Expensive Dividends – National Grid and Electra Private Equity

National Grid (NG.) are returning some of the cash received from the sale of their stake in a gas distribution business to shareholders via a large special dividend. And some will be returned via market share buy-backs, the wisdom of which may be questionable. But the real concern for private investors is that dividends are taxed as income even though this is in essence a “return of capital”. It is not being paid out of operating profits, but simply from the sale of part of the business.

In the past, companies would recognise this fact and the tax problem faced by private investors by offering a “B” share alternative that could then be redeemed and turned into a capital gain (as capital gains are less highly taxed than income for many investors). But this was outlawed in the 2015 Finance Act – there is a good article in the Daily Telegraph today that explains this in more depth.

But consider the plight of retail investors in Electra Private Equity which is much worse. They recently announced a similar return of cash via a special dividend of 2640p per share. The share price the day before it went ex dividend was 5,110p so effectively half the value of the company is being returned as a dividend. One investor who contacted me invested £20,000 in the company many years ago, and his holding is now worth near £150,000 so he will receive an enormous income tax bill. Needless to say he is not happy.

A particularly iniquitous aspect is that a lot of the “profit” he is being taxed on actually simply results from asset price inflation over the years.

Could the company have considered alternatives? Spreading the return of more than one tax year may have helped, but another possibility would be to return the cash via a tender offer to shareholders. Those taking it would realise a capital gain, while those not doing so would see the value of their existing holding unaffected (the share price would adjust to reflect the lower asset value per share and the proportionally similar fewer number of shares in issue).

There may be other possibilities that a tax and accounting expert could advise on, but unfortunately it’s probably the impact on institutional investors that is driving this desire to pay dividends and private investors are being prejudiced.

I may raise this issue at the National Grid AGM in July, but it will be too late to affect this and dividends can be declared by a company’s directors without a vote of shareholders. Similarly on Electra Private Equity, it is too late to object as the dividend has been declared and so will be paid.

This is yet another example where the taxation of capital gains and dividends is irrational and deeply prejudicial to the interests of investors. The solution, without prejudicing the Governments need to receive tax, would be harmonisation of dividend and capital gains taxes. But the latter should be index linked to avoid taxing fictitious profits.

Roger Lawson

Finance Bill and Tax Changes

When a General Election is called, with the imminent prorogation of Parliament when all Bills that are passing through Parliament are effectively abandoned, the Government has to rush through any important Bills that it wants to get passed. That is what happened yesterday (25/4/2017) when only a few hours debate was available on the Finance Bill. That Bill contained many of the recent changes announced by the Chancellor in his Budget but many of them have been removed from the Bill so as to ensure its quick passage. It also avoids any politically embarrassing changes being implemented before the election. They may get revived in new legislation after the election in the new Parliament, reconsidered or quietly forgotten about. The latter being of course likely if there is a change in the political complexion of the Government or changes of Ministers.

These are some of the tax and other changes removed from the Bill:

  1. The reduction of the Dividend Tax Allowance to £2,000 from 2018. ShareSoc raised concerns about this and asked our Members to write to their MPs on the topic – see https://sharesoc.wordpress.com/2017/03/20/double-taxation-and-broken-promises/ . It was certainly a vote loser for anyone who receives substantial dividends and it would definitely be good to get this reconsidered.
  2. The reduction in the annual pension allowance from £10,000 to £4,000 from 2017 to stop “re-cycling” of pension contributions where pensions were already being taken is out. So you may have another year to use the higher amount.
  3. The “Digital Tax” plan to force smaller companies to submit quarterly tax returns electronically is dropped. This was a very unpopular move by HMRC among small businesses as it would have imposed major extra costs on them. This is likely to simply be deferred.
  4. The change to increase Probate Fees very substantially on larger estates has been dropped – see https://sharesoc.wordpress.com/2016/02/20/it-could-get-more-expensive-to-die/. This proposed change provoked a lot of criticism from the public including several ShareSoc Members. Again it would be good if this was reconsidered rather than simply postponed.
  5. Some changes to the rules on EIS and VCT investments and social investment tax relief are out.
  6. Corporation tax relief changes are out.
  7. Disclosure of tax avoidance schemes and penalties for enablers are out.

There are quite a lot of other clauses removed – one could say that a hatchet has been taken to the Bill to get it passed. But if you take the opportunity to ask questions of your prospective MPs in the hustings, you may like to pointedly ask them about their views on some of the above and whether their Party would revive these measures.

