UK Fund Managers Seek To Gain ISA Tax Benefits

by Robert Lee, Tax-News.com, London

29 January 2004

The UK fund management industry is currently at odds with itself over the tax treatment of ‘distribution’ funds in individual savings accounts (ISAs) which are being promoted by many fund providers as a way to cushion the blow when equity ISAs lose their 10% tax credit on dividends this April.

However, whilst share ISAs are set to lose their tax advantage, corporate bond funds within an ISA framework will remain eligible to reclaim the 20% tax taken off interest payouts, and many fund managers are seeking to combine both equities and bonds in a bid to gain the maximum tax benefits.

ISA rules state that a fund must contain at least 60% interest-bearing investments in order to be classified as a corporate-bond fund. With this in mind, some money managers have sought to construct funds of 61% bonds and 39% equities in order to be eligible for the accompanying tax privileges.

However, according to a study to be published in Money Management this week, investors are likely to fare no better by using the tactic than they would in an ordinary equity ISA. This is because the way in which distribution fund income is treated means there will be no extra benefit for the equity portion, the study explains.

Many in the industry take a similar view, including Toby Hogbin, head of product development at Credit Suisse Asset Management, who was quoted by the Times as saying: “The key thing to remember is that in a distribution fund, all income, whether from bond interest paid gross or equity dividends paid net, is first subject to tax at 20 per cent before the 20 per cent tax reclaim can be made within an ISA.”

Others have also pointed out another drawback in that managers of distribution funds may be compelled to sell equities against thier wishes in order to stay within the 40% limit.

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