Technical news update 16/07/2019

Taxation and trusts 

• The UK tax gap
• Innovative Finance ISAs: HM Treasury review and FSCS update
• The Institute for Fiscal Studies looks at Jeremy Hunt’s tax plans
• The latest Companies House statistics
• Lasting Powers of Attorney and discretionary fund management
• The OTS IHT Simplification Review
• OTS IHT simplification – the second part of the review - interesting insights
• LISA guidance notes updated by HMRC 

Investment planning

• One half gone: the best first half ever for global markets?
• USA Triple Highs 

Pensions 

• The 60% tax band grows ever wider, how can pension contributions help?
• Differences in pension death benefits for same sex and opposite sex couples
• Updated pensions quality mark launched by Pension and Lifetime Savings Association

 

TAXATION AND TRUSTS

The UK tax gap

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

Official statistics published by HMRC this month show that the difference between the tax due and that collected by HMRC – known as the tax gap – remained relatively low at 5.6% in 2017/18, although that’s up slightly on 2016/17’s adjusted figure of 5.5%. This means that HMRC collected 94.4% of all the tax due under the law in 2017/18. Nevertheless, the current tax gap is a weighty figure, estimated at £35 billion - and its up £2 billion on 2016/17. 

Key findings: 

• There has been a long-term reduction in the overall tax gap, from 7.2% in 2005/06 to 5.6% in 2017/18. However, between 2015/16 and 2017/18, the overall percentage tax gap is showing a small increase of 0.3%. 

• The tax gap for income tax, National Insurance contributions and capital gains tax is 3.9% in 2017/18, at £12.9 billion, and represents the biggest share of the total tax gap by type of tax. 

• The corporation tax gap has reduced from 12.5% in 2005/06 to 8.1% (£5.2 billion) in 2017/18. 

• The inheritance tax gap is 11% in 2017/18, but is only £0.6 billion. 

• The avoidance tax gap has reduced from £4.9 billion in 2005/06 to £1.8 billion in 2017/18. The remainder of the tax gap in 2017/18 is caused by: 

• Failure to take reasonable care £6.4 billion;
• Legal interpretation £6.2 billion;
• Evasion £5.3 billion;
• Criminal attacks £4.9 billion;
• Non-payment £3.9 billion;
• Error £3.4 billion;
• Hidden economy £3 billion. 

(The figures only add up to £34.9 billion due to rounding.) 

HMRC points out that avoidable mistakes cost the Exchequer over £9.9 billion a year, of which £3 billion is attributable to VAT, and it uses the opportunity to promote Making Tax Digital for VAT as the answer to reducing tax lost due to avoidable errors by ensuring businesses make fewer mistakes (on VAT). 

Making Tax Digital was launched in April this year for VAT- registered businesses with turnover above the VAT threshold, requiring them to keep digital records and submit their VAT return using compatible software. So far, over 400,000 businesses have joined the service.

Innovative Finance ISAs: HM Treasury review and FSCS update

(FA5) 

In May, the Economic Secretary to the Treasury, John Glen, directed the Financial Conduct Authority (FCA) to begin an investigation into the circumstances surrounding the collapse of London Capital and Finance (LCF) and the FCA’s supervision of the firm. Dame Elizabeth Gloster was appointed to conduct this investigation. 

Alongside this, HM Treasury also announced it would review the wider policy questions raised by the case of LCF. These relate to the regulatory and tax treatment of the kinds of retail investment products issued by LCF (often referred to as “mini-bonds”). 

On 24 June, John Glen provided the following update, in the form of a letter to the Treasury Select Committee: 

1. Review of policy on non-transferable debt securities 

The Treasury will consider the regulatory arrangements currently in place for the issuance of non-transferable debt securities issued by companies to consumers — and similar products — including the financial promotions regime which governs the marketing of those investments. This will be supported by broader research into these investments and their role in the economy. 

This work will examine: 

• The size and economic value of this market in the UK, including how this has changed in recent years; 

• The investors active in this market, including their characteristics and the factors that influence their decisions; 

• The routes through which investors access this market and the information available to investors through financial promotions and other material; 

• The companies that access this market to raise capital, including the reasons why they choose to issue a non-transferable debt security (over other types of securities) and what this capital is used for. 

The Treasury will consider whether the current regulatory regime for these securities issued by companies to consumers is appropriate. This will include reviewing the appropriateness of: 

• The current regulatory regime for such securities issued by both authorised financial services firms and non-authorised firms;
• the existing protections in place for consumers investing in these securities, including financial promotion rules;
• Other investor protection measures relevant for this market. 

The review will take account of the investigations into LCF's failure already underway. 

2. Assessment of Innovative Finance (IF) ISA rules 

If ISAs were introduced to provide ISA holders with greater choice and flexibility in their investments, while supporting the sustainable growth of peer-to-peer and crowdfunding sectors as a source of alternative finance for businesses. It is important that the regime functions effectively for consumers, ISA managers and the Exchequer alike. 

