Whether ‘loyalty bonus payments’ by an investment service provider were ‘annual payments’

Fri 23 Mar 2018

The First tier Tribunal has held that Hargreaves Lansdown Asset Management Ltd’s (HL’s) payment of a loyalty bonus to investors was not an annual payment.  As a consequence there was no requirement to withhold income tax from the payment. The decision holds that the bonus payment is not a profit for the investor but a reduction in his net cost.

Comment

This is a helpful decision to other intermediaries with similar loyalty bonus provisions to HL, with respect to their obligations to withhold income tax. The decision does, however contain some apparently conflicting comments on the character of the receipt for the investor.  While initially accepting that the receipt was income in the hands of the recipient, the decision goes on to comment that it is not a ‘profit’ for the investor, but a reduction in his net cost.  This seems to imply there may be some force in the original industry view that the so called ‘trail commission’ payable to investors was in fact a rebate of costs, and therefore not income at all.  If a different view from HMRC is taken on any tax return based on this decision, it will need to be disclosed as a white space note.  The decision is only at the FTT level and it will be interesting to see whether the decision is appealed.

It is also worth noting that given the substantial number of investors receiving such payments, and the relatively small amounts per investor, HMRC and HL reached an agreement, intended to avoid the necessity of multiple appeals. Under that agreement, HL retained an amount equal to the basic rate of income tax on the payments to investors, and HMRC assessed HL for that amount (under section 957 of the Income Tax Act 2007). Presumably then, when there is a “final” decision in this case, it will be for HL (if it is indeed held not to be income) to refund tax deducted at source to the individual account holders.

For a further discussion of the withholding tax or private client obligations and what to do regarding any previous actions, please get in touch with a member of the Mazars private client or corporate tax teams.

Background

HL operates a platform through which investment products are distributed to investors. Prior to April 2014 it did not charge a fee for its service, but took a share of the annual management charge (AMC) levied on investors by the fund product providers.  Part of HL’s fee was received in the form of a rebate from the fund product providers, a portion of which HL passed on to investors who stayed with HL as a ‘loyalty bonus.

On 25 March 2013 HMRC issued Brief 04/13 setting out the tax treatment of trail commissions. These are commission payments paid to investors in a Collective Investment Scheme, insurance policy or other investment product, where the payment is made by fund managers, fund platforms, advisers, or any other person acting as an intermediary between the fund and the investor.  The Brief acknowledged that these payments typically originate from the annual management charge and that in the past they had not been considered taxable on the investor.  However the Brief explained HMRC considered these payment to be annual payments subject to deduction of tax at source, and as taxable income of the recipient.

What is an annual payment

The definition of an annual payment is not set out in legislation, but has developed through case law as having the following characteristics:

1. It must be payable under a legal obligation.
2. It must recur or be capable of recurrence, although the obligation to pay may be contingent.
3. It must constitute income and not capital in the hands of the recipient.
4. It must represent “pure income profit” to the recipient.

Whether the loyalty bonus was an annual payment

The FTT considered there was a legal obligation for HL to pay the loyalty bonus to the investor and that it was capable of recurrence. As it had been agreed for the purpose of the hearing that the receipt was income in the hands of the recipient, this was not considered further.  The outcome of the case then depended on whether the amount represented pure income profit.

The FTT concluded that:

• although the AMC is not paid as a separate fee by an investor, it is a compulsory charge directly borne by him as a term of investing through HL;
• HL consistently and clearly presented the Loyalty Bonus to investors as a method of reducing or discounting the net cost of investing in a fund through HL.

In other words the investor had to do something in order to get the loyalty bonus, i.e. pay the AMC. The FTT then went on to comment: “In my judgment, the evidence makes it plain that the nature and quality of a Loyalty Bonus payment is that it is not a “profit” to an investor, but a reduction of his net cost. It is quite unlike an annuity payment or interest in respect of which a recipient need do nothing but sit back and receive the payments.”