Chris Etherington

Written by: Chris Etherington

Chris Etherington

Partner

Complexity in savings taxes could lead to poor investment decisions

  • June 2018
  • 3 minutes

The Office of Tax Simplification (OTS) has published its review on how savings and investment income is taxed. While 95 per cent of us pay no tax at all on our savings income, it is clear from the report that for the 5 per cent who do, the rules are an amalgamated mess.

The fact that for the vast majority of people, no tax is paid on their savings income from interest, dividends, pensions and investment bonds and funds is commended by the OTS. Having no tax to pay is a simplification many taxpayers will be happy to retain. 

Whether the general public understand why there is no tax is another question. Many will be familiar with the concepts of ISAs but the OTS notes that other reliefs and allowances such as the £1,000 personal savings allowance are not well understood. 

That could lead to people making poor investment decisions. For example, investing savings into ISAs when a bond or bank account might give a better return and also provide tax-free returns.

Similarly, the OTS review outlines that many people still do not understand the implications of cashing in on their pensions - a particular concern given pension withdrawal numbers are now at record levels following the relaxation of pension rules introduced a few years ago. 

The complexity of the savings tax system is compounded by the fact that financial literacy in the UK is low compared to the average across the 34 OECD countries. The OTS is already working with HMRC in its approach to its guidance but clear guidance is still likely to be difficult to follow given the current state of the rules. Even HMRC’s Self-Assessment software sometimes struggles to find its way out of this ‘Escher staircase’ of tax rules and calculate the right liability.

In light of these findings, the OTS makes a number of suggestions on how matters could be improved, including:

  • specifying the order in which to apply reliefs/allowances;
  • simplifying the calculation of reliefs, e.g. make the dividend allowance an actual allowance rather than a 0 per cent tax rate; and
  • exempting interest entirely for basic rate taxpayers or those with income below a certain level.

A number of other options are also considered by the OTS such as simplifying ISA rules further and looking at early withdrawal penalties for Lifetime ISAs which have put many people off them. The possibility of a Digital Identity for taxpayers is also mooted which might make it is easier for people to compare the appropriateness of various financial products and feed into HMRC’s wider digital agenda.

Many of the current rules and allowances have their own individual merits, leading to the positive conclusion for many that no tax is due on their savings income. The issue is that these rules have been introduced piecemeal by various governments resulting in a hotchpotch system that few understand. Any reform, as the OTS suggests, therefore needs to be thought through and introduced over time as part of a longer-term plan.

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