Personal Finance Society news update from the 24th October to 6th November 2017.
Taxation and trusts
TAXATION AND TRUSTS
UK ‘tax gap’ at record low
(AF1, AF2, RO3, JO3)
Official statistics revealed recently that the difference between the tax due and that collected by HMRC – known as the ‘tax gap’ – fell to a record low of 6% in 2015 to 2016.
The tax gap fall follows the introduction of 75 measures over the last 7 years to reduce tax avoidance, evasion and non-compliance, including:
- cracking down on avoidance by multinationals to ensure companies pay the right amount of tax under UK law
- introducing tough new criminal offences that make it easier to prosecute both evaders and companies that fail to prevent evasion, as well as significantly increasing penalties
- introducing a new penalty for those who enable the use of tax avoidance schemes that are later defeated by HMRC
- investing £800 million in HMRC’s compliance operations, which are expected to bring in an additional £7.2 billion in tax by 2020 to 2021
Since 2010, HMRC has secured almost £160 billion in additional tax revenue as a result of actions to tackle tax evasion, tax avoidance and non-compliance, including £2.8 billion from offshore tax evaders, through action both at home and abroad.
The state pension lump sum and investment in an EIS
(AF3, FA2, FA4, JO5, LP2, RO4, RO8)
We were recently asked the following question:
“Can the income tax payable on a deferred State pension lump sum be relieved by a subscription to an Enterprise Investment Scheme (EIS)?”
This is not an area we had previously explored and the results of our research were as follows:
EIS income tax relief takes the form of a reduction in an individual’s income tax liability. The amount of the reduction is currently equal to tax at 30% on the amount of the subscription. However, the amount of the tax relief on a subscription to an EIS cannot exceed the amount of tax that would otherwise be paid without any EIS subscription.
Sections 22-32 of ITA 2007 set down the rules on how an income tax liability is calculated and include the rules for how tax reliefs can reduce the liability.
First total income is calculated – this is the income on which an individual is charged to tax. Then personal allowances and other reliefs (such as loss relief) are deducted. The tax liability is then calculated on this amount. EIS relief is then used to reduce the tax liability. However, this cannot result in a repayment of tax.
Although a deferred State pension lump sum is treated as income and taxed as such it is not to be taken into account in determining the total income of any person – section 7 Finance (No.2) Act 2005.
In conclusion then, the amount of income tax due on a deferred State pension lump sum cannot be relieved by a subscription to an EIS.
Landid property and others v HMRC
In the recent case of Landid Property and others V HMRC  UKFTT 0692, the First-tier Tribunal (FTT) found that payments to employee benefit trust (EBT) sub-funds constituted earnings. There were 3 appellant companies. In this article we refer to Landid Property Ltd.
Overview of the transactions:
- An EBT was established by Landid Property Ltd (the Company) with an initial trust fund of £100. The trustee was an Isle of Man-based corporate trustee.
- The trustee executed a supplementary deed (deed of appointment) establishing sub-funds within the EBT with an initial amount of £10 each. Each sub-fund related to a named employee and their family.
- The Company and trustee executed a further deed (which was described as a ‘Deed of Addition and Contribution Agreement’) by which the Company contributed the desired larger amount to each sub-fund.
- The Board of the Company resolved to pay £100 to a specified charity and made that payment. Under the terms of the EBT the amount added to the sub-funds ceased to be liable to revert to the Company.
- One or more interest-free loans were made from the sub-funds to the appropriate employees.
In summary, the Company had established an EBT with sub-funds, one sub-fund for each employee, to which it contributed funds. Interest-free loans were then made to the employees from the sub-funds. The issue was whether the amounts contributed to the sub-funds were earnings subject to National Insurance contributions and PAYE.
The facts of this case were similar to those in the Rangers case. In light of this, the FTT referred extensively to the recent Supreme Court decision in Rangers  UKSC45.After a detailed review of the facts the FTT found that payments to the EBT sub-funds constituted earnings for both income tax and National Insurance purposes.
