Elizabeth Crossan

Could’ve, would’ve, should’ve!

It is human nature to look at an investment that has done particularly well and wish you had been invested in it. We all risk being dragged into ‘if only’ mind games: ‘If only I had put a £10,000 into Amazon in 2003, I’d be retired by now’[1].  ‘If only I had bought Bitcoin at £1…’. These thoughts are dangerous to investors, as this fear of missing out (FOMO) can tempt them into taking speculative risks, often based on a rear-view mirror perspective. Concentrated risks have concentrated outcomes, both good and bad.

We have a lot of respect for the fund manager Neil Woodford, but anyone reading the news lately will have seen that his concentrated, high conviction, long-term strategy takes a lot of living with, which few investors seem to have the stomach for.  His fund, which peaked at above £10 billion, has less than £4bn in it today and the doors are currently closed to new money and withdrawals. Concentration risks are real.

A powerful insight into the dangers of owning a concentrated portfolio can be found in a piece of research on the US market from 1927 to 2015[2]. Of the 26,000 companies that have been listed on the US exchanges, only 36 made it through the whole period. The total wealth of $32 trillion generated over the period was entirely accounted for by just 4% of companies.  The market as whole – the good and bad in aggregate – delivered an annualised return of nearly 7% after inflation p.a. i.e. investors doubled their money roughly every 11 years, over this period.  That’s a pretty good outcome and a direct consequence of being diversified.

The difficulties of trying to time markets or to pick companies, sectors or managers, in the face of little evidence that professional investors have persistent skill in these fields suggests that a rational investor should eschew such approaches and seek to place their investment eggs across a wide range of baskets.

Diversification is ‘always having to say you are sorry’

The challenge with owning a diversified portfolio is that sometimes investors fail to look at the big picture, diving into the detail of their portfolio valuation to pick out the fund that is not performing well, and possibly moaning about it.  Underperformance does not mean that it is a bad fund or a bad strategy or a bad manager, particularly when systematic, low cost funds are used in the portfolio to capture market returns.  It just means that some markets (or parts of markets) are zigging while others are zagging – the very essence of diversification!

A diversified portfolio is not always easy to live with, as there will always be something you don’t own that is doing better than the portfolio and always something in the portfolio that is doing poorly.  So, if your adviser has to say they are sorry sometimes about an underperforming fund always remember that a) they are not responsible for market returns and b) they are acting in your best interests by making you remain diversified and stick with the programme.

[1]  In 2003 Amazon’s stock price fell as low as $7 per share.  At the time of writing, the share price is over $1775

[2] Bessembinder, H., (2017) Do Stocks Outperform Treasury Bills? WP Carey School of Business, Arizona State University.

Other notes and risk warnings

Risk warnings

This article is distributed for educational purposes only and must not be considered to be investment advice or an offer of any security for sale. The reference to any products is made only to make educational points and must, in no circumstances, be deemed to be any form of product recommendation.

This article contains the opinions of the author but not necessarily Pacem Glover and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Errors and omissions excepted.

Those thinking about making gifts at Christmas should take advantage of the various inheritance tax (IHT) exemptions and reliefs available to them. Note that certain gifts can also have capital gains tax (CGT) implications.

THE IHT ANNUAL EXEMPTION – USE IT OR LOSE IT!

Although not particularly generous at £3,000 per donor per annum if this annual IHT exemption is not used by 5 April it is lost, although it is possible to carry the allowance forward one year if unused. This means that if the annual allowance for 2017/18 was not used an individual may make gifts of up to £6,000 in 2018/19.

Where the gifts to individuals exceed the annual exemption there may still be no inheritance tax to pay if they survive for 7 years following the gift or the gift falls within the £325,000 nil rate band.

 GIFTS OUT OF INCOME ARE NOT TAKEN INTO ACCOUNT FOR IHT

A more generous inheritance tax exemption applies where the donor can prove that he or she is not transferring capital but is making gifts out of their income. There are detailed conditions for this exemption to apply requiring records to be kept of income and expenditure in order to prove that there is sufficient surplus income each year to make regular gifts to the beneficiaries. We can of course assist you in keeping the necessary records to satisfy HMRC.

CERTAIN GIFTS CAN HAVE CAPITAL GAINS TAX CONSEQUENCES

Although there will be no CGT on gifts of cash there may be CGT to pay where the gift comprises shares or other assets. This is because the transaction will generally be deemed to take place at market value between connected persons even though no money changes hands.

The amount of the gain would normally be determined by comparing the market value with the original cost of the asset gifted.

Where the amount of this gain is within the annual CGT allowance (currently £11,700) then there would be no CGT payable.

Where the gift comprises shares in a trading company or other business assets it may be possible for donor and recipient to sign an election to hold over the gain so that no CGT is payable by the donor at the time of the gift. The effect of such an election is that the recipient of the asset will take over the donor’s original cost for subsequent disposal. Please get in touch with us if you are considering making gifts of shares or other assets so that we can advise you fully of all the tax implications.

NOT ALL SHARES QUALIFY FOR CGT ENTREPRENEURS’ RELIEF NOW

As the result of changes announced in the Autumn Budget, and now incorporated into the latest Finance Bill, not all ordinary shares necessarily qualify for the 10% CGT entrepreneurs’ relief rate on disposal.

