PFS What's new bulletin - October I

TAXATION AND TRUSTS

Basis period reform - more HMRC guidance (AF1, AF2, JO3, RO3)

How basis period reform affects unincorporated taxpayers, i.e self-employed sole traders and those trading in a partnership

HMRC’s latest Agent newsletter provides more guidance around basis period reform and reporting profits on a tax year basis.

All sole trader and partnership businesses must now report their profits on a tax year basis, beginning with the self-assessment return due by 31 January 2025 (covering the tax year 2023/24).

Any business that previously had a non-tax year accounting period must declare profits from the end of their basis period in 2022/23 up to 5 April 2024, with the additional profit (after overlap relief) being transition profit. The transition profit will be spread by default over five tax years including 2023/24. Accounting periods ending on 31 March will now be treated as equivalent to those ending on 5 April. This also applies to property businesses.

Businesses remain free to choose their accounting date. Any business that continues to have a non-tax year accounting period after 6 April 2024 will need to apportion profits from their accounting periods to the tax year.

HMRC has now launched a package of online interactive guidance that is intended to support completion of the return and working out transition profit for these cases.  And it has provided an online service to ask HMRC what the overlap relief figure is according to its records.

HMRC adds that it has recently seen a major increase in demand and at present response times are not as quick as it would like, but it is now clearing the backlog of requests. Anyone who has applied and not heard back, can check the progress of their request. However, HMRC asks that people do not contact it directly as it expects to have cleared the current backlog in the coming weeks.

 

HMRC requests that people only use the online form if it is necessary, as it is not intended to be used to ‘check’ a figure that the individual already holds and there is no requirement to use the service before filing a return. It says, dealing with these cases can slow down its response times for all. Taxpayers can find further guidance and support at basis period reform.

 

Latest statistics show an increase in corporation tax receipts (AF2, JO3)

Recent corporation tax statistics published by HMRC, which show corporation tax receipts increased by 10% in the financial year ending 31 March 2024.

Corporation tax receipts increased by £8.8 billion (10%) in the financial year ending 31 March 2024, to £93.3 billion, up from £84.5 billion in the previous year.

The increase in total corporate tax receipts was mainly due to the increase in the corporation tax main rate to 25%, and the introduction of the Electricity Generator Levy (EGL), but was partially offset by lower offshore corporate tax receipts. Financial and Insurance (including Bank Levy and Bank Surcharge) was the largest contributor to corporation taxes receipts in in the financial year ending 31 March 2024, accounting for £20.2 billion or 24% of the total.

A £11.3 billion (18%) growth in total corporation tax liabilities, from £66.1 billion in the previous year to £81.5 billion in the financial year ending 31 March 2023, was driven by continued growth in trading profits.

In the financial year ending 31 March 2023, approximately 6,000 companies (0.4% of all companies who had an amount of tax to pay) had liabilities over £1 million and contributed 60%, or £44.7 billion, of total corporation tax liabilities. In contrast, approximately 1 million companies (65% of all companies who had an amount of tax to pay) had liabilities of less than £10,000 and these contributed just 4%, or £3.2 billion, of the corporation tax liability total.

Total capital allowances claims minus balancing charges, were £155.3 billion in the financial year ending 31 March 2023, an increase of over £24.2 billion (18%) on the previous year. Capital allowances are a type of tax relief for businesses for qualifying capital expenditure. They allow a company to deduct some or all of the value of an item from their profits before they pay tax. The purchase of capital equipment giving capital allowances will sometimes “compete” with expenditure on occupational pensions.

 

Capital allowances claims in the financial year ending 31 March 2023 were £48.9 billion, or 46%, higher than the pre-pandemic levels of the financial year ending 31 March 2020. The increase in total capital allowances claims, between then and the financial year ending 31 March 2023, was largely driven by the introduction of the super-deduction, which enabled companies to claim 130% capital allowances on qualifying plant and machinery investments. And a £5.4 billion, or 32%, decrease in Annual Investment Allowance (AIA) claims in the financial year ending 31 March 2023 was mainly due to companies utilising the super-deduction for eligible expenditure instead of the AIA. According to the statistics, 44% (£67.7 billion) of total capital allowances claims in the financial year ending 31 March 2023, were made by approximately 345 companies, or just 0.03% of the total number of companies who made a capital allowances claim.

 

You can read full details of these latest statistics here. They cover receipts data for financial year ending 31 March 2024, and liabilities data up to 31 March 2023.

