The Summer Budget 2015 contained two key announcements for the FinTech and alternative finance industries:
- the Chancellor confirmed that a new “Innovative Finance ISA” will be introduced from April 2016 for loans arranged via a peer-to-peer (“P2P”) lending platform; and
- a public consultation was launched on whether to extend the list of ISA eligible investments to include debt securities and equity offered via a crowdfunding platform.
What is an ISA?
An individual savings account (“ISA”) is a tax efficient “wrapper” around certain investments which means that any interest, dividends or capital gains that arise from those investments are tax-free for the investor. The assets that can be held in ISAs (i.e. qualifying investments) are specified in the Individual Savings Accounts Regulations 1998 and currently consist of (1) cash and (2) stocks and shares. There are limits on how much investors can subscribe to an ISA in each tax year. The annual limit for 2015-16 is £15,240; this can be invested in a stocks and shares ISA, a cash ISA, or a combination of the two.
Innovative Finance ISA
From 6 April 2016 there will be a third type of ISA, the “Innovative Finance ISA”, which will extend the tax advantages of ISAs to loans made through P2P lending platforms. This announcement comes following the conclusion of a consultation on the matter which was announced in the 2014 Budget.
Draft legislation will be published later this year but the key points from the response to the consultation on including P2P loans are as follows:
- Separate ISA: P2P lending has its own risk and reward profile and the government has decided that P2P loans should be included within a separate ISA type – the “Innovative Finance ISA” – to reflect the fact that they are different to other ISA qualifying investments, and will be subject to different rules in relation to withdrawal, transfer and ownership. However, it should also be noted that P2P loans can generally be held within investments that are currently eligible for a stocks and shares ISA, such as investment trusts. It will be interesting to see whether investors will take to the new Innovative Finance ISA or continue invest through more traditional methods.
- Definition of P2P loans: The government intends to use the definition of “relevant agreements” in article 36H of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (i.e. carrying out the activity of “operating an electronic system in relation to lending”) as a general basis for identifying P2P loans that will be eligible for ISA inclusion. This is a wide definition and would make most of the loans on the main P2P platforms eligible for the new ISA type.
- Regulation of P2P loans: The government proposes to make the provision of advice to investors in P2P loans a regulated activity. All firms currently authorised to advise on investments will be eligible to elect to have this authorisation automatically conferred upon them. For the time being, the FCA has not chosen to include P2P lending platforms within the scope of the Financial Services Compensation Scheme (“FSCS”) but this will be reviewed again in 2016.
- Ownership: The ISA rules require that all assets held within ISAs are managed by an ISA manager approved by HMRC. The ISA rules also require that non-cash investments must be legally owned, or co-owned, by the ISA manager or their nominee. This legal ownership requirement is designed to facilitate the acquisition and sale of investments held within the ISA by the ISA manager. As investors enter into loan agreements directly with the borrowers to whom they are lending, P2P loans tend to be legally and beneficially owned by the investor and thus they do not satisfy this requirement. However, the government has recognised that P2P loans can be easily acquired and, where secondary markets exist, marketed and sold by investors themselves via P2P platforms. The legal ownership requirement will therefore not apply to the Innovative Finance ISA and investors will be able to retain the legal ownership of P2P loans wrapped in the Innovative Finance ISA.
- Withdrawals: The current ISA requirements allow an investor to withdraw their ISA investment within 30 days. This will be applied in relation to any cash held in an Innovative Finance ISA but the rules around withdrawals of non-cash investments (i.e. loans) will be matters for the agreed terms and conditions between the lender and the P2P lending platform, rather than the ISA rules. Typically, an investor on one of the larger P2P platforms will be able to utilise its secondary market (assuming there is sufficient liquidity) to exit its portfolio of loans.
- Transfers: The current ISA requirements allow an investor to transfer their ISA investment within 30 days. Again, this will be applied in relation to any cash held in an Innovative Finance ISA but the government has decided not require P2P loans held within ISAs to be transferable.
Consultation on whether to include equity based crowdfunding
The government is also exploring the case for extending the list of ISA qualifying investments to include debt securities and equity investments offered via crowdfunding platforms within the Innovative Finance ISA wrapper. It has launched a consultation on the matter which will run from 8 July 2015 to 30 September 2015.
What does this mean for the alternative finance industry?
By allowing P2P lenders to use the ISA wrapper from 6 April 2016, people who lend their money to others through P2P lending platforms will not be taxed on any interest they make. The government’s response to its consultation is a sensible one and demonstrates a growing acceptance of the alternative finance industry as playing a key role in the growth of the UK’s financial sector.
The proposed extension to the ISA rules that is currently being consulted on could also see the list of ISA qualifying investments widened to include most other investment based crowdfunded products. These developments put P2P lending on a level playing field with other investments, such as banks’ savings products and equity investments, which have traditionally been tax-free when wrapped by an ISA.
It is hoped that these developments will spark a major growth in the crowdfunding sector, diversify the available sources of finance (thereby improving competition in the banking sector) and help crowdfunding become a more mainstream choice for consumers.
Fox Williams LLP are experts at advising entrepreneurs and FinTech businesses. For more information as to how Fox Williams can help you (including arranging a free consultation) or for further information on the issues discussed in this article, please liaise with either Jonathan Segal or Hannah Sensecall.