For a long time, interest rates have been held at historic lows, arguably benefitting borrowers but to the detriment of savers. However, the sharp increase in interest rates over the last 12 months requires individuals to consider how their own personal tax situation might be affected, either by increased savings income or the increased cost of borrowing money.
Savers – the obvious winners, but what about tax?
With increasing interest rates comes increases in savings interest on cash deposits, which is not something many people have thought about for several years. Indeed, I overheard a conversation just last week whereby an individual confidently asserted that they didn’t need to worry about paying tax on their savings interest as the bank would deal with that at source, which hasn’t been the case since 2016!
Banks stopped deducting income tax at source when the Personal Savings Allowance (“PSA”) was introduced in April 2016. The PSA is set at £1,000 for basic-rate taxpayers, £500 for higher-rate taxpayers and £nil for additional-rate taxpayers. Individuals with a low total income may also be able to benefit from additional allowances in respect of savings income.
Where savings income falls within the PSA, income tax is charged at a rate of 0% and as such taxpayers will not be required to file a tax return just to declare this income if it is covered by the PSA. It is important to note, however, that the savings income received should still be considered when determining total taxable income in a tax year and can give rise to other tax implications such as:
- pushing a individual into a higher tax band;
- increasing the amount of the high-income child benefit charge; and
- reducing the personal allowance for individuals with total taxable income in excess of £100,000.
If you have income tax to pay on your savings interest earned during the year ended 5 April 2023, or if any of the points above will cause you to have increased tax exposure for that year, then if you do not already submit an annual self assessment tax return, you will need to make HMRC aware of your increased tax exposure by 5 October 2023 or else they can penalise you for late notification of tax liabilities.
Savers – some thoughts about reducing your income tax exposure
Interest from investments within an ISA and certain other tax-exempt products, such as premium bonds and national savings certificates, is not subject to income tax and does not count towards an individual’s total taxable income in a tax year. Accordingly, individuals may want to make use of their annual ISA allowance and tax-exempt savings products to benefit from a reduction in tax exposure and the administrative burden of filing a tax return.
Likewise, it’s quite some time since we’ve had to give serious thought to income equalisation between spouses/civil partners in terms of savings interest, but married couples and civil partners should make sure lower earning partners are making use of their PSA together with the starting rate for savings if appropriate to ensure overall tax efficiencies.
But what else should individuals be considering for their cash deposits to reducing income tax exposure? Well, amongst other things:
- Investment bonds – investments held within a bond usually grow without being directly assessed to tax on the bondholder. The personal tax charges are instead generally deferred until the bond is encashed, although modest withdrawals can usually be made each year without giving rise to any tax implications and essentially offer the opportunity to take a tax-free income from bond.
- UK Treasury Gilts – the interest on such Gilts is taxable, but the Gilts themselves can often be acquired for less than their face value such that, on redemption, the tax-free capital gain can replicate very attractive savings rates.
- Personal or Family Investment Company (“PIC” or “FIC”) – investments in a PIC/FIC will result in the company being assessed to corporation tax on the underlying income and gains at a rate of not more than 25%, which is 20% less than the top rate of income tax for individuals and hence means there can be significant ongoing savings from housing investments in a PIC/FIC. A PIC/FIC 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 company, but other benefits can arise, 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.
There’s not a great deal that can be done to mitigate tax liabilities in the past, although investment into Enterprise Investment Scheme (“EIS”/”SEIS”) companies now can afford an opportunity to reduce last year’s tax liability. Venture Capital Trusts (“VCTs”) and EIS/SEIS companies offer a suite of tax reliefs which in addition to helping mitigate income tax on savings can also offer capital gains tax and inheritance tax incentives.
Landlords – are they the losers?
Increasing interest rates will cause concern for all businesses that rely on debt financing, especially those in the residential buy to let sector.
The restriction on tax relief for finance costs of unincorporated landlords was phased in from April 2017 and has been a significant cost for landlords. Since 6 April 2020, residential letting businesses [save for furnished holiday lettings] have been unable to deduct finance costs from their rental income and, instead, receive a flat 20% tax reduction for finance costs. This restriction saw an immediate tax increase for higher rate and additional rate taxpayers, as well as impacting on calculations relating to tapering of personal allowances and child benefit.
With interest rates at a 15 year high and residential buy to let landlords only receiving limited tax relief for costs of borrowing, will we see them look to restructure their property portfolios?
One potential option that is likely to return to the fore is to incorporate the property letting business, as corporates are not subject to the same finance costs restriction. However, there are several considerations to take into account, for example:
- There are potential capital gains tax and stamp duty land tax implications of incorporating a property business, and whilst reliefs are potentially available, these need to be reviewed very closely to ensure unintended tax charges do not arise; and
- A transfer of properties to a company is likely to lead to existing lenders wanting to renegotiate finance arrangements, so a proportion of the tax savings achieved by incorporation may be lost due to increased interest costs.
Anthony Main
Over the last 12 months there has been a significant reduction in transactions involving the higher rates of stamp duty land tax for additional dwellings which suggests a slowdown in landlords purchasing rental stock, and I suspect we will see more landlords seeking advice as to how they can make their businesses function more efficiently, which includes managing tax leakage, or even selling property and having to consider their capital gains tax position.
If you would like further information regarding the points covered in this article, please speak with your usual RG contact, or a member of our Personal Tax team.