As mentioned in last month’s Budget newsletter the definition of a personal company was tightened up so that from 29 October the shareholder must have entitlement to at least 5% of the company’s ordinary share capital, voting rights, profits available for distribution, and assets available on the winding up of the company.

The shareholder, as before, will also need to be an officer or employee of the company.

This change means that certain “alphabet” and other shares with limited rights may no longer qualify for CGT entrepreneurs’ relief when disposed of. As a consequence of this change we may need to review the rights attaching to the shares that your company has issued and make changes to ensure that the shares qualify.

 GIFTS OF UP TO £50 TO EMPLOYEES

From April 2016 new rules were introduced to allow employers to provide their directors and employees with certain “trivial” benefits in kind tax free.

The new rules were brought in as a simplification measure so that certain benefits in kind do not now need to be reported to HMRC as well as being tax free for the employee. There are of course a number of conditions that need to be satisfied to qualify for the exemption.

Conditions for the exemption to apply

• the cost of providing the benefit does not exceed £50
• the benefit is not cash or a cash voucher
• the employee is not entitled to the benefit as part of any contractual obligation such as a salary sacrifice scheme
• the benefit is not provided in recognition of particular services performed by the employee as part of their employment duties (or in anticipation of such services)

So this exemption will generally apply to small gifts to staff at Christmas, on their birthday, or other occasions and includes gifts of food, wine, or store vouchers.

Note that where the employer is a “close” company and the benefit is provided to an individual who is a director or other office holder of the company the exemption is capped at a total cost of £300 in the tax year.

Please feel free to contact us if you are considering taking advantage of this exemption.

GIFTS TO CHARITY

 Where possible higher rate taxpayers should “Gift Aid” any payments to charity to provide additional benefit to the charity and for the individual to obtain additional tax relief on the payment.

For example where an individual makes a £20 cash donation to charity the charity is able to reclaim a further £5 from HMRC making a gross gift of £25. Where the individual is a 40% higher rate taxpayer he or she is able to claim a further £5 tax relief under self-assessment, reducing their net cost to £15.

Note that the donor is required to make a declaration that they are a UK taxpayer and those that have not suffered sufficient UK tax to support the Gift Aid amount will be taxed on the shortfall.

Remember that Gift Aid does not just apply to gifts of cash. Many charity shops will now sell your donated items on your behalf and are able to treat the sale proceeds as Gift Aided donations. It is also possible to gift quoted securities and land and buildings to charity and claim Gift Aid on the market value of those assets.

From April 2019 most VAT registered businesses will need to comply with new legislation requiring them to submit their VAT returns electronically using an Application Programme interface (API) between their accounting and HMRC software.

Keeping financial records will become digital and most businesses will need to use software or apps to keep their records – the days of manual record keeping are over!

HMRC have now issued their detailed guidance on the digital record keeping and return requirements for Making Tax Digital (MTD) for VAT.

VAT Notice 700/22 clarifies that spreadsheets may still be used to keep business records provided that there is bridging software that links to the Government gateway.

There will however be a one year “grace” period during the first year of MTD when businesses will not be required to have digital links between software programs, referred to in the VAT Notice as a “soft landing”.

The VAT notice includes a number of helpful examples illustrating different accounting systems and the digital links required to comply with MTD for VAT.

The VAT notice is essential reading for all VAT registered businesses. https://www.gov.uk/government/publications/vat-notice-70022-making-tax-digital-for-vat

WHEN DOES MTD FOR VAT START?

The Making Tax Digital rules apply from your first VAT period starting on or after 1 April 2019. A ‘VAT period’ is the inclusive dates covered by your VAT Return.

For example, where a business submits quarterly returns covering the periods to 28 February, 31 May, 31 August and 30 November, the business will need to comply with Making Tax Digital rules for the VAT quarter starting 1 June 2019 and ending on 31 August.

“SOFT LANDING” FOR MTD FOR VAT FOR THE FIRST YEAR

For the first year of MTD for VAT (VAT periods commencing between 1 April 2019 and 31 March 2020) businesses will not be required to have digital links between software programs. The one exception to this is where data is transferred, following preparation of the information required for the VAT Return, to another product (for example, a bridging product) that is Application Programme Interface (API) – enabled solely for the purpose of submitting the 9 Box VAT Return data to HMRC. The transfer of data to this product must be digital.

For the first year of MTD for VAT (VAT periods commencing between 1 April 2019 and 31 March 2020), where a digital link has not been established between software programs, HMRC will accept the use of cut and paste as being a digital link for these VAT periods.

However, for VAT periods starting on or after 1 April 2020, there must be a digital link for any transfer or exchange of data between software programs, products or applications used as functional compatible software.

USE OF SPREADSHEETS IN PREPARING VAT RETURNS

Example 3 in the VAT Notice describes a business that uses a spreadsheet and bridging software from April 2019, which allows the information to be transferred to HMRC via an API.  It uses a spreadsheet to record all sales, purchases, and expenses in a digital format. The VAT Return is then prepared within the spreadsheet, using formulae already written into the spreadsheet.

The VAT Return information is then sent via a mandatory digital link to bridging software, which digitally submits the information directly to HMRC.  Example 6 shows how a spreadsheet would be acceptable in order to consolidate VAT information prior to submit a Group VAT return.

We can work with you to make sure that your accounting systems will comply with the new VAT rules before they start in 2019. Note that MTD for VAT will not be mandatory where turnover is below the VAT registration limit, currently £85,000 per annum.