Technical news update 23/04/2019

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Taxation and trusts

• The tax issues on the liquidation of EIS film production companies
• The future of tax
• Mixed-sex couples can now enter into a civil partnership

Investment planning

• Chinese bonds follow Chinese equities
• Venture Capital Trusts - sales reached £731m in 2018/19

Pensions

• Working longer and older – latest National statistics Labour Market figures
• Pension Protection Fund publishes updated PPF 7800 index - April 2019
• National Statistics - employee workplace pensions in the UK
• New ROPs list posted

 

TAXATION AND TRUSTS

 

The tax issues on the liquidation of EIS film production companies

(AF2, JO3) 

Following the decision made by Motion Picture Capital to liquidate one of its film production companies, we have had a spate of enquiries on how liquidation will affect the tax position of investors in the scheme, and to what extent loss relief can be used to the taxpayer’s advantage. 

To recap, enterprise investment scheme (EIS) investments offer a number of tax advantages where the shares have been subscribed for and the company satisfies certain qualifying conditions (see here for more information). These are briefly as follows: 

• Income tax relief – at a rate of 30% on investments up to £1m (or £2m where the additional £1m is invested in ‘Knowledge-intensive companies’). The relief can be carried back and offset against the investor’s tax liability in the preceding year if desired but will be ‘clawed-back’ in the event of disposal of the shares within three years of issue; 

• CGT deferral relief – capital gains tax (CGT) can be deferred on an unlimited amount of gains made on disposal of other assets by investing the gain in EIS shares during the period one year before or three years after selling or disposing of the other assets. The deferred gain will be revived when the shares are disposed of (or eliminated if the EIS shares are still held at the date of the investor’s death); 

• CGT disposal relief – on disposal of the EIS shares after a period of three or more years, any gain made on the shares themselves will be exempt from CGT to the extent that income tax relief was given at outset 

• IHT business relief – at 100% once the shares have been owned for the usual two-year qualifying period; 

• Loss relief – where a loss is made, this can be offset against the investor’s income tax liability in the current or preceding tax year; or against capital gains made in the current or in future years. The loss is limited to the ‘effective loss’ i.e. after deduction of income tax relief received at outset (and not withdrawn). See below for an example of how this would operate in practice.

In the usual course of events, the investor will hold on to the EIS shares for at least three years to avoid any claw-back of income tax relief and benefit from the CGT exemption/loss relief on sale of the shares. Often, however, the investment will be held for longer to benefit from a longer period of CGT deferral (or even elimination) and inheritance tax (IHT) business relief.

But what happens if the decision is taken out of the investor’s hands and the company is liquidated? And are the rules different if the liquidation takes place before the expiry of the three-year holding period?

Liquidation before expiry of three-year holding period

• Provided the company is wound up for ‘genuine commercial reasons’, income tax relief should not be withdrawn. Income tax relief can, however, be clawed back if value is received from the company on winding up within three years of issue of the shares, unless the value received is deemed 'insignificant'. An amount is insignificant for this purpose if it is less than £1,000, or, if it is more than £1,000, it is insignificant in relation to the amount subscribed for the shares; 

• The investor will be deemed to have disposed of the shares on winding up and any deferred gains will be brought back into charge (but can be further deferred if reinvested in qualifying investments within the requisite time frame); 

• Any gain made on the shares themselves will be subject to CGT. However, it is more likely that a loss will have been made. Loss relief is available even if the disposal of the shares occurs before the end of the three-year holding period and, as mentioned above, the investor is able to choose whether to offset this loss against income or capital gains (see below).

Liquidation after expiry of three-year holding period

• No claw-back of income tax relief;
• Deferred gains brought back into charge;
• Any gain made on the shares themselves will be free of CGT;
• Loss relief can be claimed if an ‘effective loss’ has been made.

EIS loss relief

Where EIS shares are disposed of for a market value consideration less than the original investment, an allowable loss may arise.

To qualify for loss relief the value of the investment at the time of disposal must have fallen below its 'effective cost'. The effective cost is the amount invested minus the amount of income tax relief previously claimed. So, for example, if £200,000 was invested into an EIS-qualifying company and income tax relief of £60,000 (i.e. 30% of the amount invested) was given upfront, the effective cost of the investment would be £140,000.