Following victory in the Rangers case HMRC said that it would issue details of how to register and settle tax in the coming weeks but to date nothing has emerged. Therefore, companies and employees who have participated in EBTs with sub-funds who have not already settled any unpaid taxes should consider contacting HMRC to settle their affairs.
The taxation of contractors
It has been reported (though with no official confirmation) that the Treasury is considering reviewing the taxation of contractors.
The Financial Secretary to the Treasury is reported to have said that “an issue of fairness was at stake” in deciding whether the private sector should be subject to the same rules as the public sector in relation to freelance workers using personal service companies.
If similar rules apply to the public sector were introduced for the private sector then the employer would be responsible for the tax if it were determined – based on the facts – that the individual supplying the services should be taxed as an employee.
There is, it seems, an expectation that any changes would not be introduced overnight and a more likely route might be the launching of a consultation with changes coming later.
The ‘off-pay roll working rules’ for those providing their services via an intermediary are in place, broadly speaking, to ensure that the same tax and NIC is paid as if they were employees.
But the rules aren’t automatically applied. The decision as to whether the new ‘off-pay roll’ rules apply or not is up to the local authority. It is their responsibility not that of the intermediary company to decide whether the rules apply.
HMRC has provided an on-line tool to check employment status. This can be used in relation to individuals providing few services as sole traders, partners or through limited companies.
This will lead to a conclusion based on the facts. Broadly, if the nature of the relationship between the provider of the service (the individual) and the user of the service (the Public Authority) would have been ‘employer/employee’ without the personal service company (ie. under the IR35 test) then the Local Authority will need to start to deduct tax and NIC based on the ‘deemed employment income’.
Extending this approach to the private sector will, in effect, turn the responsibility for deciding status on the user of the service.
In closing, it is important to note that there is no official confirmation that this approach is to be adopted. So far we have a reported expression of ‘concern’ from the Financial Secretary to the Treasury.
As stated above, one would expect any change to be preceded by consultation.
IFS Budget view
The Institute for Fiscal Studies (IFS) has published a paper similar to its normal Green Budget report. This examines the challenges and potential options that Mr Hammond will have to deal with in in two weeks’ time.
Each year, about a month before the Budget, the Institute for Fiscal Studies publishes a Green Budget examining the economic and fiscal background to the Chancellor’s announcements. The Spring Budget edition ran to over 300 pages, with contributions from not only the IFS, but also Oxford Economics and the Institute of Chartered Accountants in England and Wales (ICAEW).
For the Autumn Budget, the IFS has adopted a less wordy approach, written solely by IFS staff. The document, entitled “Autumn 2017 Budget: options for easing the squeeze”, looks at March’s Budget, what has happened since and Mr Hammond’s policy options on tax, welfare spending and public service expenditure.
The IFS starts by noting that the March 2017 Budget was presented alongside an assumption that government borrowing for 2016/17 would be £51.7bn (after adjustments). In the Spring the Chancellor was aiming for two longer term goals:
- The structural deficit, ie the ‘core’ government deficit ignoring any temporary strength or weakness in the economy, should be below 2% of national income in 2020/21.
- The deficit should be eliminated by the ‘mid-2020s’.
Back in March the Office for Budget Responsibility’s (OBR) calculations suggested that the first of these was something of a shoo-in, while the second was less certain – and conveniently outside the OBR’s standard five-year forecast period.
The latest estimate for the 2016/17 deficit is now £45.7bn, £6bn below the March figure The IFS estimates that for 2017/18 the deficit “might come in at around £51 billion, or around £7 billion lower than forecast” in March. Like the OBR, the IFS does not expect the rosy picture from the first six months to be repeated in the next six.
