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My PFS - Technical news - 08/01/16

Personal Finance Society news update from 2 December 2015 to 8 January 2016 on taxation, retirement planning, and investments.

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Taxation and Trusts

Investment planning

Retirement planning

TAXATION AND TRUSTS

Updated diverted profits tax guidance

(AF1, RO3)

HMRC has updated its guidance on diverted profits tax. As part of another anti-avoidance measure the government announced the introduction of the diverted profits tax (DPT) in the 2014 Autumn Statement The legislation was included in the Finance Act 2015, and applies from 1 April 2015.

The DPT, which has initially been set at a rate of 25%, applies where a foreign company 'exploits' the permanent establishment rules or where a UK company or a foreign company with a UK-taxable presence uses artificial transactions or entities that 'lack economic substance' to obtain a tax advantage.

HMRC's guidance note provides details on the DPT and should be read alongside the legislation, Explanatory Notes and the Tax Information and Impact Note which were published on 24 March 2015. It explains how the tax works by reference to practical examples which should prove to helpful.

Corporate tax avoidance

(AF1, RO3)

Ladbrokes have been blocked from reclaiming £54m of tax through a Tax Tribunal ruling in favour of HMRC and against an avoidance scheme promoted by Deloitte and used in 2008.  There are apparently three similar cases with a total of over £100m of tax at stake.  Seven other users of the same scheme have already conceded defeat. 

The scheme centred on (what was ruled to be) an artificial loss creation ie a loss for tax purposes that had no foundation in economic reality. 

Legislation in 2009 closed the loophole but the point of this decision was that even in a time before the new legislation was enacted the essence of the scheme failed on a "substance over form" basis.  HMRC stated "Avoidance just doesn't pay: we win about 80 per cent of cases taxpayers choose to litigate and many more concede before litigation."

The "take away" from this case and others like it is not related to the facts of the case or the particular scheme, but to the fact that:

  • HMRC is prepared to litigate and defend to secure rulings where the desired  tax advantage has no economic foundation - and/or defeats the intention of Parliament
  • HMRC appears to be building an impressive success record.

The combination of:

  • success in the Tribunals and Courts
  • telling the public about this success
  • anything to introduce and publicise anti-avoidance legislation and
  • strengthening the GAAR

all build a very convincing case for warning off individuals and companies from aggressive tax avoidance contrary to the intention of Parliament.

The strong recommendation underpinning financial planning strategy must be "stick to the tried and tested" or be prepared for the fight.

HMRC launches Personal Tax Accounts

(AF1, AF2, RO3, JO3)

At March Budget 2015, HMRC published a paper ' Making tax easer: the end of the tax return' outlining proposals for a new system of digital accounts that would ultimately replace the current system of self-assessment for millions of individuals and businesses.

A second paper - Making tax digital - published recently in conjunction with the official launch of Personal Tax Accounts, provides further detail on these plans and includes a timeline setting out how the Government plans to achieve its aim, which is to be interacting digitally with all taxpayers by 2020.

The main features of the proposed new system are:

  • Taxpayers will be able to see a complete financial picture of their tax affairs in one place, with all individuals and small businesses having access to a digital tax account by April 2016.
  • Taxpayers will not have to give HMRC information that it already has access to. From 2016, information on bank and building society interest will start to be included in tax codes and, in spring 2016, HMRC will publish a consultation document to gather views on how information might be obtained directly from more third parties.
  • Most businesses, including the self-employed and landlords, will be required to keep digital records and update HMRC at least quarterly where it is either their main source of income or a secondary source of income above £10,000 and their main income is from employment or a pension. These changes will be introduced for some businesses from April 2018, and will be phased-in fully by 2020.
  • Taxpayers will able to see the information that HMRC holds at any given time and will report changes or submit other information through their digital tax account.
  • Outstanding tax which can't be collected through PAYE will be collected through a new system of online billing and taxpayers who need to meet more than one liability will be able to make a single payment - off-setting any tax owed on one liability against an overpayment on another.  HMRC will work with stakeholders to establish precisely how this will work.

Alongside the main document, HMRC has also published a discussion paper which explores moving towards a simpler and more aligned payment system for tax that operates closer to real time; as well as a series of case studies to illustrate howMaking tax digitalwill affect customers. HMRC will be holding a series of consultation events in January and February 2016 to discuss these payment issues with stakeholders.

While HMRC states that the new measures will 'transform the tax system, making it more effective, more efficient and easier for taxpayers'; others may be sceptical. Not only will a requirement for quarterly tax returns place a greater administrative burden on small businesses, there is a significant risk that HMRC could misinterpret data received from third parties - particularly banks where deposits do not necessarily represent the receipt of sales income - leading to demands for additional tax where none is owing. The government will consult widely on the details of these measures in spring 2016, including on whether they should apply to charities, sports clubs and their trading subsidiaries.

Dividends - Finance Bill 2016 draft clauses

(AF1, AF2, AF4, JO3, RO2, RO3, CF2, FA7)

The July 2015 Budget announced the reform of dividend tax. At the time we commented that detailed information was lacking, leaving a number of questions unanswered.

While a dividend allowance factsheet, issued in August, did give a little more insight - the allowance isnotan allowance - we were still left waiting for the full facts. The Autumn Statement said nothing, so our hopes then turned to the Finance Bill 2016 draft clauses and accompanying material, which emerged on 10 December. Alas, we are still scratching our heads.

