The British ISA – how to turbocharge the UK

• The issue – UK markets are in a deep-set malaise, with a sharp decline in the number of companies, capital market activity and liquidity. UK markets are failing to support growing companies, which is leading to many selling far too early in their life-cycle.

• Reforming investment – There has been welcome progress in encouraging investment in private companies. A similar impetus is required for public companies.

• BRISA to the rescue – A British ISA would reverse the long-standing withdrawal of funds from the UK market and turbocharge the UK public markets. This would drive economic growth and enhance tax revenue. We recommend switching the full £20k allowance to UK investments.

In this article we look at a variety of options for a BRISA and the potential benefit. We certainly do not have a monopoly on ideas, so any further insight or thoughts would be very helpful.

The problem.

We have written about this a number of times, but it is worth repeating that there is a material issue in UK capital markets. We highlight:

• The 20% reduction in companies in the SmallCap index in the past five years, with a c.50% reduction in available market cap.
  
• The 15% reduction in companies in the MidCap index in the past five years, with a c.40% reduction in available market cap.
  
• Thirty companies with >£100m market cap potentially leaving the market in 2023 alone, with only one meaningful arrival. Ten of these are in technology and healthcare, 20 are being acquired by financial purchasers and 19 by overseas buyers.
  
• The number of companies aspiring to be listed in the US rather than the UK (nb Europe has a similar issue).
  
• The dearth of technology companies in the FTSE 100.
  
• The reduction in tax revenue (CGT, stamp duty, capital markets activity).
  
• Growing ownership by overseas investors and passive funds.

The performance of the UK economy has had some bearing on this, but a more important driver has been the reduction in UK equity exposure from a broad range of investors (pensions, insurers, charities, wealth managers, retail investors etc). The impact has been particularly stark in the small & midcap sectors, where valuations are at multi-year lows. 

Our recommendations

Below, we discuss the ISAs currently available, details of the ISA market, and make a number of suggestions to improve the impact of ISAs. However, to set out our stall, our key recommendations are:

1. Simplification – Merge the Cash and Stocks & Shares ISAs and reduce the number available.
   
2. UK focus – Mandate the full £20k ISA subscription to be invested in UK companies, funds investing in UK companies, or in cash-saving products.
   
3. Small & midcap focus – It is key that any product is targeted at growth companies, which is where the main funding problems currently reside. In addition, these companies are more focused on the UK than those with a larger market cap.

This would ensure that UK capital (and taxpayer funds) is directed at UK companies. It would drive a win:win situation through enhancing UK growth, improving tax revenue and increasing investment into UK growth companies. It would also drive a multiplier effect, whereby an improving UK equity market would attract additional capital.
There would be zero initial impact on UK tax take, but overall tax would increase from higher stamp duty (from higher liquidity in UK markets) and higher CGT (improving valuations), as well as longer-term benefits from enhanced economic growth and investment. 

Domestic capital for domestic investment

Over the past 25 years there has been a massive change in UK capital allocation, from a focus on UK growth and income to a focus on capital preservation, multi-asset and global exposure. This has been particularly manifest by pension funds and insurance moving from c.40% ownership of UK equities 25 years ago to only 4% today. However, this has been a broad theme encompassing charities, wealth managers and retail investors. There are many good reasons for a broad spread of investments, but do we really need to provide tax incentives to encourage this? UK capital and taxpayers’ money is being used to fund overseas companies.

Here are some examples of countries having savings products aimed at supporting their domestic economies.

French PEA – France’s saving scheme for retail investors (known as the PEA) had 6.6m accounts in 2020 with €112bn of assets. The funds need to be invested in European-listed shares, ensuring a focus on home markets. France also has a PEA dedicated to financing small and midsized companies, with a market cap of less than €1bn at the time of acquisition. The PEA-PME is separate to the PEA and has a maximum deposit of €15,000. It has raised over €700m for investment in small & midcap companies since inception and has a five-year holding period to be tax exempt.

Japan NISA – This was introduced in 2014 and was based on the UK ISA. The aim was to increase retirement income and to move cash out of bank accounts and into the Japanese economy. The scheme allows investment of up to 6m yen (£32k). The investments need to be in pre-approved Japanese stocks, ETFs and trusts (overseas companies and bonds are not permitted). There are c.19m NISA accounts in Japan, which is growth of c.25% over the last three years.

