rate taxpayers can earn up to £1,000 in interest per year, tax-free, while for higher rate taxpayers it’s £500 and if you are on the additional rate, bad luck – your Personal Savings Allowance is zero.
As Neil Faulkner, founder of P2P analysis firm 4th Way points out, that allowance means many small investors’ P2P earnings are tax free – even without special instruments such as the Innovative Finance ISA (IFISA), of which more later. “As a basic rate tax payer, your personal allowance equates to £20,000 to £30,000 of P2P investments – more than most basic rate payers have to invest anyway,” Faulkner explains.
However, it is up to the individual to declare their interest and pay any tax that falls due. For those who are used to having their income tax deducted at source by their employer, this is probably the most important thing to remember.
Fortunately, P2P platforms typically provide annual statements of interest earned which can be sent to HMRC – if the total earned is less than £3,000, often all that is required is an adjustment of an individual’s tax code to add the tax due to the regular monthly PAYE deductions. Or it can be done via the usual online self-assessment tax return process so drearily familiar to many of us.
Losses and defaults can be offset against gains, too – a positive change to the tax rules which was introduced in 2016. But watch out, says Faulkner, for platforms which still use the term ‘direct lending fees’ for any charges they levy on investors – these are taxable. “It’s just lazy, because if [the platforms] did them in a slightly different way and just called them loan service fees instead they would not be taxable,” he says.
However, the biggest tax incentive that applies to P2P investment is of course the IFISA. Just like the established cash and stocks and shares ISAs, the IFISA is a tax-free vehicle for debt-based securities such as P2P loans. Individual investors can invest up to £20,000 annually in an ISA, but only one ISA – whether IF, cash or stocks and shares – can be opened in any given tax year.
Although on one level, the IFISA can be seen as adding another level of complexity to the tax position, in practical terms it actually makes life simpler for the majority, says John Goodall, chief executive and founder of buy-to-let mortgage platform Landbay. “Our product is split into the tax free ISA and our regular account – which we call classic – that is subject to tax.”
But although that clarity is welcome, it’s not the main reason why demand from holders of existing cash ISAs wishing to transfer is on the rise, he says. “There are hundreds of billions sitting in cash ISAs paying very low rates. People are switching to IFISAs to get better rates at slightly more risk.”
The latest data from HMRC certainly shows that take-up is accelerating. After a slow start – a modest £36m was invested in IFISAs in the 2016/17 tax year – IFISA subscriptions rose 700 per cent year-on-year to over £290m in 2017/18, while the sum invested in cash ISAs fell by 10 per cent over the same period.
But while accessing the tax advantages of a new IFISA – or transferring old cash ISAs into one – is relatively straightforward, the situation for those wishing to transfer existing taxable P2P holdings is not so simple. These must be realised as cash first, which generally means finding buyers on the secondary market, where demand – and prices – are not guaranteed.
If it sounds like a hassle, it is – but there is a good reason for it, says Bruce Davis, chief executive and founder of renewables crowd bonds platform Abundance. “It’s to ensure fair market valuation at the time you subscribe, and is the same for stock and shares too,” he explains. Changing those rules would create a lot of admin and potential uncertainty around valuations which would add cost for platforms and be more likely to confuse investors than encourage them, he claims.
In theory, selling loans on the secondary market can also attract Capital Gains Tax (CGT), says 4th Way’s Faulkner, although in practice this is usually something that only those who do a lot of secondary trading need to worry about. Should the CGT position be made clearer? “The liability is a bit ambiguous, but I don’t like the clearest solution,” he comments. “HMRC would probably want to fix it by charging CGT on all gains.”
One small but nonetheless incongruous hold up – especially in a sector known from providing a slick online customer experience – is the distinctly low-tech ISA transfer process inherited from the traditional banking system. It requires wet signatures and closing balances are often remitted by cheque – surely an unnecessary relic of a bygone age in the era of BACS and CHAPs transfers. “The system is paper based and takes a couple of weeks – it is a bit clunky,” says Landbay’s Goodall. “Streamlining it would be a good thing, but I can think of several banks who would not want that.”
Another, more significant change that is gaining support – it’s been mooted by the Office of Tax Simplification amongst others – is the proposal to relax the rules so that more than one of each type of ISA may he held and opened in a year.
As Goodall points out, it could encourage investors to spread their P2P risk more widely. “It would make sense to be able to diversify across different ISAs and different loan products,” he states. Stocks and shares ISAs, he adds, are diversified across different shares, but IFISAs, by and large, comprise loans from only one platform.
Some investors looking to boost their retirement funds choose to include P2P holdings in a Self- Invested Personal Pension (SIPP). But in the case of P2P assets the tax advantages of a SIPP are more than eroded by increased costs for all but the wealthiest investors. Why? Because when it comes to SIPPs, “P2P loans are classed as nonstandard assets. It means that SIPP managers have to hold additional capital if they want to invest in them, and also that there is a lot of due diligence involved,” says Goji’s Wombwell-Povey.
The non-standard SIPP classification arises from pensions regulations which require ‘standard’ assets to be realisable within a 30-day cycle, so that if a provider fails, those assets can be readily transferred to another provider. Wombwell-Povey would like to see it changed. “It’s a bit of an anomaly and we hope to encourage the Treasury to classify P2P loans as standard assets,” he says. “Commercial property is considered a standard asset, but there is no way you could put a warehouse on the market tomorrow and have sold it in 30 days’ time.”
Abundance’s Davis would also like to see changes on the SIPP classification front – his business invests through debt instruments, which were classed as standard through an exemption for corporate bonds which disappeared abruptly in 2015. “It was an unintended consequence, and we have asked them [HMRC] to reinstate it,” he comments. “The SIPP is a good vehicle for pensions and people should not be stopped from using it n this way.”
He also raises the interesting question of whether shares in some kinds of companies should be made eligible for inclusion in IFISAs. “There are companies – mine included – whose eligibility for the Enterprise Investment Scheme [a tax break for investors in early stage businesses] is coming to an end, but aren’t eligible for stocks and shares ISAs because they are not listed on Aim. There’s a funding gap for these companies and I think that will be revisited.”
So despite the relative novelty of the sector, the overall tax position for P2P investments is not substantially more complicated than it is for most comparable retail investments.
But that generally benign overall picture does hide a few anomalies with the potential to generate confusion and unexpected liabilities. So, as usual when it comes to tax, the best policy is that if you are at all uncertain, get professional help and make sure you pay what is due.
As that more recent but much less celebrated American, the disgraced former President Richard Nixon, noted, “Make sure you pay your taxes; otherwise you can get into a lot of trouble.”
This article featured in the February edition of Peer2Peer Finance News, now available to read online.