The Tax Information and Impact Notes (TIIN) on dividend taxation set out the new tax rates for individuals beyond their £5,000 dividend allowance (7.5% basic rate, 32.5% higher rate and 38.1% additional). However, the relevant draft clause only spells out that "The dividend nil rate is 0%" (surprise, surprise!) in a new subsection A1 to section 8 ITA 2007. Section 8 contains the dividend tax rates, but there are no changes to the existing rates made by the draft clause. Similarly, the draft clause does not reach section 9 ITA 2007, which defines the dividend trust rate. Thus we can still only assume that will be 38.1%, in line with the additional rate stated in the TIIN.

At one level it is certainly odd that the new dividend tax rates have been omitted from the draft clauses.  However, if one considers that the purpose of issuing draft clauses is to secure feedback and comment then maybe it was thought that it was unnecessary to secure comment on the rates themselves (pure numbers that they have made clear in the tax impact notes and policy statements as opposed to legislative form and structure) and they will go straight into the Bill without being put out for comment.

We wrote to HMRC for clarification on these points and it confirmed to us that the dividend rates would be 7.5%, 32.5% and 38.1% and be included in the final legislation.

The other draft clause (12 pages long) deals with consequences flowing from the abolition of tax credits. These include the repeal of the concept of "franked investment income", which was defined in terms of tax credit entitlement. In its place we have "exempt ABGH distributions", so named because they are distributions falling within paragraphs A, B, G or H of s1000(1) of CTA 2010.

The position with regard to the taxation of dividends for life companies remains unclear. The fact that the government has made no changes to the taxation of interest for life companies despite the creation of the personal savings allowance makes a 7.5% (basic rate) charge look more of a possibility. We have asked HMRC to clarify the position.

The Personal Savings Allowance - Finance Bill 2016 Draft Clauses

(AF1, AF2, AF4, JO3, RO2, RO3, CF2, FA7)

When the Chancellor announced the personal savings allowance (PSA) in the March 2015 Budget, we were all left guessing how it would work in practice. Very little in the way of background information appeared beyond a consultation issued in July on the implications for savings not covered by the tax deduction scheme for interest (TDSI).

The publication of the Finance Bill 2016 draft clauses, supporting papers and a response to the TDSI consultation now give us a clearer - but not yet definitive - picture of the PSA:

  • First off - and most irritating - the PSA proves not to be an allowance. Once an explanation of the dividend allowance emerged, here was always a suspicion that the PSA would be another 0% tax band and this proves to be the case. To quote the TIIN on the PSA, 'Income that is within an individual's savings allowance will still count towards their basic or higher rate limits'. The result is that there will be two 0% bands for savings income, as the £5,000 starting rate band will continue, subject to its own different set of rules.
  • the PSA will have two cliff edges. The basic PSA is £1,000, but
  1. if any of an individual's income attracts higher rate tax, then the PSA is £500; and
  2. if any of an individual's income attracts additional rate tax, then the PSA is nil.

In other words, there is no tapering.

  • From 6 April 2016, banks, building societies and NS&I will no longer be required to deduct tax from interest.  However, despite the summer consultation, "The government has not yet reached a decision on this question [of gross payments] in respect of authorised investment funds, investment trusts and P2P lending. The government is continuing to analyse information provided to understand fully the impact of potential changes, and an announcement will be made as soon as possible." Given that the start of the new tax year is less than three months away, this means no change and a boost for offshore fixed interest funds (which pay interest gross) over their onshore (net-paying) competitors. In the case of life insurance, the rumours that the tax treatment of policyholders' interest would be changed have proved incorrect: 'the government has not identified a compelling case for specific changes, and does not intend to amend the existing arrangements.
  • The government estimates that the PSA will give 18m people a tax reduction on their savings income averaging £25 a year. "Around 95% of taxpayers" will not have any tax to pay on their savings income. However, 1.4m people will still have tax to pay on savings income and, as HMRC notes "Most will be additional rate taxpayers or individuals with higher than average savings".

            HMRC says that it "will introduce automated coding out of savings income that remains taxable through the Pay As You Earn (PAYE) system, on the basis of information supplied by accountproviders[our italics]". HMRC promises that "further details for customers will be provided in good time before any tax becomes due," and in the longer term is relying upon the planned digital tax accounts to deal with the issue.

           Two groups will potentially face more tax compliance: trustees and executors. Neither will benefit from the PSA, but both will have to deal with gross interest payments and accounting for the tax due on them.

We have used the words of former US Treasury Secretary William Simon before and it is worth repeating them now: we should have a tax system which looks "like someone designed it on purpose". It would be very hard to say that about the starting rate band for savings and the new personal savings allowance.  

The net closes in on offshore tax evaders

(AF1, RO3)

As announced in the March 2015 Budget, the deadline for using the existing offshore disclosure facilities (Jersey, Guernsey, the Isle of Man and Liechtenstein)  is fast approaching.

From 2016, the existing disclosure facilities will be replaced by a new tougher, last-chance facility. Those who continue to evade will face new tougher financial and criminal sanctions.

David Gauke, the Financial Secretary to the Treasury, said:

"Hiding money in another country at the expense of honest UK taxpayers is not acceptable and we have made it clear we will put a stop to it.

"Under our new regime the small minority who evade tax offshore, facilitate or turn a blind eye to offshore tax evasion will face tougher sanctions.

"With over 90 jurisdictions now agreeing to automatic exchanges of information, the net is closing in on offshore tax evaders."

