Individual Savings Accounts (ISAs) were introduced in the UK in April 1999. The concept was very simple: retail investors could invest in stocks, shares and bonds through an ISA product (usually referred to as an ISA wrapper); and any capital gains or income earned on these investments would be free of tax.
The ability to generate tax-free investment returns mean that ISAs have become an exceptionally popular way of investing for retail investors. Over time the ISA product range has expanded and there are now four different types of ISAs available:
- Cash ISA
- Stocks and shares ISA
- Lifetime ISA
- Innovative finance ISA
What is an Innovative Finance ISA?
Innovative Finance ISAs (IFISAs) were introduced by the government in April 2016.
IFISAs were developed as an investment product to encourage more investing in the growing number of online peer-to-peer (P2P) lenders. This was part of a government initiative to promote alternative sources of finance to small and medium sized enterprises (SMEs).
Under the P2P loan-based crowdfunding model, the investor lends money to small businesses, property developers or individual borrowers through a P2P platform. This platform facilitates and manages the loans on behalf of investors.
The money invested in the lending platform can be placed within an IFISA wrapper. This allows the retail investor to earn a tax-free return on interest income generated from their investment. IFISAs are sometimes referred to as P2P ISAs.
IFISAs can only be offered by those P2P lenders who are authorised and regulated by the Financial Conduct Authority (FCA) and by providers who have received approval from HMRC to act as an ISA Manager.
IFISAs are only available in respect of loan-based crowdfunding platforms (P2P lenders). Equity-based crowdfunding platforms are not eligible to offer IFISAs.
IFISA rules:
The current annual amount that can be invested in an ISA is limited to £20,000 (tax year 2020/21).
The annual ISA allowance amount can be invested in a single type of ISA or it can be allocated across all four types (for Lifetime ISAs there is an age limit and is restricted to retail investors under 40)
Innovative Finance ISAs are not protected by the Financial Service Compensation Scheme (FSCS). Investors who suffer a capital loss on lending will not receive compensation.
With effect from 9th December 2019, individuals will no longer be permitted to have more than 10% of their net investible assets invested in P2P lenders, unless they have been certified or self-certified as ‘sophisticated investors’ or are certified as a ‘high net worth individual’. You can check your eligibility here.
If you are required to file an annual tax return, you do not need to declare any ISA interest, income or capital gains on it.
IFISA risks:
Investors in loan-based crowdfunding platforms are exposed to two separate specific risks: platform risk and product risk.
Platform risk is the risk that the P2P lender, responsible for managing your investment, will fail either though mis-management, incompetence or bad judgement.
Product risk is the possibility that the P2P borrowers will default on their loans, resulting in capital losses as the value attached to the underlying security for the loans was insufficient to cover the debt.
The Financial Conduct Authority (FCA) has found evidence that IFISAs are being promoted alongside Cash ISAs but they have very different risk profiles.
Investments held in IFISAs are generally high-risk with the money ultimately being invested in products like mini-bonds, unsecured personal loans, bridging finance arrangements or property development loans.
The risk of investing through a peer–to-peer lending platform is significantly higher than cash ISAs and there is no guarantee that your capital or interest will be repaid.
Retail investors are also exposed to liquidity risks; that is, the ease with which your investment can be quickly turned back into cash. There is a possibility that investors money will be locked in for the duration of the loans in which they have invested.
Which IFISA provider?
There are scores of loan-based crowdfunding platforms which offer Innovative Finance ISAs. As the ‘product’ has only been available for just over four years, it will be difficult to obtain meaningful performance metrics and decide which one offers the best long-term returns.
Before deciding which IFISA fits your investment criteria best, it may be useful to research independent reviews of different IFISA providers, conducted by trusted comparison websites like Which?.
Loan-based crowdfunding
Before investing in an Innovative Finance ISA, retail investors should learn more about loan-based crowdfunding business models. To understand the features & risks attached to this investment opportunity, please click here.
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