Consumers could face VAT charge for financial advice

The Financial Services Authority's plans to reform investment advice came under fresh criticism yesterday as it emerged they could expose millions of people to paying extra value-added tax.

The revelation came as Ron Sandler, who is heading the government investigation into the UK savings and investment market, broadly endorsed the FSA's plans.

The FSA is recommending a new definition of independent financial advisers (IFAs) under which they must charge fees for advice and rebate excess commissions back to clients. But the FSA admitted that fees for general advice, such as the initial "get to know you" session with clients, were liable to VAT. Fees for product-specific advice that gives rise to an investment is exempt from VAT because, like insurance premiums and bank charges, they are considered payment for a financial service. A typical introductory client assessment can cost anything from £300 to £5,000, which would mean a VAT bill of between £52.50 and £875. Annual reviews would also be liable.

Paul Smee, director-general of the Association of Independent Financial Advisers, said: "It is extremely complicated. This is not going to encourage customers to switch to a fee-based service, and therefore it is not going to encourage an existing IFA to switch from charging commission to charging fees."

He added that only 1 in 20 IFAs charged fees, but more than 90 per cent offered a choice between fees and commission.

Meanwhile, Mr Sandler told an Association of British Insurers conference: "The FSA has been radical but it is an area that warrants a radical move. It is pointing the industry in a direction that is desirable and inevitable."

Mr Sandler said there was a "fundamental lack of clarity" in the structure of with-profit bonds and policies, and questioned whether the industry's initiative to explain terms such as "reversionary bonus" – the sum paid to policyholders every year – was adequate.

The former chief executive of Lloyd's of London identified an "inherent conflict of interest" between with-profits policyholders and shareholders. Shareholders are meant to own 10 per cent of profits which accrue in the with-profits fund, with the remaining 90 per cent going to policyholders. Because life offices do not disclose the real rate of return on customers' investments they can in theory hold profits back from policyholders, swelling the amount passed to shareholders.