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Isas on the verge of breakdown

Since the Treasury announced the ending of the 10 per cent tax break on Isa dividends in April 2004, the industry has been calling for a change of mind.

The Pep & Isa Managers Association recently met with Treasury financial secretary Ruth Kelly in an effort to convince her that removing the tax break will add to the £27bn savings gap.

By Pima&#39s own account, the meeting was inconclusive, with Kelly giving nothing away in terms of the Treasury&#39s latest thinking.

Neither has the IMA had any positive feedback from the Treasury. It expects any announcement to made in the March Budget although it holds little hope of the tax break being retained.

Cofunds chief executive Clive Boothman says the Government clearly lacks a coherent view on how best to tackle the yawning savings gap. He says: “As far as savings overall are concerned, this will be one less reason for people to defer spending. Dismantle too many incentives to save and there is a danger that increasing numbers of people will become a burden on the state later in life.”

At present, the Government only intends to scrap the tax break on UK equity Isas, keeping the incentive for bond and cash Isas. Therefore, it is equity income funds, which invest in dividend-paying stocks, which are most likely to feel the pinch.

Cofunds says five of its top 10 biggest-selling funds are equity income products but Credit Suisse – one of the biggest players in the sector – says it doubts whether the loss of the tax break will have much of an impact on sales.

Managing director Ian Chimes says: “If people were buying only for dividends, then it would be bad news. But we believe the economic environment favours equity income so much at the moment that dividend-paying stocks will do very well in terms of income and capital growth, which is the reason many people buy.”

Nevertheless, some IFAs say the loss of the tax break will affect the way they construct client portfolios, especially for new investors.

David Aaron Partnership senior consultant Jason Bevan says: “If we were building from scratch, then we would look more towards corporate bonds. We would be wary of using income stocks with high yields because the tax will hit them quite hard.”

There is also the question of how many people will lose the incentive to buy an Isa, as the only remaining concession will be on capital gains tax.

But Pima chief executive Tony Vine-Lott argues that it is the message the Government is sending out that is important, not the number of people the lack of tax incentives will alienate.

Vine-Lott says: “The Government is targeting people with no savings, which is around 13 million in this country. So why, when we are close to the bottom of the equity cycle, is the Treasury encouraging people to go into cash? It makes no sense.”

Fidelity suggests that the Government is not only making it harder for people to save but also potentially marginalising existing Isa holders. Associate director for international tax Christopher Brealey says: “We do not know how many people are not paying CGT because they are already in an Isa. Even if some investors are not currently higher-rate taxpayers, it does not mean they won&#39t be in the future.”

According to some providers, the Government might pay a high price for scrapping the tax break. Artemis product development & communications director Nick Wells believes the Treasury&#39s intransigence could prove to be the straw that breaks the camel&#39s back. He says: “Stakeholder has been an appalling flop and essentially restricting people to bond Isas will not help.”

Wells says the Government should be encouraging people to plough into the market when it is low, not creating further disincentives to save.

However, the Treasury is standing firm. It says the removal of the tax break will benefit investors as companies will be more inclined to boost their growth. A spokeswoman says: “Firms will be encouraged to reinvest and grow their earnings, which will be good for the economy and good for investors. The time we have given investors to adjust to this is a benefit.”

Henderson Global Investors head of UK retail Simon Ellis thinks the Treasury may have more prosaic motives.

Ellis says: “The idea that the tax break is affecting corporate behaviour is a nonsense. What is more likely is that the Treasury has its own idea of what it wants people to buy – Sandler&#39s suite of stakeholder products. It is trying to make everything else look less attractive.”

If this is the case, the prospects for the future are bleak. Few providers are interested in offering low-margin stakeholder products but the Government seems intent on doing things its way, even if that means widening the gap it is supposed to be closing.

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