The Treasury will therefore work with HMRC to review the tax rules for, and administration of, the IF ISA. Working with the FCA, the review will also look at the relationship of these rules to the wider regulatory framework for consumers and financial services firms. 

Separately, a review will consider how the market for IF ISAs has developed since they were introduced in 2016 to ensure the IF ISA rules remain appropriate and have the right flexibility to respond to future market developments. 

Once this work is completed, I will consider whether there should be any reform to the legislative framework. I expect that this assessment will be complete by early next year. In any case, I will update the committee on the progress of this work and on any decisions or consultations that arise from it.’

3. Compensation 

Meanwhile, the FSCS has published an update on 28 June 2019 stating that its investigation into LCF leads it to believe that there are protected claims, which may result in compensation for some of its investors. The FSCS says it believes that Surge Financial Ltd, acting on behalf of LCF, provided a number of LCF clients with misleading advice. As this is a regulated activity, it means that FSCS protection would be triggered and that there may therefore be a number of customers with eligible claims for compensation.

Source: HMT Treasury Correspondence: Economic Secretary sets out detail of HMT reviews of “mini-bonds” – dated 24 June 2019.

The Institute for Fiscal Studies looks at Jeremy Hunt’s tax plans

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

In the last bulletin we reviewed the analysis by the Institute for Fiscal Studies (IFS) of Boris Johnson’s tax proposals, which had a potential cost of £20bn a year (£9bn for the increase in the higher rate threshold and National Insurance contribution (NIC) upper limit to £80,000 and up to £11bn for an uplift in the NIC primary threshold). As anything associated with BoJo attracts more media attention than the actions of his contender for PM, Jeremy Hunt’s tax and spend proposals have largely been ignored. The IFS has now corrected this deficit (sic) with a new briefing note. Perhaps surprisingly, Mr Hunt would appear to be the more profligate: 

Cutting the main corporation tax rate to 12.5% 

• The main rate of corporation tax (i.e. that paid by most companies other than North Sea oil companies) is currently 19% and, under existing legislation, will drop to 17% from next April. 

• Jeremy Hunt’s plan is to bring the rate down to 12.5%, matching that which currently applies in Ireland and making it the second lowest in the OECD (after Hungary). 

• The IFS says such a move would cost around £13bn a year in the short run, though probably somewhat less in the long run. The Institute does not believe that it would be a self-financing tax cut (as some claim). The Institute’s view is that the UK’s existing tax base is too big for it to be plausible that a £13bn loss of revenue could be made up a result of higher profits being reported in the UK. 

Raising the primary and secondary NIC limit 

• Jeremy Hunt has spoken of raising the NIC threshold to make the first £1,000 of monthly earnings NIC-free. Quite why he has not simply suggested matching the personal allowance of £12,500 is unclear. 

• Repeating what it said on a similar proposal from Boris Johnson, the IFS puts the cost of scrapping employee/self-employed (but not employer) NICs at £3bn per £1,000 threshold increase. Thus, raising the threshold to £12,500 would cost £11bn a year and 2.4m workers would be taken out of NICs. 

Cutting the rate of interest on student loans to RPI 

• New student loans attract “interest” at RPI + 3% (i.e. currently 6.3% in total, falling to 5.4% in September) during study and a sliding scale of RPI to RPI + 3% thereafter, based on earnings (£46,305 currently triggers the top rate). The Augar review has proposed reducing the rate during study to RPI. 

• Hunt would cap the rate at RPI throughout the loan period, which the IFS says would have minimal short run cost, but in the long term would mean the Government foregoing over £1bn a year of income. 

• As the IFS rightly notes, “The RPI is a measure of inflation which is wrong, discredited and which does not qualify as a “national statistic” because of problems in the way in which it is constructed. Much better to move to a system based on the CPI.” However, if this were done, Mr Hunt would have to own up to a student loan interest rate of roughly inflation +1% or forego more revenue. 

Increase defence spending to 2.5% of GDP over the next five years 

• UK defence spending is currently 2% of GDP, in line with the level expected (but often not met) from NATO members. In May 2019, Mr Hunt went as far as suggesting a doubling of that figure for the UK. 

• Since his May speech, he has wound back his ambitions, possibly because doubling would mean more than £40bn a year of extra spending. His goal now is an increase of a quarter over the next five years, to 2.5% of GDP. 

• The IFS calculates that this would imply defence spending in 2023/24 around £15bn higher than today (in current terms) and around £12bn more than if spending remained at its current 2% level. 

As with Boris Johnson’s proposals, there is little evidence that the development of Mr Hunt’s wish list has been accompanied by much thought about how it would be financed. 

Source:  IFS 27/6/19

The latest Companies House statistics

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

At the end of March 2019 there were 4,202,044 companies on the Companies House register, up 4.2% on March 2018. The Companies House register can be a very useful source of publicly available business information. You can view company data and document images, including company accounts and information on company directors, simply by searching at the above link. 