The IFS has an interesting graphic showing what has happened since 2007/08 (pre-crisis) to 2017/18. Government borrowing as a proportion of national income (GDP) is virtually the same: 2.8% in 2007/08 against an estimated 2.9% in the current year. En route borrowing reached 9.9% in 2009/10, which marked the peak effect of the financial crisis. Over the 2007/08-2017/18 period spending is up 0.5% of GDP, while government receipts (primarily taxes) have risen 0.4%, but this does not tell the full story. Between 2007/08 and 2009/10 spending rose by 6.1% and receipts dropped by 1.1%, whereas since 2009/10 spending has been fallen by 5.6% and receipts have risen by 1.4% (roundings creep in here for those keeping count). Thus, bringing the deficit back to pre-crisis levels has been 80% achieved via expenditure cuts. This helps to explain why there are growing calls for an increase to government spending, despite the March Budget’s plan of £24bn in further cuts by 2020/21.
The OBR has said earlier it will be cutting its assumption about productivity growth in its Autumn Budget numbers and the IFS has examined what this might mean for public finances. It has set out three different scenarios, from a ‘moderate’ downward adjustment in line with the Bank of England’s current estimates to a ‘very poor’ scenario in which output per hour grows by just 0.4% a year. All other things being equal, only the moderate scenario keeps finances firmly on track for 2020/21 under the 2% borrowing target. The middle ‘weak’ scenario wipes out half of the headroom in the March Budget, leaving a 1.5% deficit, while in the ‘very poor’ scenario borrowing is over 2.5%. Thus, the OBR’s productivity growth decision will be a key point to watch on 22 November.
What can Mr Hammond do? The IFS echoes some comments we made earlier.
‘…given that this is the first Budget since a general election, we might have expected some tax rises to be announced this time around. However, the Chancellor must balance the needs of the economy, strains on public services and other pressures with the costs of having higher debt. Much of the public debate in the lead-up to the Budget has been about ways to ease the squeeze rather than options for reducing borrowing, and any takeaway measure would have to pass a vote in the House of Commons – no small challenge given current parliamentary arithmetic.’
In terms of specific tax changes, the IFS says “a 1 percentage point increase in all income tax rates, or all employee and self-employed NICs rates, would each raise around £5½ billion. And either would do so in a progressive manner, i.e. the takeaway would, on average, represent a larger share of the incomes of higher-income households than of lower-income households.” However, the IFS then says, with more than a tinge of regret “In practice, these options appear politically infeasible.” After six years of a fuel duty freeze (equivalent to an overall loss now of £5.4bn in revenue), the IFS suggests that the Chancellor might limit the freeze to only petrol this year, given the cloud (sic) diesel is under. Corporation tax is also in the IFS’s sights, with the 2020 cut to 17% a £5bn cost that could be clawed back. Maintaining the 19% rate would still leave the UK with the lowest headline rate in the G20, the IFS notes.
In its conclusion the IFS says “When faced with similar changes in forecasts, his predecessor tended to offer small giveaways in the short term, with a medium-term takeaway offsetting only a relatively small proportion of the overall downgrade. Mr Hammond may not deviate far from that practice.” That could mean another step towards the £12,500 personal allowance/£50,000 higher rate threshold pledge from the 2017 manifesto, a move which has become less expensive due to higher than expected inflation. It might also mean in the longer term a deferral or cull of that 2% corporation tax cut. We could see an extension to the employer-determined IR35 status rules for contractors, an idea doing the rounds earlier. This treatment has applied to the public sector since April 2017 and a consultation paper about making employer decision universal could be a first step to emerge on November 22.
The final sentence of the IFS paper is perhaps the most telling: ‘… given all the current pressures and uncertainties – and the policy action that these might require – it is perhaps time to admit that a firm commitment to running a Budget surplus from the mid-2020s onwards is no longer sensible.’ Thus even the IFS is recommending that the Chancellor accepts the principle of more government borrowing…
Class 2 NIC contributions
(AF1, AF2, RO3, JO3)
A bulletin we issued shortly after the March Budget highlighted the loss to the Exchequer which Mr Hammond suffered because he was forced to abandon the Class 4 NIC increases announced for 2018/19 and 2019/20 only days earlier. Although the press headlines mentioned a £2bn black hole, this was down to the Gordon Brown trick of adding up revenue for four years to arrive at an impressive-sounding number. In fact, the Treasury’s estimate was that in the coming tax year (2018/19) a 1% increase to Class 4 NICs would generate £325m. This doubled in the following year, in line with the doubling of the increase to 2%.
