HMRC has decided that tax will apply to any rebates that investors receive from fund platforms on funds held outside of individual savings accounts (Isas) and pensions. The tax applies at the investor's highest rate of income tax and came into force on 6 April 2013.
Justin Modray, founder of comparefundplatforms.com, says HMRC's decision will "undoubtedly prove the death knell for the rebate system".
The rebates typically originate from the trail commission, an annual sum paid by the fund to the platform for the life of the investment. If we assume a £100,000 portfolio enjoying an annual 0.5 per cent rebate of £500, the new tax will cost a basic-rate taxpayer £100 and higher-rate taxpayer £200 a year. On a fund portfolio of £1m, the annual charge for a higher-rate taxpayer would be £2,000.
The new tax has been highly criticised. Martyn Laverick, director of sales and marketing at Broadstone, an independent financial planner and wealth manager, says: "The law of unintended consequences has come in to play in full force in this situation. The aim of a client rebate is to allow a platform to pass back to the client some of the advantage it has negotiated with the fund management group. It is a simple law of economies of scales working for the end-user. It must be remembered that these are charges the client is paying, so a rebate is in reality a return to the investor of their own money. Therefore why should it be taxed?"
Stuart Welch, chief executive officer of TD Direct Investing, adds: "The reality is that trail commission rebates on funds are merely giving investors their own money back, in most cases."
The majority of fund platforms still rely on commissions to earn their crusts. Big platforms Hargreaves Lansdown and Bestinvest still pocket healthy margins by collecting commissions and fees from fund managers and then giving rebates to customers.
Ian Gorham, chief executive of Hargreaves Lansdown, has condemned the proposal, vowing to "fight this tax". "The discount tax is anti-competitive," he says. "Loyalty bonuses have been hugely popular with investors and helped them save money on investing in their favourite funds. We have saved investors over £1bn in the form of discounts and loyalty bonuses, helping clients benefit from lower costs.
"Just as worrying is the precedent being set. Loyalty bonuses and cash-back offers are common practice across many industries in the UK. The government may have set a precedent in taxing such loyalty schemes and savvy shoppers could well be next with multi-buys, cash-back credit cards and cash-back websites, all possible targets in the future."
Hargreaves says that it will in due course be able to offer clients access to funds that have no commission built into charges. It is currently awaiting clarity from the Financial Conduct Authority (which has replaced the Financial Services Authority) on its 'platform rules' (due to be published at the end of April 2013) before implementing this change.
Clean share class funds do not pay a rebate but do offer a lower annual management charge. For example, a rebate-paying fund may have had an annual management charge of 1.5 per cent and a rebate of 0.75 per cent, but the clean version is now typically available at 0.75 per cent.
Several platforms have already moved to a business model based on these 'clean' funds. These include Alliance Trust Savings and Charles Stanley Direct, with TD Direct Investing also part-moving to a clean funds model.
Patrick Mill, managing director of Alliance Trust Savings, says: "Having led the way in adopting clean share classes on our platform from 31 December 2012, we remain committed to converting our clients with money invested prior to that date to clean share classes in 2013 - meaning our platform will be 100 per cent clean by the end of the year."
The new tax charges may be enough incentive for investors to move any funds they can into Isas or pensions. For any surplus held over these tax allowances, they may consider switching to a platform that offers lower cost clean or commission-free versions of funds rather than rebates.
However, any decision to transfer will also need to take into account any leaving or transfer charges incurred by a fund platform. Some platforms charge up to £35 per fund holding for in specie transfers, which could wipe out the first year of income tax savings for higher-rate taxpayers on a £100,000 portfolio comprised of six funds.
You also need to bear in mind that the Financial Conduct Authority's paper is widely expected to say that platforms will have to move to a clean model within a year. So any tax issues could be short-lived.
