Lending on P2P platforms has become an everyday decision, almost like opening a savings account or building up a retirement portfolio of bond funds. Of course there is investment risk to P2P, but a little known trap (until it bites) is that P2P income is always taxable, but with no credit for any losses made. Until now.

A lender through a P2P platform currently has two unexpected tax hurdles.  The first comes at the end of their first tax year, when they (even if they are a basic rate taxpayer), need to pay tax on interest received.  This remains, though from April the savings allowance may help.

The second unexpected tax hurdle comes when the lender first incurs a bad debt.

On £2,000 lent at 7.5%, and assuming repayments are promptly reinvested, the lender may be used to seeing her portfolio grow at around £150 per year.  She then pays £30 tax (or £60 if she is a higher rate taxpayer) through a tax return or adjustment to PAYE code.

Then one year a £300 loan goes bad and the lender has lost money (even with £125 interest on the good loans remaining).  But she still has to pay tax – no credit given.  That puts people off P2P (just read the forums on moneysavingexpert.com).

Thankfully for lenders and P2P platforms, the government has realised the unfairness of this situation.

With effect for the current tax year (though not unfortunately the 2014-15 year where people are currently submitting returns), P2P bad debt can be set off against P2P income

From April 2016 onwards, it will also be possible to carry forward surplus P2P losses, to set off against P2P income in future years (up to 4 years from the bad debt).

From being an incentive to quit the platform, tax relief on bad debt may now be a reason to stay, after making a loss, if other lending opportunities (risk-adjusted) look profitable.