Note that where an EIS fund manager has constructed a portfolio of EIS qualifying companies (as in the case of the Motion Pictures scheme), for loss relief purposes each company is considered a distinct investment. This means that if any of the individual holdings within the portfolio is sold at an effective loss, it may qualify for loss relief even if the overall portfolio performance is positive.

The allowable loss can be offset against the CGT or income tax bill of the investor, depending on which option better suits their individual needs. The relief can be set against: 

• Capital gains generated in the tax year of the disposal or thereafter, or
• Taxable income of the current or preceding tax year.

 

(a) Ofsetting the loss against income

Where the loss is offset against income, the amount of relief claimable is worked out by multiplying the effective loss by the investor’s marginal rate of income tax. So, continuing the example above, if the effective cost of the investment was £140,000, and it is sold for £20,000, the effective loss is £120,000. Assuming a marginal rate of income tax of 45%, then the amount that could be claimed as loss relief against income tax is £54,000. (£120,000 x 45% = £54,000).

(b) Offsetting the loss against capital gains

It will usually be more tax-efficient to offset the effective loss against income due to the higher tax rates that apply to income as compared to capital gains. However, where the investor is a non or basic rate taxpayer, it may be preferable to use the loss to reduce CGT in the current or future tax years. The relief is then calculated by multiplying the effective loss by the rate at which the investor pays CGT.

Claiming the loss

EIS losses (whether they are to be offset against income tax or CGT) are claimed through self-assessment by completing the SA108 form.

New film and TV companies working on a project basis are likely to find it difficult to secure investment via the Enterprise Investment Scheme as a result of the introduction of the new ‘risk to capital’ condition, introduced in Finance Act 2018 (see our earlier bulletin here).

However, for investments made prior to 15 March 2018, reliefs should continue to be available on the basis described – particularly as most schemes will have obtained advance assurances from HMRC prior to marketing the investment opportunity.

Sources:

• HMRC Venture Capital Manual VCM13070 - EIS income tax relief, the issuing company ceasing to meet trading requirement because of administration or receivership - dated 16 October 2018;
• HMRC Venture Capital Manual VCM 74100 - Share Loss Relief: individual and corporate claimants: individual claimants: distributions by a company which are treated as disposals made by its shareholders - dated 16 October 2018;
• Moore Stephens article: Disposal of EIS shares – dated 15 September 2017.

The future of tax

(AF1, AF2, AF3, AF4, ER1, FA2, FA4, FA5, FA7, JO2, JO3, JO5, LP2, RO2, RO3,RO4, RO5, RO7, RO8) 

The Institute for Fiscal Studies (IFS) was set up in 1969 and is celebrating its half century in 2019. As part of its anniversary events, the IFS gave a presentation entitled “The Future of Tax” at the Royal Institute in early April. The attendee list included many people from HMRC and the Treasury, a reflection of the relevance of the IFS in setting Government policy. 

The main presentation, from the IFS’s Deputy Director, Helen Miller, was as much a look back at the last 50 years as it was a piece of futurology. Her key points were: 

• The overall tax level. Currently, the total tax take in the UK is 35% of GDP. As Helen said, that means that the Government is spending over £1 in every £3 produced by the economy. 35% is the highest level since the end of the 1960s. Back in 1993/94 the tax take reached a low of just below 29%. The increase since then has not been smooth – there was a jump in the period up to 2000 and a more random progress afterwards.

          The 35% tax level places the UK marginally below the OECD average and is substantially lower than in most European countries – in 2017 France and                    Denmark both raised around 45% of GDP in taxes. The implication for the IFS is that there is scope for the UK to raise taxes, if the Government so                        decides. 

• The main sources of tax. 63% of UK tax revenue is derived from just three taxes: income tax (26%), National Insurance (19%) and VAT (18%). The pattern of reliance on income tax, social security tax and sales tax is widespread around the world, mainly because these items are the easiest to tax and can produce the largest revenue. The IFS does not see this pattern changing in the future. 

