On 9 August, the upper tribunal of the tax and chancery chamber ruled “loyalty bonuses” to retail investors constituted annual payments for tax purposes, in contrast to the first-tier tribunal, which ruled in favour of Hargreaves in May 2018.
The first-tier tribunal ruled that rebates were a reduction of net cost, but HMRC in its appeal argued against the annual management charge from which the rebate is taken does not involve a direct payment from the investor.
Hargreaves Lansdown chief executive Chris Hill said in a statement: “We challenged the discount tax on behalf of investors as we always felt it was an unnecessary and unwarranted attack. Naturally we are very disappointed and have reluctantly accepted this ruling.”
The D2C platform had been planning to return £15m if the upper tribunal rejected the HMRC appeal.
“This decision effectively weakens price competition in the asset management market,” says Platforum research director Richard Bradley, pointing to the fact the most cost-effective way for the industry to differentiate on price is now less tax efficient for clients.
Bradley reckons rebates will continue to be used because they are a more flexible way to offer preferential rates.
HMRC position at odds with platforms market study
Altus principal consultant Ben Hammond reckons the administration of running rebates versus multiple share classes are effectively equal.
But from the customer perspective the rebate model is more appealing, Hammond argues.
“It does make that a little bit more difficult for the customers to be able to move their units between platforms if those platforms haven’t got access to those super clean share classes. There is some work underway to help address some of that, but that might take a little bit longer to sort things through.”
That puts it at odds with the Financial Conduct Authority push to improve competition and the ability for investors to be able to move between platforms with ease.
The FCA refused to comment on whether the ruling in favour of HMRC clashes with its aims outlined in the platform markets study.
Platforms lacked a collective voice
Lang Cat consultant Mike Barrett is surprised more platforms did not back Hargreaves’ position given it has implications for the wider industry.
“I just wonder if it had been a bit more of an industry collective voice, rather than just Hargreaves fighting this, then it might have had more chance of winning the appeal,” Barrett says.
He thinks rebates are less complex and encourage competition compared to the superclean share alternative, which results in a proliferation of fund share classes.
The Woodford fund suspension highlights that in some cases discounted share classes may prevent investors from transferring between platforms at all with Interactive Investor only able to receive Hargreaves clients after Woodford and its authorised corporate director, Link, stepped in.
Hammond says it would be good to have “a bit more interaction” between HMRC and the FCA although he concedes they have different aims. “HMRC is going to say, ‘Well, this is income, therefore you should be taxed’. It’s their job to make sure that those rules are carried out effectively.”
The industry could also step up and lobby the regulator, he says.
“They could say ‘Well, we can do as much as, and we are here for the good of the customer, but it is being made little bit more difficult by decisions being made elsewhere’.
The FCA did not wish to comment on its working relationship with HMRC.
Superclean results in plethora of share classes
AJ Bell was the one platform to offer a statement in line with Hargreaves’ position when contacted by Portfolio Adviser.
Spokesperson Charlie Musson said it was odd to class a rebate as income when it is just a saving on the charge the customer is paying.
“This makes the discounts platforms negotiate for customers in the form of fund rebates less valuable and has resulted in a plethora of fund share classes as platforms have negotiated discounted share classes instead,” Musson says.
“Multiple share classes are confusing for customers and are a barrier to efficient transfers between platforms because they often lead to delays while share class conversions are carried out.”
Share class conversions could add several weeks to a platform transfer that may otherwise take about four weeks to complete, depending on the number of conversions required, he said.
The case for superclean share classes
Although not everyone is sold on the benefits of rebates over superclean share classes.
GBI2 managing director Graham Bentley described the ruling as a “bit of a storm in a teacup” stating it effectively meant a six-year status quo had been maintained.
“Given there is no tax issue anyway on Isas, Sipps or personal pensions, onshore or offshore bonds, or General Investment Accounts (GIAs) owned by overseas investors or charities, then the only contract this affects is a GIA held by a UK investor,” Bentley says.
Although Bradley says there are plenty of negatives that come with superclean share classes, he says they are more transparent than rebated funds because investors can see the various share classes available and determine if lower cost options are available.
On the other hand, Bradley says it costs asset managers more to run additional share classes, they add complexity when transferring assets between platforms and there is “the additional burden of navigating the ‘alphabet soup’ of available share classes” particularly for nonprofessional investors.
Fidelity did not wish to comment on the ruling, nor did Aviva or Old Mutual Wealth in the advised space. Interactive Investor said it did not envision the ruling would lead to a further proliferation of share classes.
A spokesperson from Standard Life said: “We were the first in the market to move to clean share classes recognising rebates create confusion for customers. As most of our platform assets sit in clean asset classes this has no significant impact for our platforms.”