Roger Lawson

Double Taxation and Broken Promises

The most recent changes to dividend taxation in the Chancellors Spring Budget are a major attack on private investors. The simple change to reduce the Dividend Tax Allowance from £5,000 to £2,000 only a year after it was introduced will have a big impact on the tax paid by many investors. It’s also another example of a broken promise about “no increases in taxes” made in the Conservative manifesto.

The Chancellor, Philip Hammond, has already had to back-track on the increases to National Insurance over the broken promise. Perhaps he should reconsider the above changes also.

Let’s go back eighteen months when his predecessor George Osborne issued his last budget. That scrapped the dividend tax credit system and introduced the Dividend Tax Allowance. This is what I said at the time about that:

“Dividend tax change. Few people understand the dividend tax credit system so this might be seen as a worthwhile simplification, but it will increase the Government’s tax take, particularly from wealthy investors, very substantially. For example it is forecast to raise over a billion pounds per year in tax!

The original reason for dividend tax credits was to avoid double taxation on the same profits. When both corporation tax and personal tax rates were high, profits made by a company could effectively be taxed twice – once within the company by corporation tax and then when the profits were distributed in dividends. It could result in very high combined rates. But tax rates are now lower, particularly corporation tax.

The new £5,000 allowance will mean the vast majority of individuals who receive dividends will not be adversely affected. However, those with substantial dividend income will be. For example, someone who receives £50,000 a year in dividend income may be £3,800 per year worse off!”

The latest reduction in the Dividend Tax Allowance to £2,000 will mean some investors are now an additional £1,000 worse off than stated above.

What did the Conservatives say in the 2015 Manifesto (which you can read here: https://www.conservatives.com/manifesto)? It says on page 27 that “A Conservative Government will not increase the rates of VAT, Income Tax or National Insurance in the next Parliament”. Most people will have read that to mean that they will not be paying more Income Tax or National Insurance. Hence the complaints from the self-employed concerning changes to the latter. But the impact of these changes to dividend taxes are even more damaging to those living on dividend income in retirement.

Obviously the way we are headed is for the Dividend Tax Allowance to be scrapped altogether and dividend income is clearly now a target for more tax raising from the Chancellor.

I would urge all private investors to complain to their Members of Parliament about this change. You can write to your M.P. by post or email. You can obtain their contact details from this web page: http://parliament.uk  (enter your post code at the bottom left). This will take you to a page giving their name, postal address and email address – an email will do fine.

Roger Lawson

It’s a Budget – But Not As We Know It

The Chancellor, Philip Hammond, delivered his Spring budget yesterday. But as most of the big changes have been moved to the Autumn, this was a “steady as you go” statement in essence.

However there were some significant changes for private investors. The biggest is that the tax free allowance on dividends has been reduced from £5,000 to £2,000. So if you rely on dividend income, say in retirement, this will cost you substantially more – over £1,000 extra in tax in some cases if you pay higher rates of income tax.

The Chancellor seems to have decided to attack the growing number of “self employed” and those who are paying themselves via limited companies. Hence the change to dividend income. Hence also Class 2 and Class 4 National Insurance being raised but the impact of other changes are actually quite complex. Irrespective the Chancellor has decided that the current high differentiation between taxes (and benefits) between employed and self-employed “undermines the fairness of the tax system” even though the latter get fewer benefits. One surely cannot argue with that although he has been accused of breaking a Conservative manifesto promise not to raise taxes.

There are of course some simple steps to avoid higher taxes on dividends. If you don’t need the cash for spending money, then move your high dividend paying investments into an ISA or SIPP. The ISA allowance will increase to £20,000 from April this year as previously announced so enabling you to shelter substantial amounts from the taxman, particularly if you are married and hence can put in twice as much. In addition you might consider investing in Venture Capital Trusts (VCTs) where dividends are tax free. These have become more popular of late because of the limits on pension contributions and the recognition that they have generated good returns in recent years from the best companies, although the availability of new subscriptions to them is now low.

The Chancellor has taken some steps to increase productivity in the UK which is a hot Government theme at present – see the last ShareSoc Informer Newsletter for more discussion on that. So there is money for research into hot technology areas, investment in 5G networks, improvements to the road network (£690m), and £500m to improve technical training (for “T-Levels”).

How is the economy doing generally? Economic growth is now good after the failure of the Brexit decision to dent it as expected. But the Government is still planning to run a deficit so overall Government debt will still rise this year to a new record of over £1.6 trillion. Indeed with some attacks on tax avoidance, overall tax raised will rise under this budget to the highest proportion of GDP since the 1980s. Will this prove a drag on the UK economy and businesses in general? We have yet to see. The Government is also considering how it can raise taxes on on-line retailers who often avoid business rates and will try to close a loophole whereby sales are made VAT-free by being made from overseas.

