Stock ISAs - Tax free confusion

Johnny_WL

Sorry if I've missed the point here but when MSE describes Stocks and Shares ISAs there's a suggestion that:
2: 'They're tax-efficient, but not always tax-free'

I'm confused as HMRC states on it's website Individual Savings Accounts (ISAs)
2: How ISAs work - 'With a stocks and shares ISA or an innovative finance ISA, you don’t pay tax on any income or capital gains from your investments.'

My understanding from HMRC is so long as I stay within my 2016/17 allowance (£15,240) within a stock and shares ISA I'll never have any tax to pay for that ISA regardless of appreciation.

There seems to be a difference of opinion here. Who is right?
Thanks in advance if anyone (Eesha Mohindra?) can share some clarity on this.

masonic

They won't protect you from stamp duty or foreign taxes. There are probably others.

Biggles

That part of the article does seem to be a bit confused. It doesn't mention the items masonic mentioned; but it does mention under 'B. Dividends' that

Any dividends received above this allowance will be taxed - at 7.5% for basic-rate taxpayers, 32.5% for higher-rate tax payers and 38.1% for additional-rate taxpayers. If you're a higher or additional-rate taxpayer who receives dividend income, then you must inform HMRC.

but without mentioning that that's only for dividends outside an ISA and there is no further taxation or need to notify HMRC if they are paid within the ISA. Nor does it even mention the fact that dividends are already taxed prior to being paid, whether inside or outside an ISA.

bowlhead99

Biggles wrote: »

That part of the article does seem to be a bit confused.

In "the old days"(well, for quite a while, until last tax year) there was an archaic system of notional tax credits (left over from a historic corporate tax and dividend tax system) meaning that you wouldn't pay any tax on dividends if you were a basic rate or nil rate taxpayer. As a nil rate taxpayer or ISA holder or pension, you wouldn't pay any tax at all, but neither could you "claim back the amount of the tax credit" because you didn't need a tax credit, because you didn't have any tax to pay.

MSE and others used that concept to write their headlines that investing in UK shares through an ISA "wouldn't avoid all taxes on the income" because an ISA holder couldn't claim back the notional tax credit. Despite the fact that they had not suffered any tax and did not need a credit. Effectively the rules just meant that basic rate taxpayers and nil rate taxpayers (who didn't have any tax to pay on dividends income anyway) were not able to save any dividend tax by using an ISA, because there was no dividend tax to save.

Now, the notional tax credit system has been scrapped. So the writer has gone and got the new dividend tax rates (which are paid after someone has exhausted their annual dividend allowance) and shoehorned it into the article.

Obviously it is now going to be quite confusing if the article's bullet point is that ISAs are not always tax free, and then tells you what you would pay on dividends as a basic, high or higher rate taxpayer after you used up your dividend allowance (7.5, 32.5, 38.1%) versus what you would pay on dividends in an ISA (0%). Blatantly, ISAs *are* tax free in terms of UK taxes on dividends.

So, clearly, the old (pretty tenuous) idea that ISAs were not tax free because you couldn't reclaim some notional tax credit, is completely blown out of the water if the tax credit system is entirely scrapped, and replaced with annual allowances open to all followed by tax payable by all.

Nor does it even mention the fact that dividends are already taxed prior to being paid, whether inside or outside an ISA.

It should not mention that, because it would be factually incorrect.

If I am directing my FTSE100 company, or my little one man personal company, or any UK company in between those sizes, and I decide to declare 50p per share dividend out of the spare money which exists in the company after the company has paid its running costs and worldwide corporation taxes, then the mechanism to give it to my shareholders is as follows:

1) company pays 50p per share to the shareholders;
2) shareholders receive 50p per share
3) done.

The 50p dividend is not taxed, and is simply received -in full -by the shareholders. The shareholders then have to pay their appropriate taxes. If they have spare annual dividend allowance there may not be anything to pay. If they don't, there probably will be, at the graduated rates, and they can do a tax return to declare it. But if the shares were held in an ISA or pension, HMRC does not care, and no dividends tax is due, and the 50p dividends certainly haven't been taxed before they are received.

