The attempts by the RDR to improve transparency of cost must not lead to worse tax outcomes for investors but there is a risk that investors will end up paying more tax on their investments which, coupled with the monster that is VAT, would leave them out of pocket.
While I was delighted to read HMRC’s letter to the industry promising clarification, we also need results that do not produce an unintended sting in the tax tail that is contrary to the aim of ensuring a better deal for consumers.
One potential problem will concern ongoing advice fees and the fact that post-RDR the investment will have to be physically cashed in to meet fees. Currently, ongoing “fees” can be paid by way of trail commission, made from within the product without any tax consequences.
The post-RDR world will abolish trail commission although it will be permissible to take an advice fee from the underlying investment. At face value, there is little difference but beware the tax tail.
Presently, insurance bond ongoing commission is paid from within the bond and while the value of the client’s bond is reduced by the amount of the commission, it is not treated as a chargeable cash-in. Post-RDR, it is believed HMRC has taken the view that where a fee is paid from an insurance bond, this will be treated as a formal chargeable event, meaning that the client will effectively face tax on the fee in a way that they do not with ongoing commission.
The precise effect and disadvantage will differ from client to client but for all investors, the fee will eat into the 5 per cent allowance.
With collectives, one possible outcome of the RDR is that we will move to share classes shorn of commission and rebates. At present, a fund may have an AMC of 1.5 per cent from which commission of 0.5 per cent is paid. The new world may see an AMC of 1 per cent with the 0.5 per cent derived by cashing-in units.
One would need the assistance of Nasa’s super-computers to analyse each and every scenario but even cursory observations show the investor to be in a slightly worse position.
More profound is that by cashing in units each year to meet the advice charge, adviser fees are now using the client’s annual CGT allowance in a way they didn’t before.
If rebates are retained, FSA thinking is that they must be re-invested and cannot be taken as fees. This truly takes us into new CGT territory.
The favoured interpretation is that we treat the rebate as a mere “cashback” which is then used to buy new investments. However, HMRC might argue that the rebate is a return of the original capital, thus reducing the original base cost and increasing the tax bill on the original investment.
There are three options – one is favourable whereas the other two seem likely to cost the investor additional hard cash in the future.
Finally, to the leviathan that is VAT. It has been suggested that the move to fees alters nothing and, in an academic sense, I agree. However, in the real world, it seems almost inevitable that the cost of advice will increase.
The rules are complex and require an IFA to make a subjective call on the primary purpose of their advice while a VAT inspector may take a differing view.
To complicate matters further, there are myriad permutations on how fees for advice could be split so that some may be subject to VAT and others not.
It would be the easiest thing in the world to say that all IFA work should incur VAT but that would hardly be in the interest of consumers. We need further clarity, simplicity and fairness.
Paul Kennedy is head of trusts and tax planning at Fidelity International