JCER: New Tax-Free Accounts A Prime Chance For Banks

From January 2014, banks and securities houses will be allowed to offer new tax-free investment accounts. This change is expected to spur intense competition among financial institutions to win new customers.

The scheme is being called a Japanese version of an individual savings account, or ISA, which originated in the U.K. Instead of the current system of preferential taxation on capital gains and dividends for stocks, the new framework will allow people 20 or older to start tax-free investments of up to 1 million yen annually.

Unlike the U.K. version, however, the Japanese system will waive taxes for investors until the end of the fifth year from the original investment. Investors who redeem their original investments will lose their tax-free status, even if the five years is not yet up.

Growth Opportunity

For financial institutions, the tax scheme will provide an excellent opportunity to acquire promising new customers. Since 1988, when the widely used tax-free savings account system was abolished except for the elderly and the physically disabled, there have been virtually no tax-free financial instruments for the general public.

The annual ceiling may seem low for those who have already accumulated their wealth. But for the average corporate employee, 1 million yen is likely sufficient. For financial institutions, winning a customer's initial account is a good way to win a lifetime customer.

The rules will allow only one account per person and no switching accounts to another financial institution for at least four years. This is likely to make for heated competition to win new customers, which will probably manifest itself in two ways: aggressive promotional campaigns and efforts to offer the most attractive financial instruments.

Competing For Customers

Promotional activity will probably include introductory seminars, lower commission fees, offers of cash-equivalent coupons and giveaways, such as a one-night stay at luxury hotel.

The battle for customers is set to begin. Before making any investments, each customer will need to have his or her account authorized as tax-free by the local tax office. People who want to open an account need to submit their certificate of residence bearing their address as of Jan. 1, 2013, to their tax office via a financial institution.

Tax offices will start accepting applications on Oct. 1, so financial institutions are busy planning how to spur existing and potential customers to obtain their residence certificates.

Solid Products

Some financial institutions acknowledge that to retain customers, having good products is more important than offering one-time incentives. Kazuhiro Yoshii, head of the legal and tax research department at the Daiwa Institute of Research, says the financial products to be offered will probably be designed to maximize the tax advantages.

For example, he predicts financial institutions will offer investment trusts that deliver all returns from their holdings as a one-time dividend at the end of the fifth year. Today, investment trusts with monthly dividends are very popular in Japan. But if the principal for a year's worth of investment is already 1 million yen, the annual tax-free ceiling, the reinvestment of the monthly dividend will not be allowed to be made within a tax-free account. Providing a one-time dividend at the end of the fifth year will be an efficient way to continue tax-free reinvestment.

Limited Fee Revenue

Products such as exchange-traded funds and exchange-traded notes will be popular among ISA holders. Financial institutions will not be very enthusiastic about offering exchange-traded products, however, because the annual management fees for these products are relatively lower than fees for normal investment trusts, meaning more dividends and capital gains will be passed onto investors.

The Financial Services Agency predicts that the outstanding value of Japanese ISAs will be 25 trillion yen by 2020. Assuming that all fees and commissions will be 1% of total assets under management, that would mean Japan's financial industry would see additional revenue of 250 billion yen annually. Competition for good investment returns would be more welcomed than a battle to win the most accounts.

Masataka Maeda
Senior Economist
Japan Center for Economic Research