Investments outside an ISA/SIPP

pip895

The £5000 savings starter rate seems odd - you would need to have about £250,000 in unwrapped cash accounts to get that much.. Doesn't really seem the cohort to need a tax break..

Also, this may be a numpty question but here goes anyway..

Why do we have completely different tax treatments for interest and dividends - and capital gains for that matter?

bowlhead99

pip895 wrote: »

The £5000 savings starter rate seems odd - you would need to have about £250,000 in unwrapped cash accounts to get that much..
Doesn't really seem the cohort to need a tax break..

Imagine an improvement in interest rates so that you get £2k of interest income off about £40k of cash savings. Then think of some retiree who has a state pension, modest personal pension and his £2k of interest income from his life savings (the £40k of 'rainy day money' which needs to last him the next four decades, now he no longer has a job).

As he has generally low income, HMRC allow him to get the interest income that he earns on his prudent rainy day money, tax free.

Whereas the guy with hundreds of thousands in cash and bonds and a bunch of earnings, doesn't get to use the band at all, even though he has lots of interest income and would dearly like a tax break.

Also, this may be a numpty question but here goes anyway..

Why do we have completely different tax treatments for interest and dividends - and capital gains for that matter?

I would look at it as:

Interest income
a) from a bank, a fixed return on deposited cash which the banks can use in their own operations while you don't want to use it yourself, as long as they give you back the full amount - they will give you a return that's predominantly to compensate you for the time value of money but is also an incentive for you to deposit with them rather than with their competitors.

b) from an investment, a loan arrangement allowing you the lender/investor to participate in the revenues of someone else's endeavours, on a fixed or variable basis but with lower risk to principal than if you had provided them with equity.

On the scale of different types of returns from 'savings and investments', returns paid as interest are the safest.

Dividend income

- from an equity investment, an ownership share of the distributed profits of a business funded by the capital you injected into the business or acquired from someone else, with considerably less certainty than a loan arrangement and with the profits having already been subject to relevant corporate tax rates; you are only receiving the post-tax residual profits that do not need to be retained in the business for growth or general corporate purposes.

Dividend income is harder-won than interest income, due to the risk and uncertainty that exists there beyond simple credit risk and counterparty risk. Investment in dividend-producing assets is currently incentivised through a different tax regime than interest income

Capital gains

The capital return made on a business or speculative investment being the amount which eventual realised proceeds net of selling costs exceed initial purchase costs. It's most uncertain of the types of returns mentioned here, as it requires tangible (or market-recognised) value to have been created between acquisition and exit for you to prosper, and is separate from the ongoing fixed or periodic returns which might be paid over to you out of the ongoing business operations of an investment which are perceived as 'safer' than a punt on the capital value growing.

The provision of assets or equity capital to others is essential to help the wheels of commerce keep turning, while the hope of a valuation increase carries a higher risk of failure than the generation of interest payment or dividends; if it goes wrong, losses can be total. Also while capital returns may become more certain /less variable over the long term *if* the business is successful enough to survive for the long term, there is a 'time value of money' here too, in that £10,000 invested into a business in 1990 may become significantly more than £10,000 by 2020 while there will not have been such a substantial return 'in real terms'.

Hence capital gains is subject to a separate tax regime or certain reliefs in the UK and many other developed countries, as capitalism requires people to embrace the concept of providing their capital to others, and hey may need to be incentivised.

The incentivisation by demarcating it as a different (and lower) type of tax helps investors be willing to provide long-term capital - because real-terms appreciation in value of that capital does not have the same certainty / reliability as 'income' from the capital, and people do not want to give away a lot of the returns from their high risk activity as tax if they 'win', while they understand that government does not generally want to give individual investors a break on their income taxes if they 'lose'.

pip895

IanManc wrote: »

I've changed the bold/italics on your quote to emphasise the point you've missed.

Equity unit trusts pay dividends, not interest, so the savings allowance doesn't cover them.

Bond unit trusts pay interest, so the savings allowance covers the interest they pay.

That's why the website quote you posted says that the allowance applies to interest.

Yes I have got there - just saw Investment trusts there and didn't associate them with interest..