The inflow in 2018/19 from the rapidly abandoned Class 4 increase was just about matched by the outflow from the planned ending of Class 2 contributions – the OBR calculated that in 2016/17 Class 2 raised about £290m. Various reports have appeared recently (eg from Torsten Bell at the Resolution Foundation) that the government has decided to prolong the life of Class 2 NICs for one year. The Class cull was due to be implemented in a National Insurance Contributions Bill 2018, but this now looks to have been deferred, too.
Retaining Class 2 for now has some logic as it removes temporarily the issue of giving access to state pensions for those self-employed people with earnings below the small profits threshold (£6,025 in 2017/18). At present such people can pay voluntary Class 2 contributions (a bargain at £2.85 a week) to gain access, but without Class 2 their only option would be to pay Class 3 contributions (currently £14.25 a week). This was a problem raised in the consultation paper on the abolition of Class 2 and its replacement by a “new contributory benefit test”.
The government has now announced a one year delay to the abolition of Class 2 NICs. Class 2 NICs will now be abolished from 6 April 2019 rather than 6 April 2018.
The Government has explained that the delay will 'allow time for the government to engage with interested parties and Parliamentarians with concerns relating to the impact of the abolition of Class 2 NICs on self-employed individuals with low profits.'
Another dividend record
(AF4, FA7, LP2, RO2)
Dividend payouts hit a third quarter high of £28.5bn in 2017, helped by special payments and rehabilitated miners.
The demise of sterling after last year’s referendum result is now beginning to fade from annual comparative figures. For example, against the euro, sterling is now down just 0.3% over the last 12 months, while it has appreciated by 7.6% against the US dollar. It might have been expected that the pound’s performance, particularly against the dollar, would impact on the rapid dividend growth UK shares had been recording this year. However, the latest Capita quarterly dividend monitor suggests that solid dividend growth has continued into the third quarter of 2017, with – as in the second quarter – a helping hand from one-off payments. According to Capita:
- The latest figures show UK dividend payments rose to a new record for the third quarter of £28.5bn, up 14.3% over the previous year – an almost identical increase to Q2.
- Special dividends were up 40% year-on-year to £1.5bn. Compass Group was the main contributor, with a £960m payout.
- Capita reckons that growth in underlying dividends (ie excluding the one-off specials) was 13.2% year-on-year. Strip out the currency effect and underlying growth is barely changed at 12.9%, the fastest in any quarter since 2012.
- 12 sectors raised dividends, while in 7 there was a fall, the same mix as in Q2. The mining sector continued its bounce back, accounting for two-thirds (£2.4bn) of the total dividend increase.
- Financial companies remain the largest dividend payers, accounting for 16.3% of total payments. However, their dividend growth was only 1% in Q3, almost entirely driven by Lloyds. The next highest payers were oil, gas and energy companies, many of which declare dividends in US dollars. Dividend growth in this group was 4%.
- Payouts from the top 100 companies rose 14.5% year-on-year, while the more UK-focused mid 250 registered a 12.2% increase.
- Concentration of dividend payments remains an issue. Capita says the top five companies account for 34% of all dividends (against 36% a year ago), while the top 15 covered 64% (cf 65%). The biggest payer was Royal Dutch Shell, whose 47c a share dividend has been unchanged since June 2014. The next three – Vodafone, HSBC and BP – have all inhabited the top four Q3 dividend places since 2012. BAT came in at number five, a slot occupied last year by SAB Miller (which has since been taken over by AB Inbev).
In its Q2 report, Capita expected the end of the Brexit currency boost to bring down annual underlying dividend growth to 7.4% in 2017. With the strong showing in Q3, Capita has now upped its forecast to 11.1%.
November interest rate decision
(AF4, FA7, LP2, RO2)
After ten years the Bank of England has raised interest rates for the first time to 0.5%. By a 7-2 majority the Monetary Policy Committee (MPC) has voted to unwind the 0.25% referendum-inspired cut made in August 2016. Curiously enough the September vote had been 7-2 to hold rates. The rise, to 0.5%, is the first increase since 5 July 2007 (when base rate was pushed up to 5.75%).
