Potential tax consequences of cap on ISA allowances
Contributed by Chris Etherington, Private client tax partner, and Becky Thompson, Tax associate, RSM UK
Sweeping overhaul of ISA allowances leaves great uncertainty about HMRC’s proposed anti-avoidance measures and the sense it may be a return to pre-2014 rules. Chris Etherington, private client tax partner, and Becky Thompson, tax associate at RSM UK assess the tax implications.
The Chancellor’s Spring Statement passed by without a single mention of tax. This is a welcome relief for taxpayers and advisers alike, given the volume of changes announced in recent fiscal events. There do, however, remain a number of loose threads that need to be tied up in the forthcoming tax year.
One of the bigger cliffhangers from the autumn 2025 Budget relates to the Government’s plans to introduce a £12,000 annual cap on cash ISA contributions for investors under the age of 65, effective from 6 April 2027.
Investors will still have an overall ISA allowance of £20,000; however, once those impacted have used their £12,000 cash ISA allowance, the remaining £8,000 will need to be invested in a stocks and shares ISA if they wish to fully maximise their allowances.
Aim of the policy
There has been considerable debate as to whether the proposals will be effective, but the policy aim is clear – the Government wants to shift the balance of how much of taxpayers’ savings are sitting in cash investments.
Recent statistics suggest that around two-thirds of all ISA subscriptions are held in cash. On one hand, the fact millions of taxpayers have savings held in cash ISAs means the original policy objective has clearly been met.
However, it could be argued that the cash ISA is now a victim of its own success. In these times of higher inflation, there is more risk of taxpayers’ savings being effectively eroded over time, and the UK economy might benefit if such savings were put to more productive use.
Ban on transfers from stocks and shares and innovative finance ISAs to cash ISAs
However, the Government wants to go further than just changing the annual subscription limit of cash ISAs. Further details released by HMRC indicate that a set of anti-avoidance measures will accompany the new limits, aimed at preventing investors from bypassing the reduced cash ISA allowance.
The specifics remain unclear for now, with HMRC only confirming that draft legislation will be issued for industry consultation ahead of April 2027.
Although we currently remain in a fog of uncertainty, the proposed measures are reminiscent of the rules in place before the 2014 ISA reforms, when cash and stocks and shares ISAs were subject to different limits.
Currently, investors can move money from a stocks and shares ISA into a cash ISA without affecting their annual allowance. Under the proposed reforms, this option would be removed.
Once funds are placed in a risk-based ISA, they would no longer be transferable back into a cash product within the tax-free wrapper.
The change is designed to stop investors using investment ISAs as a temporary staging post for cash and then shifting the money into a cash ISA to avoid the new £12,000 limit.
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New test to determine whether an investment is ‘cash like’
Since the anti-avoidance announcements were made, there has been growing speculation over what types of investments will be considered ‘cash like’ and therefore excluded from stocks and shares ISAs.
A lot of the early commentary has focused on products such as money market funds, short-dated bonds, and funds that hold significant levels of cash or near-cash securities. It’s perfectly plausible that all of these could be caught by the forthcoming rules.
One way HMRC may introduce the new regime is to adapt the existing ‘60% test’ used for open-ended investment company (OEIC) and authorised unit trust distributions. This ‘60% test’ can result in a fund being classified as a ‘bond fund’ if more than 60% of its market value consists of qualifying investments, such as cash or fixed-income securities.
Any distributions from such funds are taxed as interest in the hands of the investor. A similar threshold could easily be used to define when an investment is sufficiently ‘cash-like’ for ISA purposes.
Alternatively, an old test for ‘cash like’ investments from the pre-2014 ISA regime could be dusted off. Under the former rules, investments expected to return at least 95% of their value were treated as ‘cash like’, and bonds maturing within five years were not permitted in stocks and shares ISAs. This would exclude money market funds entirely but would still be more generous than the ‘60% test’.
A charge on any interest paid on cash
A further proposed anti-avoidance measure is a new charge on any interest earned on cash held within non-cash ISAs. The wording used by HMRC suggests this could take the form of a flat-rate charge on interest retained inside stocks and shares or innovative finance ISAs.
This proposed approach mirrors the pre-2014 rules, which applied a 20% charge to cash interest in stocks and shares ISAs. It will be inevitable that cash will sometimes be held in these ISAs for investment and historically, it was the ISA manager’s responsibility to determine whether the cash held in stocks and shares ISAs is ‘for the purpose of investment’.
The proposed anti-avoidance reforms will bring an added layer of complexity to the ISA landscape, but ultimately the Government may simply end up dusting off some old rules and repackaging them. Like those old flares in the cupboard, if you wait long enough then they will come back in fashion. The real question is whether they still fit.