         Those countries that raise more revenue than the UK typically do so via sales taxes (eg through a wider tax base without many of the UK’s exemptions) and           higher social security taxes. 

• Taxing companies and multinationals. Corporation tax in the UK was 52% in 1980 and is now 19%, en route to 17% next year. A similar downward pattern applies to other G7 countries, albeit the decline has been less rapid, to around 27%. The income from corporation tax has been varied in the UK, but surprisingly today, at 2.7% of GDP, it is slightly higher than in 1980. That is down to other corporate tax changes, eg on capital allowances, and the growth in revenue from the financial sector. 

          The issue of taxing multinationals is not one to which the IFS sees any easy solution. Current corporate tax systems were largely created to tax activity                within a country, something that sits uncomfortably with globalised supply chains, the growth of intellectual property and digital services (think Apple). Any            restructuring needs global agreement to work, but as that would create winners and losers, it would be difficult to implement – the losers would not sign                up. Similarly, tax competition between countries would be a disincentive to make changes.

          The IFS sees more unilateral action being likely in the short term, targeting revenue and/or customers within a country rather than the slippery, border-                shifting concept of profit. 

• The top 1%. The share of income of the top 1% is a controversial subject. It was therefore surprising to see that in the UK it fell by almost three quarters between 1920 and 1980. Since then it has more than doubled, leaving the 1%’s share at about 13% of national income. 

The corollary is that the top 1% now pay 28% of total income tax whereas in 1990 their share was about 15%. The 1% will provide about £55bn of income tax in the coming tax year – over 7% of total Government revenue. This dependency on a small rich population segment makes trying to turn the tax screw further at the top end dangerous in the view of the IFS. The risk is that not only will higher rates fail to produce extra revenue, they may also lead to a loss of existing revenue. 

Arguably a good example of this is given by the growing number of NHS consultants who have found the pensions annual allowance taper rules an incentive to take early retirement, removing not only the taper income tax, but also income tax on some earnings and National Insurance contributions from the Government’s coffers. For its part, the IFS noted that in Scotland, the OBR had projected that almost 10% of the increased income tax revenue from the Scottish 2018/19 tax changes would be lost if only a small number (fewer than 20) of additional rate taxpaying Scottish residents chose to move south of the border. 

• Wealth. The total value of UK household wealth is £13trn, of which 36% is represented by property and 42% by private pensions. These two asset classes both enjoy favourable tax treatment, eg no tax on main residence capital gains and no inheritance tax (IHT) on pension death benefits. The IFS suggested that while a direct wealth tax would be difficult to operate and be a disincentive to saving and investment, there was scope to raise tax from wealth in other ways. A good – and politically near-impossible – example would be to use up-to-date valuations for council tax bands in England, rather than 30-year old values. 

The message from the IFS was that in many ways tax will not be changing greatly because moving away from the heavy reliance on the income tax, National Insurance contributions and VAT trio was just too difficult. The corollary is that they will be the areas where Governments look to raise more revenue in coming years – and not just from the top 1%. 

Source:  Presentation on 3 April 2019

Mixed-sex couples can now enter into a civil partnership

(AF1, AF2, AF3, AF4, ER1, FA2, FA4, FA5, FA7, JO2, JO3, JO5, LP2, RO2, RO3,RO4, RO5, RO7, RO8) 

The Civil Partnerships, Marriages and Deaths (Registration etc) Bill has received Royal Assent on 26 March 2019.  It will permit the first mixed-sex civil partnerships in England and Wales by the end of the year and come into force on 26 May 2019.

The Civil Partnership Act 2004 came into effect from 5 December 2005. It broadly confers the same rights and tax treatment to same-sex couples who enter into a civil partnership with each other, as is afforded to married couples. We then saw the introduction of the Marriage (Same-Sex Couples) Act 2013, which applies in England and Wales, allowing equal access to marriage for all couples and closing some of the political gaps that still existed between the two separate legal frameworks for marriage and civil partnerships. However, this meant that same-sex couples had a choice between marriage or entering into a civil partnership whereas mixed-sex couples didn’t. So, by further changing the law, this ‘imbalance’ has now been finally addressed.