The MPC’s decision was widely expected – Reuters estimated that the markets had given a near 90% probability on its arrival. The focus was therefore not in the rate change, but what the Bank said about its reasoning and future course of action. There have been arguments about whether the reversion to the 0.5% rate originally set in March 2009 was a precursor to further increases or a “one and done” strategy.
On the evidence so far, the “one and done” camp seems to be winning:
- The Bank made clear that the 0.25% increase is driven more by the prospects for inflation rather than the current rate, which it expects to top 3% when the October figure is published.
- The Bank says “…the pace at which the economy can grow without generating inflationary pressures has fallen relative to pre-crisis norms”, a situation that reflects persistently weak post-crisis productivity growth and, more recently, a shrinking availability of labour. The Bank thus feels “the time has come to ease our foot off the accelerator”. That is not the same as applying the brakes: as Mr Carney said in his introductory remarks at the press conference “even after today’s rate increase, monetary policy will provide significant support to jobs and activity”.
- The Bank’s November Quarterly Inflation Report (QIR) shows inflation coming back to 2% by the end of the projection period (Q3 2020), ‘conditioned on the gently rising path of Bank Rate implied by current market yields’. Those market numbers imply two more 0.25% rate increases over the next three years – a 1% base rate around the end of 2019/early 2020. As one commentator remarked, “for gradual, read glacial”.
- This time around the Bank has not repeated its warning that the markets are underestimating the pace of rate increases. The implied market rates are now about 0.25% higher than in August, largely due to the Bank’s heavy hinting.
What effect will the rate rise have?
- At the press conference Mark Carney said that he expected the rate increase to be passed on to savers. However, instant access rates have already been rising – the best instant access rates are already over 1%.
- Most mortgage holders will not notice the difference. The Bank says 60% of mortgages are now on fixed rates. It also points out that “many households will re-finance onto lower interest rates than they are currently paying by around 30 basis points (0.3%) for those moving from an expiring two-year fixed rate deal to around 2 percentage points for someone refinancing an expiring five-year fixed rate deal”.
On the variable rate front the Bank notes that “Only about one fifth of people with mortgages have never experienced an increase in Bank Rate. Of those, almost half took out their mortgage after the Financial Policy Committee (FPC) introduced its affordability stress in 2014, which requires mortgagors to be able to withstand an increase in their mortgage rate to around 7%.”
- The sense of “one and done” seems to have pleased the UK equity and gilt markets. On the other hand, sterling came under pressure, falling about 1.4c against the euro and 1.7c against the dollar.
With the ECB having announced its not-quite-tapering of QE earlier and the Bank of England making its first rate rise since 2007, all eyes are now on the US Federal Reserve, which is due to make its final rate announcement of the year on 13 December, with the odds on another 0.25% rise (to 1.25%-1.50%).
FCA publish fg17/9: guidance for firms on how to calculate redress for unsuitable defined benefit pension transfers
(AF3, FA2, JO5, RO4, RO8)
The final guidance document, FG17/9: Guidance for firms on how to calculate redress for unsuitable defined benefit pension transfers has been published following the guidance consultation GC17/1. GC17/1 consulted on guidance to update the methodology used to calculate redress for unsuitable pension transfers from a defined benefit pension scheme to a personal pension. Summary of the feedback received on the consultation can be found the summary feedback document.
This guidance applies to any complaint received by a firm after 3 August 2016 about advice given to a customer to transfer all or part of the cash value of accrued benefits under a DB pension scheme into a money purchase arrangement.