The message is clear - those affected should use this opportunity (if they haven't already done so!) to get their offshore tax affairs in order and pay the tax they owe plus any interest due to avoid facing the tougher sanctions going forward.

Changes to the tax treatment of non-domiciles

(AF1, AF2, RO3, JO3)

Anticipated announcements on the reform of the tax treatment of non-domiciles have not been included in the draft Finance Bill 2016. Further details are now expected in early 2016.

Changes to the UK tax rules concerning individuals who are not domiciled in the UK but are either resident in the UK or own property here were announced in the July 2015 Budget. This was followed by the publication of the consultation paper 'Reforms to the Taxation of Non-Domiciles' on 30 September 2015 and further details had been expected in the December Finance Bill 2015.  However, no further details were included in the draft Finance Bill 2016 published on 10 December.  Instead it was announced that the government will publish its response to the consultation (which closed on 11 November 2015) in early 2016 together with drafts of any necessary amendments to legislation (including transitional provisions).

Here is what we already know about the proposed changes. Broadly, these changes consist of:

  • amending the deemed domicile rule for long-term residents to 15 out of 20 (from 17 out of 20) tax years for all tax purposes from 6 April 2017, i.e. extending it to CGT and income tax;
  • amending the "returning to the UK domicile rule" so that anyone who returns to the UK will reacquire their UK domicile from the date of  return; and
  • bringing UK residential property owned by a non-UK domiciled individual into the IHT net.

The new rules, which are intended to take effect from April 2017, will mean that the remittance basis charge of £90,000 (that currently applies to those who have been UK resident for at least 17 of the past 20 tax years) would no longer be applicable from the tax year 2017/18; and an individual will become deemed domiciled for IHT at the start of their 16th consecutive tax year of UK residence, rather than at the start of their 17th tax year of UK residence as is the case under the current rules.

In order to allow non-domiciles, who are internationally mobile, to continue to benefit from "non-dom" status in a way that is not appropriate for those who are firmly based in the UK, the legislation will allow someone who has lived in the UK for 15 consecutive tax years and who then leaves the UK for 6 or more consecutive tax years, to return here and claim non-dom status again for another 15 years (assuming they still had a foreign domicile status under general law).

However, this would mean that, while an individual who has become deemed-UK domiciled and ceases to be resident in the UK will continue to be deemed-UK domiciled for up to 6 tax years following their departure, an individual who is domiciled in the UK who leaves and acquires a domicile of choice in another country could potentially become non-domiciled for IHT purposes more quickly. This is because the current IHT rules provide that an individual who ceases to be domiciled in the UK will only continue to be treated as domiciled in the UK if they have been domiciled in the 3 tax years immediately preceding the chargeable event.

To address this disparity, the government is proposing to introduce a rule which treats a UK domiciliary as non-domiciled on the later of the date that they acquire a domicile of choice in another country, and the point when they have not been resident in the UK for 6 tax years. A similar situation arises in respect of non-domiciled spouses ofUKdomiciles who elect to be treated asUKdomiciled for IHT purposes. Under the current rules, such an election will cease to have effect if the electing spouse is resident outside theUKfor more than four full consecutive tax years. It is proposed that this period is also aligned to 6 tax years under the new rules.

Clearly, we need to wait and see what the final shape of the proposed legislation will be but, any advisers with clients falling into the "non-dom" category need to be aware of the proposals and discuss them with their clients. As always professional advice will be necessary in all such cases.

Consultation on higher rates of SDLT for second homes

(AF1, AF2, RO3, JO3)

At the Autumn Statement, the Government announced that it would be introducing higher rates of Stamp Duty Land Tax (SDLT) as part of a Five Point Plan for housing which aims to re-focus support for housing towards low-cost home ownership for first-time buyers.

The higher rates will apply to transactions completed on or after 1 April 2016 in England, Wales and Northern Ireland where, at the end of the day of the transaction, an individual purchaser owns two or more residential properties (or, in the case of joint purchasers, either one of the joint purchasers owns two or more residential properties) and they are not replacing their main residence. So, a person who already owns both a main residence and a buy-to-let and who sells their main residence and buys a new one, will not pay the higher rates (despite owning two properties at the end of the day of the transaction) because they are replacing their main residence. Contrast the person who first purchases a buy-to-let (which is not to be used as a main residence - perhaps because the purchaser is living in rented or job-related accommodation or with parents) and later buys a main residence. In this situation, the higher rates will be payable because the person owns two properties at the end of the day of the transaction and has not replaced their main residence. 

Note that if the purchaser has sold a previous main residence within 18 months before the day of the transaction and the transaction is a purchase of a new main residence, the purchaser will be considered to be replacing a main residence. Whether or not a property constitutes a 'main residence' will be determined according to the facts.

Where it is intended that the second property will replace the main residence but the main residence has not yet been sold, the transaction will be subject to SDLT at the higher rates but a refund will be given if the original residence is sold within 18 months of the transaction.

Both inherited property as well as property owned overseas will be relevant in determining the number of properties owned at the end of the day of the transaction where the new property is situated in England, Wales or Northern Ireland. Where the new property is located overseas, SDLT will not of course be payable on the purchase (although instead it may be liable for any property transactions tax in that jurisdiction).

