New Clause 1 — Tax Credits for Individual Savings Accounts and Personal Equity Plans

Part of Finance Bill – in the House of Commons at 2:30 pm on 1st July 2003.

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Photo of Stephen O'Brien Stephen O'Brien Conservative, Eddisbury 2:30 pm, 1st July 2003

I beg to move, That the clause be read a Second time.

This year's Red Book stated:

"Individual Savings Accounts . . . are the Government's primary vehicle for tax-advantaged saving outside pensions."

However, the Finance Bill contains no provisions to prevent the 10 per cent. tax credit for individual savings account and personal equity plan dividends from being removed after April 2004. As we well know, the removal of the dividend tax credit for pensions—worth £5 billion a year in tax—has resulted in typical personal pension savers retiring on half what they would have received only five years ago.

It was not surprising that the director general of the PEP and ISA Managers Association and the director general of the Investment Management Association wrote to the Chancellor of the Exchequer on 4 June. The letter said:

"We were highly disappointed that there was no announcement in the Budget that the 10 per cent. dividend tax credit for stocks and shares ISAs would be extended beyond April 2004.

Our research, which we have shared with the Financial Secretary, among consumers and ISA providers clearly demonstrates that abolishing the dividend tax credit will significantly discourage, rather than encourage, equity based savings through ISAs. In the present investment climate, this is precisely the wrong incentive to be giving people needing to build their long-term savings."

The letter continues:

"In excess of 12 million ISA and PEP account holders will be disadvantaged, not to mention those potential savers that have already been dissuaded by the looming abolition of the tax credit, as ISAs will, according to the FSA, lose their tax-free status in 2004."

The letter urges the Government, at this late stage, to consider approving new clause 1 and says that it is important

"to extend the life of the tax credit and thereby the sustainability of Stocks and Shares ISAs for other than high rate tax payers."

I shall illustrate why we find ourselves in such an extraordinary situation. The Government are long on rhetoric by saying, "For the many, not for the few", but they are deliberately taking action to avoid prolonging an important tax credit with the intended effect—they cannot pretend that it is unintentional—of preferring the few higher rate taxpayers rather than the many, despite the fact that there is such a blight on all income groups' savings.

A PIMA press release was published on the same date as the letter and said:

"However, this figure of 12 million"— people—

"is not taking into account the number of potential savers that have already been dissuaded . . . Recent evidence shows that stocks and shares ISA Subscriptions have slumped by 40 per cent. in April 2003 compared to the same period last year, in spite of a surge in investment in bonds.

By removing the tax credit, PIMA research has shown that the Chancellor will significantly discourage rather than encourage, equity based savings through ISAs."

Mr. Tony Vine-Lott, the director general of PIMA, said:

"PIMA will continue to lobby for this recommendation throughout the passage of the Finance Bill. 12 million accounts is a significant amount and the Chancellor needs to recognise that the removal of the tax credit will do more harm than good for consumers and the savings industry alike". 2.45 pm

I have examined carefully the representations that we received, which happens with all representations received by the Opposition. It is important for those who observe our proceedings to have the opportunity to submit representations and for them to be reflected. I have given the comments careful thought. As hon. Members will note from the amendment paper, I, like several of my colleagues, have a registered interest, which I put on the record. It is no surprise that many of us hold PEPs and ISAs as part of our best efforts to save during our earning lifetime. We try to be responsible so that we will not be dependent on the state when we are no longer in a position to earn.

A representation that we received said that because

"the Government have promised to abolish the 10 per cent. tax credit that ISAs receive on dividend distributions . . . investment in Equity ISAs will only be attractive to higher rate taxpayers."

Perhaps the easiest way to explain the situation is to go through an example. Like always, it would be easier to use a slide-show presentation while dealing with figures, but as I cannot do that, I shall have a go at outlining my point.

Let us consider a basic rate taxpayer who receives a cash dividend from a company—outside an ISA—of £90. Under the current rules, which are familiar to most people, a notional tax credit of a ninth—£10—is added, which gives a notional gross dividend of £100. The situation is exactly the same for a higher rate taxpayer: £90 plus £10 equals £100. The basic rate taxpayer is taxed at 10 per cent., which means that there is a 10 per cent. deduction. The £10 tax credit is deducted from that, which effectively means that there is no tax liability. The cash dividend was £90, there was a notional tax credit of £10 and £10 of tax was deducted, so we return to a situation of no tax and £90 cash.

The situation is different for a higher rate taxpayer. After receiving a notional gross dividend of £100 made up of a cash dividend of £90 and a notional tax credit of £10, a higher rate taxpayer pays tax at a rate of 32.5 per cent. Therefore, he or she is liable to £32.50 of tax on the £100. The £10 tax credit is taken off that—although it is notional, it is removed—so the tax liability on a higher rate taxpayer is £22.50, meaning that the cash receipt is not the £90 received by a basic rate taxpayer, but £67.50.

Why is that important? In a basic rate taxpayer's equity or stocks and shares ISA, a cash dividend of £90 attracts a notional tax credit of £10, which adds up to £100. Of course, there would be a cash equivalent of £90. The situation is exactly the same as before: there is £90 real cash and lots of 10 per cents. flow all over the place for the purposes of the tax regime, meaning that basic rate taxpayers end up with £90 in their hands. A higher rate taxpayer also ends up with £90.

Let us consider what will happen after 2004 when the notional tax credit is removed from equity ISAs. The basic rate taxpayer would receive £90 cash but not receive the tax credit, and thus end up with £90 rather than £100, which was the case with the notional tax credit. The tax position would be reduced to £90, yet the cash outside an ISA would also be £90. What is the incentive for the basic rate taxpayer if the measure is removed? A higher rate taxpayer would end up with £90, nevertheless, versus £67.50. So there is a huge incentive for a higher rate taxpayer to remain in the scheme given that instead of receiving £67.50 outside an equity ISA, they will receive £90, whereas the removal of the £10 notional tax credit gives the basic rate taxpayer no incentive whatsoever. Unsurprisingly, the higher rate taxpayer will benefit. Why should the basic rate taxpayer, for whom the scheme has been an important part of their thinking and activity in terms of saving and the incentive to save, be penalised?