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Fund investors must watch out for new ‘discount tax’

HMRC wants a slice of loyalty bonuses

HM Revenue and Customs has decided that annual discounts on fund charges, or ‘loyalty bonuses’, should be taxed as income.

Quickly dubbed a ‘discount tax’ by leading broker Hargreaves Lansdown, the measure means that those investing outside tax shelters like stocks & shares Isas and self-invested personal pensions (Sipps), could lose out.

What are loyalty bonuses?

When investors buy collective investment schemes like unit trusts and Open ended investment companies (Oeics) through a discount broker, or ‘fund supermarket’, the individual funds available typically charge between 1.5% and 2% every year  – they keep most of this but usually pass around 0.5% in commission back to the broker. 

Increasingly, brokers have rebated a portion of this ‘trail commission’ back to investors, calling it an annual discount or loyalty bonus – these payments can be anything up to the full trail commission but typically 0.25% is rebated.

What has HMRC decided?

HMRC has announced that rebates are to be taxed as income from 6 April, the start of the new tax year, giving brokers just a week to adapt. Previously, these payments have been given to investors without any tax deduction or need to mention them on tax returns.

HMRC now argues that payments made to investors are ‘annual payments’ for tax purposes and therefore subject to income tax. As a consequence, fund supermarkets will now be required to deduct basic rate income tax from payments. Higher and additional rate taxpayers will also now have to declare any payments received on their self-assessment tax return.

Are there any wider ramifications?

Brokers have been quick to point to the precedent that is being set. If loyalty bonuses can be classed as income, they argue, what about other rebates and discounts? There are fears that the tax could also apply to Cashback credit cards and also to cashback websites

We put these concerns to HMRC and a spokesman said there is no question of tax becoming payable on cashback received from credit, debit, or loyalty cards or from any other kind of cashback payment. They stated that trail commission is taxable because it is a distribution from a fund. A comparison is with dividend and interest payments from funds, which are taxed as income. 

For investors, tax-efficient wrappers like Isas and Sipps, in which the tax will not apply, now look even more valuable.

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