ColdIron

pip895 wrote: »

The £5000 savings starter rate seems odd - you would need to have about £250,000 in unwrapped cash accounts to get that much.. Doesn't really seem the cohort to need a tax break..

The Starting Rate for Savings benefits people on low income. Those that have little or no earned income. Many retired people (particularly those who have not reached state pension age) structure their pension income to fall within the Personal Allowance and their cash interest (which at 60 or 70 can be considerable) to fall within the Starting Rate for Savings and the Personal Savings Allowance. It's a matter of planning

pip895 wrote: »

Why do we have completely different tax treatments for interest and dividends - and capital gains for that matter?

Interest and dividends are treated in a similar manner, albeit with different allowances and rates beyond the common Personal Allowance. They are both periodic annual payments. Capital gains are not periodic and are not subject to the same regime. Capital investments are longer term and it would be unfair to levy an annual tax (a wealth tax if you like) on unrealised paper profits. Who would put up capital on a long term venture that may take a decade to come to fruition, with likely loss making years in between, if your original capital was regularly eroded? The current tax regime is equitable that rewards, rather than discourages, investment

Or something

pip895

bowlhead99 wrote: »

Imagine an improvement in interest rates so that you get £2k of interest income off about £40k of cash savings. Then think of some retiree who has a state pension, modest personal pension and his £2k of interest income from his life savings (the £40k of 'rainy day money' which needs to last him the next four decades, now he no longer has a job).

As he has generally low income, HMRC allow him to get the interest income that he earns on his prudent rainy day money, tax free.

Whereas the guy with hundreds of thousands in cash and bonds and a bunch of earnings, doesn't get to use the band at all, even though he has lots of interest income and would dearly like a tax break.

But right now (and in the foreseeable future) you need hundreds of thousands to get that much interest.. Someone with modest means will surely have stashed all he/she has into ISAs. Its just the guy/girl with hundreds of thousands who has already filled his/her ISA that will benefit. To some extent that is me - and i'm not sure I really deserve the tax break tbh.. :rotfl:
Also if the idea is to reward risk - why is there a bigger apparent tax break for interest (5k) than there is for dividends (2k)?

pip895

ColdIron wrote: »

Interest and dividends are treated in a similar manner, albeit with different allowances and rates beyond the common Personal Allowance. They are both periodic annual payments. Capital gains are not periodic and are not subject to the same regime. Capital investments are longer term and it would be unfair to levy an annual tax (a wealth tax if you like) on unrealised paper profits. Who would put up capital on a long term venture that may take a decade to come to fruition, with likely loss making years in between, if your original capital was regularly eroded? The current tax regime is equitable that rewards, rather than discourages, investment

Or something

Capital gains should obviously still only be payable on disposal of the asset but wouldn't it be simpler if all income was treated the same? There would need to be some allowance to transfer capital gain from one primary residence to another of course. Wouldn't suit me - or I suspect a lot of people who frequent this board but it would seem "fairer"..

bowlhead99

pip895 wrote: »

But right now (and in the foreseeable future) you need hundreds of thousands to get that much interest..

Interest rates can change multiple times per tax year. Doubling or halving the thresholds due to financial markets rate cuts or raise is politically difficult; other tax allowances may go up in line with levels of average earnings, inflation, or gradual shift towards some aspirational target to be achieved over time, etc etc. If interest rates go from (e.g.) 1% to 3% over the course of a year or two are they going to announce a trebling the personal savings allowance and starter rate band for savings income with effect from the next April? The market rates might even have declined again before they even get there.

So no, they are not going to tie it in real time to what market rates happen to be currently doing, and therefore they shouldn't set it at some ineffectually low rate which then has to be increased again when it stops being useful.

Someone with modest means will surely have stashed all he/she has into ISAs.

If ISA products pay the best rates, which is not a given, and if the person of modest means is financially savvy enough to understand the various tax wrappers that could be of use, which is not a given.

Huge numbers of people who might have low incomes and cash savings don't hang out on savings and investment forums or have any real interest in maximising the financial planning opportunities of tax thresholds, or are simply not numerate. So will benefit from the automatic exclusion of a wide band of interest income, provided their total earned and unearned income is low.

