Who’s to blame for the rebate tax debacle?

When you invest in funds via a discount broker or fund supermarket of any kind, you tend to do so for one main reason: commission rebates. When you buy a mainstream fund you will find that it still comes with an annual fee of something in the region of 1.5%. Around 0.5%-75% of that will usually be earmarked for trail commission an annual payment designed to be made to the independent financial advisor (IFA) or broker who put you in the fund in the first place. You can think of it as a financial thank you' from one financial service provider to another. IFAs are no longer allowed to accept these payments, but the investing platforms still are. So, in order to cut your costs and keep their offerings attractive, they rebate them back to you.

So here's a question: whose money is the broker giving you? Is it simply a return of your own money? It might have been through the broker and the fund manager and then back through the broker before it gets to you, but as you paid it in the first place, you might think it's yours. HM Revenue & Customs (HMRC) doesn't agree. A new ruling classifies the rebates as income (a payment of the broker's money to you). And that makes them taxable. From 6 April, all rebates (except those to self-invested personal pension and individual savings accounts) must have basic-rate tax deducted at source. Higher and top-rate taxpayers must stump up the rest via their self-assessment tax returns.

You might think this outrageous. But I suspect that if it makes you angry with HMRC, you are angry with the wrong group. After all, while you might think of it as a rebate, the trail it follows in getting from you and then back to you is pretty complicated. So you should instead be angry with a financial services system that has long been so weirdly structured that it makes sense for the supermarkets all to take the same amount of your money, and then to compete on the basis of who can give the most back to you. Nuts really.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

You also need not bother being angry for long. It has long been likely that the Financial Services Authority (now the Financial Conduct Authority) would ban the platforms from accepting trail commission at the end of this year, so all this ruling is likely to do, as the Daily Mail puts it, is "hasten the demise" of commission-paying funds and speed the introduction of more "clean funds" those that charge a management fee only (no commissions involved).

TD Direct Investing has more than 1,400 clean funds on its platform, and the likes of Charles Stanley Direct have already put in place a system whereby clients pay direct fees rather than roundabout commissions. This is the right result. The only thing to watch for? Just how high those fees are and how they are charged. We'll be publishing a comparison table in the next few weeks to help you figure out the right broker for you.