05 August 2023
With rapidly rising interest rates, there are clear winners and losers. Those with large mortgages and high monthly repayments may find themselves dipping into their savings to pay the bills whilst others may find themselves with much higher savings income. However, there are tax consequences for those benefitting from a savings windfall, who may suffer tax on savings and investment income and gains for the first time in many years.
For some years now, most interest payments have not suffered tax at source and dividends have not been received with a corresponding tax credit. Many individuals will not have had any additional tax to pay previously but will now need to notify HMRC of a tax liability on their interest by 5 October 2023 for the 2022/23 tax year, whether or not they have to submit a self-assessment tax return. This will apply where their interest income exceeds £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. Additional rate taxpayers do not benefit from such a savings allowance. Although Scottish taxpayers pay different rates of income tax to the rest of the UK on certain elements of their income, UK tax rates and bands are used for the purposes of savings income and allowances. A dividend allowance of £2,000 is available to all individuals in the 2022/23 tax year.
Not only will more individuals suffer tax on savings income, but they will also need to deal with possibly unfamiliar reporting systems.
Can anything be done to minimise the impact? For savings and dividend income that arose in the 2022/23 tax year, there is little that can be done as the tax liabilities and reporting requirements have already arisen. However, making tax-efficient investments in the current year, such as investments into venture capital trusts (VCTs) and enterprise investment scheme (EIS) companies, may give rise to an opportunity to relieve income tax liabilities and defer capital gains that arose in the previous year.
Going forward, UK resident individuals over 18 years of age (16 years for cash ISAs) might wish to consider using individual savings accounts (ISAs) to house both their savings and investments, where appropriate. Interest and dividends arising within an ISA are tax free and do not need to be reported on a tax return. A maximum of £20,000 (£9,000 for junior ISAs) can be invested in ISAs each year. Both the dividend allowance and the capital gains tax (CGT) annual exempt amount were reduced significantly on 6 April 2023, to £1,000 and £6,000 respectively, and are both set to be halved on 6 April 2024. This may make using ISAs even more valuable, particularly considering that any gains arising within the ISA will also be free of CGT.
However, for taxpayers with significant savings and investments, the annual ISA allowance might seem insignificant. For these individuals, it may be time to think about using an alternative wrapper to house savings and investments, which may include an (offshore or onshore) investment bond or the use of a personal investment company (PIC).
Investments held within a bond usually grow without being directly assessed to tax on the holder. The tax charges are instead generally deferred until the bond is encashed, although small withdrawals, of less than 5% of the investment amount, can usually be made each year without giving rise to any immediate tax implications.
Making investments in a PIC wrapper will result in the company being assessed to corporation tax on the underlying income and gains at a rate of 25%. This is 20% less than the top rate of income tax for individuals – 45% on savings income, which means there can be significant ongoing savings from housing investments in a PIC. However, a PIC may not be suitable for short-term investment plans, as an individual will generally incur an additional layer of taxation when extracting profits from the PIC. Other benefits can arise from holding investments in PICs, such as the fact that companies do not generally suffer tax on dividend income and that some investment management fees may be deducted in calculating the company’s profits.
Advice should be sought from an independent financial adviser when considering changes to investment holdings.