Change in Isa rules shouldn't be taxing

Next month investors who have a stocks and shares Isa will lose one of their tax perks. Should you be worried? How will it affect you? Is it still worth buying an Isa? According to research by Fidelity, 59 per cent of Isa investors don't even know about the change.

Neither do I. Should I worry?

Not unduly. According to Richard Wastcoat, managing director of Fidelity Investments, 'the tax changes to equity Isas will only cause a minimal reduction to investors' returns over the long term'. Jason Hollands, a director at ISIS Asset Management, says: 'The real damage is the negative signal [the change] sends, rather than its impact on investments.'

Yes, but what does the change actually mean?

Currently, payments of dividends on shares in UK companies are accompanied by a tax credit of 10 per cent which - if the shares are held in an Isa or in an equity fund in an Isa - can be reclaimed from the Inland Revenue. So if a company pays a dividend of £100 the accompanying tax credit is worth £11.11.

That's not 10 per cent of £100.

No, it's 10 per cent of the £100 dividend plus the tax credit - or, to put it another way, the tax credit is the same as the dividend payment divided by 9. To an expert in advance corporation tax, it all makes perfect sense.

And if I'm not?

All you need know is that after 6 April your Isa manager won't be able to get the extra £11.11 for every £100 of dividend payment back from the Inland Revenue.

So I'm getting a bit of a bonus but only until the new tax year?

Exactly.

I'm still losing out, aren't I?

Hardest hit will be people with income-producing equity Isas, which depend on dividends from UK companies to generate income. According to Fidelity Investments, if you had invested the full £7,000 Isa allowance in the UK equity income sector for the last five years, being able to have tax credits repaid was worth £345 over the five-year period. If the same amount had been invested in the UK all companies sector - where dividend income makes up a smaller proportion of the investment return - the value was £25 a year.

Why do you keep going on about UK equities?

Because they are the ones affected by the removal of the dividend tax credit concession.

Dividends paid on shares in companies outside the UK don't carry a reclaimable tax credit so the change won't make any difference. Cash Isas and those that invest in corporate bonds won't be affected either.

Should I move out of equities?

Not because of this change, no. Peter Hargreaves, chief executive of discount brokers Hargreaves Lansdown is adamant that you 'shouldn't be panicked into making tax decisions ahead of investment decisions because you should always choose the investment first'. This sentiment is echoed by Jason Hollands, who says that you should invest 'in what suits your goals and risk profile' rather than letting your 'investment decision be led by tax'.

You haven't mentioned income tax at all.

That's because the income tax position is unaffected by what is essentially a change to the reclaimability of advance corporation tax by individuals. Dividend income received in an Isa continues to be free of income tax for all types of taxpayer - although it's true that, for non-, lower and basic-rate taxpayers, the tax position on dividends is the same whether dividends are received inside or outside an Isa.

So why bother with an Isa if that's the case?

First: because you never know when you might become a higher-rate taxpayer.

Second: to avoid a potentially hefty capital-gains-tax bill when you finally cash your investments in - which, the industry generally agrees - is the real value of holding investments in an Isa.

Third: and don't knock it, you don't have to give details of an Isa on your income tax return.