According to the latest statistical release by Companies House, there were 672,890 company incorporations in 2018/19. This is an increase of 8.5% when compared with 2017/18 and is the highest number of incorporations since 2009/10. 

2018/19 also saw the largest number of dissolutions since 2009/10, at 508,865. 

The average age of a company on the total register at the end of March 2019 was 8.5 years. Despite fluctuations in recent years, the average age of a company has gradually declined from 10.7 years since 2000. 

Since 2004, private limited companies have consistently accounted for over 96% of all corporate body types. During this time, the three corporate bodies accounting for the highest proportion of all corporate bodies remained unchanged. Private limited companies, limited liability partnerships (LLPs) and limited partnerships have consistently accounted for over 98% of all corporate body types. 

At the end of March 2019, the number of overseas corporate bodies on the register with a physical presence in the UK reached 12,241. Overseas corporate bodies originating from the USA accounted for just over 21%. 

The full Companies House report can be found here. 

Source: Companies House Statistics: Companies register activities - statistical release 2018 to 2019 – dated 27 June 2019.

Lasting Powers of Attorney and discretionary fund management

(AF4, FA7, LP2, RO2) 

A standard Lasting Power of Attorney (LPA) allows the donor to delegate the investment of their savings to their attorney.  However, this does not extend to a third party, such as a discretionary fund manager (DFM) or bank. 

Whilst the donor still has capacity this does not cause any problems as they are able to appoint a DFM themselves. However, issues arise when the donor loses capacity. If there is no express provision contained within the LPA, the appointed DFM may not be able to make discretionary investment decisions without an application to the Court of Protection.  This is because (in the absence of express power in an LPA) only attorneys can make these decisions and they cannot delegate them. 

The England & Wales Office of the Public Guardian (OPG) has recently updated their guidance, but nothing has changed since 2015 in respect of DFMs - 

You the donor must make sure that ‘you do not delegate decisions to an investment fund manager unless you have permission within the LPA, EPA or court order (you can take advice, but if you want them to make decisions, you may need to apply to the Court of Protection)’.  This means that if clients want DFMs to continue to act when they lose capacity they will need to include wording to that effect. 

The latest form LP12 from the Government, updated in June 2018, carries the same information i.e. – 

The only circumstances in which you must write an instruction is in a financial LPA if: 

• you have investments managed by a bank and want that to continue;
• you want to allow your attorneys to let a bank manage your investments. 

In these cases, you could use wording like this: 

‘My attorney(s) may transfer my investments into a discretionary management scheme. Or, if I already had investments in a discretionary management scheme before I lost capacity to make financial decisions, I want the scheme to continue. I understand in both cases that managers of the scheme will make investment decisions and my investments will be held in their names or the names of their nominees’. 

However, the OPG can’t guarantee that your bank will accept this wording. You must ask your bank to confirm in writing that they’ll accept the wording before you register your LPA. That will minimise any difficulties in using the LPA if you lose mental capacity. 

You may also want to seek legal advice before you approach the bank. 

If the LPA has already been registered, the attorney(s) will have to apply to the Court of Protection to allow them to use a discretionary fund manager. 

A few years ago, the Society of Trust and Estate Practitioners (STEP) said they were hoping to present a test case to the OPG to highlight the practical difficulties faced as a result of this guidance. However, it seems things have not changed since 2015, so it is really important to consider these issues when advising clients about using an LPA. 

Sources: -  OPG Guidance: Investing for someone as their attorney or deputy – dated 28 May 2019; - OPG Guidance: Make and register your lasting power of attorney - a guide (LP12) – dated 17 June 2018.

The OTS IHT Simplification Review

(AF1, AF2, AF3, FA2, JO2, JO3, JO5, RO3, RO4, RO8) 

The OTS has published the second part of its IHT review, covering the design of the tax.

Back in February 2018, when the Office of Tax Simplification (OTS) published a letter setting out the scope of its “IHT General Simplification Review”, it stated its aim was to publish a report in Autumn 2018 with “specific simplification recommendations for government to consider”. At the time, it looked possible this would feed into the Autumn 2018 Budget. However, it did not work out that way. 

The OTS split its report into two, with the first report covering administrative matters issued in November 2018, after the Autumn 2018 Budget. The second report, examining the structure of the tax, was published on 5 July 2019. 

In some ways the OTS’s second report is less radical than had been expected, although it will still give the Chancellor of the Exchequer plenty to consider. As both candidates for Prime Minister are talking about no-deals and emergency Budgets, it looks unlikely that the OTS’s work will feed into the next Budget – whenever that might be – although it might appear in the Spring Statement 2020 (assuming the new Prime Minister survives that long). In his letter thanking the OTS for the second report, Mr Hammond noted that “The Government will consider the recommendations…and will respond in due course”. 

