Societies fear pounds 15bn Tessa outflow: Higher interest rates could threaten housing market unless tax-exempt status is extended before 1996

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MORE THAN pounds 15bn could be withdrawn from building societies on the fifth anniversary of Tessas, the tax-exempt savings accounts, forcing building societies to raise mortgage rates.

The Building Societies Association is calling for an extension to the tax-exempt status of Tessas to dissuade savers from removing their money when they mature.

Tessas were introduced in 1990 by John Major when he was Chancellor of the Exchequer. They allow savers to accumulate up to pounds 9,000 over five years, without paying tax on the interest.

Under existing rules, however, they lose their tax-exempt status after five years, prompting fears among building societies that savers will withdraw the cash to invest in other tax-exempt products such as personal equity plans and National Savings when the first Tessas mature in January 1996.

That could force societies to raise savings rates to stem a flow of funds, which would have to be paid for with a rise in mortgage interest rates, threatening to undermine the housing market.

Tessas have so far attracted 4 million savers, who have invested pounds 25bn over three-and-a-half years.

The BSA said: 'It is clear that at the beginning of 1996 there will be considerable instability within the retail deposit market. Building societies and banks could face a significant outflow of funds at that time. This may have implications for lending markets also.'

Building societies fund most mortgage lending from retail deposits. The fear is that if societies suffer big cash outflows they will struggle to find retail finance, or have to raise interest rates to attract new money.

In a submission to the Treasury, timed to allow legislation to be introduced in the November Budget, the BSA calls for changes to put Tessas on an equal footing with other forms of tax-efficient investments.

It suggests that maturing Tessas should be allowed to keep tax-exempt status, and that investors ought to be permitted to start a new tax-free savings scheme based on deposits.

It argues that the Treasury will not lose significant amounts of tax revenue by extending the Tessa schemes because a likely home for ex-Tessa money would be personal equity plans, which also enjoy tax- exempt status.

The BSA maintains that Tessas and PEPS are similar, both having been designed to provide small investors with tax shelter. But it says it is unfair that a Tessa is a fixed- period investment while PEPS can be renewed indefinitely.

'Competition between unit trusts and deposit-based products is distorted and . . . as a result there will be significant outflows from deposit accounts from January 1996 onwards because the tax rules are weighted in favour of equity investments.'

Building societies and banks run the schemes, the first of which were authorised in January 1991. Investors are allowed to deposit pounds 3,000 in year one, and then a maximum of pounds 1,800 in each of the next four years.

Inflows of Tessa money were largest in January 1991, when a total of pounds 2.4bn was invested. In succeeding Januaries inflows have peaked as investors topped up account balances at the earliest opportunity. The average monthly inflow to Tessas is about pounds 500m. But in past Januaries total receipts have doubled.

The BSA bases its estimate of the pounds 15bn- pounds 16bn loss on the funds deposited between 1990 and 1993.

A spokesman for Halifax, Britain's largest building society and administrator of 500,000 Tessa accounts, said: 'There are two Budgets between now and when the first Tessas mature. I would not be surprised if the rules changed to extend tax-exempt status.'

The BSA also suggests Tessa and PEP tax shelters could be combined.

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