As Masonic says, there are other taxes that ISAs may not shield you from such as stamp duty (which is not a tax on income or gains), or foreign income taxes. The latter is because although HMRC can create a tax exempt wrapper which *it* respects, it cannot always stop a foreign tax authority applying withholding tax in the local country on their foreign investors. As HMRC don't apply any taxes on the ISA investments you hold, they can't let you offset your overseas tax costs against your UK tax costs on the same assets - because there aren't any UK tax costs on those assets.

Johnny_WL wrote: »

My understanding from HMRC is so long as I stay within my 2016/17 allowance (£15,240) within a stock and shares ISA I'll never have any tax to pay for that ISA regardless of appreciation.

Correct. As long as you don't break the rules by exceeding the annual contribution limit in any one tax year, you keep the tax free status. You could put £1k a month in for the next 5 years, and leave that £60k to turn into £250k over a couple of decades. HMRC would not want a penny of tax on the capital growth, or the dividend income received, or the interest distributions received, or the property income distributions received. It is a tax free investment wrapper.

Malthusian

Dividends in ISAs are taxed, because the company has to pay corporation tax on its earnings before it pays out the dividend to you.

We don't talk about this any more because the government likes to pretend it doesn't tax the same money twice. (Even though it does, constantly.)

By contrast, if you have a corporate bond that pays interest, the company pays your interest before the government applies corporation tax. So to misquote Animal Farm, all distributions received by ISAs are tax-free, but some distributions are more tax-free than others.

All of the above is a history lesson and not really relevant to the decision of whether to open a stocks & shares ISA now.

bowlhead99

Malthusian wrote: »

Dividends in ISAs are taxed, because the company has to pay corporation tax on its earnings before it pays out the dividend to you.

We don't talk about this any more because the government likes to pretend it doesn't tax the same money twice. (Even though it does, constantly.)

By contrast, if you have a corporate bond that pays interest, the company pays your interest before the government applies corporation tax. So to misquote Animal Farm, all distributions received by ISAs are tax-free, but some distributions are more tax-free than others.
.

If you own a share in the company your reward for that risk is to own a share of all the "leftover" profits and all the assets after it's finished running its business. Those remaining profits and assets which you'll get to share in, are inherently net of any running costs of the business including supplies, rent, salaries, servicing of borrowings, and taxes that the business paid on its profits.

If you choose not to own a piece of the business, and instead just act as lender to the business, the interest that they'll pay you is not "what's left after paying all the running costs including taxes", it is just a contractual payment. So arguably it's not net of anything.

But in a sense, it *is* net of taxes, and of cost of supplies and rent and salaries and servicing of other borrowings etc - because if all those various amounts end up being too high, there won't be enough in the pot to pay you your interest. However, generally as a lender to a reliably profitable business you don't give two hoots about what costs of running the business they paid off before they paid your interest... so you don't think of your interest as being net of anything.

If you want to complain about the government, you can say that someone who invests in equities - who doesn't use an ISA - has been a victim of an evil "double tax", and someone who does use an ISA has still "paid tax on their dividends", implying that the ISA-user's investment returns via dividends are still "net of" a tax on that investment activity. But that seems like it's just making a political point. There are no taxes payable by the company on declaring dividends to its owners.

As someone that chooses to invest in equities, I recognise that the corporate taxes a company has to be willing to pay on its operations in the countries in which it does business, is just a cost of doing business. Companies pay it to get legal access to the infrastructure, legislative environment and workforce of the jurisdiction involved. Call it a profit-related entrance fee.

If you choose to invest in a business by way of equity, keeping all the dividends and retained profits of the business for yourself, you will inherently pay that "entrance fee", just like you inherently "pay" the employees salaries, or the rent and rates or mortgage interest on the premises out of which the company trades, even if you're not writing cheques for those things yourself.