 

When a company submits a corporation tax return to HMRC with details of the taxable profits for their accounting period, the amount of tax that needs to be paid is known as their liability. When a company makes a payment to HMRC in relation to corporation tax, these are known as receipts. Liabilities are recorded against the tax year to which they accrue, whereas receipts are recorded against the tax year in which they are paid. It will be 31 March 2025 before all companies will be required to submit their corporation tax return form for liabilities in the financial year to 31 March 2024.

 

It will be interesting to see what the next set of Office for Budget Responsibility (OBR) projections say regarding future corporation tax receipts, due for publication on 30 October.

Separately, HMRC has also published Patent Box relief statistics. The Patent Box enables companies to apply a lower rate of corporation tax to profits earned after 1 April 2013 from its patented inventions.

 

 

INVESTMENT PLANNING

ISAs and fractional shares - a confirmation from HMRC (FA5)

HMRC’s latest tax-free savings newsletter provides an update on fractional interests in Individual Savings Accounts (ISAs) and Child Trust Funds (CTFs).

It says that consultation has recently closed on draft regulations which will enable certain fractional interests to be held in an ISA or CTF and that HMRC expects these changes to take effect in coming months.

For the purposes of the regulations, a ‘fractional interest’, commonly known as ‘fractional shares’, is a contractual arrangement between the ISA manager and the investor that allows the investor to invest in a proportion of a whole share that is held by the ISA manager or their nominee. 

HMRC says that it will be focusing on ensuring ISA managers are fully compliant with the new regulations. Where any ‘fractional shares’ are not eligible under the new regulations, ISA managers will be required to remove them from their affected ISAs. 

Any fractional interests acquired prior to the changes to the regulations may be retained within the account but, once the amended regulations come into force, all fractional interests held in ISAs or CTFs must meet the requirements of those amended regulations. This may require ISA and CTF managers to make changes to:

• how those investments are held within their products;
• the terms agreed between the manager and the account investor.

HMRC says that it will enforce compliance strictly where an ISA or CTF does not comply with the amended regulations, including considering the removal of ISA manager status, where necessary.

It will work with managers and their industry representatives over the coming months to make clear what the new regulations require of managers.

Background

With fractional shares, rather than owning a share in a company, individuals own fractions of one or more shares. This could be useful, where, for example, the price per whole share in a company is prohibitively high, or a whole share would cost more than the £20,000 annual ISA subscription.

The emergence of fractional shares post-dates the ISA regulations. Last October, HMRC issued a definitive answer on the topic of fractional shares in ISAs, by way of its tax-free savings newsletter. At that time, HMRC said, a fraction of a share is not a share and therefore cannot be held in ISAs. ‘Shares’, as referred to in paragraph 7(2)(a) of the ISA Regulations, refers only to whole shares and not parts or derivatives thereof. A fraction of a share does not give the investor the same legal rights as a whole share does. Fractional shares could only qualify for inclusion in ISAs if the ISA Regulations were amended to allow them. HMRC’s then newsletter went on to say that, where fractional shares are an underlying investment in a collective investment scheme or fund (for example an exchange traded fund), they are not subject to the same restrictions. At that time, HMRC said that any ISA managers who allow fractional shares to be purchased or held within their ISAs as a qualifying investment under Regulation 7(2)(a) should contact HMRC by email at savings.compliance@hmrc.gov.uk.

The previous Government announced, in the November 2023 Autumn Statement, that it intended to “permit certain fractional shares contracts as eligible ISA investments” and would engage with stakeholders on the implementation of new legislation. This commitment was repeated in the March 2024 Spring Budget, with it saying that it was “working as quickly as possible to bring forward legislation by the end of the summer”. This was then put on hold by the general election in July.

We recently reported on a recent AccountingWEB article, which quoted a spokesperson for the new Government has having said: “We have committed to changing the ISA rules to allow certain fractional shares. Taking a pragmatic approach, HMRC will not raise an assessment on managers or investors for fractional shares acquired before these changes are made.”

UK Government introduce Bill to define the legal status of cryptocurrency in England and Wales (AF4, FA7, LP2, RO2)

The new Property (Digital Assets etc) Bill, which regards cryptocurrency, non-fungible tokens and carbon credits as personal property

Having been recommended in the Digital Assets: Final Report published by the Law Commission in June 2023, it has been announced in Parliament that the Government are going forward with the Property (Digital Assets etc) Bill, via the Law Commission’s special procedure.

Under the Bill, cryptocurrency, non-fungible tokens (NFTs) and carbon credits will be regarded as personal property under law for the first time in the UK. Prior to this, England and Wales property law traditionally recognised two categories of personal property, which excluded such digital assets.

These categories were:

• Things in possession – assets which are tangible, moveable and visible such as furniture or a bar of gold.
• Things in action – assets which can be claimed or enforced through legal action or proceedings such as debts or shares in a company.

