What is the Tax on Peer to Peer Lending?
What is the tax on peer to peer lending?
You have many things to keep in mind when investing — finding the best, most appropriate types of investment, how long to hold your investment, the return you will end up earning each year, how to mitigate risk and, of course, how much tax you will have to pay on your returns. This is just as true of peer to peer lending as any other type of investment. Earning money through peer to peer lending is usually classified as both income and capital gains, so you could be charged both income tax and capital gains tax.
So, what is the tax on peer to peer lending? What are the rules you need to know about?
It’s important to know the answers to these questions so you can make an informed decision about whether to invest. Factors to keep in mind include methods of peer to peer investment, different taxes you may owe depend on your choice of investment, your income bracket, and potential tax breaks and deductions.
Is some peer to peer lending tax free?
While some peer to peer lending is taxed to a degree, many forms are tax free.
A key example of a tax free option with a low minimum entry point is an Innovative Finance ISA (IFISA), also known as a peer to peer lending ISA. All interest and gains made from IF ISAs are tax free, which can add a significant chunk to your per annum earnings. Just bear in mind that you can invest a maximum of £20,000 in an IF ISA in any given tax year.
The House Crowd’s property-based IFISA requires a minimum investment of just £1,000 for an average return of 7% p.a. This is an excellent option for investors looking to reduce their tax burden. Investing via your pension is also a tax efficient method, if not an entirely tax free one: within the pension wrapper itself, there are no taxes on income besides equity dividends, and it’s possible to reclaim some deductions at the source of income. There’s also no tax on capital gains, and contributions can usually attract tax relief. However, you will be subject to income tax when you come to take your pension benefits and there are various other complex (and ever-changing) tax rules that apply.
What type of taxes could you owe?
Generally, the tax on peer to peer lending is either capital gains tax or income tax. Capital gains tax is payable on earnings of over £11,300 in any given tax year. Many people pay no income tax as peer to peer lending is included in the Personal Savings Allowance. This allows for up to £1,000 tax-free interest for basic-rate tax payers and at £500 for higher rate payers.
Any income earned above the savings allowance can be taxed at your income tax rate. As a reminder those rates are as follows:
- 20% for basic rate
- 40% for higher rate
- 45% for advanced rate
This means that if you are a higher rate payer and earned £1,500 in interest, then £500 of that is tax free. You will then pay a tax of £400 on the remaining £1,000.
As for capital gains taxes, most peer to peer lending investors do not invest large enough amounts of money to have to pay them. However, capital gains taxes may be owed if you are an investor who does a significant amount of buying and selling of existing loans outside of your IF ISA or pension lending.
What other peer to peer lending tax breaks or deductions are available?
In addition to the Personal Savings Allowance and other automatic breaks for most people, you should also know that bad debts are tax deductible. You are not taxed on losses and you can offset the losses of one peer to peer lending company against gains made at another one. This can help reduce your tax burden. However, you cannot offset your losses against other types of income or investments.
You can also forward losses up to four years as needed or recommended by your financial advisor.
As you can see, the tax on peer to peer lending can be smaller than you might expect, which means you’ll ultimately end up with more in your pocket and less in the taxman’s at the end of the year. Investing in property via short term peer to peer lending (bridging or development loans) in our IF ISA is a great way for an investor with less capital to get started, without worrying about complicated tax issues.
What’s the process for paying my P2P taxes?
Declaring and paying taxes on your P2P income is usually straightforward.
Simply print a hard copy of your annual tax statements from your provider, send them to your tax office with a letter indicating that you have untaxed P2P income and that this evidence is within the envelope, and ask HMRC to adapt your personal allowance accordingly.
When I buy an existing loan, do I have to pay income tax on interest paid?
It depends. If interest is generated but currently unpaid – i.e. with a loan that rolls interest to the end of the agreement – you’ll have to pay tax on the interest. If it’s repaid early, you could wind up with an overall tax loss.
That said, if you’re buying a loan that’s already commenced through a secondary market, interest will typically be paid to the previous lender regularly. So, the overall tax impact should be negligible, if there is any at all.
If you would like to know more about taxes on secured peer to peer lending, give us a shout.