The new rates

The higher rates will be 3 percentage points above the current SDLT residential rates and will be charged on the portion of the value of the property that falls into each band as follows:

Band

Existing residential SDLT rates

New additional property SDLT rates

£0 - £125k

0%

3%

£125k - £250k

2%

5%

£250k - £925k

5%

8%

£925k - £1.5m

10%

13%

£1.5m +

12%

15%

Example 

An additional residential property is purchased for £200,000. SDLT is calculated as follows:

  • 3% on the first £125,000 = £3,750
  • 5% on the remaining £75,000 (the portion between £125,000 and £200,000) = £3,750

The total SDLT due is therefore: £3,750 + £3,750 = £7,500

Note that the higher rates will not apply to transactions completed after 31 March 2016 if contracts were exchanged before 25 November 2015 or to purchases of commercial properties.

Married couples, trusts, companies and other specific situation 

It is important to note that married couples and civil partners are to be treated as one 'unit' for the purposes of the new rules. This means that properties owned by either partner (or their minor children) will be relevant when determining the number of properties owned at the end of the day of the transaction. This means that an individual buying their first or only property could in some cases be charged the higher rates of SDLT on the purchase (i.e. if their spouse owns a property already). This will be the case unless the parties have formally separated (although the consultation specifically seeks views on this aspect of the proposed rules).

It is also proposed that the 'one unit' approach will apply to joint purchasers generally, regardless of their relationship but, again, the consultation document acknowledges that this could result in an inequitable situation in some cases (for example, where one party owns no other property and is buying jointly with someone else as a way of getting onto the property ladder) and seeks views on how joint purchasers might alternatively be treated to ensure a fair result.

Note that where parents help their adult children purchase a property, the new higher rates will only apply if the parents become owners of the new property (sole or joint) and they also have a residence of their own. The higher rates will not apply where a parent simply lends or gifts money to assist the purchase in the name of the (adult) child or acts as a guarantor on the mortgage.

The higher rates will also generally apply to purchases of residential property by companies (even if it is the first residential property purchased by the company) and to purchases of residential property made by trustees of discretionary trusts. Where the trust is a bare trust or an interest in possession trust, the question of whether or not the higher rates will apply to the transaction will be determined by reference to the number of properties owned by the absolutely entitled or interest in possession beneficiary. Likewise, where a beneficiary with an interest in possession in a trust holding residential property makes a purchase of an additional property outside the trust, the new higher rates of SDLT will apply unless the beneficiary is replacing his or her main residence.

Specific rules will also apply to purchases of multiple dwellings (i.e. purchases of 6 or more residential properties in the same transaction) and it is proposed that an exemption will apply to bulk purchases (of at least 15 residential properties) which significantly contribute to new housing supply and the government's wider housing objectives, regardless of whether the purchaser is an individual or non-natural person (such as a corporate or fund).

This consultation will run from 15 December 2015 to 1 February 2016 and confirmation of the final design will be announced at the Budget on 16 March 2016.

The proposed wording of the new rule ensures that any person who either becomes an owner of a second home for the first time on or after 1 April 2016 or replaces an existing buy-to-let on or after that date will pay SDLT at the higher rate.

However, administration and compliance may present challenges. The existing SDLT return will need to be adapted to include questions such as whether any newly purchased residential property will be a main residence and will be replacing a previous main residence; and HMRC recognises that it may be necessary for it to ask for information in support of an individual's claim that a property was or was intended to be their only or main residence to ensure that the correct amount of tax is collected. HMRC will also need to design a system for the filing of claims and payment of refunds (the incidence of which is likely to increase significantly after 31 March 2016).

While SDLT will almost certainly not be a main area of advice for financial advisers, a number of their clients may well be interested in purchasing an additional residential property:

  • as an investment to let
  • as a holiday home
  • for their children or parents

In all of these cases the additional initial cost imposed by the new higher stamp duty must be taken into account.

An overview of the new downsizing provisions for the IHT residence nil rate band

(AF1, RO3) 

The draft Finance Bill 2016 clauses published on 9 December include further details on the 'downsizing' provisions announced at Summer Budget 2015. Broadly, the measure ensures that an estate will not be prevented from benefiting from a 'residence nil-rate band' linked to a former property with a higher value where an individual either downsizes to a lower value home or sells (or otherwise disposes of) a qualifying residence on or after 8 July 2015, provided that other assets of an equivalent value to the 'lost' residence nil rate band are left to direct descendants ("closely inherited").

A technical note on the proposals was published for consultation in September 2015 and the issues raised have, according to HMRC, been taken into account in the draft legislation which has now been published in a Schedule to clause 44 of Finance Bill 2016. The Schedule amends new sections 8D-8F IHT Act 1984 (introduced by Finance (No. 2) Act 2015) and introduces new sections 8FA-8FE which provide that a person's estate will benefit from a downsizing addition where prior to death (but on or after 8 July 2015) the deceased had:

  • Either downsized to a less valuable residence or sold or otherwise disposed of a qualifying residence - so that the full residence nil rate band (RNRB) can no longer be claimed; and
  • Left either the lower value residence (or an interest in it) or some other assets to direct descendants on their death.

Note that in cases where the RNRB has been lost as a result of a downsizing move, it is not necessary for the new residence to be closely inherited in order for the estate to qualify for the downsizing addition - the addition will be available even where the new residence is left to someone else provided that some other assets are closely inherited. However, in such cases, the amount of the downsizing addition will be limited to the lower of the amount of RNRB lost as a result of the downsizing or other disposal, and the value of the property or other assets being closely inherited.