Those recommendations cover four key areas, with some set together as ‘packages’ of proposals, a strategy designed to prevent the Treasury adopting a pick-and-mix approach: 

1. Lifetime Gifts

a) Gift exemptions package 

This has three elements:

• The replacement of the £3,000 annual gift exemption and the exemption for gifts in consideration of marriage or civil partnership with an overall ‘personal gifts allowance’. The OTS does not put forward a specific figure, but suggests that were the annual exemption to have been uprated with inflation (RPI and CPI, as appropriate) since it was last increased in 1981, it would now be £11,900.
• A review of the level of the small gifts exemption alongside the new personal gifts allowance. Again, the OTS uses an inflation adjustment (from 1980, in this instance) to reach a revised but not specifically recommended figure of £1,010.
• Either:
  • Reform of the normal expenditure out of income exemption by removing the ‘regular’ requirement and fixing it at a percentage of income limit (possibly based on a tax return figure); or
  • Replacement of the normal expenditure out of income to exemption with a higher personal gift allowance. Although the OTS again avoids a specific suggestion, the document includes a demonstration of the impact of fixing the enhanced allowance at £25,000.

b) Gifting period and taper package 

• Reduce the seven-year period to five years, so that gifts to individuals made more than five years before death are exempt from IHT. This would be accompanied by the scrapping the so-called 14-year rule which, for example, requires a look back on death at chargeable transfers made in the seven years prior to a failed potentially exempt transfer. Between the lines the OTS recognises that much of what happens more than five years ago is lost in terms of records and/or memory.
• Abolish taper relief. This would remove a poorly understood relief, ease the reporting requirements for executors but, as the OTS acknowledges, create a cliff edge at five years. 

c) Liability for payment and the nil rate band 

• Options should be explored for simplifying and clarifying the rules on the liability for the payment of tax on lifetime gifts to individuals and the allocation of the nil rate band. The OTS refers to problems with the current chronological approach under which the earliest recipient is the winner and the liability for any tax on a lifetime gift at death initially falling on the recipient rather than the estate.

2. Interactions with capital gains tax (CGT) 

• Where an IHT relief (eg business or agricultural relief) or exemption (eg inter-spouse) applies, the CGT uplift on death should not be available. Instead, the recipient would be treated as acquiring the assets at the historic base cost of the person who has died. The OTS says that this would make the treatment of lifetime gifts and bequests more consistent and avoid the current perverse incentive to hang onto the relievable/exempt assets until death purely to wash out CGT.

3. Businesses and Farms 

• Three areas of business relief are addressed:
  
  • Raise the level of trading activity for business relief to be consistent with the level that applies for gift holdover relief or entrepreneurs’ relief. The implication of this is that a business would only qualify for business relief if ‘substantially’ (80% upwards) of its activity was trading rather than the current ‘wholly or mainly’ (50% plus).
  • Revise the treatment of indirect non-controlling holdings in trading companies. This is a technical measure designed to avoid the current difference in IHT treatment that exists between minority holdings that are personally owned (and qualify for relief) and those placed in a holding company (even where that company has few other assets) that do not receive relief.
  • Align the IHT treatment of furnished holiday lets (FHLs) with that of income tax and CGT. For the latter pair, FHLs are normally treated as trading, whereas for IHT HMRC normally denies any claim for business relief.
• Revise the treatment of limited liability partnerships to ensure that they are treated appropriately for the purposes of the business property trading requirement. At present, corporate trading groups may be treated differently for the purposes of the relief dependent on whether they have a company or an LLP as their holding vehicle.
• Revise the agricultural relief eligibility rules for farmhouses in ‘sensitive cases’, such as where a farmer needs to leave the farmhouse for medical treatment or go into care. The current requirement to occupy the property can cause difficult issues here.
• Clarify when a valuation of a business or farm is required and, if it is required, whether this needs to be a formal valuation or an estimate. Even if an asset is 100% relieved, it may still need to be formally valued because the total value of the estate needs to be known (eg for residence nil rate band taper calculations).

4. Other areas of IHT 

Perhaps, surprisingly, there are only two explicit recommendations under this catch-all heading, although various topics are covered, including the treatment of pension transfers: 

• Make death benefit payments from term policies IHT free on the death of the life assured without the need for them to be written in trust. The OTS distinguishes between term policies and whole life contracts but makes no comment about how its proposal would address term assurances written to very advanced ages, eg 100.
• Review the pre-owned assets tax (POAT) rules and their interaction with other IHT anti-avoidance legislation (GWR, GAAR, DOTAS) to consider whether they are still necessary.

On pension transfers, the OTS says it considers it would be helpful if HMRC were to provide further detailed guidance (once the appeal process in the Staveley case has been processed) on the circumstances in which a gratuitous benefit (and a potential IHT charge) may arise when making certain pension transfers, such as from a defined benefit scheme into a personal pension scheme shortly before death. 