This guidance should also be used to determine appropriate redress where a respondent upholds a complaint received after 3 August 2016 about a pension transfer between 29 April 1988 and 30 June 1994 in circumstances where either:
- the firm did not review the relevant pension transaction in accordance with the regulatory standards or requirements applicable for the review of the transaction at the time; or
- the particular circumstances of the case were not addressed by those standards
The guidance gives general guidance then goes on to stipulate the assumptions used, which include the following:
- Consumer’s retirement age
- Pre-retirement discount rate
- Pension increases in payment
- Personal pension charges
- Post-retirement discount rate
- Spouse’s age difference
- Proportion married at retirement
- Enhanced transfer values
Consultation issued on bulk transfers of defined contribution pensions without member consent: draft regulations
(AF3, FA2, JO5, RO4, RO8)
This consultation follows a call for evidence on bulk transfers of defined contribution pensions without member consent which opened in December 2016 and closed in February 2017. Alongside the consultation the draft regulations, The Occupational Pension Schemes (Preservation of Benefits and Charges and Governance) (Amendment) Regulations 2018, have been published.
The proposed regulations take into account the responses the Government had to their call for evidence. The proposed changes include:
- Removal of the need for an actuarial certificate for pure DC to DC transfers where there are no guarantees; and
- Removal of the scheme relationship requirement for pure DC to DC transfers where there are no guarantees.
In addition there are further proposed regulations to protect members which include:
- Where the transfer is to a scheme authorised under the master trust regime, trustees will have their fiduciary duties to act in the best interests of members, and we will consider the need to develop some further guidance for trustees on how to review the suitability of the receiving master trust.
- Where the transfer is not into an authorised scheme, the trustees of the ceding scheme will also need to review the receiving scheme, under their responsibilities in trust law, with the assistance of appropriate guidance from The Pensions Regulator or the DWP. Additionally, we propose that trustees should consult with a professional who they have verified to be independent from the receiving scheme under consideration.
- Where members are protected by the automatic enrolment default fund charge cap in the ceding scheme, we propose also that the receiving scheme will be required to continue to apply the charge cap in respect of those members in the arrangement into which they are transferred. Finally, for the avoidance of 8 confusion, we are also consulting on the policy that any funds into which members protected by the cap are switched without making an active choice should continue to be subject to the cap.
Consultation closes on 30th November 2017 and responses should be sent to:
- Liz Roebuck, Department for Work and Pensions, Private Pensions, 1st Floor Caxton House, 4 Tothill Street, London, SW1H 9NA. Or by email to PENSIONS.BULKTRANSFERS@DWP.GSI.GOV.UK
DWP publishes results of pension charges survey 2016
(AF3, FA2, JO5, RO4, RO8)
The DWP have published the full results and a summary document of the Pension Charges Survey 2016, which investigate the charges on occupation defined contribution pension schemes following the introduction of the charge cap of 0.75%.
The key findings are as follows:
- The charge cap had lowered charges in qualifying schemes to the level of the cap or below: as many as 98 per cent of members of qualifying contract-based schemes and 99 per cent of members of qualifying trust-based schemes now paid a maximum of 0.75 per cent.
- Among qualifying scheme members, the members of the smallest schemes, which previously charged higher than the cap, benefitted the most. For example, ongoing charges for qualifying contract-based schemes with 12 or fewer members fell by 0.2 percentage points on average.
- Non-qualifying schemes, whose charges are not subject to the cap and were already typically higher than it, had not generally brought down their charges in response. In non-qualifying contract-based schemes just 21 per cent of members paid charges within the cap; and in non-qualifying trust-based schemes 50 per cent of members paid charges within the cap – both showing little change since 2015.
- Charges for unbundled trust-based schemes, measured for the first time in the 2016 survey, were typically comparable to their equivalent bundled trust-based schemes, although a relatively small number of closed, non-qualifying schemes charged markedly higher than the average.
- ‘Legacy’ charges that were banned under the charges measures (i.e. Active Member Discounts (AMDs), consultancy charges and member-borne commission) had been eliminated from qualifying schemes, and remained extremely rare even among non-qualifying schemes.
- There was virtually no improvement in providers’ abilities to report on transaction costs compared to 2015, with many providers, unbundled scheme trustees and their fund managers awaiting further guidance from the Government.
It is clear that the charge cap is working and those who were in high charging smaller schemes have benefitted the most. It is a shame that those schemes not currently impacted by the cap haven’t reduced their charges in line with other schemes but there may well be good reasons for this.