The downsizing addition must be calculated in percentage terms with the percentage of the RNRB lost by reason of the downsizing or other disposal being applied to the person's default allowance at death to determine the lost relievable amount. The precise formula for calculating the residence nil rate amount is complicated but in simple terms the lost (additional) RNRB is calculated via a four-step process:

  1. Calculate the percentage of the then available RNRB that the individual could have claimed had they died at the time of disposal of the former residence.
  2.  Calculate the percentage of the currently available RNRB that the individual is actually able to claim on death.
  3.  Calculate the difference between these two percentages.
  4.  The lost RNRB is the resulting percentage multiplied by the RNRB that the individual is otherwise able to claim on death.

This amount (or, if lower, the value of the closely inherited assets) is added to the RNRB that would otherwise have been available (taking account of any amount carried forward under the transferable nil rate band rules) to determine the total amount of RNRB available to the estate.

While HMRC is yet to update their technical note to include detailed examples of what this will look like in practice, we would envisage the new rules operating as follows:

Example 1 - downsizing 

Shirley's husband, Tom, died in January 2014 leaving his entire estate to Shirley. In September 2015, Shirley sold the property in which she and Tom had lived together prior to his death for £400,000 and purchased a smaller property for £199,950. Shirley dies in May 2020, leaving her estate worth £415,000 to her children. At the date of her death, the property that Shirley owns is valued at £210,000. As Shirley's situation meets the conditions outlined in new s8FA - 8FE IHT Act 1984, her estate will qualify for the downsizing addition which is calculated as follows:

  • Step 1: Percentage of RNRB that would have been used if Shirley had died at the point that the more valuable property was sold = 400,000/200,000* = 200%. Note that the rules provide that where this figure is greater than 100%, the percentage should be taken as 100%.
  • Step 2: Percentage of RNRB used at date of death = 210,000/350,000 = 60%
  • Step 3: Percentage of RNRB lost by reason of downsizing = 40%
  • Step 4: Lost relievable amount = 40% x 350,000** = 140,000

The downsizing addition is therefore £140,000 (as this figure is lower than the amount that is being closely inherited). This downsizing addition must then be added into the calculation required by s8E IHTA to determine the residence nil rate amount. This has the effect of increasing Shirley's residence nil rate amount to £350,000 (which is what it would have been under the transferable nil rate band rules had she still owned the original, higher value residence at the date of her death).

*    the new clause provides that where the property was sold before 6 April 2017, the residential enhancement should be taken to be £100,000.

**  the percentage lost by reason of downsizing is applied to the deceased's default allowance as defined in the primary legislation. This is essentially their residence nil rate amount taking account of the transferable nil rate band rules. Note that where the first death occurred before 6 April 2017, a 100% uplift is always given.

Example 2 - disposal

Barry sells his home worth £275,000 in May 2020 following a move into residential accommodation. At the time of the sale the available RNRB is £175,000. Barry dies two years later leaving his estate of £450,000 to his children in equal shares. For simplicity we will assume the RNRB is still £175,000 at the date of death.

Barry's lost relievable amount is calculated in accordance with a two-step process as follows:

  • Step 1: Percentage of RNRB that would have been used if Barry had died immediately before disposing of the property = 275,000/175,000 = 157%. As before this figure is restricted to 100%.
  • Step 2: Apply this percentage to Barry's default allowance, so 100% x £175,000 = £175,000

The downsizing addition is the lower of the lost relievable amount and the amount of the estate being closely inherited i.e. the lower of £175,000 and £450,000. This is Barry's residence nil rate amount. Barry also has a standard nil rate band of £325,000 to offset against his estate and consequently no IHT is payable.

Other points worthy of note are that:

  • the additional RNRB will be tapered away in the same way as the RNRB if the value of the estate at death is above £2m
  • the additional RNRB will be applied together with the available RNRB but the total for the two will still be capped so that they do not exceed the limit of the total available RNRB for a particular year
  • a claim must be made for the additional RNRB in a similar way that a claim is made to transfer any unused RNRB to the estate of a surviving spouse or civil partner

While the broad result of the measure is clear: an estate will remain eligible for such proportion of the RNRB as is foregone as a result of downsizing or disposal of a property prior to death - the reality is that the downsizing clauses run to some 8 pages which are difficult to negotiate and contain some anomalies on which clarification will be required before the Finance Bill becomes law.

INVESTMENT PLANNING

FTSE 100 gets a makeover

(AF4, RO2, CF2, FA7)

The latest review of the FTSE 100 constituents has taken place.  These constituents are reviewed quarterly by the FTSE Group, although changes can take place between times, eg in the event of a takeover. The system involves two stages:

  • Any stock having a market capitalisation ranked below 110 is placed on the ejection list and replacement candidates with rankings of 110 and higher are placed to the entry list, with the largest companies at the head of the queue.
  • An FTSE Index committee then reviews the results and the new Index structure is confirmed.