The Government have indicated that the introduction of the Bill will also give owners and companies more legal protection over scams and fraud. Also, it is expected to aid judges in dealing with complex cases whereby digital holdings are disputed or form part of a settlement, for example in a divorce case.

It is said that the Bill will better equip the legal sector in responding to new technologies. The Government say: ‘It is essential that the law keeps pace with evolving technologies and this legislation will mean that the sector can maintain its position as a global leader in crypto-assets and bring clarity to complex property cases’

The Government have also asked the UK Jurisdiction Taskforce to take forward the recommendation that the Government should set up an expert group on control of digital assets. This was a further recommendation made in the Digital Assets report by the Law Commission.

It is expected that HM Treasury will review other recommendations from the report. One of these recommendations is setting up a multi-disciplinary project in order to formulate a statutory framework for the operation and enforcement of specific crypto-token and crypto-asset collateral arrangements. Parliament have advised that HM Treasury will provide an update on this in due course.

 

PENSIONS

PPF publishes consultation on draft levy rules for 2025/26

(AF8, FA2, JO5, RO4)

The Pension Protection Fund (PPF) published its 2025/26 Levy Consultation on the levy to be invoiced in autumn 2025. The PPF expects to collect a total levy of £100 million, which equals its lowest ever target and is in line with last year. The distribution of the total levy between schemes would change slightly based on the proposals, but the PPF expects only 5% of schemes that pay a risk-based levy to see an increase of more than 0.01% of their liabilities.

A levy collection target of £100 million is in line with expectations. Given restrictions in legislation on the PPF’s ability to increase the levy from one year to the next, the PPF stated last year that it planned for the collection target to remain “at or above £100 million in future years” – at least until such time as those legislative restrictions are amended. This year the PPF has added “we will continue to engage with the Government on legislative changes to enable us to reduce the levy further and even to zero. We will keep progress on this under review and not charge for longer than we need”.

Except in areas whether the changes are most significant (notably, the process for certifying Deficit Reduction Contributions), the PPF has not published draft appendices and guidance documents on the various core topics – rather, it has incorporated detail of the proposed changes in the consultation document.

What are the main proposals for 2025/26?

• Collect £100 million total levy, rather than a smaller amount that is, arguably, justified by the current funding positions of schemes and the PPF itself, in order to retain the ability to increase levies significantly in future, if needed.
• Prevent a decline in the pool of schemes that pay risk-based levies by amending some of the parameters within the levy calculations. Without these changes to parameters, the PPF estimates that the number of risk-based levy payers would decline by 40% (which would otherwise concentrate the £100 million levy collection upon fewer schemes).
• Widen the definition of contributions that can be certified as Deficit Reduction Contributions, to recognise that sponsors may pay contributions to a scheme without a Recovery Plan, for example in order to accelerate the path towards an insurance transaction, and also extending the simplified Option Beta certification option to all schemes.
• Make it easier for schemes with full insurance buy-ins to access risk-based levy waivers.

 

What technical changes are proposed in order to achieve these aims?

• Increase the scheme-based levy (SBL) multiplier to 0.0018% from 0.0015%, so that the proportion of the levy that is scheme-based is set to the legislative maximum of 20% (as in 2024/25).
• Reduce the Levy Scaling Factor (LSF) to 0.35 from 0.40, in isolation reducing risk-based levies.
• Base levies on the latest ‘A11’ version of the PPF’s s179 valuation assumptions, to take account of changes in buy-out pricing in the insurance market.
• Retain a cap on the risk-based levy of 0.25% of protected liabilities.
• Update asset and liability stress factors in the levy calculation to two standard deviations rather than one standard deviation. This is aimed at protecting the PPF from low-probability but high-impact downside scenarios. In isolation, this change would increase levies for schemes whose funding positions are less resilient to economic shocks.
• Further update asset and liability stress factors to include historical volatility data up to December 2023. This update would mean that the stress factors would incorporate the period of increased interest rate volatility in 2022 for the first time.
• Following the PPF’s change to using two rather than three credit rating agencies in insolvency scoring last year, update the mapping of credit ratings to levy bands and rates.

Changes affecting certain types of employer

The PPF has also included content in the consultation about certain categories of employer whose insolvency risk may be measured differently from the majority of pension scheme sponsors. In particular, the PPF has asked for stakeholder views on:

• Whether there are any types of employers that are not currently able to be recognised as ‘Special Category Employers’ but are similarly at very low risk of insolvency (currently, this includes organisations that are part of Central Government, the Crown, or are established by legislation or treaty).
• Whether it is appropriate to make a different set of amendments in relation to “Alternative Covenant Schemes” (meaning those which form part of a commercial consolidator and schemes without a substantive sponsor).