The OTS also suggests that, at some point in the future, the Government consider a wider review of the tax system and pensions, possibly carried out by the OTS. 

There was a near kennel-full of dogs that did not bark in the report, although much snarling could be heard in the report’s 107 pages. For example, the OTS ducked the question of changes to the residence nil rate band (RNRB) on the basis there was not enough experience of its operation. Nevertheless, it did note that if the current £150,000 RNRB were to be replaced with an enlarged NRB at equal cost to the Exchequer, the NRB would increase by only £51,000 (based on HMRC estimates).  

Similarly, there was a nod to scrapping IHT on AIM shares, accompanied by another HMRC calculation that removing both business and agricultural relief entirely would allow only a 6.3% reduction in the overall IHT rate to 33.7%.  

The report has made a lot of recommendations that many will welcome given the current complexity of IHT, but we need to remember we have been here before and it will be interesting to see how much of this progresses onto the statute book. 

SOURCE: OTS IHT Second Report 5/07/19

OTS IHT simplification – the second part of the review - interesting insights

(AF1, AF3, FA2, JO5, RO3, RO4, RO8) 

The second part of the OTS IHT review may have pulled a few punches, but it provided some interesting insights. 

As we have noted in the preceding article, the OTS review of IHT design was not as radical as had been expected by some commentators. However, it did contain a raft of information about IHT, some of which arguably was more surprising than the recommendations in the report. For this insight HMRC can be thanked as it was able to use its data to supply the answers, many of which would be impossible for external observers to find. Here are half a dozen such nuggets: 

1. Normal expenditure out of income. Based on about 275,000 2015/16 IHT returns, there were just 579 normal expenditure out of income claims made (other than in respect of gifts into trust). The majority (321) were under £25,000, as demonstrated in the table below: 

Value of Gift (£)	Number of Claims
Less than 25,000	321
25,000 - 49,999	90
50,000 - 74,999	52
75,000 – 99,999	36
100,000 and above	80
TOTAL	579

 

The normal expenditure gift rules are often pointed to as a lost planning opportunity, which this data confirms. 

2. Taper relief on lifetime gifts. The report rightly notes that “Taper relief is complicated and not well understood”. It also highlights the difficulty in dealing with gifts at the end of the taper tail, i.e. more than five years before death, “given the difficulties in retaining or obtaining records”. In 2015/16 only 20% of IHT-paying estates (4,860) recorded gifts made within seven years of death: 

Years	Number of gifts*	Net value (£m)	Median gift (£)
0 - 1	1,590	160	31,000
1 - 2	1,120	140	41,000
2 - 3	980	110	50,000
3 - 4	830	120	64,000
4 - 5	740	110	72,000
5 - 6	700	120	100,000
6 - 7	770	110	94,000

            * One estate may have made multiple gifts 

3. Replacing IHT with capital gains tax (CGT) on death. This option is sometimes suggested as a way of scrapping one tax and producing more consistent results between lifetime gifts and those made on death. However, based on 2015/16 data (when the standard CGT rates were 18% and 28%), the switch would have produced a greater number of taxpaying estates, but considerably less tax, even if CGT were levied on the main residence: 

Estimated	CGT on death	CGT on death inc. main residence	IHT
Taxpaying estates	55,000	182,000	24,500
Tax raised	£1.3bn	£2.8bn	£4.38bn

4. Business and agricultural relief. Over the five years from 2019/20, IHT on its current basis is projected to raise £30.43bn from 120,650 estates. Across that period: 

• 16,380 estates are projected to benefit from agricultural or business reliefs;
• The cost to the Exchequer of the reliefs will be £5.85bn; and
• The average benefit to each estate claiming relief will be £357,000. 

To achieve the same IHT revenue with both reliefs scrapped would require an IHT rate of 33.7%. 

This data emphasises that the number of relief claims are small (about 3,300 a year), but the benefit to each claimant is substantial. This finding was supported by the graph in the first OTS report, which highlighted that the effective rate of IHT dropped sharply on estates valued at £9m and above. 

5. Residence nil rate band. The OTS received many comments about the complexity of the current rules for the residence nil rate band (RNRB). It avoided making any recommendations on the basis that “the residence nil rate band is still very new, and more time is needed to evaluate its effectiveness”. Nevertheless, it did supply some HMRC projections which demonstrated the impact of the band in terms of both revenue and estates subject to tax. These show that what looks like the obvious solution – increasing the NRB to £500,000 and scrapping the RNRB – would hurt the Exchequer. They also reveal that the RNRB is reducing the number of taxpaying estates by about 40%. 

