Although interest earned from peer to peer lending (P2P) is a taxable income there are a number of tax breaks which can be exploited, making P2P investing tax free. As all returns are paid without any tax deducted, it is the responsibility of the investor to pay any requisite tax.
Peer to Peer Lending Tax Summary
- The first £1,000 earned from P2P can be tax free under the Personal Savings Allowance. For higher rate taxpayers this is capped at £500.
- P2P investments held within an Innovate Finance ISA (IFISA), yield tax-free returns. This includes ISA transfers and new ISA money, upto £20,000 per tax year.
- P2P can be held within a SIPP account. However, only niche SIPP providers offer these accounts and they can be expensive.
- Any losses due to defaults can be offset against any gains.
What is the Personal Savings Allowance?
Since April 2016, non-cash ISA savings benefit from a tax relief known as the Personal Savings Allowance. Interest from current accounts and any peer to peer investments are eligible under the allowance. The allowance is £1,000 for basic rate tax payers and £500 for higher rate tax payers. Considering a 5% return, a basic rate taxpayer could invest £20,000 and receive £1,000 interest tax free. Similarly, a higher rate taxpayer could invest £10,000 before paying tax on the £500 earned.
This allowance was commonly used amongst investors in P2P while they waited for the larger P2P platforms to offer the IFISA. The levels of returns and investment amounts generally align with the average investment amounts of the industry (£8,000 – £20,000). It’s further common for a husband to open an account in their wife’s name (or vice versa), spreading the benefit across the household.
Investing through an IFISA
The Innovative Finance ISA (IFISA) was launched in April 2016, allowing peer to peer investments (P2P) to be held within a tax-efficient ISA wrapper. Investors are allowed to subscribe a limit of £20,000 per tax year, either entirely to the Innovate Finance ISA (IFISA) or split between multiple ISA types. ISA transfers are also generally accepted by the P2P platforms offering the IFISA.
The majority of the UK P2P platforms are now offering the IFISA, as displayed in the Orca IFISA table by clicking below.
Can I invest through my pension?
In short, yes, it is possible to hold P2P investments in a SIPP account. However, due to specific rules, only a number of smaller more niche SIPP providers offer this as an option. Peer to peer lending is classified as a non-standard asset which increases the capital adequacy requirements of the SIPP providers. This comes at a cost which is passed on to the customer, incorporated into the fees of the SIPP. This makes the tax benefit of investing through a SIPP only worthwhile for large holdings. Morgan Lloyd and London Colonial offer SIPPs which accept peer to peer investments.
SIPPs were discussed at length in a previous article here: ‘Will Major SIPP Providers Ever Adopt P2P?‘
Can losses be offset against gains?
Any losses suffered from defaulted loans can be offset against any gains from loans repaid. For P2P platforms that operate an Autobid function, where diversification occurs automatically, this offset is incorporated into the Autobid.
How to pay tax on P2P income
P2P platforms provide annual tax statements which can be used to help declare any tax obligations. Investors who complete annual tax returns are required to declare their P2P income in their tax return. If paying tax through PAYE, investors are able to contact their local tax office and declare their income by sending the P2P annual tax statements, accompanied with a letter. In this circumstance, the local tax office will be able to adjust the PAYE tax code for the deduction to occur through the investor’s salary.