Important changes could be made to the way our savings and investments are taxed if some of the many ideas aired recently by the government’s Office of Tax Simplification come to pass.
In a report published in May, the OTS looked at income from cash or stocks and shares directly and in tax wrappers such as pensions, Isas and life assurance policies. “Income” here excludes property or capital gains.
The OTS recognises there are clear benefits both to individuals and to society as a whole when people have enough savings. As such, the UK tax regime includes various reliefs to encourage people to save.
These reliefs work well for most taxpayers but aspects of the regime, including the interaction of various reliefs and allowances, are “complex and can produce anomalous outcomes”.
One reason the system works well enough for most of us is that 95 per cent of people pay no tax on such income. This is often because of the personal savings allowance, which means the first £1,000 of savings income (for basic-rate taxpayers) is taxed at nil per cent.
For individuals with very low non-savings income (such as earnings), there is an extra nil per cent tax rate on savings income up to £5,000. Then there is the annual Isa allowance of £20,000. Dividends of less than £2,000 outside an Isa are not taxed.
Perhaps unsurprisingly, people are much more aware of the tax efficiency of Isas than of these savings and dividend allowances. The OTS thinks this can lead to investors making unnecessary mistakes with their money: for example, placing cash in an Isa they know is tax free when an ordinary deposit account might offer a higher rate of interest – which, for most people, would also be tax-free.
Part of the problem is consumers are very ill-informed. The OTS cites studies showing that financial literacy in the UK is below the Organisation for Economic Co-operation and Development average. So, while there is lots of scope to improve guidance, it is a long-term proposition.
What is more, so complicated are the structures of tax – especially at the margins – that the OTS has revealed it is proving to be difficult to create an algorithm to calculate the tax correctly in all circumstances.
Its main recommendations are to streamline the ways income tax rates and allowances interact with each other. For example:
l Making the personal savings allowance and the dividend allowance true allowances or exemptions rather than a nil rate of tax, so they do not count towards an individual’s total income (e.g. for calculating their higher and additional rates)
l Exempting savings interest for basic-rate payers, those with total income below a certain threshold, or people over pension age
l Amalgamating the starting rate with the personal savings allowance, resulting in £6,000 for basic-rate taxpayers, or £5,500 for higher-rate taxpayers.
The OTS argues for a strategic approach to reform, avoiding piecemeal changes, which risk adding further layers of complexity.
Turning to Isas, it thinks the general principles are pretty well understood but some of the detail is confusing.
It is critical about Lifetime Isas, in particular, which are so complicated that many providers have been put off introducing them. It urges the government to revisit the penal rules on early withdrawal.
The OTS has high hopes for the Open Banking project and thinks a digital ID for consumers would simplify the process – for example, by requiring them to provide their National Insurance number whenever they take out a product, as is currently required for Isas.
It has also raised the issue of the tax treatment of lump-sum withdrawals from personal pensions, particularly HM Revenue & Customs’ use of emergency tax codes, which generally results in the deduction of too much tax.
Another area for review is the taxation of life assurance bonds once the new rules about excess withdrawals have bedded down.
Quite when and if these new provisions will come in is anyone’s guess. Simplification may turn into complification, and hope of a strategic approach might fall to a series of random pragmatic reforms by an impatient Treasury.
Danby Bloch is chairman of Helm Godfrey and consultant at Platforum