Tax Year		2019/20	2020/21	2021/22	2022/23	2023/24
Baseline	Tax £m	5,500	5,770	6,050	6,370	6,740
	Estates	22,680	23,340	24,050	24,870	25,710
No RNRB	Tax £m	6,350	6,820	7,180	7,590	8,070
	Estates	36,820	39,500	40,810	42,490	43,820
£500,000 NRB only	Tax £m	4,090	4,360	4,580	4,830	5,110
	Estates	15,880	16,850	17,320	17,810	18,420

6. Pension transfers and death. Frustratingly, no numerical data was supplied on this topic, probably because the figures are so small. However, the OTS did make a telling observation, which we quote in full: 

‘6.15 The OTS has heard that the operation of the two-year rule regarding gratuitous benefits is causing a high degree of uncertainty for financial advisers because at the time of undertaking such transfers, there can be no certainty as to whether a transfer will be considered to be creating a gratuitous benefit.

6.15 The OTS understands that in practice, it is very unusual for HMRC to argue that there has been a transfer of value. HMRC will only argue that a transfer of value has arisen where there is evidence of an intention to confer a gratuitous benefit.’ 

There are many other insights in the report, which could make a good – and not too long – piece of holiday reading.   

SOURCE: OTS IHT Second Report 5/07/19

LISA guidance notes updated by HMRC

(FA5) 

HMRC has recently updated its guidance notes on Lifetime ISAs (LISAs). 

LISAs became available from 6 April 2017 and, while the LISA is similar to other ISAs, the key differences are that a LISA can only be opened by those aged between 18 to 40 and contributions can’t be accepted once the saver attains age 50, the subscription limit is restricted to £4,000 per tax year, a Government bonus of 25% is paid on qualifying contributions and withdrawal charges of 25% can be deducted by the LISA manager in specified circumstances.

The main aim of the LISA is to provide funds for house purchase or retirement.

The guidance includes information on the following areas:

• Applying to be a LISA manager
• Who can open a LISA
• Opening a Lifetime ISA
• How people pay into their LISA
• Transferring LISAs between LISA managers
• Claiming the Government bonus for LISAs
• Qualifying investments
• Withdrawal charges and charge-free withdrawals
• Withdrawals for first-time residential purchase
• Closing a LISA

When first introduced, the LISA did not prove to be popular nor did many providers offer it. However, the number of providers offering a LISA account has increased in the past few years so it will be interesting to see whether more individuals are likely to consider it as a savings alternative. According to Which magazine’s July 2019 update there are currently 13 LISA providers on the market, offering either cash or stocks & shares investment options.

SOURCES: Which Money update: Lifetime ISAs – dated July 2019; HMRC updated Guidance: Lifetime ISAs for ISA managers – dated 28 June 2019.

INVESTMENT PLANNING

One half gone: the best first half ever for global markets?

(AF4, FA7, LP2, RO2)

The first half of 2019 is over. After the dismal ending to 2018, these six months have been much better for investors as illustrated in the FTSE 100 Index graph below.

 

Source: http://www.londonstockexchange.com

The final quarter of 2018 saw a drop in world markets which took many investors by surprise. In contrast, the first quarter of 2019 produced a bounce back. That rally continued more modestly into the second quarter. The result is that the first half figures shown below paint a rosy picture which, according to Reuters, could well be the best first half ever for global markets: 

	31/12/2018	28/063/2019	Change in H1	Change in Q2
FTSE 100	6728.13	7425.63	10.37%	2.01%
FTSE 250	17502.05	19462.1	11.20%	1.80%
FTSE 350 Higher Yield	3391.45	3648.22	7.57%	-0.16%
FTSE 350 Lower Yield	3709.33	4226.99	13.96%	4.48%
FTSE All-Share	3675.06	4056.88	10.39%	1.98%
S&P 500	2506.85	2941.76	17.35%	3.79%
Euro Stoxx 50 (€)	3001.42	3473.69	15.73%	3.64%
Nikkei 225	20014.77	21275.92	6.30%	0.33%
Shanghai Composite	2493.9	2978.88	19.45%	-3.62%

MSCI Em Markets (£)	1418.635	1550.757	9.31%	2.07%
UK Bank base rate	0.75%	0.75%
US Fed funds rate	2.25%-2.50%	2.25%-2.50%
ECB base rate	0.00%	0.00%
2 yr UK Gilt yield	0.75%	0.60%
10 yr UK Gilt yield	1.14%	0.79%
2 yr US T-bond yield	2.56%	1.86%
10 yr US T-bond yield	2.76%	1.99%
2 yr German Bund Yield	-0.66%	-0.70%
10 yr German Bund Yield	0.18%	-0.40%
£/$	1.2736	1.2727	-0.07%	-2.33%
£/€	1.1141	1.1176	0.31%	-3.70%
£/¥	139.7323	137.1209	-1.87%	-4.93%

 

A few points to note from this table are: 

• The UK market recovery slowed in the second quarter, but considering all that has happened in Brexit terms a positive result was arguably surprising. The yield on the FTSE All-Share ended the quarter at 4.13%, making the UK still look relatively cheap. The corollary is that dividend cover has shrunk further to 1.41, down from 1.91 at the end of last year. 