If you don't want to be an equity holder and just buy a corporate bond, you won't feel you've paid anything: no entrance fees, no taxes, no salaries, no rent and rates, etc - because you're just getting paid off according to your contract. It is a different type of risk and a different type of return.

But to me it seems disingenuous to say that investing through an ISA is "not free of tax", or that "hey, dividends in ISAs *are* taxed, because companies pay taxes".

You might as well say that investing in a company through ISAs is "not free of paying London commercial rent and rates", or that "hey, dividends in ISAs *do* incur expenses, because companies pay salaries".

Malthusian wrote: »

All of the above is a history lesson and not really relevant to the decision of whether to open a stocks & shares ISA now.

Agreed, philosophical musings on the nature of investment returns are not really relevant for OP in terms of whether they should use an S&S ISA or not. Generally, any explicit taxes from HMRC on an individual's investment income are avoided if the individual uses an ISA.

masonic

bowlhead99 wrote: »

If you want to complain about the government, you can say that someone who invests in equities - who doesn't use an ISA - has been a victim of an evil "double tax", and someone who does use an ISA has still "paid tax on their dividends", implying that the ISA-user's investment returns via dividends are still "net of" a tax on that investment activity. But that seems like it's just making a political point. There are no taxes payable by the company on declaring dividends to its owners.

On the subject of 'evil double tax', it's an interesting situation that is created when 'double taxation' is invoked in cases where the entity paying the first tax is not the same as the entity paying the second tax.

It is the main thrust of the argument against inheritance tax, because the individual who has passed away was taxed on the income they saved and invested and so some believe their heirs should not be taxed again when that money is inherited by them.

Of course, why should it stop there? If someone has paid tax on their income, perhaps they shouldn't be taxed again when they spend it. If they spend it in a shop, perhaps that shop shouldn't pay tax on any profits derived from it. Perhaps employees of that business shouldn't pay income tax as the money has been already been subject to income tax when it was earned by the person who last spent it.

I think double taxation should only be invoked when money has not changed hands between the first and second taxation.

bigadaj

masonic wrote: »

On the subject of 'evil double tax', it's an interesting situation that is created when 'double taxation' is invoked in cases where the entity paying the first tax is not the same as the entity paying the second tax.

It is the main thrust of the argument against inheritance tax, because the individual who has passed away was taxed on the income they saved and invested and so some believe their heirs should not be taxed again when that money is inherited by them.

Of course, why should it stop there? If someone has paid tax on their income, perhaps they shouldn't be taxed again when they spend it. If they spend it in a shop, perhaps that shop shouldn't pay tax on any profits derived from it. Perhaps employees of that business shouldn't pay income tax as the money has been already been subject to income tax when it was earned by the person who last spent it.

I think double taxation should only be invoked when money has not changed hands between the first and second taxation.

Well we wouldn't want things to be clear and straight forward, how would accountants make their money then.

After the changes to the rules on liability of tax avoidance schemes the poor dears will be struggling to make a living.

george4064

Its completely free from the below taxes;

- income tax
- capital gains tax
- inheritance tax

hoc

Long story short, you don't ever have to pay tax to HMRC for an ISA but some earnings are taxed before they reach you hence not always tax free.

bowlhead99

george4064 wrote: »

Its completely free from the below taxes;

- income tax
- capital gains tax
- inheritance tax

Correct on the first two. You seem to have included inheritance tax by mistake. Any assets in an ISA form part of a person's estate and if the owner of the ISA dies, beneficiaries will pay the same inheritance taxes on the contents as if it was just a regular pile of stocks and shares or cash.

But in some sense you're right: you will not receive an inheritance tax bill just for the action of funding an ISA with cash and using it to buy shares or investment funds. Inheritance tax is simply something that might be levied as a result of you dying. Similarly you won't receive a bill for other taxes either, like council tax, landfill tax, national insurance, vehicle excise duty, just for the action of funding an ISA with cash and using it to buy shares or investment funds. Because those things are levied for other reasons.