Taxman gets tough on Isas

Around 35,000 investors holding an estimated £400m in Isas face losing valuable tax benefits, potentially worth thousands of pounds, in an Inland Revenue crackdown.

The taxman has targeted Isa buyers "with continuous applications" - forms designed to last more than one tax year and used mainly by monthly savers - who made mistakes during the first Isa year in 1999-2000.

In the initial confusion over maxi and mini Isas two years ago, many investors inadvertently applied for illegal combinations of maxi and mini Isas, leading to the erasing of tax benefits for the second product taken out.

But it is only now that the Inland Revenue has decided these investors should also lose income and capital gains tax freedom in the two subsequent years. This potentially exposes their holders to up to £21,000 for tax. It reasons that because the original application was faulty, then further Isa money on the same form is equally out of order.

In letters to fund managers the Inland Revenue writes: "The investor named above has subscribed to more than one maxi Isa, more than one of each type of mini Isa or a combination of maxi and mini Isas for 1999/00. As the Isa with you was the second (or subsequent) Isa you must:

Void the investor's subscription for that year and any other subscriptions made by this application form

Repay any payment of tax or tax credit

Deduct tax at the lower rate from interest paid."

Early Inland Revenue figures suggested 85,000 savers were caught by this - but many of these were later found to have complied. If 35,000 have transgressed, they could lose tax benefits on up to £400m in savings.

Pima - the Pep and Isa Managers Association - is lobbying the Inland Revenue to change the ruling.

"Investors are being punished for a carry over from the original confusion," says Pima's Peter Shipp. "We want the Inland Revenue to go back to their previous Pep practice which minimised losses to investors where there was a genuine error.

"This punishes people not just for the first year but for subsequent years when they have had no chance to repair the problem. Continuous application is the only practical option for regular schemes," he says.

Jeffrey Mushens at fund managers M&G says: "This is the first we've heard of this. In the past, the Inland Revenue has been pragmatic. If it has changed, it is silly and not worth it for anyone."

Fidelity uses these forms for monthly savings. It says: "This does not seem fair. They should be flexible when there is a genuine mistake."

The Inland Revenue says: "We have received representations from Pima and have agreed to consider the points they have made."