• The US market faced its own headwinds with the ramping up of the China trade war. However, Wall Street has been helped by the Federal Reserve, which now looks likely to cut interest rates in this month. The market consensus has moved towards the possibility of three rate cuts by the year end, although that might prove optimistic if the latest weekend cooling down of the US/China trade dispute lasts beyond Trump’s next few tweets. 

• Despite the various economic worries (Italy, Germany, Brexit…), the Eurozone markets performed well. As in the US, there was central bank assistance, with the ECB changing its no rate change signal from the end of 2019 to Summer 2020 and hinting at further monetary assistance. 

• Emerging markets joined the recovery, although their performances were by no means consistent. China fell in the second quarter as trade wars took their toll. 

• Bond yields reacted to the more dovish stance of the central banks. The US yield curve has now inverted to the point where the 10-year benchmark bond yield is edging 2%, while the Fed funds rate remains at the 2.25%-2.50% set last December. The corresponding 10-year yield in Germany has sunk slightly further into negative territory while the value of negative yielding bonds globally has reached a new record of $12.5tn according to Bloomberg. In spite of the resignation of the Prime Minister and the ongoing Brexit pantomime, 10-year UK gilts joined in the yield-falling fun, dropping 0.18% over the quarter and 0.35% since the end of 2018. 

Whether or not it was the best first half ever, it was certainly a better performance than nearly anyone would have predicted in the gloomy days of late December.   

Sources: FT, FTSE, MSCI, LSE, Stoxx, Bank of England, Federal Reserve, European Central Bank

USA Triple Highs

The three most commonly quoted US stock market indices hit all times highs simultaneously on 3 July.

 

Source: uk.finance.yahoo.com

The USA went into its 4 July Independence Day holiday with its three main stock market indices having each closed at an all-time high the previous day. As the graph shows, the path to this triple achievement has not been smooth over the past year – broadly speaking the indices are only marginally above where they were eight months ago, after a rollercoaster ride in the last quarter of 2018 and first quarter of 2019, and a smaller repeat in May and June of this year.

Given that the rally in US equities started back in March 2009, it is surprising that new highs are still being achieved over ten years later. The latest market fillip can be pinned on several factors, most of which we have discussed in Bulletins before: 

• US short-term interest rates look to be heading down. As we recently remarked, the Federal Reserve has changed tack in the past six months and July could see its first rate cut. The market is pricing in three reductions during the remainder of the year. 

• The appointment of Christine Lagarde as the next head of the European Central Bank has also helped, as she is expected to follow her predecessor’s plans for further easing of European monetary policy. 

• It is the third year of the US presidential cycle, which has traditionally been the strongest for US equity markets. Presidents seeking re-election will not risk the economy faltering in the run up to the polls. The Donald, who measures himself by the Dow, is no different – hence his recent bitter criticism of the chairman of the Federal Reserve for not cutting interest rates. 

• The US/China trade war seems to have cooled slightly. That is down to Trump’s decisions to suspend the next round of tariff increases and ease back on Huawei following his G20 meeting with Xi Jinping. 

• The technology story is still going strong. Although not obvious from the graph above, the technology sector (aka FAANGs) has been a significant factor in driving up the US market over the last 10 years. For example, since March 2009 the NASDAQ Composite, which has a heavy tech weighting, is up 432% against 275% for the S&P 500.

This latest set of peaks arrives as trading volumes will start to thin for the Summer holidays. From current levels, anything that knocked the market’s confidence could lead to considerable volatility – as happened last December.

SOURCE: Yahoo Finance

 

PENSIONS 

The 60% tax band grows ever wider, how can pension contributions help?

(AF3, FA2, JO5, RO4, RO8) 

In recent years the personal allowance has seen significant increases and now stands at £12,500 for 2019/20.  The threshold for the loss of the personal allowance, however, has remained fixed at £100,000 since its introduction in 2010.  This means the band at which client’s pay an effective rate of 60% has grown substantially to £25,000.  It is a strange quirk of the tax system to have marginal income tax rates of 20%, 40%, then 60%, then falling back to 40% before finally rising to 45% again once income reaches £150,000. 

The 60% effective rate is due to the fact that income in this band is not only taxed at 40%, it also reduces the personal allowance on a 2 for 1 basis.  That is for each £2 of additional income above £100,000 the personal allowance reduces by £1.  At income levels above £125,000 the personal allowance is zero.  

The personal allowance income limit is based on an individual’s adjusted net income.  For those familiar with tapered annual allowance calculations, note that this is quite different from the adjusted income figure used there.  However, adjusted net income involves the same first step, which is to calculate the individual’s total taxable income or ‘net income’ before the personal allowance. This includes income such as earnings, profits from self-employment, rental income and dividends and is after deductions for pension contributions made gross, such as occupational pension contributions deducted from salary before tax is calculated, or an AVC paid gross to an occupational scheme.  

From the ‘net income’ figure two important deductions are made to arrive at ‘adjusted net income’.  These are the grossed up value of any relief at source pension contributions and any charitable donations made by Gift Aid. 

