UK Government: Promoting P2P lending through changes in tax

The UK Government has recognised the growth of the peerto-peer (P2P) industry through several announcements made over recent months, particularly in the Summer Budget, setting out plans for changes to the taxation of P2P lending.

In issue 4 of Credit Funds INSIGHT, the exponential growth of the P2P lending industry was highlighted. This has been recognised by the Government through several announcements made over recent months, particularly in the Summer Budget, setting out plans for changes to the taxation of P2P lending. The Government’s objective is to encourage the growth of the P2P sector and, in doing so, improve competition in the banking sector, providing savers and investors with an increased choice of investments, and individuals and small enterprises with another potential source of capital.

Withholding tax consultation

HMRC has consulted on a new withholding tax regime for UK P2P lending.^[1] HMRC accepts that the current rules (which apply to interest other than that paid by banks or building societies on deposits) are difficult for P2P platforms to apply, and cause confusion for prospective lenders and borrowers.

Under the current system of interest withholding tax, the treatment of the interest depends on the identity of the borrower, and the identity and location of the lender. Borrowers and/or P2P platforms may be obliged to pay interest gross to some lenders, and net of withholding tax to others. This is also confusing from a lender’s perspective, as they may be receiving both gross and net interest on loans made through the P2P platform. Furthermore, the P2P platform may have confidentiality agreements with borrowers which prevent it disclosing the identity of the borrower to the lender and/or vice versa.

The proposals being considered are whether the obligation to deduct tax should be placed on the platforms, and whether the applicability of withholding on a P2P loan should depend only on the status of the lender.

In relation to the first question, the aim is to simplify the process without constraining the P2P market by not allowing any flexibility as to who deducts the tax. The consultation document envisages a potential way round this, being that interest could be deducted either by the platform themselves or another intermediary who undertakes payment services on their behalf.

In relation to the second question, it is intended that income tax would be deducted at source if the lender is an individual or is based overseas.

An alternative to the introduction of a new withholding tax regime for the P2P sector would be to abolish the deduction of tax at source completely – this would arguably achieve the simplest result. This prospect is currently being explored (among other options) by a separate consultation on the deduction of tax at source from interest other than that paid by banks and building societies which will apply to P2P arrangements.^[2] A decision to abolish withholding tax on such interest would render the P2P consultation obsolete, as all interest would be paid gross.

What you need to know

• Withholding tax rules for P2P loans will be simplified.
• The ISA rules will be amended to create a new type of ISA for P2P loans.
• Individual investors in P2P loans will be able to benefit from a new P2P bad debt relief.

P2P ISA investments

The Summer Budget also announced the introduction of the new Innovative Finance ISA. This followed a consultation held at the end of last year, and confirms the Government’s intention to allow P2P loans to be held in an ISA from 6 April 2016, to achieve its objective of increasing the choice of investments available to ISA investors and encouraging the growth of the P2P sector. The rationale behind the creation of a third type of ISA is to “send a clear signal to consumers that peer-to-peer loans are different to more traditional forms of investment”^[3]– a fact that is highlighted by the restrictions on withdrawal and transfer due to the lack of guarantee that all P2P platforms will have an active secondary market. With most of the larger P2P platforms offering a secondary market, this is unlikely to prevent investors taking advantage of this welcome opportunity to enjoy tax savings on a new type of investment which generally offers a higher return than banks’ traditional products, and we would expect this to result in further growth in the P2P lending sector.

Other conclusions reached include the Government proceeding with its proposal to make advising on P2P loans a regulated activity, although investors will not be protected by the Financial Services Compensation Scheme. Also, P2P platforms that become ISA managers will not be required to legally own or co-own loans held within the ISAs they manage. This should provide additional flexibility for structuring these arrangements.

The ISA eligibility of P2P loans accompanies the announcement that, from 1 July 2015, it is generally sufficient for the relevant bonds or shares to be held in an ISA to be admitted to trading (even if unlisted) on a “recognised stock exchange” within the European Economic Area. Previously, where a group has not had its shares listed, its unlisted bonds were not ISA-eligible.

A separate consultation on whether to include crowdfunded debt securities and equity investments as ISAqualifying investments is also underway. The ISA regime is perceived to be relatively low risk and limited to regularly traded assets. One wonders whether extra safeguards might be appropriate for crowd funding or whether the existing tax relief regimes, such as the Seed Enterprise Investment Scheme relief, better promote such investments in a context where investors would be aware of the level of investment risk.

Bad debt relief

A new measure was announced in last year’s Autumn Statement providing for bad debt relief when lending through P2P platforms. More information on this was released in the March Budget. This relief provides that if a P2P loan is not repaid, the loss suffered by an individual lender of that loan can be set against the pre-tax income that individual receives on other P2P loans (but not against non-P2P income). It is intended that the relief will be available when a loan has been determined to be a “bad debt” (HMRC is currently in discussions with P2P platforms on that definition) and either formal recovery procedures have been commenced or the debt has been released by the lender. Some established P2P platforms operate a “safeguard” or “provision” fund to mitigate the risk of their participating lenders losing their money. In the event a borrower misses a payment, investors are repaid out of the fund, ensuring there is no delay in receiving interest due. For P2P platforms operating a compensatory mechanism such as this, losses are actually suffered by the platforms rather than the individual lenders and this relief is unlikely to be available for the P2P platform.

Conclusion

The Government has clearly embraced P2P lending as an important source of capital and these measures should promote an upsurge in the amounts invested in P2P loans and in investment in equity crowd-sourcing structures.

This article is part of Issue 5 of our Credit Funds Insight for 2015. To see the full publication, please click here.

_Notes

_{[1] See “Deduction of income tax from interest: peer-to-peer lending”, HMRC consultation document, published on the gov.uk website, July 2015.
[2] See “Deduction of income tax from savings income: implementation of the Personal Savings Allowance”, HMRC consultation document, published on the gov.uk website, July 2015.
[3] See “ISA qualifying investments: response to the consultation on including peer-to-peer loans”, HM Treasury report, published on the gov.uk website, July 2015.}