While the rise of Sipps has been widely documented, the growth in the peer-to-peer market is yet to attract the same level of attention. This is unlikely to remain the case for long, with experts predicting it will double in size every six months.
With such impressive growth, it is interesting the touch points between the two markets have so far been limited. Why is this?
There are two main points of concern. The first is the perception the P2P market is still immature, implying the risk of losses is too high. The second is that HM Revenue & Customs rules mean loans could lead to tax charges on the Sipp member, which providers cannot prevent.
Perception of the market’s maturity needs to be reassessed given the pace of growth. The three largest players each have between 20,000 and 60,000 lenders on-platform. The largest recently broke through the £1bn barrier in funds lent. Meanwhile, it has been subject to FCA regulation since April 2014 and appears to have welcomed it well. The same cannot be said of parts of the Sipp industry at times.
P2P lending has also attracted an impressive level of Government support, with millions of pounds injected into it by the British Business Bank and the proposed launch of Innovative Finance Isas.
Risk of failure
Another concern has been the possibility of platform failure. Indeed, a few have hit problems. In the last few weeks, problems with TrustBuddy, one of the smaller platforms, have highlighted the importance of the issue. The biggest previous failure was YesSecure, although lenders reportedly received funds back. In late 2014 GraduRates closed but one of the big-three platforms, RateSetter, took over. The only failure known to have resulted in the loss of funds was Quakle in 2011. All of the issues have arisen with the smallest platforms but the Sipp market itself has not been immune to provider failure.
Most P2P platforms now offer protection from the risk of loss for individual borrowers. A common option is a protection fund, typically funded by a fee from each borrower. The biggest is now around £20m.
You would expect HMRC’s rules on pension scheme lending to be the source of less debate. But even here there has been uncertainty. The key considerations are whether there is a connection between the lender and borrower, and whether the loan is used by the borrower to purchase taxable property.
If the Sipp lends money to a person connected with a member or ex-member of the pension scheme, an unauthorised payment occurs. The test is not applied at individual Sipp arrangement level but at the level of the registered pension scheme sitting above the arrangement. It might be easy to check whether a borrower is connected to the Sipp member but it is less straightforward when the test is applied to all, say, 80,000 members of the same scheme or anyone connected to them.
The solution may come from the way P2P platforms structure their loans. While some offer direct lending between individuals and borrowers, the bigger platforms tend towards a pooled, anonymised model. Funds can be spread across dozens, with neither the lender nor borrower knowing who is involved in the transaction. Some platforms also require clients to self-certify they will not intentionally lend to, or borrow from, connected parties and have processes to highlight any chance of collusion.
The question is whether this will satisfy HMRC. Using its definition of connection, it is impossible for the party on either side of a P2P transaction to know whether the other is connected. Would this be sufficient to demonstrate an absence of collusion, or would Sipp providers be expected to prove this beyond all doubt? If the latter, the position becomes unworkable on any sort of scale. It is hoped that HMRC comes to a sensible conclusion.
The use of loan funds to purchase taxable property has also been misunderstood. If a Sipp lends money to someone and the funds are used to purchase taxable property, HMRC says it can have an interest in that property. This is a problem regardless of whether the lender and borrower are connected and whether the loan is secured or unsecured.
Again, the solution may come from the platform’s model. If the loan is directly between a single lender and borrower, and funds are used to purchase taxable property, the Sipp member is likely to have inadvertently incurred an unauthorised payment charge. However, where lending is pooled, the Sipp may be treated as having an insufficiently significant interest in the taxable property for a tax charge to apply. Again, It comes back to how HMRC views this.
Although the lending is pooled, an individual contractual relationship is likely to exist between lender and borrower for their part of the overall transaction. If HMRC applies the ‘level of interest’ test at the combined amount of funds borrowed, individual Sipps may not have an issue. If the test is applied at the level of the individual contractual relationship between Sipp and borrower, there is a problem.
Discussions are ongoing between P2P lenders, Sipp operators and HMRC to resolve the technical issues. It will be a shame if the Government’s own rules, introduced a decade ago when P2P was not a consideration, prevent greater collaboration in today’s financial landscape.
Gareth James is head of technical resources at AJ Bell