Thinking of moving overseas for your retirement? The Chancellor is imposing a tax charge of 25% on pension transfers to qualifying schemes (Qrops) from the new tax year with some exceptions. This is to try and frustrate the move of pensions to more favourable tax regimes which has apparently been subject to abuse of late.

But as rather expected, the Government is making a lot of money from pensions being cashed in under the new freedoms to do so devised by former Chancellor George Osborne. The latest estimate has doubled to £1.6 billion!

Or considering what to do after your time as Chancellor ends? Just take note that former Mr Osborne is going to be earning £650,000 per year as an advisor to Blackrock for working four days per month. It was disclosed in the register of MPs interests on budget day.

Roger Lawson

AIC Press Release on VCTs

To follow on from my last blog post, another interesting press release from the AIC today was that on the performance of Venture Capital Trusts (VCTs). That’s particularly so when everyone is considering their tax bills at this time of year, i.e. those just paid and how they can avoid such big ones for the current year and next.

VCTs do of course offer upfront income tax relief when investing in new shares, and also tax free dividends thereafter. Many have been achieving high dividend yields in recent years. The AIC notes that the VCT sector “as a whole is up 82% by share price total return over the last decade”. In addition the top 20 VCTs are up an average of 141% over the last 10 years and have paid our an average total tax free dividend of 87 pence per share. The press release tells you which have been the top performing VCTs and when buying shares in these trusts it’s probably best to go for those who have demonstrated good long term performance as running these funds is not easy and proven experience is what seems to count. AIC press releases are given here: http://www.theaic.co.uk/aic/news/press-releases

Needless to say perhaps that Foresight VCT, which ShareSoc recently commented on, does not get a mention as it’s not in the top 20.

The AIC does of course give you comparative historic performance data on most investment trusts including VCTs on their web site.

Roger Lawson

Brexit, Industrial Strategy and Productivity

What next now that we are committed to Brexit? Well first we need an “industrial strategy” to help us develop a new place in the world and possibly to pay for the up to £60 billion that might be demanded by the EU (as settlement for outstanding commitments if you believe that – yes divorce can be expensive). Now it just so happens that the Government has just published a Green Paper entitled “Building our Industrial Strategy” on that topic which is worth reviewing.

If you don’t think revolution is in the air, or would prefer it was not, it’s worth quoting from the Prime Minister’s foreword to the document: “Last summer’s referendum was not simply a vote to leave the European Union, it was an instruction to the Government to change the way our country works – and the people for whom it works – forever.”

Another comment in her foreword is on the need to tackle low productivity in the UK and she says: “This is vital because if we want to increase our overall prosperity, if we want more people to share in that prosperity, if we want higher real wages, and if we want more opportunities for young people to get on – we have to raise our productivity.”

That is undoubtedly true. Productivity in the UK has been a problem for many years as the Paper explains. It improved up until the financial crisis in 2008, but then fell behind our competitors in France, Germany and the UK (they produce as much in four days as UK workers do in five). There are also bigger disparities across the UK than in other countries, with London being 72% higher than the UK average. Note: this probably reflects the very high “added value” achievable in financial services in London and over reliance on that distorts the UK economy in many ways.

Now Governments, particularly socialist ones, tend to talk at length about improving the economy by improving productivity, backing new technology, backing selected winners, developing sectors where we have obvious strengths, improving capital investment, developing a more educated workforce and suchlike. This makes for good political speeches but in practice does not often result in much change. Or worse, a lot of money is wasted on backing losers, or subsidising industries in decline.

So let’s just pick out what might be new in the Green Paper. The Government proposes ten “pillars” for the strategy – investing in R&D, developing skills, upgrading infrastructure, supporting start-ups and early stage businesses, and several others with somewhat woolly definitions.

The Government is to invest an extra £4.7 billion in R&D funding. How this will be spent has not yet been determined but a whole list of possible “hot” sectors are given that might be supported by the new “Industrial Strategy Challenge Fund”.

There will be effort expended to develop improved technical education and improvement in STEM skills where the UK has long been behind other countries (we basically have too many people studying for useless or easy degrees, and not enough focus on less glamorous technical skills – best not to comment perhaps that the Prime Minister has a degree in Geography; she may have realised her mistake as she promptly joined the Bank of England before going into politics). The creation of a new system of technical education is promised.

