At PMQs today, Ed Miliband attacked the Government for what he described as a tax loophole for hedge funds. This was quite a misleading way to describe a strategic tax cut to boost the investment management industry and ultimately make it easier to generate returns for most people’s pensions. It is also telling that Miliband chose to describe a tax cut as a form of tax avoidance. In his worldview, it would seem, all earnings belong to the state and it’s only through the benevolence of those in power that we get to keep some of it. This is of course to say nothing of the fact that Labour also did its bit when in government to reduce the burden of stamp duty reserve tax.
Obviously, tax avoidance and evasion are a concern for many. The solution is to make the system much simpler and more transparent. This would level the playing field and boost revenues. The problem with this particular tax hike proposal from Miliband is that perversely it may encourage more tax avoidance. Imposing this extra cost would encourage funds to move to other countries and to go offshore as they have been doing in recent years. Whilst the “moving abroad” argument can sometimes be overplayed, investment funds out of all businesses are almost uniquely capable of actually doing so.
In The Cost of Labour which we published last year, I analysed the party’s tax policies including its proposals to reverse the cut to stamp duty reserve tax. I think it is worthwhile quoting a section from the paper which highlighted the problems with Miliband’s proposal:
“The Coalition abolished the SDRT charge on unit trusts and open-ended investment companies (OEICs) in 2014. Labour has since proposed reintroducing the Stamp Duty Reserve Tax (SDRT) charge from Part 2 of Schedule 19 of the Finance Act 1999.
Unit trusts and OEICs are professionally managed collective investment funds. Managers pool money from many investors and buy shares, bonds, property or cash assets and other investments.
SDRT is a tax for electronic ‘paperless’ share transactions and is payable on paperless transaction when buying shares in a UK company, shares in a foreign company which are registered in the UK and rights arising from shares already owned amongst other transactions. SDRT, unlike Stamp Duty, is payable when shares are bought electronically without a stock transfer form.
It is assumed that Labour will reintroduce SDRT in the same form as it was before its abolition. SDRT is set at 0.5% of the transaction value and for the majority of UK shares SDRT is deducted automatically from chargeable trades. SDRT is not charged when buying units from a fund manager but when units are surrendered the fund manager is charged SDRT.
The investment management industry accounted for about 1% of the UK’s GDP in 2011 and a similar proportion of tax revenues. It manages £4.9 trillion of funds and is also a major source of funding for businesses, accounting for over a third of all investment in UK equities.
The size of the UK’s fund management industry is generally measured by the value of Funds under Management (FUM) of Authorised investment funds (AIFs), £468 billion at 30 September 2007. This is a subset of the total £4.9 trillion assets under management in the UK.
Over the last ten years the UK has lost ground to both Luxembourg and Ireland as the leading location for European funds. The UK is also under competitive pressure from jurisdictions outside the EU.
A report published by IMA and KPMG confirmed that taxation has a significant influence on the decision of participants to locate funds outside the UK. The main specific tax reasons for locating funds outside the UK are direct tax at the fund level and SDRT.
Further research suggests that Schedule 19 SDRT accounted for approximately 16% of the total net investment costs in the relevant industries. Reintroducing SDRT would therefore place the UK at a competitive disadvantage. This is especially the case given the growth in offshore funds; the amount of offshore funds under management in 2013 at £64.5 billion was three times higher than in 2007.
From the OBR’s policy costings, it is assumed that the reintroduction of SDRT would be a tax rise of £160 million in 2015/16 and 2016/17, £165 million in 2017/18 and £170 million in 2018/19. Fund managers pay the SDRT directly to HMRC and it is assumed that 50% of this will be largely passed on to the unit holders through higher management fees i.e. higher prices.
These higher prices will reduce returns to savings and affect GDP in the longer term. However, the tax rise will also reduce the ability of UK funds to attract non-UK investors. This will have an impact on the total fees and thus investment, dividends and employee compensation which the industry can generate.”
So Miliband’s proposal would cut the returns to savings, damage a highly mobile, important industry and maybe even push firms abroad. Not his best idea.