The Japanese financial industry is gearing up for the introduction of Individual Savings Accounts (ISA). This new system will start on 1 January 2014 and is aimed at providing a boost to the government’s effort to move more of Japan’s ¥1,500trn yen of household assets away from “saving” into “investment”. So far these efforts have by-and-large failed: nearly 56% of household assets are lingering on bank deposits; less than 6% is invested in the equity market and less than 4% in mutual funds. Compare that with the numbers for the US: less than 15% in deposits, more than 30% in equity and over 12% in mutual funds.
Already in 2003, by reducing the tax rate on dividends and capital gains from 20% to 10%, Japanese authorities tried to entice individuals to take their money from the bank and participate in the stock market. However, it has been mostly the high net-worth part of the population that took the opportunity, while most regular savers have proven too risk-averse to make a move. The bulk of Japan’s vast savings pool thus remains stubbornly unproductive.
The temporary tax relief measure of 2003 will now expire at the end of this year and be replaced by the ISA system, modeled in part after the successful example in the UK. Each individual of 20 years of age or older will be allowed to open an ISA from next year onward and invest up to ¥1m per year, exempt from dividend- and capital-gains taxes. The system has a fixed 10-year period, with tax-exempt status granted for 5 years and capped at ¥5m of investments.
Whether the new system will turn out to be a success remains to be seen, but several amendments to the initial proposals, requested by the financial industry, appear to make the system slightly more attractive for distributors and product providers than initially feared. The increase from an initial maximum ¥3m of assets eligible for tax-exemption, to the current ¥5m is one. The drop of the requirement to open a new account for each additional year of investing is another.
However, in a society largely averse to risk, excluding bonds or fixed income mutual funds from the eligible investment universe of ISAs continues to be seen as an impediment to the potential popularity. Given that the stated purpose for introducing the ISA system changed from the initial “to encourage the shift from saving to investing” towards the current “to provide households an opportunity to build wealth through tax-efficient long term diversified investments”, adding other asset classes to the eligible product mix seems justifiable. Also the fixed 10 year maturity of the provision and maximum 5 years of tax-exemption makes it difficult for financial institutions to gauge the consistency of the plan and invest large amounts upfront for setting up IT systems and offer clients high levels of service features, such as automatic salary-deductions, until the long term viability and size of ISA-plans have been established.
The Financial Services Agency’s wish list for amendments to the Tax Commission included all of the above, but – as in 2001 with the introduction of individual DC – Japan’s tax-man has limited the scope and length of tax-exemptions.
Japan would do good to take example from the UK, where in 1999 the ISA-system was introduced also as a 10-year plan, but during the course of the programme, the term was extended into perpetuity. Tax-exempt limits have been increased in recent years and the programme allows for investing, not only in equity type product, but also deposits, bonds, bond mutual funds and insurance products. Further, by linking the ISA system with payroll administrations, employees can invest via automatic salary-deductions, which have spurred the development and popularity of the plan. In 2011 a “Junior ISA” system was introduced for children below the age of 18. As of September 2012, nearly 24 million Brits or nearly 50% of the adult population had an ISA.
It has taken Japan 12 years to reach 4 million participants (or less than 7% of its working population) in its individual DC system. At ¥6trn, the system comprises less than half a percent of Japan’s household assets. The system has so far fallen victim to tax authorities unwilling to allow broad tax-incentivisation or enhance the plans’ flexibility. Large financial institutions such as Fidelity, who were enthusiastic initially and made substantial upfront investments in IT systems, pre-marketing and staff, have dropped out as, over time, the revenues did not justify the costs by far.
Let’s hope that in case of ISA plans, time till introduction on January 1st will allow for more fine-tuning to increase the probability of success for achieving a broad-based national investment platform.
Oscar Volder CFA is Head of Institutional Sales at BNP Paribas Investment Partners Japan