Budget proposal relaxes Isa tax on interest rule

No date has been set for implementing the change and the government says it will consult the industry on the proposals. The Investment Management Association says it will be an administrative nightmare to make two types of distributions and an educative process will be required for investors.

Currently, if at least 60% of a fund is invested in fixed interest, income paid from this proportion of the fund is regarded as interest, enabling investors to reclaim tax of 20%. But if less than 60% is invested in fixed interest, the income is regarded as dividends and investors cannot claim back any tax. This follows the decision to stop investors reclaiming 10% tax on dividends from equities last year.

Under the proposals, investors will be able to claim back tax on any proportion of an Isa invested in bonds and cash, and so will benefit investors if a fund invests less than 60% in bonds. Thus if 20% of a fund is in bonds, income from that 20% will be viewed as interest and entitled to a tax reclaim. Income from the other 80% of the fund in equities will be regarded as dividends and investors will not be entitled to reclaim the tax as before.

Nick Wells, product and communications director at Artemis, says the proposals mean a fund would no longer have to hold an arbitrary proportion of its portfolio in fixed interest for investors to reclaim tax: “It will give fund managers greater flexibility.”

The government says funds could make both interest and dividend distributions, or decide to classify all income as dividends. But in the latter case, investors will not be able to reclaim any tax.