Its just the guy/girl with hundreds of thousands who has already filled his/her ISA that will benefit. To some extent that is me - and i'm not sure I really deserve the tax break tbh.. :rotfl:

Whatever tax rates, rules and thresholds are set, government knows that some people who are quite well off will get to use them right to the limit of their abilities and squeeze every penny possible out of their allowances.

But as people with really high levels of taxable non-investment income can't use this 'starter rate', it can't be exploited by those with really high incomes. Of course, it can still be used by people without significant earned income and a lot of wealth, but we don't have a general wealth tax or capital-based means-testing for income tax bands in this country and it would be a big faff to start doing that.

Also if the idea is to reward risk - why is there a bigger apparent tax break for interest (5k) than there is for dividends (2k)?

(i) Cash deposits and things generating fixed income returns - rather than risk-based investments yielding dividends - are perhaps more likely to be used by a broad swathe of the unsophisticated (non investment savvy) low income population, who are perhaps in most need of the assistance;

(ii) the dividend rates once you exceed the allowance are pretty low while your total income is at 'basic rate' levels and so arguably a wide 0% dividend band is not needed - as the discounted rate of tax (vs 20%, 40%, 45% on interest or earned income) provides most of the tax incentive. But from an admin perspective, the £2k 0% band for dividend income allows someone to have £50k or more of modestly-yielding investments before they need to declare and file taxes. This keeps a lot of people out of needing to file tax returns, just like the basic rate taxpayers didn't need to file tax returns under the previous dividend tax regimes when there was a 'dividend tax credit' available.

(iii) A proportion of the working population take on consulting or other self-directed work through 'personal service companies' which allows them to structure their personal income as dividend rather than salary - a good wheeze that saves them payroll taxes. It is politically difficult as government or HMRC to say you want to 'crack down' on such creative tax avoidance/ business structuring while also saying you and other related 'owners' of your personal company can have a pretty large amount of dividends out of a the company entirely free of personal income tax. So, the 0% dividend band offered is not going to be really really wide. After a couple of grand (to avoid people with modest investments needing to file taxes), it stops and you have to pay your 7.5% or more.

(iv) probably others which I can't be bothered to think of or type up.

Whether you agree or disagree with how the allowances and rates work, the summary is:

We do have different regimes for interest, dividends and gains which - like most other things in the world of tax - have their separate and reasonable historic backstories for why they might exist.

This is why the UK tax law is over ten thousand pages and perhaps over ten million words long.

Everyone and his dog have their own ideas on 'but why that?', and 'why not this?' for each section and policy objective, and the government and opposition is changed every few years, and its members from time to time always have their own views too.

You are not going to see it simplified to a 'nice simple flat tax' because it would cease to work to incentivise or disincentivise desirable or undesirable behaviours, and there would be an incredible number of special interest groups or lobbyists who would be up in arms because they would be made worse off if their particular circumstances ceased to be recognised, and the pursuit of 'simplicity' could be a catalyst for people to relocate to a different tax jursidiction to pursue their economic activity instead, with a detrimental effect overall.

Dazed_and_confused

However you can also earn £2000 in dividends tax free each year so you might well be fine

It is £2,000 dividend income which is taxed at 0%.

Even when the dividend income is taxed at 0% it can still make your overall tax liability higher in a few circumstances.

As can interest taxed at either of the 0% tax rates applicable to interest.

pip895

A good explanation thank you bowlhead but you still haven't quite convinced me that it isn't a dogs breakfast that's in need of sorting.

Don't get me onto the LTA and some of the IHT exemptions and forms. It all needs looking at holistically by someone willing to take on the vested interests and willing to face the ire of the press complaining that one impoverished old lady has been disadvantaged (while ignoring the many more who are better off)

If you want to support savers it would be better to stop supressing interest rates -if you are going to supress interest rates anyway, and are worried about the effects on pensioners then introduce some more pensioner bonds rather than an exemption that is only of use to a small proportion of cash rich individuals who are either very well off or need to be incentivised/educated to use tax wrappers.

While I'm in the mood for a rant - their intervention on ISAs hasn't been helpful either - first increasing the amount you can put in to far more than the average saver can aspire to, then adding in other types of ISAs to make what used to be a simple and straight forward investment much more complex.