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A look at the OTS’s thoughts on savings income tax simplification

28 August 2018

Prudential’s Graeme Robb examines key areas from the Office of Tax Simplification paper on how the taxation of savings income can be simplified

In May, Liz Hardie explored the consultation issued by the Office of Tax Simplification (OTS) regarding potential simplification of the inheritance tax (IHT) regime. That consultation has now closed and we will need to wait until the OTS publishes its Report later this year for more information.

In a recent article I considered the OTS Business Lifecycle Report. Now it is time to consider the recent OTS paper exploring how the taxation of savings income can be simplified.

What was in the paper?

It provides a comprehensive picture of the taxation of:

  • Interest and dividend income
  • ISAs
  • Pension withdrawals
  • Life insurance bonds
  • collective investment vehicles such as unit and investment trusts

It could very well be an important paper given that it is the first broad review of its type into the tax system as it applies to savings and investment income.

It’s a 50 page report, and with that in mind, I’ll just focus on the key recommendations for further work.

Streamlining the interaction of income tax rates and allowances

The starting rate for savings, personal savings ‘allowance’, dividend ‘allowance’ and other allowances and features of the tax system mean that most people pay no tax on their savings, but the interactions between the rates and allowances is sufficiently complex at the margins that even HMRC’s self-assessment computer software has sometimes failed to get it right. The OTS considers that it would be useful to open up a discussion about the reasons for the number of rates and allowances (which will be added to by some of the new differences resulting from devolution) and the impacts of possible alternative approaches in this area.

Introduce a personal tax roadmap (to incorporate plans for the taxation of savings)

Although savings taxation currently works well for most taxpayers, there are opportunities to improve the position further, especially as a minority experience real challenges at present.

The OTS considers that further work on options to consolidate some of these rates and allowances should be undertaken. To approach this area in a strategic way, a personal tax roadmap, along similar lines to the current business and corporate tax roadmaps, could set the future direction for income tax, including for savings income, and outline the stages needed to get there. People need a level of certainty in order to plan their financial futures and this part of the personal tax system has seen a significant number of changes in recent years: a roadmap could help stabilise the position as well as increasing transparency.

Increase flexibility on ISAs

The OTS considers further changes can be made to simplify ISA rules for investors: for example, allowing partial transfers of money invested in year (in line with transfers from previous years’ ISAs), or removing the requirement that an investor may only take out one ISA of each type per year, subject to the overall annual limit.

Revisit the rules on early withdrawals from the lifetime ISA

The long-term nature of the lifetime ISA and the charge for early withdrawal mean that savers are potentially tied into the product for decades.

Major financial institutions have told the OTS that they have decided it would be inappropriate to offer cash LISAs to unadvised retail investors. The OTS understands that the number of authorised ISA managers is still relatively small and suggests that further consideration should be given to how best to ensure that the LISA rules work effectively for unadvised savers. Indeed, the OTS would like to see a full review of the current ISA landscape, to simplify the regime.

Review guidance relating to pension withdrawals, and the use of the emergency tax code for lump sum withdrawals from personal pensions

More could be done to help people understand the tax implications of withdrawals from pension funds and the actions they may need to take. The OTS would like to explore this further with HMRC, in addition to working to identify options other than initial tax deduction using emergency tax codes on personal pension lump sums, which generally results in the deduction of too much tax when the payment is made.

Next steps?

The OTS considers it important not to make piecemeal changes, which risk adding further layers of complexity. For example, the number of rates and allowances for personal savings and dividends is a significant cause of complexity: cutting one or more of the reliefs would be one way to simplify matters, but it would be important to ensure that there are no unforeseen negative consequences.

At the moment, it is not easy for a taxpayer (or the OTS) to understand what the plans are for digital tax accounts and how these interact with tax return processes.

It is against this background that the OTS suggests a roadmap or plan for changes to the personal tax system, to ensure that future changes may be made in a transparent and planned way over time.

As noted earlier in the document, there is a full chapter devoted to life insurance bonds. The chapter is rounded off with this comment.

“The way in which the gains on such policies interact with the tax system is complex, and the OTS believes that this area of savings taxation warrants further review once the new system has bedded down.” The new system referred to is the “wholly disproportionate” gains rule in Finance (No 2) Act 2017 covered here https://www.pruadviser.co.uk/knowledge-literature/knowledge-library/wholly-disproportionate-gains/

Chapter 5 considers collective investment vehicles such as Open Ended Investment Companies (OEICs). The OTS has however no significant observations on this area albeit it flagged up the slight complexity of distribution being dividends or interest.

Finally, remember that the OTS does not implement changes – these are a matter for government and for Parliament. Instead, the OTS is the independent adviser to government on tax simplification, challenging tax complexity to help all users of the tax system.