It has taken around two years for the Bill to make its way through Parliament and for many this is a welcome change especially for those who have ethical or personal objections to marriage. It will therefore be interesting to see how this change in the law evolves going forward.

Source:  Parliamentary Statement made 29 March 2019

 

 

 INVESTMENT PLANNING

 

Chinese bonds follow Chinese equities

(AF4, FA7, LP2, RO2) 

Over recent years we have regularly commented on the growing role of Chinese onshore shares in MSCI’s Emerging Market Index, the latest example being the increased weighting announced in March. A similar move is now taking place on the bond front. 

At the start of April, Bloomberg started to include onshore Chinese Government bonds and policy bank securities in its Bloomberg Barclays Global Aggregate Index (BBGAI). (The policy banks, of which there are three, finance state projects and economic and trade development.) Over the next 20 months, 356 Chinese securities will be added to the BBGAI, an index which currently covers $54.9tn of debt. By November 2020, China will account for more than 6% of the index (it was under 1% in March) and the Chinese currency, the renminbi, will be the fourth largest currency component after the dollar, euro and yen. 

The Chinese bond market is worth $13tn, making it the world’s third largest, just shy of Japan’s in size. Currently only about 2% of those Chinese bonds are held by foreign investors, even though yields are relatively attractive – the 10-year China Government bond currently yields 3.30% against 2.52% for US 10-year Treasuries, 1.11% for UK gilts and 0.00% for German bunds. International investors have been held back by a number of factors, including lack of liquidity and a credit rating system that seems only to provide high ratings. 

As with Chinese shares, matters have been improving. In 2017 the Hong Kong Bond Connect was launched to make it easier for foreign investors to make direct Chinese purchases, mirroring a similar earlier development for equities. Standard & Poor’s has recently gained a license to start rating domestic bonds in China. 

Bloomberg is leading the way with its inclusion of Chinese Bonds, but other major bond index providers, such as FTSE Russell, are reviewing their position. One estimate is that Bloomberg’s move alone will drive $100bn into Chinese bonds this year.

Source:  Bloomberg News 28/3/2019

Venture Capital Trusts - sales reached £731m in 2018/19

(AF4, FA7, LP2, RO2)

2018/19 was a more normal year for the VCT market than its immediate predecessor. In 2017/18 there was a surge of funding in early Autumn, as trusts sought to raise capital before an expected Autumn Budget crackdown which never quite materialised. In 2018/19 the focus moved back to the traditional post-Christmas run up to the tax year end.

There was a strong element of buy-now-while-stocks last about those Autumn 2017 sales. As a result, in 2018/19 some big name VCTs that had gathered in sufficient cash in 2017 chose either not to raise any more or limited the size of their share issues, targeting existing shareholders. Nevertheless, the total funds raised in 2018/19 amounted to £731m, £3m more than in 2017/18 according to the Association of Investment Companies (AIC) and a new record at the 30% tax relief level. A significant portion of the money raised went to just one trust – the Octopus Titan which raised over £220m.

The strong inflow to VCTs comes despite what providers have been stressing is a higher risk investment profile than in the past. New VCT capital is going into much younger companies. Often VCT managers are thinking in terms of several funding rounds for their chosen targets, rather than a one-off investment. Down the line that is likely to mean more volatile returns, especially as the old management buyout holdings in existing trusts are gradually run down and/or diluted.

Source: AIC 9/4/2019

 

PENSIONS

 

Working longer and older – latest National statistics Labour Market figures

(AF3, FA2, JO5, RO4, RO8) 

The latest National Statistics Labour Market figures, for the December 2018 to February 2019 period, showed the employment rate for those aged 16-64 was 76.1%, up 0.7% year-on-year and the joint-highest figure on record. A closer look at the figures shows that the total number employed rose by 457,000 between December 2017-February 2018 and December 2018-February 2019. Of this increase, 320,000 (70%) were aged 50 and over. In the subset of those aged 65 and over, the employment numbers increased by 82,000 (6.8%) to 1,282,000. 

