How the make-or-break Budget could affect trusts
A make-or-break Budget threatens to bring a raft of tax rises for savers and investors; here’s how investment companies will fare.
Nobody is expecting any giveaways when chancellor Rachel Reeves delivers her Budget on 26 November given the need to fill a £20bn blackhole with a combination of spending cuts and tax rises.
In a rare pre-Budget speech earlier this month, Reeves signalled to financial markets and the public that tough choices are on the way and she was willing to do ‘what is necessary to fix the economy’, even refusing to rule out breaking manifesto pledges not to raise income tax, VAT or national insurance.
Investors are bracing for a hit, including those with their money in the £263bn investment companies’ sector.
Stifel analyst Iain Scouller warned that ‘any measures to increase tax-take on dividends and capital gains are detrimental for the sector and equity investment more broadly’.
He added that any measures, such as freezing income tax thresholds, reducing salary sacrifice on pensions, and even raising council tax rates ‘all have the effect of leaving investors with less money in their pocket to put towards saving and investment’.
An eye on ISAs
The £20,000 a year allowance for investing in tax-free cash individual savings accounts (ISAs) is a prime candidate for a cut and rumours have been swirling that Reeves could slash it to as low as £4,000.
Scouller said the argument for cutting the cash ISA allowance but not the stocks and shares ISA allowance is to ‘encourage greater investment in equities, including investment companies’.
But he is sceptical of this plan: ‘We doubt that would be the case with many cash holders not wanting to take equity risk while they save for house deposits or care home fees.’
Instead he said the cut in the allowance was more likely to be a Treasury ‘ploy to reduce the tax leakage resulting from investors saving through ISAs as tax-free wrappers’.
‘Any change would probably just deter savers full stop and not result in flows re-directed to investment companies and broader equities,’ said Scouller.
The Association of Investment Companies (AIC) has called for ISA reform ahead of the Budget, urging the government to scrap the different cash and stocks and shares ISA and replace it with a ‘single investment ISA’.
Richard Stone, chief executive of the AIC, said too much money is held in cash where inflation erodes its value.
‘The chancellor should create a lower limit of £10,000 on ISA contributions for providers who only offer cash as an option,’ he said.
The latest HMRC figures show only a third of cash ISA savers had more than £10,000 in their pot in the 2022/23 tax year.
British ISA revival
The spring Budget last year brought with it the short-lived idea of a British ISA. Then Conservative chancellor Jeremy Hunt announced plans for a seventh ISA that would given savers an extra £5,000 allowance as long it was used to invest in British companies.
The idea was scrapped by the new Labour government following a consultation which sprouted widespread criticism over its complexity.
It appears, however, that the idea hasn’t gone away entirely, with Scouller predicting it could ‘reappear in some format’ at the upcoming Budget.
Under Hunt’s proposal, all UK listed companies would have qualified, but this was a conundrum for the investment company industry given ‘many companies only derive a small part of their revenues from the UK’, said Scouller.
‘In the case of investment companies, many of the assets are invested in companies based outside the UK,’ he said.
‘For example, should companies such as Baillie Gifford US Growth (USA ) or Fidelity China Special Situations (FCSS ) benefit from being eligible to be included in a British ISA? Many would suggest not.’
Recent data from Hargreaves Lansdown shows investors are already backing British companies in their ISAs.
Despite UK companies making up just 3% of the MSCI All Country World index, they account for 35% of investments held through either shares, equity-focused active and passive funds, and trusts by Hargreaves’ 2m clients,
However, proving the trust conundrum that Scouller highlights, the top holding in client portfolios on the platform is Scottish Mortgage (SMT ).
While the £15.7bn flagship Baillie Gifford trust is a top pick for investors, it is very firmly focused on the US, which makes up more than half of the portfolio.
Top holdings are Elon Musk’s SpaceX, Brazilian online marketplace Mercado Libre, and Taiwan Semiconductor Manufacturing – proving that a British ISA may be problematic to police.
Tax take
It is unlikely that anyone will come out of the Budget with their bank balance unscathed, and with capital gains tax (CGT) in the firing line once again, there has been some trust and equity selling in recent weeks.
Scouller said investors were worried about higher CGT rates appearing, similar to last year when there had been calls to align CGT rates with income tax rates but ended with rates increase from 10% to 18% for basic rate taxpayers and 20% to 24% for higher rate taxpayers.
‘We assume last year’s Budget reflected the Treasury’s models that indicate the higher CGT rates went, the lower revenue receipts would be,’ he said.
‘We hope this logic still holds, and lobbying from some parties for higher CGT rates will be rejected.’
Scouller said it was also unlikely that Labour would follow through with its manifesto suggestion of aligning the CGT rate on carried interest – which is the net gain on investments earned by private equity managers – with income tax rates.
‘The 2024 Budget decided against alignment, although CGT was still raised, but by a lower amount under a complex formula,’ said Scouller.
‘We assume no change this year, given the need to have long-term stability for private equity sector employees taxation, given these tend to be highly mobile international individuals.’
Stamping out duties
The AIC is once again calling for the abolition of stamp duty for investment companies that Stone said ‘puts the UK stock market at a disadvantage to overseas exchanges’.
‘It encourages investors to invest in overseas shares at the expense of home-grown companies, since they avoid a 0.5% hit on their investment returns,’ he said.
Stamp duty on AIM shares were exempted in 2014 which was ‘a good first step’ and removing it from trust shares ‘would be another one’.
‘Competing products such as open-ended funds are not taxed, which distorts the market,’ he said.
‘The current approach is also an example of double taxation, since investors pay stamp duty when they buy investment company shares, then the investment company pays it again when it invests in UK companies.’
Stone said the government could remove the stamp duty on all shares purchased within ISAs and pensions, which would ‘encourage private investors and pension funds to hold more UK shares, and remove the self-defeating bias that the UK tax system currently creates in favour of overseas equities’.
