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Budget 2015 – Bad debt relief & tax free lending

The way people are taxed on their savings and investments has been in the news over the last few days thanks to reforms announced in last week’s Budget.

There’s more on how these proposals will affect peer-to-peer lending below, but a more imminent change is due which could cut income tax bills for customers of Zopa and other P2P platforms from next month.

Bad debt relief

According to measures outlined in last year’s Autumn Statement, any bad debts incurred by lenders from April 6 can be deducted from returns before income tax is calculated.

So for example, if between April 6 and April 5 2016 you make £1,000 from lending but suffer bad debts worth £50, the taxable amount will be £950 rather than the full £1,000.

For a basic-rate 20% taxpayer, this would effectively shave £10 of the “cost” of the bad debt – for someone in the higher-rate bracket taxed at 40%, the saving would be £20.

The government says that this bad-debt relief will have to be claimed through the self-assessment system: tax returns for the upcoming 2015-16 financial year have to be submitted by the end of January 2017 at the latest.

Bad-debt relief brings P2P lending into line with the capital-gains tax system, in which losses on investments in shares, funds or property, say, can be deducted when calculating tax liability.

Clearly it makes sense only to be taxed on money you have actually made. And although it has taken 10 years for this eminently sensible measure to be introduced on P2P lending, it is nonetheless very welcome.

Tax free lending

The same can be said for the latest set of reforms to tax on savings. In last week’s Budget, Chancellor George Osborne surprised most observers by announcing the introduction – from April 2016 – of a savings tax allowance.

This is similar to the personal income tax allowance, which allows individuals to earn up to around £10,000 a year before their wages are taxed.

The personal savings allowance means that most people can receive up to £1,000 interest a year before they are subject to income tax. (Higher-rate taxpayers can only earn £500 a year before tax kicks in, so the value of the tax relief to both groups is limited to £200 per person.)

It has since emerged, however, that this allowance will also be available to lenders on P2P platforms. So for a hypothetical basic-rate taxpaying customer with £20,000 loaned out at an average return of 5% (after fees and bad debts), there will be no income tax to pay.

This policy has come as a pleasant surprise to the P2P industry, and certainly took the edge off the news that the government has pushed back its review on how P2P will be included in ISAs until the summer.

The personal savings tax allowance means that many P2P lenders will face no income tax bill at all. But a P2P ISA still has much to offer, because it would mean that customers could build up a substantial holding of loans (at a rate of £15,000+ a year), returns on which would never be taxed.

Over time, this is likely to generate a far larger tax saving than the £1,000-a-year allowance.

(With peer-to-peer lending, your capital is at risk)