Personal contributions to both occupational schemes and personal pensions schemes will therefore reduce the adjusted net income figure and so can restore some or all of the personal allowance. 

Making personal pension contributions, example: 

Keith has income of £125,000 in 2019/20.  A net (relief at source) pension contribution of £20,000 receives £5,000 relief at source.  His net income falls by £10,000 in return for a pension contribution of £25,000 - an effective rate of tax relief of 60%. 

	No pension	Personal pension contribution
Income	£125,000	£125,000
Personal allowance	£0	£12,500
National Insurance	£6,464	£6,464
Tax	£42,500	£32,500
Net personal pension contribution	£0	£20,000
Net income	£76,036	£66,036
Effective tax relief		60%

 

Salary Sacrifice 

Where salary sacrifice is available clients can receive even greater benefits.  As well as reducing taxable income, a reduction in salary will also lower both the employee and employer National Insurance (NI) contributions.  Where the employer is willing to re-invest their NI savings the effective rates of tax can be up to 66%. 

If Keith instead was able to make his pension contribution via salary sacrifice for a net cost of just £9,500 an employer contribution could be made of £28,450. 

	No pension	Salary sacrifice and employer contribution
Income	£125,000	£100,000
Personal allowance	£0	£12,500
National Insurance	£6,464	£5,964
Tax	£42,500	£27,500
Net income	£76,036	£66,536
Employer contribution		£28,450
Effective tax relief		66.61%

 

Note though that in terms of the tapered annual allowance, whilst any personal contributions via relief at source schemes will reduce the client’s Threshold Income, using salary sacrifice will not.  Any new salary sacrifice arrangements will be added back to the client’s other income. 

Differences in pension death benefits for same sex and opposite sex couples

(AF3, FA2, JO5, RO4, RO8) 

Following the Marriage (Same Sex Couples) Act 2013 the Government are were obliged to review survivor benefits in occupational pension schemes. The review looked at differences in occupational pension schemes, namely: 

• same sex widows and opposite sex widows
• same sex widowers and opposite sex widowers
• opposite sex widows and opposite sex widowers

It doesn’t make any distinction between civil partners or married couples because there shouldn’t be any difference in benefits available. 

HMT liaised with relevant parties both inside and outside of Government to obtain details of any differences applicable. GAD was also commissioned by HMT and DWP to estimate the costs of removing these differences. 

Key findings of the review include: 

• The capitalised cost of removing differences in survivor benefits between opposite sex surviving spouses, same sex surviving spouses and surviving civil partners in the public service pension schemes is estimated at around £2.9 billion.
• Of this around £1 billion would be payable immediately in respect of benefits due before 1 April 2015. It is estimated there would then be ongoing costs across public service schemes of around £0.1 billion per annum into the 2020s, reducing thereafter.
• The estimated cost to the private sector schemes of removing these differences is around £0.4 billion.
• Removing differences in the survivor benefits provided to surviving same sex spouses and civil partners on the one hand and those provided to opposite sex widows on the other is estimated to have a capitalised cost of around £0.08 billion to the public service schemes
• The estimated cost to private sector schemes of removing these differences is around £0.1 billion.
• If private sector schemes were to provide benefits to same sex couples on the same basis as opposite sex widowers, as most public service schemes do, this is estimated to cost £0.1 billion.
• Public service schemes exceed the statutory minimum requirement which permits occupational pensions schemes to provide survivor benefits for same sex couples only taking account of service since 2005. However, the majority of public service schemes only take into account service from 1988 when calculating same sex survivor benefits, and so rely on paragraph 18 of Schedule 9 of the Equality Act.
• Of the 27 per cent of private pension schemes that were found to have a difference in the way survivor benefits between surviving opposite sex spouses and surviving civil partners were calculated, around two-thirds only took into account accruals after 2005 in those calculations.

Full details of the findings can be accessed here.

Updated pensions quality mark launched by Pension and Lifetime Savings Association

(AF3, FA2, JO5, RO4, RO8) 

The PLSA have updated their Pension Quality Mark (PQM) standards for new applications from July 2019. Those renewing will be able to transition to the new standards over time. 

The changes in the standard reflect not only changes in regulation and practice since the original launch in 2009 but also a report produced by the PLSA in 2018. 

The report called Hitting the Target has resulted in the minimum contribution standard being increased. These are:  

• 12% for PQM with at least 6% from the employer 
• 15% for PQM Plus with at least 10% from the employer

In full to obtain PQM accreditation, sponsoring employers must:   

• Set default contributions designed to deliver an adequate retirement income
• Enrol employees at minimum combined contribution rates of pensionable pay as above
• Provide the trustee board or pension committee with adequate support and resources to operate effectively
• Encourage participation in the pension scheme and, where appropriate, higher contribution rates than the PQM minimum
• Support retiring members of the scheme in making pension decisions