US IRA – Although foreign shares can be owned in an IRA, there is a tax disadvantage from doing so due to withholding taxes by the foreign government as you cannot take advantage of the credit from the US Government (nb this does not apply to Canadian stocks as Canada does not tax dividends on stocks held in IRAs).

Italy PIR –The piani individuali di risparmio (PIR) was introduced in 2017. This product is exempt from CGT and financial income. At least 70% of the investment portfolio has to consist of equity or debt securities issued by Italian companies (or EU companies having an Italian branch) or units or shares of UCITS complying with such requirements; 30% of the issuers of such securities are SMEs (ie 30% of the 70%). There is a €30k limit per annum and the investment has to be held for five years.

ISA – a successful savings product

Individual Savings Accounts (ISAs) were introduced by Gordon Brown in 1999 as a successor to PEPs and TESSAs. They have become a key part of the UK savings market for individual investors, particularly as they are more flexible than a pension. Over 27m adults hold an ISA and 13m ISAs were opened in 2021-22 with a total subscription of £68bn (source ONS). This article by Gordon Brown gives his views on their purpose and success 20 years after launch.

The key elements of the existing ISA rules are:

• A total of £20k can be invested per annum and there is no carry forward of allowances. Investments in an ISA are not subject to income tax on dividends or CGT, but stamp duty is paid on purchases where required (0.5% on shares). ISAs are part of an estate when considering inheritance tax (40% tax over certain exemptions).
• The key advantages of ISAs are that they are not subject to a holding period, there is no limit on the total held within ISAs and the only time limit is the decease of the holder (and even then they can be passed on to a partner). This is particularly attractive for people wanting to save, but also wanting access to their savings as required.
• The total annual investment in an ISA is £20k, which can be spread across a combination of the ISAs available.
• You must be over 16 for a Cash ISA and over 18 for other ISAs. You must be under 18 for a Junior ISA and these have lower limits on subscriptions.
• The attraction of ISAs has increased with the changes in the UK dividend tax-free allowance (reduced from £2k to £1k in April 2023 and reducing to £500 in April 2024) and the reduction in the tax-free element of capital gains (reduced from £12.3k to £6k from April 2023 and reducing to £3k from April 2024).

Currently, six different ISAs are available:

• Cash ISA (£20k limit).
• Stocks and Shares ISA (£20k limit).
• Cash Junior ISA (£9k limit), which was introduced in 2011.
• Stocks and Shares Junior ISA (£9k limit), also introduced in 2011.
• Innovative Finance ISA (IFISA £20k limit). This enables savers to access peer-to-peer lending through an ISA. The 2021-22 data showed that there were 16,000 new IFISA accounts in the year. This was a topical area when first introduced in 2016, but take-up has been very low.
• Lifetime ISA (LISA £4k limit). This was introduced in 2017 and is aimed at people aged 18-39 wanting to save for a first home or retirement, with the government providing a 25% bonus on your contributions (ie £1k per annum). The number of people that have actually used it for their first home is still modest (5,800 in 2021-22 and 56,100 in 2022-23). There was £1.7bn of subscriptions into LISA last year at a cost of £425m to the taxpayer.

There also was a Help to Buy ISA, which was introduced in 2015 and enabled people to save to purchase a first-time property. There was a maximum subscription of £2,400 per annum and a total limit of £12,000. The government topped it up by 25% (max £3,000). This scheme ended in 2019, but holders of existing Help to Buy ISAs can continue to subscribe until 2029. The total of government-funded bonuses from inception to March 2023 was £887m, supporting 558k property completions.

The Stocks & Shares ISA

As mentioned above, £20k can be invested in a Stocks & Shares ISA per annum. The majority of these funds are invested through platforms (eg Hargreaves Lansdown, AJ Bell and interactive investor) and wealth managers (eg Rathbones Group#, RBC Brewin Dolphin and Evelyn Partners. Having originally been focused on UK investments, the spread of available products is now diverse and includes:

• UK companies
• UK funds
• Overseas companies
• Gilts
• Corporate bonds

There is a choice between self-selecting the constituents of the ISA, or by having an expert (eg wealth manager) or robo-adviser choose the investments. An example of the latter is the Nutmeg ISA, which uses ETFs.
You have to be aged over 18 and UK resident for tax purposes to subscribe for a Stocks & Shares ISA, which means that 54m people meet the eligibility criteria. 
The ability to invest in a broad spectrum of assets and geographies has helped to spread risk and increase choice. However, this means that UK investors are receiving a tax break from the UK Government and increasingly using it to invest overseas. 

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