The results of the latest review were announced on 2 December based on market capitalisations at the close on the previous day and will take effect from 21 December. This time three constituents dropped from the FTSE 100 to the FTSE 250:

                        OUT

Company

Sector

Comment

 

G4S

 

Support

Suffering from 'reputational damage' and emerging market slowdown

 

Morrison (Wm) Supermarkets

Food/Pharmacy Retail

Victim of food deflation and hard discounters

 

Meggit

 

Defence & Aeronautics

Profit warning in late October

                       IN

Company

Sector

Comment

 

DCC

 

Support

Dublin-based support services company

 

Worldpay Group

 

Support

Global payments processor floated in October

 

Provident Financial

 

Financials

Doorstep lender helped by FCA's measures against payday lenders

 

This is more of a tidy up than a radical change, although that is not to say that weightings in the Index have been little moved over 2015. The routs in the mining sector (down 47% over the last 12 months) and oil & gas sector (down 17.5%) have made holes in the ground a less significant part of the Footsie (itself down 4.4% over the last year). One miner and two oil & gas companies have been demoted from the FTSE 100 this year, but the sector will not disappear from the Index because some of the surviving companies are so large (Shell, BP, BHP Billiton and Rio Tinto are all in the top 20).

As at 30 November, the FTSE 100 breakdown was:

Sector

No of Companies

Weighting (%)

Banks

5

12.86

Oil & Gas

4

12.82

Personal & Household Goods

9

12.74

Health Care

5

9.98

Insurance

9

6.92

Telecommunications

3

6.49

Food & Beverage

4

6.23

Industrial Goods & Services

14

6.11

Basic Resources

8

4.47

Utilities

5

4.41

Travel & Leisure

8

3.81

Media

5

3.78

Retail

8

3.38

Real Estate

4

1.59

Financial Services

5

1.4

Technology

2

1.36

Construction & Materials

1

0.97

Chemicals

1

0.35

Automobiles & Parts

1

0.32

There is a certain irony that as the 2007/08 financial crash fades into history, the largest FTSE 100 sector is banks...  

November inflation numbers

(AF4, RO2, CF2, FA7)

Annual inflation on the Consumer Prices Index (CPI) measure turned positive in November, with the rate rising to +0.1%. The November inflation numbers from the Office for National Statistics (ONS) were slightly above market expectations but still mean that the CPI has been in a band between +0.1% and -0.1% since February.

The CPI showed prices flat over the month, whereas between October and November 2014 they fell by 0.3%. The CPI/RPI gap widened by 0.2% this month to 1%, with the RPI jumping by 0.4% to 1.1% on an annual basis. Over the month, the RPI rose 0.1%, marginally less than the CPI.

The rise in the CPI annual rate was due to three main upward and one main offsetting downward contributions, according to the ONS:

Upward

Transport:Overall prices fell by 0.7% between October and November this year compared with a larger fall of 1.2% between the same two months a year ago. The upward effects came principally from motor fuels and second-hand cars. Petrol prices fell by 1.5p a litre this year compared with a fall of 3.0p a year ago while diesel fell by 0.6p this year compared with 2.9p a year ago. Second-hand car prices rose by 1.6% this year compared with a fall of 1.0% a year ago.

Alcoholic beverages and tobacco:Overall prices fell by 0.1% between October and November this year compared with a fall of 1.2% between the same two months a year ago. The upward contributions came from spirits and wine.

Miscellaneous goods and services:  Overall prices rose by 0.3% between October and November this year compared with a fall of 0.1% between the same two months a year ago. Some of the upward effect came from car insurance premiums thanks to the July Budget Insurance Premium Tax (IPT) hike from 6% to 9.5%, which took effect at the start of November. There was also an upward contribution from other personal effects, where prices of items such as luggage rose by more than a year ago.

Downward

Clothing and footwear:  Overall prices fell by 0.1% between October and November this year compared with a rise of 0.7% between the same two months a year ago. This is the first fall in prices between October and November since official records began in 1996 and follows the largest September to October price increase on record. It continues the trend seen since the summer of atypical monthly price movements in the clothing and footwear sector. The contribution to change this month came primarily from price movements for a broad range of outerwear with more products on sale this November than a year ago.

Core CPI inflation (CPI excluding energy, food, alcohol and tobacco) was an annual 1.2%, up 0.1% from the previous month. Three of the twelve components of the CPI index are now in negative annual territory, the same as last month.

The unwinding of fuel price falls in the annual figures was expected and, with recent drops in crude oil prices, may now be back on hold. Inflation could be returning below zero soon as pump prices drop under £1 a litre. The benign inflation figures will reinforce the view that changes in US interest rates will not prompt the Bank of England into immediate action.

A mixed year for UK shares

(AF4, RO2, CF2, FA7)

The FTSE 100 ended the year down 4.9%, marking a second consecutive year of decline and its worst performance since 2011. However, more than ever the FTSE 100 is not the whole story.

The FTSE 100 ended 2015 almost 5% down from where it started as this year's late Christmas rally stuttered in the approach to 2016. Add back in dividends (the FTSE 100 now has a historic yield of about 4%) and the total Index return was a loss of about 1.3% over the year. 

However, in 2015 more than ever the Footsie's bias towards energy and other commodity companies had a marked impact on its performance. This shows up when other UK market indices are examined, as the table below shows.

Index

2015 Change

Comment

FTSE 100

 -4.9%

Index's global commodity bias takes its toll

FTSE 250

+8.4%

UK-focused cos outperform Footsie yet again

FTSE Small Cap

+6.2%

Small caps outperform big cap, not mid-cap

FTSE 350 Higher Yield

  -10.1%

Value-investing lagged - commodities again

FTSE 350 Lower Yield

+5.3%

More UK, non-commodity focus helps

FTSE All-Share

-2.5%

Outperformed Footsie due to mid/small caps

FTSE Household Goods & Construction

+29.1%

Top sector: housebuilders rose on the back of Help to Buy and increasing house prices

FTSE Industrials Metals & Mining

-53.0%

Bottom sector: the commodity effect again

Over the year the dividend yield on the FTSE All-Share rose from 3.37% to 3.70%, implying dividend growth of 7.0%. However, this figure needs to be treated with caution. Part of the dividend rise (in sterling terms) is down to the strength of the dollar, the accounting currency for many multinationals, which rose over 5% against sterling in 2015. Dividend cover (the ratio of profits to dividends) has fallen sharply from 1.88 to just 1.52 and there are 2016 dividend cuts due, both announced and expected, from the commodity behemoths, such as Glencore.