The consultation closes at 5 pm on Wednesday 23 October 2024. Please let us know if you would like a further discussion on these topics or support in responding to the consultation.

It is expected that the final rules will be published in December 2024.

 

IFS: Policies to improve employees' retirement resources

(AF8, FA2, JO5, RO4)

 

The Institute for Fiscal Studies (IFS), in partnership with the abrdn Financial Fairness Trust, has published research report: Policies to improve employees' retirement resources. The report examines how public policy can be adapted to improve retirement outcomes for employees by accumulating private pension wealth. Using new modelling from the Pensions Review (O’Brien, Sturrock, and Cribb, 2024), along with public engagement and focus group insights, it focuses on private sector employees and the defined contribution (DC) pension system. A significant emphasis is placed on automatic enrolment, which has been highly effective in shaping private sector retirement savings (Cribb and Emmerson, 2020).

 

The modelling shows that private sector employees face significant challenges in accumulating pension wealth. Key factors influencing this are:

 

• State Pension Enhancements: Over the past two decades, the State Pension, particularly its flat-rate component, has become more generous, especially for women, the self-employed, and low-income earners. This stronger foundation for retirement income reduces reliance on private pensions for certain groups.
• Automatic Enrolment Success: Automatic enrolment has brought millions of private sector employees into workplace pensions, particularly those on lower and average earnings. However, around 25% of private sector employees still do not contribute to a workplace pension. Of those who are enrolled, fewer than half contribute more than 8% of their total earnings, which is considered insufficient for a comfortable retirement.
• Economic Challenges: Recent economic changes, such as slower earnings growth, lower asset returns, and increased longevity, make it harder to build pension wealth. Middle- and higher-income earners, who rely more on private pensions, are particularly affected.

 

While more than half of DC savers are on track to meet retirement income adequacy benchmarks, a substantial minority is at risk of undersaving. For example, when using the Pensions and Lifetime Savings Association’s (PLSA) 'minimum standard' for retirement, one-third of DC savers fall short, with this rising to two-thirds among those in the lowest earnings quartile. For these groups, saving more for retirement may not be feasible given their current financial pressures.

 

The report suggests a range of policy recommendations to balance the need for higher pension savings with the challenge of maintaining adequate living standards during working life:

 

• Wider Automatic Enrolment Eligibility: Automatic enrolment should cover all employees earning enough, starting from age 16 up to 74 (instead of the current 22 to State Pension Age). This would simplify the system and include more workers in workplace pensions.
• Non-contingent Employer Contributions: Employers should provide a minimum contribution of 3% of total pay, even if employees choose not to contribute. This would ensure that those opting out or ineligible for automatic enrolment still benefit from employer contributions, particularly helping lower earners.
• Cautious Approach for Lower Earners: Raising pension contributions for lower earners should be handled carefully to avoid reducing their take-home pay, which could affect their ability to meet current financial obligations.
• Lowering the Qualifying Earnings Threshold: Lowering the earnings threshold to zero could increase pension contributions by £500 annually for those automatically enrolled. However, for low earners, this may result in a notable reduction in take-home pay, so a gradual approach may be preferable, potentially through liquid savings accounts similar to the NEST sidecar model.
• Targeting Higher Contributions Later in Life: Increasing pension contributions for individuals in their 50s or 60s when they are typically more financially stable (after major expenses like mortgages or student loans) would help raise overall pension savings without impacting working-age living standards.
• Raising the Upper Earnings Limit: Currently, employees earning above £50,270 contribute a declining percentage of their earnings to pensions. The report suggests raising this limit to £90,000 to ensure higher earners contribute a higher proportion of their income.
• Regular Reviews of Automatic Enrolment: Given the dynamic nature of pension savings, the parameters for automatic enrolment should be reviewed regularly to ensure they align with inflation and earnings growth, ensuring the system remains relevant to current savers.

 

In summary, these policy suggestions aim to boost private pension saving without significantly reducing employees' take-home pay. By targeting higher contributions at stages in life when saving is easier and ensuring automatic enrolment thresholds keep pace with economic changes, the recommendations aim to improve long-term retirement outcomes. Additionally, allowing employees flexibility to ‘opt down’ to lower contribution rates rather than ‘opting out’ would help protect their employer contributions and support a more sustainable pension savings system.