There will also be a commitment to improve our transport infrastructure – rated second lowest among G7 countries. That includes, roads and railways, energy production, housing and even our digital infrastructure. The failure of long term planning in these areas is surely obvious to everyone. The road network is a particularly good example of under investment and obstructive planning processes resulting in some of the worst traffic congestion in the developed world. This certainly damages productivity.

The low level of investment in infrastructure, and in plant and machinery, is a long established aspect of the UK economy which the Government wishes to change.

To promote the growth of long term investment the Government has launched a new Patient Capital Review, led by the Treasury. It will be looking at the problems of obtaining and providing development capital for growing innovative firms. And it will consider the role of “market practice and market norms” in facilitating investment. It even suggests that dual class share structures such as those of Google, Facebook and LinkedIn where founders can retain dominant voting control might assist in the development of winning businesses, even though UK stock market investors generally dislike them.

One can anticipate a big fight over this idea as surely this is not the cause of those companies success. Indeed if you look at Apple, where in its early days Steve Jobs was dominant he made so many mistakes that he was removed and replaced by a businessman. Only later did he return and make a success of the company in a conventional share structure. The dominance of Henry Ford over Ford Motor Company and his reluctance to change meant that he subsequently lost out to General Motors where a more normal corporate share structure was present. The beauty of a conventional structure is that when the CEO is going awry, they can be changed. A dual share structure can block change. The Government’s analysis here is surely simplistic and they have spent too much time talking to entrepreneurs rather than students of business history.

Anyway it seems we are soon going to get a discussion paper from the Financial Conduct Authority that will review the structure of the UK’s listed markets. So that’s one more consultation to add to the current pile – we seem to be snowed under with them at present. But it sounds like we will definitely need to respond to that one. And you can of course respond to the Industrial Strategy Green Paper as it poses some questions to which they would like answers.

For those who invest in smaller companies, the Minister for Small Business will take on the role of “Scale-Up Champion” and there will be a review into entrepreneurship led by the “Chief Entrepreneurial Adviser to the Department for Business, Energy and Industrial Strategy (BEIS).

Comment: The responses to the Green Paper by businesses and the media was unenthusiastic (“politely lukewarm” as the FT called it). They have no doubt seen it all before, with no obvious benefits arising. Unfortunately asking civil servants, or politicians, to develop sensible business development strategies does not work simply because they have no relevant experience or understanding. There are not many people with MBA degrees for example in the Treasury or BEIS I would guess, and even fewer with real business experience. In simple terms asking them to pick technology or market sectors to back is not realistic, and they will waste a lot of money backing projects and people that fail.

The existing approach of providing tax relief to those who back smaller companies (via EIS and VCTs for example), and risk their own money, has worked. Providing direct stimulation does not. Exiting the EU will enable us to escape from the limitations of EU rules in this area concerning tax relief. But providing a good educational framework can help and that should surely be one of the key roles for Government to play. Fixing the infrastructure is also where Government can assist.

If you wish to make your own comments, the Government’s Green Paper is present here: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/586626/building-our-industrial-strategy-green-paper.pdf

Note that I hope to write an article for the next ShareSoc newsletter than will explain the conundrum of poor UK productivity. There are a lot of misconceptions about what can and what cannot improve productivity.

Roger Lawson

Losses From Withholding Taxes on Dividends

An issue that has come to the notice of ShareSoc is the problem of the Withholding Tax introduced on dividends in South Africa. Even though Pan African Resources Plc (PAF) is registered in the UK, it is dual listed on AIM and the Johannesburg Exchange (JSE). Because of the way South Africa introduced the tax change, any shareholder is going to get 15% deducted before payment (or 10% for UK residents under a dual tax treaty).

To get the lower rate, you need to submit a “Tax Resident Beneficial Owner Declaration Form” to the company’s registrar (Capita). So far, so good, if your shares are held directly (i.e. you are on the register).

However, if your shares are held in a nominee account (i.e. in an ISA or SIPP), your broker would have to submit such a claim for you (and any other clients for which they are holding the company’s shares in a pooled nominee account).

Checking with a couple of brokers, AJ Bell Youinvest and the Share Centre, they are refusing to submit such claims on the basis that they never reclaim such taxes. That’s despite the fact that they do reclaim tax deducted on UK listed REIT dividends.

This seems somewhat unreasonable even if it would be some effort to ensure the 5% of dividends were not lost. At least investors should be warned of this. Pan African is not likely to be the only company affected by this.

This is of course, yet another example of the negative aspects of nominee accounts. The fact that you are not the registered owner of the shares if you hold them in an ISA or SIPP account, or indeed in most broker accounts, undermines your legal rights including your dividend rights!

Roger Lawson