April 6th 2016 brings important changes to ISAs (Individual Savings Accounts) which allow you to earn tax-free interest on your savings or investments. We explain the main changes below, and how they could affect you:
Innovative Finance ISA
Currently if you want to earn interest free of income tax you have two ISA options: the Cash ISA or the Stocks and Shares ISA. You are able to invest or save up to £15,240 over the tax year in either one of these or split it between both ISA types.
On April 6th 2016, a new ISA will become available – the Innovative Finance ISA – which will allow you to hold peer-to-peer loans within the tax-free ISA wrapper. Up until now P2P loans have only been ISA-eligible when held within Investment Trusts in a Stocks and Shares ISA, but this new ISA makes peer-to-peer lending more accessible as all over 18s will be able to open one directly through a peer-to-peer lending platform.
Lending to businesses or individuals through an Innovative Finance ISA (IFISA) will make peer-to-peer lending tax-free (up to the ISA investment limit) and a more lucrative investment. You will be able to invest the full £15,240 yearly ISA allowance in peer-to-peer loans, or you could share the allowance with a Cash ISA or Stocks and Shares ISA as well. Peer-to-peer lending offers better expected returns than cash ISAs which currently on average offer approximately 1.17%, and is less risky than investing in shares. However investing in peer-to-peer loans carries its own risks and all investors should be aware of these risks before investing in an Innovative Finance ISA. Unlike Cash and Stocks and Shares, peer-to-peer loans will not be eligible for the Junior ISA or Child Trust Funds.
Changes to ISA rules
The introduction of a third ISA category was necessary as the Innovative Finance ISA (IFISA / IF-ISA) rules will be different due to the illiquid nature of peer-to-peer lending. Unlike other ISAs the IFISA will not require that investors can withdraw all investment within 30 days, as some peer-to-peer lenders do not have secondary markets allowing loans to be sold quickly. However, platforms which do have secondary markets can allow withdrawals if loan parts are sold to other investors, and the ISA requirement allowing withdrawal within 30 days will apply to any cash held in an Innovative Finance ISA.
The current ISA rules regarding transfer of investments to other ISAs will also be different for the Innovative Finance ISA. Again, the current rules apply for cash held in an Innovative Finance ISA, but there is no requirement for investors to be able to transfer loans. Procedures for withdrawals and transfers will depend on the account rather than overall ISA rules.
ISA rules regarding the legal ownership of investments have also been changed. Currently, non-cash ISA investments must be owned by an ISA manager who is approved by HMRC. However, with peer-to-peer lending the loans are owned by investors rather than the ISA manager, so this legal ownership rule will not apply for the new ISA. P2P platforms will become ISA managers without having to have legal ownership of the loans held in Innovative Finance ISAs.
With the launch of the IFISA, giving financial advice on P2P will become a regulated activity and the FCA is considering banning commission on financial advice for peer-to-peer investments. The new rules relating to P2P advice will be announced in April and will apply to all companies which provide an Innovative Finance ISA to investors.
Peer-to-peer lending will still not be covered by the Financial Services Compensation Scheme, so your capital remains at risk when investing in peer-to-peer loans.
So the introduction of the Innovative Finance ISA on April 6th is good news for customers who are discontent with low rates on cash ISAs, allowing investors to earn higher expected returns from peer-to-peer lending while still not paying income tax on the interest received with a limit of £15,240 invested across all types of ISA per year.