Industry awaits final decision on whether rebates should be taxed

As with all good TV box sets this isn’t a straight up battle between good and evil; it is more nuanced than that, and whilst we are probably going to have to wait until next year to find out the outcome it’s likely to impact anyone investing via advised or direct platforms.

The big question is whether fund rebates paid by the fund group to the client should be treated as annual payments for tax purposes when held outside of a tax wrapper. Currently the answer is 'yes they are', therefore platforms such as Hargreaves Lansdown (and others) are forced to deduct basic rate tax at source, with investors expected to declare any additional higher rate liability on their tax returns.

Those nice people at Hargreaves Lansdown launched a legal challenge to this, arguing that the current position is unfair to investors and that rebates should in fact not be taxed. It is worth noting that were there to be any change to this position it would not directly benefit them.

The rules around payments from fund groups to providers ban the provider from retaining even the smallest percentage of any rebate, so the end client would be the sole beneficiary. Having said that, Hargreaves are not doing this for completely altruistic reasons, and they clearly believe that their scale allows them to negotiate large discounts from asset managers on behalf of their clients, thereby making their platform more attractive.

It is, however, an issue that impacts clients on most of the other large platforms, for example AJ Bell, Old Mutual Wealth and others, so it is certainly not just the boys from Bristol fighting their own corner. 

This case ended up in a tribunal, with HMRC countering HL’s view. It was heard in November last year, with the judgement released in March 2018. You can read full details of the judgement at https://www.pumptax.com/wp-content/uploads/2018/03/Decision-TC2016.05395-Hargreaves-Lansdown-8.3.18-1.pdf , however the initial finding from Judge Thomas Scott was that HL had won, and that rebates should indeed not be treated as annual payments.

HMRC are perfectly entitled to appeal this judgement, and as has recently been reported this is exactly what they have done. Platforms, asset managers, advisers, and most importantly, clients are now waiting to see what the final outcome will be. And sadly, it looks like we will have to wait until 2019 to find out.

Key points

• There is an argument between Hargreaves Lansdown and HMRC over fund discounts
• Rules dictate that the end client is the sole beneficiary of discounts
• Superclean share classes are one answer but have their own problems

So, while everyone waits for the final judgement the industry is in limbo. Normal service will of course continue, however all participants will be waiting to find out what, if anything, will be changing, and what they will need to do about it.

This state of flux also extends to the FCA. Their recent market studies for the Asset Management and Platform sectors have posed some hard questions as to the value for money that the asset managers are delivering to their clients. The interim findings for the Platform Market Study are due in the next few months, and among other areas will be looking at whether “platforms and similar firms are willing and able to negotiate a competitive price on investment charges”. It will be interesting to read their findings.

If the FCA is going to reaffirm its view that platforms such as Hargreaves Lansdown should be negotiating a discount from asset managers on behalf of their clients, then there are two methods that this discount can be facilitated, via a rebate, or a discounted (or “superclean”) shareclass.

The Hargreaves Lansdown argument is that the former represents the best outcome, not only for customers but for everyone else involved. For the fund groups, rebates mean fewer share classes to launch/administer, and the level of discount can be more easily flexed as required for different distributors. Platform providers also in turn have a reduced number of share classes to administer, thereby reducing the complexity of their offerings and operations.

Advisers will breathe a sigh of relief with a common share class being used across all platforms. And most importantly, from the client’s perspective, they are able to benefit from a lower cost of investing with no barriers to exit, or tax liability. However, when the rebate is taxable for some investors, they are suddenly less attractive.

A solution of sorts appeared in the form of “Superclean” share classes. Rather than paying the discount to the client via a rebate, these funds have a lower ongoing charge, negotiated on behalf of the client by the platform provider.

Unfortunately, these come with a couple of big downsides. Firstly, it is another share class for asset managers and providers to administer, and this in turn creates complexity for advisers and clients alike as they are forced to wade through multiple versions of the same fund.

And secondly, it creates a barrier to exit. If you want to move away from one provider and you are invested in a superclean shareclass it can be difficult if not impossible to move these assets without incurring cost and/or time out of the market, an issue the industry is still struggling to resolve. 

There is a separate debate to be had as to the overall impact of these discounts, by whatever method they are delivered, especially as more often than not the amounts involved are, sadly, only a few basis points.

The total cost of investing is the only cost figure that should matter to investors, so any fund discount needs to be considered alongside the totality of the charges involved. There is little point having a small discount if the platform charge is excessive.

It will be interesting to see how the FCA addresses this point as part of its current platform market study. If there is to be an increased emphasis placed on platform providers to use their scale to reduce asset management charges, then the sooner this current scrap between Hargreaves Lansdown and HMRC can be resolved, the better. 

Mike Barrett is consulting director of the Lang Cat