The rise in the equity dividend yield parallels a smaller upward movement in yields on gilts - 10 year gilts reversed their 2014 yield drop and ended the year offering 1.96% (from a 1.76% starting point). Two-year gilt yields, more sensitive to that ever-deferred base rate rise than their longer brethren, moved from 0.50% to 0.87%.

The performance of the UK equity market was similar to most other major stock markets. For example, the Euro Stoxx 50 rose by 3.9%, but for UK investors there was a 5.2% decline in the euro against sterling, turning a euro profit into a sterling loss of 1.5%. Currency worked the opposite way for Japan: the Nikkei 225 rose by 9.1% and the yen added 4.5% against sterling. As mentioned above, sterling fell against the all-conquering US dollar, which more than countered a small drop in the S&P 500 of 0.7%. 

In the emerging markets, which had their own commodity and political excitement during the year, investors were given a lesson in divergence between countries. For all the frights in August, the Shanghai Composite ended up 9.4% over the year (mostly wiped off in the first trading day of 2016). Brazil's main index, the Bovespa, dropped 13.3%, but to that must be added a near 30% decline in the Brazilian real against sterling. The MSCI Emerging Markets index, combining all the ups and downs of the different markets, fell 12.2% in sterling terms.

The Footsie reached 7,103.98 in late April 2015, having finally passed through its previous (end 1999) peak in February. Look at a long-term chart and, with the exceptions of a few brief flurries either side of the round 000's, the Index has been bouncing about in a range of 500 points either side of 6,500 since January 2013.

A good year for bonds

(AF4, RO2, CF2, FA7)

While UK shares ended up roughly where they started over 2014, bonds enjoyed an unexpectedly good year.

In 2014 UK bond funds produced some reasonable returns, with UK Index-linked Gilts the top-performing sector and the UK Gilt sector coming in third out of 37 according to Trustnet.  2015 was not such a pretty picture.

If it was not the oft-predicted end of the 30-year bull market in bonds, then at least it was a pause for reflection. Despite nearly a complete year of zero inflation and another deferral of the first base rate increase, most sterling bond yields moved marginally upwards across 2015, as the table below shows.

Bond/Index

31/12/2014

Yield

31/12/2015

Yield

Yield

Change

5 year benchmark gilt

1.34%

1.46%

+0.12%

10 year benchmark gilt

1.76%

1.96%

+0.20%

30 year benchmark gilt

2.51%

2.67%

+0.16%

1.875% Treas index-link 2022*

-1.10%

-0.75%

+0.35%

1.25% Treas index-link 2055*

-0.70%

-0.74%

-0.04%

Markit gilts 10 year +

2.37%

2.53%

+0.16%

Markit AA 10 year +

2.41%

2.58%

+0.17%

Markit BBB 10 year +

4.22%

4.49%

+0.27%

Markit Corporates 10 year +

3.72%

4.14%

+0.42%

* Real yields

Long-dated index-linked stock was the exception, as demand for this asset class from pension funds remained strong. The general drift upwards in other bond yields was enough to counteract interest income in 2015, leaving overall returns flat. This is echoed in the performance of the various IA sterling fixed interest sectors over 2015:

IMA Sector

2015 Total Return

Sterling High Yield

-0.7%

Sterling Strategic Bond

-0.2%

Sterling Corporate Bond

-0.3%

UK Index-linked Gilts

-1.3%

UK Gilts

-0.3%

Source: Trustnet

The UK was not alone in experiencing a year of gently rising yields. US yields rose across the board, with the 10-year Treasury benchmark rising from 2.17% to 2.27%. Eurozone yields were kept in check by the European Central Bank's bond-buying activities, which saw Germany end 2015 with negative yields for five year bunds.

2016 could be a significant year for bond funds. Across the Atlantic, the end of 2015 saw several high yield funds put into wind up because of the combination of heavy redemptions and limited liquidity for the underlying bonds. In the UK some major fund managers have expressed concerns that similar issues might arise here if retail investors' appetite for bonds waned further.

PENSIONS

FCA further clarifies capital requirements for SIPP operators

(AF3, RO4, RO8, JO5, FA2, CF4)

The Financial Conduct Authority (FCA) has provided further details of how to distinguish between 'standard' and 'non-standard' assets, after operators of self-invested personal pensions (SIPPs) called for more clarity over new capital requirements.

From September 2016, SIPP operators will be required to increase their minimum capital holding from £5,000 to £20,000, which is intended to cover the cost of winding down an operator in the event of financial difficulty. Additional requirements will apply to firms that offer non-standard assets.

Back in August 2014, the FCA reclassified commercial property investments as 'standard' assets providing that certain conditions were met in response to feedback from SIPP operators. The FCA had originally proposed classifying all commercial property as 'non-standard'. Commercial property should be classed as 'standard' if it could "be transferred between pension providers at relative ease", which would not be the case where "it would take more than 30 days" to do so, according to a paper published at the time.

