UK Income tax relief for ISAs: How does the sheltering of earnings work?

Question

I have been led to believe that earnings may be 'sheltered' by placing some amount of them into an ISA. I've not been able to find a great deal out about this, and I don't have a personal accountant. Can anyone advise?

My situation is that I am both employed and self-employed. I am in the middle bracket tax band. Last year I paid around £4000 in income tax under my self-assessment.

If I had placed the entire profit from self-employment (less expenses) into an ISA, would I have had to pay any additional income tax under my self employment assessment?

Answer 1

What you have been led to believe is not what the person doing the leading was trying to lead you to believe, I think.

Generally when people talk about 'sheltering earnings' they are referring to ways of making income count as not taxable. For example, in the UK as an employee you can usually arrange for some childcare costs to be paid direct to a provider 'before tax', so they are deducted from your gross pay and don't contribute to your taxable income. In the past there used to be all sorts of fancy schemes (eg being paid in fine wine, or gold bullion) for employers/employees to collaboratively reduce the total tax burden, but generally those are all closed now except for a very few limited state-sanctioned schemes (eg the childcare mentioned above).

By contrast, an ISA is simply an envelope with the special property that gains within the envelope are completely free of tax (and do not contribute to any other tax calculations). The source of funds that enters the ISA is irrelevant - earned income, inherited income, dividends, it doesn't make any difference.

Your last paragraph is missing a clause or two, I think, but basically wherever you invest your money after getting it (having been taxed on it already) is irrelevant to how it was taxed in the first place.

Answer 2

Couple of clarifications. You can only invest £15000 for 2014-2015 and £15240 for 2015-2016 in an ISA. So if you earn a million or £50000, you can only get tax benefits on the first £15000. £15000 isn't deductible from your earnings to offset tax but the interest you gain on your ISA is taxfree. Only for Cash ISA.

Source

For shares ISA:-

So let’s say you invest £10,000 in a share fund this year. The fund performs well and is worth £30,000 when you sell, realising a £20,000 profit. You would normally have to pay capital gains tax (CGT) at 18% or 28% on any growth in the value of your investment above the annual allowance of £11,000. In other words, you would have to pay CGT on £9,000. Even at the lowest EGT rate that would cost you £1,620, a charge you can avoid by investing in stocks and shares ISAs. By the same token, any losses on your ISAs cannot be used to offset any gains on other investments. However, a stocks and shares ISA can minimise your income tax bill by allowing you to avoid tax on rental income on commercial property, or on the interest from any bonds or gilts.

If I had placed the entire profit from self-employment (less expenses), would I have had to pay any additional income tax under my self employment assessment?

This is a different question altogether. You earnings are cumulative. Didn't you mention your both employment details in your SA form ? And the more you earn, you might have to pay more tax depending on the slab you are in.