 

PPI: Pension scheme assets — a deep dive into alternatives

(AF8, FA2, JO5, RO4)

The Pensions Policy Institute (PPI) recently published Pension Scheme Assets – A Deep Dive into Alternatives, analysing the changing investment landscape for UK pension schemes, with a particular focus on alternative assets. This is the first in what will be a series of reports. The report outlines the evolution of pension fund investments, assesses current investments in alternatives, and discusses potential future trends for Defined Benefit (DB) and Defined Contribution (DC) schemes.

Shifting Towards Alternative Assets

Alternative assets, which include private equity, private credit, property, and infrastructure, are not publicly listed and tend to be less liquid than traditional investments like equities and bonds. Historically, pension schemes have primarily invested in publicly traded assets, but the investment landscape has shifted, with both DB and DC schemes increasingly adopting alternatives into their portfolios.

 

The report highlights that alternatives allow pension funds to diversify, manage risk, and seek enhanced returns through the illiquidity premium, which compensates investors for holding less liquid assets. However, accessing alternatives requires larger-scale funds due to higher costs and the need for specialised expertise.

DB Schemes and Alternatives

DB schemes have evolved significantly in their investment strategies over the past 50 years. In the 1960s and 70s, pension funds diversified into alternatives, especially property. By the 1980s, however, the focus shifted toward equities, particularly international equities. The 2000s, following the Global Financial Crisis, saw a reversal back to bonds and alternative assets as schemes de-risked.

Today, private sector DB schemes, though closed to new members in most cases, still hold the largest share of pension assets. Around 14% of these assets are invested in alternatives, with the majority held in bonds. For schemes targeting buyout, divesting from alternatives is common to make their portfolios more attractive to insurers. However, once the liabilities are transferred, insurers may look to increase exposure to alternatives to meet long-term income needs, especially in areas like private credit and infrastructure.

Public Sector DB Schemes

Public sector DB schemes, which remain open to new members, have a broader investment approach. The Local Government Pension Scheme (LGPS), for example, allocates 24% of its £500 billion in assets to alternatives, with the rest largely in equities. The ongoing contributions from active members and the younger age profile of these schemes mean that growth assets, including alternatives, continue to play a key role in their investment strategies.

The Universities Superannuation Scheme (USS) is another example of an open DB scheme that has embraced alternatives. It currently invests 34% of its £75 billion in assets into alternatives, demonstrating the potential for DB schemes to leverage alternatives for long-term growth.

DC Schemes and the Future of Alternatives

The PPI report underscores the growing role of DC schemes, especially since the introduction of automatic enrolment. Despite rapid growth, only 3% of DC assets are currently allocated to alternatives. The size of the DC market is expected to triple by 2030, from £143 billion to £420 billion. As these schemes continue to expand and consolidate, their ability to invest in alternative assets will increase.

One of the main challenges facing DC schemes is the technical and regulatory barriers to investing in illiquid assets. The requirement for daily valuations in DC schemes makes it harder to include illiquid alternatives. Additionally, the charge cap on DC schemes has limited investment in higher-cost alternatives. However, recent regulatory changes allow trustees to exclude performance fees from the cap, giving schemes more flexibility to invest in alternatives.

 

The Long-Term Asset Fund (LTAF)

The introduction of the Long-Term Asset Fund (LTAF) by the Financial Conduct Authority (FCA) is seen as a solution to the liquidity challenges faced by DC schemes. The LTAF is designed to facilitate investments in long-term private assets such as infrastructure and private equity while managing liquidity risks.

Major asset managers, including Schroders and Blackrock, have launched LTAFs to offer DC schemes access to alternative assets. While these funds may increase charges for members, they provide diversification and potential for long-term growth.

The Expanding Role of Alternatives in Pension Investments

The report indicates that the role of alternatives in pension investments is set to expand significantly. For DB schemes, particularly those targeting buyout, alternatives will play a critical role in generating long-term income streams that align with liabilities. Open DB schemes, such as LGPS, will continue to allocate assets to alternatives as part of their growth strategies.

For DC schemes, the transition to alternatives will be slower but is expected to accelerate as consolidation increases and larger-scale funds emerge. The growing emphasis on value for money (VFM) within DC schemes, along with regulatory flexibility, supports this transition. Environmental, social, and governance (ESG) considerations, particularly in relation to Net Zero targets, are also likely to drive pension schemes to invest more in alternative assets like social housing and green infrastructure.

Conclusion

The PPI report provides a detailed examination of the evolving role of alternative assets in UK pension schemes. While DB schemes have historically led the way in alternative investments, DC schemes are poised to follow as they scale up. The introduction of the LTAF and regulatory changes around fees will enable this transition. Overall, the increased use of alternative assets offers pension schemes the opportunity to diversify their portfolios, manage risk, and seek higher returns, ultimately benefiting both schemes and their members.