RegulationMar 21 2016

Personal savings allowance - interesting times

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Personal savings allowance - interesting times

From 6 April 2016 the new personal savings allowance (PSA) will be introduced and the payment of tax on the interest from bank and building society accounts under the tax deduction scheme for interest (TDSI) will cease. Going forward, interest payments which had been paid net of the basic rate of tax will now be paid gross, that is, with no tax deduction.

That said, savings income such as interest will remain taxable (unless within an Isa or Sipp). However, basic-rate taxpayers will be able to receive £1,000 in savings income-tax-free on top of the personal allowance (which is £11,000 for 2016/17). Higher-rate taxpayers will be able to receive up to £500; additional-rate taxpayers will not qualify. Any tax due on savings income paid gross has to be met directly with HMRC via self-assessment.

The headlines from the announcement of the introduction of the PSA in the March Budget 2015 included that 95 per cent of taxpayers will no longer pay any tax on savings interest, rendering the TDSI and the R85 form redundant.

However, interest payable on cash is not the only income which will fall within the definition of savings income and the new PSA. And of course this change should not be confused with the changes to dividend taxation and the introduction of the dividend allowance.

Savings income

Savings income is defined under section 18 of the Income Tax Act 2007 (ITA) and includes interest from all of the following:

• Credit union accounts

• Certain National Savings and Investments products, including the “pensioner bond”, the 65+ growth bond

• Interest distributions from authorised unit trusts, Oeics and investment trusts

• Income from gilts and corporate bonds

• The interest element of purchased life annuity payments

• Income which is equivalent to interest, for example the profit on government or company bonds which are issued at a discount or repayable at a premium

• Income from certain alternative finance arrangements such as peer-to-peer (P2P) investments (see below).

• Gains from certain types of life insurance contract.

Savings income paid to an individual is usually taxable, however, section 12 of the Income Tax Act applies a savings rate of tax (currently 0 per cent) in certain cases. This is known as the starting rate for savings and is applied to the first £5,000 of otherwise taxable savings income.

This starting rate for savings does not apply if total taxable income after allowances is greater than £5,000. The 0 per cent rate is applied after any personal savings allowance and personal allowance. In combination, the personal savings allowance, starting rate for savings and standard personal allowance can provide tax-free income of up to £17,000 (2016/17).

So will it be all change? Not quite. Savings income under TDSI will change from net paying (for the majority) to gross paying with no tax deduction. However, there is no compulsion for other income sources to change. The likelihood is that savings income will continue to be paid in the same way it currently is, for the short term at least. For example, corporate bond funds paying net will continue to do so, for now.

As an aside, industry representations to HMRC hope this position will change but at the time of writing, no decision has yet been made.

There are implications for fund pricing and the payment of interest distributions in practice and there are challenges for fund accounting if the change is made within a distribution period.

Trusts and TDSI

The new personal savings allowance only applies to individuals, not to company money or trusts. However, trusts receiving savings income net of basic-rate tax under the TDSI system will, from April, also receive interest gross, which will be taxable.

Personal allowance interaction

The PSA is in addition to the personal allowance. The personal savings allowance (and dividend allowance) is ignored when determining whether an individual is a non-, basic-, higher- or additional-rate taxpayer.

The standard personal allowance for 2016/17 is £11,000, although different personal allowances apply for those entitled to the married couple’s allowance (only applicable if one of the couple was born before 6 April 1935) or blind person’s allowance. The age-related personal allowance no longer applies from 6 April 2016.

Further, 10 per cent of the standard personal allowance can be transferred to a spouse or registered civil partner. This is known as the marriage allowance, but only applies where neither person would be a higher- or additional-rate taxpayer. An election to transfer can be made if married or in a civil partnership for some or all of the tax year and when the election is made. Once accepted, the application is valid for the entire tax year and for future tax years until further notice.

The standard personal allowance reduces by £1 for every £2 of taxable income above £100,000, as shown in the Graph. Someone with taxable income of £130,000 would have no personal allowance but is still entitled to the PSA, up to £500.

Interest from Isas does not count towards the PSA because it is already tax-free.

Pension contributions

A pension contribution could lead to a higher-rate taxpayer becoming a basic-rate taxpayer and so being able to use a transferred personal allowance. This is because a Relief at Source pension contribution (for example, to a Sipp) increases the higher-rate threshold and a Net Pay pension contribution (for example, to an occupational pension scheme) reduces taxable income. A salary sacrifice derived contribution will reduce salary.

P2P taxation

The new Innovative Finance Isa permits P2P loans as qualifying investments. Some Sipps allow P2P investments although there is a risk of connected party issues. In both these cases, the returns from P2P are tax-free.

The tax position of P2P loans not in an Isa or a pension (where the loan is intended to be at least 12 months) is detailed below.

Tax treatment of peer-to-peer lending

CIRCUMSTANCESTREATMENT
Borrower is a company and lender is a UK resident individual P2P platform or borrower deducts tax at source and pays interest net of tax
Borrower is a company and lender is a UK resident company Interest can be paid gross
Borrower is an individual and lender is a UK resident individual or a UK resident company Interest can be paid gross
Borrower is anyone and lender is non-UK resident individual or non-UK resident companyP2P platform or borrower deducts tax at source and pays interest net of tax
If the loan is not intended to be less than 12 monthsInterest can be paid gross

Beyond this, a UK resident individual lender will also need to know whether they have received interest from a company (paid net of tax) or an individual (paid gross).

Current rules state that it is the borrower or the P2P platform that is responsible for deducting any tax due (where required). It is proposed that this should always be the P2P platform, or potentially another intermediary.

Danny Cox is a chartered financial planner at Hargreaves Lansdown