Simplifying tax on savings income
Tax incentives to encourage saving would be more effective if taxpayers understood them, and Donald Drysdale welcomes the new OTS report on this topic.
Help for savers
Saving is generally regarded as a good thing for individuals to do, and there are clear benefits to individuals and society as a whole when people have sufficient savings. Around 65% of UK adults save some of their income, and a variety of tax incentives exist to encourage them to do so.
Most UK taxpayers needn’t worry at all about whether they have to pay income tax on their savings. Since April 2016, savings income (i.e. interest) of up to £1,000 a year has been covered by the personal savings allowance (though this reduces to £500 for higher rate taxpayers and Nil for those who pay income tax at the additional rate).
Savers can contribute £20,000 a year to their ISAs on which income and gains are not taxed. For those with further dividend income, the dividend allowance gives added flexibility. Those with long memories will appreciate that these are changed days indeed from the 1970s and early 1980s, when investment income attracted a 15% income tax surcharge.
Pension savings enjoy special tax privileges. Following the introduction of auto-enrolment, 78% of employees have private pensions, although it is disappointing that only 17% of self-employed individuals can say the same.
Thus the UK tax regime offers a range of tax reliefs to encourage people to put money aside for their future needs. These reliefs work well for most taxpayers. However, aspects of the regime, including the interaction of various reliefs and allowances, are complex and can produce anomalous outcomes – and, of course, become even more complicated in the case of Scottish taxpayers.
In a report released in May, the Office of Tax Simplification (OTS) has published a broad review of the application of the tax system to savings and investment income.
According to the report, 95% of people pay no tax on savings income including interest, dividends, and income from pensions, investment bonds and funds – though I suspect this owes as much to prevailing low interest rates as it does to tax reliefs. In spite of the reliefs and allowances that exist, the OTS finds that many taxpayers fret about the tax treatment of their savings income even when they don’t have any further tax to pay. There are also many specific complexities which taxpayers find difficult and confusing.
The OTS concludes that there is a need to review the savings rates and allowances. Factors causing disproportionate complications include the starting rate for savings, and the fact that the personal savings allowance and dividend allowance are nil rate bands rather than exemptions. The interactions between the rates and allowances are sufficiently complex at the margins that even HMRC’s own self-assessment software has failed to cope and isn’t expected to work correctly until 2018/19.
Looking ahead, the report calls on the Government to publish a personal tax roadmap setting out its plans for income tax, including for savings income, and the stages needed to get there. This roadmap should build on the Government’s strategy to take a more measured approach to tax policy changes, giving citizens greater certainty and stability in planning for the future.
The OTS emphasises that there is scope for significant improvement of guidance and education on the taxation of savings to help citizens understand their options and make better informed choices. It strongly urges HMRC to focus on improving guidance on the taxation of savings income and making it easier to understand.
Following the abolition of tax deduction at source from interest, the OTS suggests that trusts and personal representatives should be entitled to the personal savings allowance to simplify tax administration for them and HMRC.
The report advocates changes to the ISA rules to make them simpler for investors and easier to administer. These might include enabling partial transfers of money invested in-year; removing the requirement that an investor may take out only one ISA of each type in each year; facilitating future transfers from Help-to-Buy to Lifetime ISAs without affecting the annual Lifetime ISA allowance; and modifying the rules on early withdrawals from the Lifetime ISA.
Financial providers have suggested that a digital ID for each customer might simplify the Open Banking Project, and the OTS report considers whether national insurance numbers (already required for ISAs) might be used for this purpose for all financial products whilst also simplifying tax assessment.
In a chapter devoted to pension income, the OTS discusses the use of the emergency tax code for personal pension lump sum withdrawals. It hopes to work with HMRC and other stakeholders on options to simplify the tax treatment of pension income and make it more comprehensible to pensioners.
The report devotes a further chapter to life assurance bond withdrawals, expressing concerns about the complex way gains on such policies interact with the tax system. Rather than reforming unsatisfactory aspects of the pre-existing legislation, Finance (No. 2) Act 2017 s 9 offers the possibility of relief in a small number of cases where the law produces a “wholly disproportionate” gain on part surrender. The OTS considers it would have been preferable for the legislation not to result in disproportionate gains, and believes this area of savings taxation warrants further review once the new system has bedded down.
In spite of the individual recommendations made by the OTS, the report says little about the general policy direction for the taxation of savings income and contains no fundamental proposals for streamlining the regime, particularly for Scottish (or Welsh) taxpayers.
Is there a will?
It is simply good governance that citizens should be encouraged to manage their financial affairs in a prudent and responsible manner, and this should generally include saving for those proverbial rainy days.
The report demonstrates the inevitable tensions between, on the one hand, successive Chancellors who have introduced greater complexity into the tax regime for their party-political ends and, on the other, the OTS which is charged with giving independent advice to the Government on simplifying taxes.
If Philip Hammond has a genuine will to simplify the taxation of savings and investment income, the OTS offers him a way – in the form of a number of constructive suggestions for improvement.
Some commentators may regard shortcomings in the tax regime as insignificant compared with the Government’s pressing tasks of managing the economy and achieving an orderly Brexit. Nonetheless, a tax system that savers don’t understand and HMRC’s IT specialists can’t tame is doing nobody any good.
Article supplied by Taxing Words Ltd