Innovative finance ISA investments for ISA managers

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Innovative Finance ISA

Innovative Finance ISAs are designed to include more long-term, less-liquid investments, and cash.

Qualifying investments

Qualifying investments are investments that managers can buy, make or hold in an Innovative Finance ISA.

Qualifying investments can be:

peer-to-peer loans
crowdfunding debentures
alternative finance arrangements
overseas fund regime
less-liquid investments
cash

Within the meaning given in section 170 of the Income Tax Act 2007:

the investor must not be connected with the issuer of the investment
the investment must not be connected to any investment held outside the ISA wrapper
an investment will not be eligible for an Innovative Finance ISA if it is made available to an investor because they, or another person, are employed by an issuing company or charity

Peer-to-peer loans

Eligible peer-to-peer loans are managed by an operator authorised under section 31(1)(a) or (c) of, or Schedule 5 to, the Financial Services and Markets Act (FSMA) 2000.

The operator must have permission, other than interim permission under Chapter 4 of Part 8 of the Financial Services and Markets Act (FSMA) 2000 (Regulated Activities) (Amendment) (No. 2) Order 2013, to carry on one or more of the activities specified in Articles 36H (operating an electronic system in relation to lending) and 39G (debt administration).

If a borrower defaults and the loan is assigned or replaced in exchange for a payment to the lender, the payment will not be made under an Article 36H agreement, but will be eligible to remain in the ISA wrapper as long as the loan was an Article 36H agreement when the lender entered into it.

All loans must be made using cash held by the ISA manager. They must be entered into for genuine commercial terms and not as part of a scheme or arrangement the main, or one of the main purposes of which is the avoidance of tax.

Peer-to-peer loans held outside of the ISA wrapper cannot be sold and re-purchased inside an Innovative Finance ISA, except when the loans are sold and are made available for purchase (using cash held by the ISA manager), at the same price, by any lender in the open market. That is, the loans must be available for purchase by more than one prospective purchaser.

It will not usually be open to a platform to purchase a lender’s portfolio of loans and for the proceeds to be used to reacquire the same loans inside the ISA wrapper. Any purchase would need to be of loans made openly available to any prospective lender.

Crowdfunding debentures

Crowdfunding debentures are provided for in the Individual Savings Account (Amendment No. 3) Regulations 2016, which extends the range of investments that can be held in an Innovative Finance ISA. These investments are:

crowdfunded debt securities issued by companies
bonds issued by registered charities

Eligible crowdfunding debentures must:

be transferable securities in accordance with section 102A(3) of the Financial Services and Markets Act (FSMA) 2000
create indebtedness
be arranged by a person with Financial Conduct Authority (FCA) permissions to arrange deals in investments
be made through an electronic system operated by that person in the UK or the European Economic Area (EEA)

The ISA investor must be treated as the client of the person operating the crowdfunding platform, or a person acting on behalf of the platform. This arrangement offers the investor FCA regulatory protections and recourse to the Financial Ombudsman.

The platform (or the person acting on their behalf) must receive payments, make payments and exercise (or arrange the exercise of) rights under or in respect of the debentures.

Qualifying debentures must be invested in within an Innovative Finance ISA and using cash subscriptions held by the ISA manager. They must be entered into for genuine commercial terms and not as part of a scheme or arrangement, the main or one of the main purposes of which is the avoidance of tax.

Alternative finance arrangements

Alternative finance arrangements are arrangements falling within section 564A and 564E of the Income Tax Act 2007 (savings products providing similar types of return to a deposit savings account).

Alternative finance arrangements include:

purchase and resale arrangements
diminishing share ownership arrangements
deposit arrangements
profit share agency arrangements
investment bond arrangements

Overseas Fund Regime (OFR)

The OFR provides FCA recognition for authorised and supervised overseas collective investment schemes who wish to market to retail investors in the UK. Investment funds under the OFR that are eligible to be held in an ISA include:

a non-UCITS retail scheme recognised by virtue of section 271A of the Financial and Services and Markets Act (FSMA) 2000, including a sub-umbrella of a fund
a UK UCITS by virtue of section 271A of FSMA that is within the meaning of section 236A of FSMA

Under the OFR, a fund’s recognition may be revoked if:

the country of origin’s equivalence determination is withdrawn
the FCA deems it necessary for consumer protection

An OFR’s recognition can also be suspended.

An investment fund will stop being ISA eligible when its recognition is revoked or suspended. When this happens, the manager of the fund will have 30 days in which to either divest (potentially at a loss) retaining the cash proceeds in the ISA wrapper, or transfer the fund out of the wrapper.

Less-liquid investments

Investments that can usually be held in a Stocks and shares ISA but cannot be readily liquidated, are eligible to be held in an Innovative Finance ISA. This is providing the underlying investments meet criteria set out within regulations, including:

the title to investments must be vested in the ISA manager or their nominee, or jointly in one of them and the investor
the share certificate must be held by the manager or a custodian of their choosing
the investments must be in the beneficial ownership of the investor

The underlying investment will need to follow the rules set out within the Stocks and shares ISA guidance, except for the liquidity rules. Find out more about Stocks and shares investments.

When an investment loses ISA eligibility, the manager will have 30 days in which to either divest (potentially at a loss) retaining the cash proceeds in the ISA wrapper or transfer the investment out of the wrapper.

Cash

An investor’s cash subscription and any other cash held in an Innovative Finance ISA (for example, loan repayments and other payments when loans default) must be held in sterling and must be deposited in:

an account with a deposit-taker
a deposit account or a share account with a building society that is designated as an ISA

In practice, managers can operate a single account, which may also hold other savings products, such as cash ISA, feeder fund and current account balances, as long as:

the account is designated as an ISA account
the monies relating to each investor’s ISA are recorded and can be accounted for separately

Electronic money providers

Subscriptions from ISA investors cannot be held in e-money wallets while they are waiting to be invested, because e-money wallets do not meet the requirements in the ISA regulations. ISA managers must make sure that cash subscriptions and other investor funds comply with the ISA regulations.

ISA regulation 6(4) states that cash subscriptions and other cash held by an ISA manager must be deposited in an account with a deposit taker as defined in section 853 of the Income Tax Act 2007.

The account with a deposit taker must be designated as an ISA account for the purposes of the ISA regulations. It should be in the name of the investor.

Transfers and withdrawals

The rights to transfer or withdraw non-cash investments in an Innovative Finance ISA are explained in the terms and conditions of the account.

Payments when loans default

When loans default, some ISA managers allow access to a provisions fund to compensate lenders. Alternatively, the loan may be paid up or bought from the lender, with the loan being taken on by the ISA manager or a debt collection specialist.

When compensation for the poor performance, loss (in whole or in part), depreciation or risk of depreciation of a qualifying investment is received:

by the ISA manager, it can be used to purchase qualifying investments
outside of the ISA wrapper, the investor will be able to make a defaulted investment subscription

This applies whether or not the qualifying investment is held in the ISA at the time the payment is made.

Innovative finance ISA investments for ISA managers