Individual Savings Account - Tax Treatment

Tax Treatment

Interest on deposits in a cash ISA is not taxed, whether it is an instant access or term deposit.

Interest on cash in a S&S ISA is subject to a 20% charge. Dividends are not subject to additional tax, interest on bonds is not taxed and all capital gains are not taxed, nor may capital losses be claimed to offset other gains.

There is no need to report interest or other income, capital gains or trades to HMRC and it is not considered to be taxable income. This is a considerable paperwork reduction for active traders or those who may otherwise be required to report their trades because they have total sales value exceeding four times the annual CGT allowance, which outside a tax wrapper would require that all trades be reported even if there is no CGT to pay.

Since the income is not taxable it also does not count for age-related personal income tax allowance reduction, making ISAs useful for those aged 65 or over with incomes approaching £22,900, who could otherwise lose personal allowance.

From 6 April 1999, advance corporation tax (ACT), payable by companies when they paid dividends, was abolished. Previously, under the imputation system of taxation, recipients of a dividend were entitled to a tax credit which reflected the payment of ACT by companies. This tax credit reduced the amount of tax that was payable by the recipient of a dividend and, where the recipient's tax liability was less than the tax credit, the excess could be reclaimed (particularly by non-taxpayers, such as charities, pension funds and PEPs).

From April 1999, companies have not been required to pay ACT, and dividends are accompanied by a 'notional' 10% tax credit. The ability of certain non-taxpayers to claim a repayment of this 'notional' tax credit was phased out from 6 April 1999 to 5 April 2004, effectively removing some of the originally tax-free status (although higher-rate taxpayers have no further liability which they would do on dividends held outside an ISA). The result is that a fund primarily used for income rather than capital growth is far less tax efficient (especially for non higher-rate taxpayers) when placed in an equity fund, whereas a fund based exclusively on other asset classes (such as bonds) continues to be tax-free in terms of income as well as capital growth.

Past end dates for the ISA system have been eliminated and ISAs are now expected to be available indefinitely.

The cost to government of tax reliefs on ISAs is given as £2.2 billion in 2008–09 and £1.6 billion in 2009–10.

Cash ISAs have been beneficial to savers through providing savings that require little investment, meaning that the first part of cash savings each year can be placed in a tax-free environment. By way of contrast, only the interest could be withdrawn from a TESSA before its five-year period had finished or the tax free status would be lost. Further, due to competition cash ISAs continue (as at September 2004) to offer the highest rates of interest, irrespective of tax status, often meaning £1 in an ISA gains a higher rate of gross interest than many thousands invested in another account with the same provider. The market is further advanced as non-taxpayers still benefit from the use of cash ISAs due to the favourable interest rates.

Read more about this topic:  Individual Savings Account

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