Drill further into the data and, as the graph above shows, the increase in workers aged 50 and over is being driven by a growth in the number of women working for longer. At the start of the millennium, the employment rate for women aged 50-64 was 52.6% and for those aged 65+, 3.6%. The latest figures are 68.1% and 7.9% respectively. In just over 14 years, the proportion of women aged 65 and over in work has doubled. 

COMMENT

The graph shows a clear upward drift for both sexes from the start of the millennium, with women outpacing men. The ratcheting up of State Pension Age (now at least 65¼ for both sexes) is undoubtedly one reason, as is the fading coverage of defined benefit pension schemes. The skew towards higher employment rates at older ages may even be part of the explanation of why productivity growth has been so slow, despite such a low unemployment rate (3.9%) and rising wages (3.5% including bonuses).

Pension Protection Fund publishes updated PPF 7800 index - April 2019

(AF3, FA2, JO5, RO4, RO8)

PPF publishes April 2019 updates to estimated funding position of schemes

Since July 2007 the Pension Protection Fund has published the latest estimated funding position, on a s179 basis, for the defined benefit schemes in its eligible universe. 

April 2019 Update Highlights

• The aggregate deficit of the 5,450 schemes in the PPF 7800 Index is estimated to have increased over the month to £43.9 billion at the end of March 2019, from a deficit of £8.6 billion at the end of February 2019.
• The funding level decreased from 99.5 per cent at the end of February 2019 to 97.4 per cent.
• Total assets were £1,649.1 billion and total liabilities were £1,693.0 billion.
• There were 3,267 schemes in deficit and 2,183 schemes in surplus.

The PPF 7800 index is published on the second Tuesday of every month, and the PPF publishes The Purple Book each year. 

National Statistics - employee workplace pensions in the UK

(AF3, FA2, JO5, RO4, RO8) 

The Office of National Statistics has produced Employee workplace pensions in the UK: 2018 provisional and 2017 revised results as part of the information uncovered by The Annual Survey of Hours and Earnings.   

Headline findings  

• Over three-quarters (76%) of UK employees were members of a workplace pension scheme in 2018, up from 73% in 2017; this is a 29 percentage points increase compared with 2012, when automatic enrolment was introduced. 

• The number of employees with defined contribution (pension wealth dependent upon factors such as investment performance) workplace pensions has increased considerably in recent years; in 2018 the proportion of employees with workplace pensions of this type (34%) almost equalled that of defined benefit (which guarantee a specific retirement income 36%). 

• Both the public and private sectors saw a rise in the share of employees with a workplace pension between 2017 and 2018, with the private sector seeing the largest growth; 90% of public sector and 72% of private sector employees were participating in an occupational pension in 2018 with the gap between these sectors narrowing. 

• In 2018, employees aged outside automatic enrolment age eligibility (less than 22 years or over State Pension age) had low proportions of workplace pension participation (35% or less), whereas approximately 80% of employees within the age boundary criteria were members of their workplace pension scheme. 

• Private sector employers with 1 to 99 employees had the largest growth in workplace pension membership between 2017 and 2018, from 51% to 62%; however, this group still had the lowest rate across the public and private sectors. 

• The proportion of defined contribution scheme members contributing between 2% and 3% of their earnings rose to 38% in 2018, up from 6% in 2017, while the share contributing less than 2% fell; this is likely to be explained by the phasing of automatic enrolment minimum contribution levels. 

• The vast majority (85%) of defined benefit pension members received employer contributions equivalent to 12% or more of their earnings in 2018, while just 8% of defined contribution members received employer contributions of this size: this reflects the legal requirement on employers to ensure defined benefit schemes are funded sufficiently to pay future pensions. 

New ROPs list posted

(AF3, FA2, JO5, RO4, RO8) 

On 15 April 2019, HMRC published a new list of schemes that have informed HMRC that they meet the updated conditions to be a Recognised Overseas Pension Scheme (ROPS).  This list only contains pension schemes that have asked to be included on the list. 

There are now a total of 1607 schemes listed, from 28 countries, and an EU institution, the most recent update added 29 schemes (25 of which were Australian) and removed 3.