The FCA's latest update covers how firms should decide "whether an asset is capable of being readily realised within 30 days". The FCA go on to say that firms should "consider whether the transaction can be concluded within that time limit in the ordinary course of business"; for example, "such a date can be the date of exchange of contract, or any other date when both parties have unconditionally agreed to undertake their contractual obligations to realise the asset".

The FCA has said that for the purposes of this 30-day test:

  • the period runs from the date when the transaction is initiated until the date it is concluded, and
  • an asset can still be considered standard if the transaction takes longer than 30 days to complete due to delays in receiving information from third parties, or delayed third-party permissions.

The FCA has now updated its handbook for SIPP operators to include delays caused by waiting for the consent of mortgage lenders, joint owners or lease holders as examples of delays due to outstanding third-party permissions. It does not intend to clarify its stance on commercial property any further, because "the right policy principle has been set, and it should be for the firms to consider this within common practices for the specific asset market", it said in its policy update.

Michael Lewis of Pinsent Masons is reported as saying that although the update was "not particularly helpful, it did not contain any major surprises. A firm needs to determine whether an asset is standard or non-standard based on its knowledge of the asset and its experience of realising that asset. The concern is that the FCA will use this rule against SIPP operators after the event.".

The FCA said that it did not intend to include crowdfunding and peer-to-peer assets in the standard asset list at this stage, despite proposals from the industry. However, it may review its position when it conducts a full market review of the industry in 2016, it said.

Dependant scheme pension changes

(AF3, RO4, RO8, JO5, FA2, CF4)

An anti-avoidance measure was introduced with effect from 6 April 2006 to limit the amount set aside to pay dependants' scheme pensions from a registered pension scheme. This is so that it cannot be excessive in comparison with the amount used to provide the member's scheme pension, in that way avoiding the lifetime allowance charge.

This anti-avoidance measure applies to members who die on or after 6 April 2006, have reached age 75 before their death and are actually or prospectively entitled to receive a scheme pension at their death.

The calculation (as set out in Part 2, Sched 28 FA2004 - see PTM072120) is carried out if the scheme pensioner had reached age 75 at the time of their death. The total amount of any dependantsʹ scheme pensions have to be tested against the amount of the memberʹs scheme pension so that excessive amounts from the memberʹs pension savings cannot be set aside to pay benefits for dependants so that the member can avoid paying a lifetime allowance charge. These tests are to be carried out annually for all dependantsʹ scheme pensions regardless of the size of the memberʹs pension savings.

Proposed revisions

Legislation will be introduced in Finance Bill 2016 to reduce significantly the number of calculations that need to take place to determine whether a dependants' scheme pension exceeds the authorised limit.

If the total value under a pension scheme is not more than 25% of the standard lifetime allowance at the earlier of member's death (if the member did not have an actual right to a scheme pension at death) or the date the member became entitled to the pension (rounded up to the nearest £100), then the scheme administrator is authorised to pay the dependants' scheme pensions without the test carried out.

If the total value exceeds the threshold then the calculations will need to be carried out to determine how much of the payment to the dependant is an authorised payment. The calculation as set out in Schedule 28 FA2004 will need to be carried out every year.

The threshold test is: 

SPx20 +DSPx20+LS+CBV+MPV

With SP being Scheme Pension

DSP = Dependants scheme pension

LS = lump sum

CBV = Cash balance valuation

MPV = Money purchase valuation

If the threshold test results do not exceed 25% of the standard lifetime allowance there is no requirement for the scheme administrator to carry out the calculations.

The other 2 new exceptions from the test in the Draft Finance Bill 2016 are:

  • There is no requirement to carry out the calculation if the individual had valid enhanced protection in place immediately before the individual members death.
  • The calculation requirement is also disapplied if every BCE in relation to the individual member under a particular pension scheme relates to having unused funds in a money purchase arrangement at age 75.

Clause 14 of the Finance Bill 2016 contains the new exemptions from the calculations. 

Draft clause 14

Explanatory Notes

Draft legislation published to permit bridging pensions continue with state pension changes

(AF3, RO4, RO8, JO5, FA2, CF4)

Draft Clause 13 of the Finance Bill 2016 contains provision to allow the payment of bridging pensions up to a memberʹs state pension age following the introduction of the single tier state pension.

A bridging pension is a higher level of scheme pension that may be paid between the dates the member retires until the date the member reaches state pension age. The changes to the State Pension from April 2016 mean that legislation needs to amend do that DB schemes can continue to pay bridging pension.

The current legislation (Paragraph 2 of Schedule 28 FA 2004) sets out when a pension payable to a member is a scheme pension. One of the conditions to be a scheme pension is that the pension must not decrease except in prescribed circumstances.

Paragraph (2)(4)(c) allows the pension to reduce not earlier than when the member reaches state pension age, by an amount that does not exceed the relevant state pension rate. This allows the scheme to pay a higher scheme pension at the outset and reduce it when the member starts to receive the state pension. This is known as a bridging pension.

Legislation will be introduced in Finance Bill 2016 to remove Paragraph 2(4)(c), along with the provisions which relate or refer to it. New regulations will be introduced under paragraph 2(4)(h) for 2016 to 2017 and subsequent tax years to align pensions tax legislation with the Pensions Act 2014. This will allow the payment of bridging pensions to continue as at present.

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