Taxation of Trusts, LTIPs and Technology Stocks

The Government has announced a review of the Taxation of Trusts. You can read the consultation document and respond thereafter here: https://www.gov.uk/government/consultations/the-of-taxation-of-trusts-a-review

It’s not about investment trusts, but all kinds of traditional trusts whose origin goes back hundreds of years and enables “settlors” to move assets into a trust and out of their personal wealth. There are a number of different reasons why trusts are created as the above document explains. The Government does not dispute that they have genuine uses but wishes to ensure that they are not used for tax avoidance. They also wish to try and simplify the taxation of trusts if possible.

One particular concern they have is about foreign resident trusts controlled by UK residents where they cannot necessarily see what is going on, i.e. they lack “transparency”.

I do have an interest as a settlor in a simple UK based family trust. These are not straightforward things to set up but as for many people it was created to try and move some assets out of the scope of inheritance tax. However, apart from the fact that you can retain some control of where the money goes as a trustee, you may almost as well just give your money to the beneficiaries directly. But you can include minors and unborn offspring as beneficiaries so there are some advantages in the trust form.

Taxation is paid on trust income and capital gains but in a somewhat different form to personal tax. I won’t even attempt to explain the differences here as it would take too long. You can be worse or better off than having it in a personal name, but it won’t be as tax free as ISAs or SIPPs. The major income tax benefits of trusts have long ago disappeared. But certainly one problem with trusts at present is that calculating tax and making tax returns is no simple task so trusts tend to be used by those who can afford professional assistance or have a trustee who can do the necessary work.

But the expense of preparing trust accounts and tax returns are deductible which does not apply to personal tax returns. They suggest this is unfair in that trusts are being favoured which I certainly would not agree with! Of course if the taxation of trusts was simplified so that any amateur could do the work, I might take a different view. But certainly dealing with trust accounts at present is not simple.

Indeed the whole area of trust creation and management is too complex but no doubt there are lots of professionals who make a good living out of advising on them so their consultation responses might be somewhat biased.

I have not yet gone through the document in detail and I’ll probably even need to take some advice on it before responding, but this consultation will be very important to some people.

LTIPs

The case of Persimmon and the value that departing CEO Jeff Fairburn obtained from their LTIP scheme continues to get a lot of media coverage. Best guess seems to be about £75 million, but there are similar every large sums of money to other executives and there could be millions also to each of more than 100 staff under the same scheme.

This comment in the FT’s LEX column this morning is very much apposite: “There are two lessons. First, UK boards should ditch LTIPs in favour of vanilla stock awards. LTIPs are too complicated, sometimes delivering fat payouts when investor returns are thin. Second, chief executives should avoid saying they have no responsibility for their own pay. No one believes them”.

Why did shareholders vote for the original LTIP at Persimmon? Probably because nobody anticipated what the scheme might pay out after the housing market became buoyant and the Government introduced the “Help-to-Buy” scheme. There was of course no cap imposed on the payout which should have been done. But LTIP schemes are so complex many shareholders can’t be bothered to read the details (as I found out talking to one investor at the recent Abcam AGM).

I very much agree that LTIPs would be best replaced by conventional share options.

I have never liked LTIPs for a number of reasons: 1) typically too complex with confusing targets rather than simple numeric ones; 2) they are too long term – incentive schemes need to pay out quickly if you want behaviour to be incentivised by them. Short term cash bonuses are simple to administer and have some merits but there was a demand a few years back to make remuneration relate to long-term performance as short-term schemes can create perverse incentives. Share options do at least align employee interests with that of shareholders.

One change that is also required to avoid executives determining their own pay is to take remuneration setting out of the control of directors and into the hands of shareholders, e.g. via a Shareholder Committee for which ShareSoc has been campaigning.

Technology Stocks Due a Revival?

Sophos (SOPH) shares tumbled yesterday. The cyber security group closed down 28% after a disappointing report about future revenues in a half-year statement. This was one of those UK stocks that reached very expensive valuations until about July since which it’s been heading south. Indeed that’s a common story among small cap technology stocks with many having fallen back sharply in the last few months. That’s despite the fact that many are still growing revenues and profits well above inflation, i.e. they are still growth stocks. Sophos did have a particular problem of comparability with previous year’s figures which were very buoyant after numerous cyber attack scares. The valuation of Sophos now appears more sensible and it would seem other folks also feel it is time to dip their toes back in the water because the share price rose. Or was that a “dead-cat” bounce today? But there do appear to be some buying opportunities appearing in this area, although nobody would say it’s not a high-risk field for investors. At least the valuations are not so daft as they were only a few weeks ago.

Note: I do hold both Persimmon and Sophos shares.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Alliance Trust, Katherine Garrett-Cox and Perverse LTIPs

I have previously commented positively on the outcome of the “revolution” that took place at Alliance Trust (ATST) as reflected in their latest accounts which were recently published. That revolution resulted in the departure of former CEO Katherine Garrett-Cox who resigned in February 2016.

The latest Annual Report shows that she is still being paid large amounts though. For example, total “single figure” remuneration for the 2016 calendar year is given as £1,305,000 and was £832,000 for 2017.

She is likely to be paid still more in future as she is still entitled to LTIP and performance share awards that will vest in 2020. The pay-outs will depend on the positive performance of the company which has been achieved since her departure, which she obviously will have had little influence over. Certainly not by 2020.

Now she may be contractually entitled to these payments under her contract or as might have been agreed to ensure her timely departure, but is it fair and reasonable for her to claim such amounts? Some shareholders think not and are writing to her to suggest that she might like to consider waiving her entitlement or donating the value to charity.

This is of course yet another example of how LTIPs and other performance schemes in public companies lead to perverse outcomes.

P.S. Would anyone like a proxy appointment to enable them to go to the Persimmon AGM on the 25th April in York – and harass them about the wonders of their LTIPs? I can supply if you telephone 020-8295-0378.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Government To Review Share Buy-Backs

The BEIS Department of the Government has announced a review of share buy-backs. That’s where the company buys its own shares in the market, a practice that used to be illegal but is now very widespread.

Business Secretary Greg Clark said: “…there are concerns that some companies may be trying to artificially inflate executive pay by buying back their own shares. This review will examine how share buyback schemes are used and whether any action is required to prevent them from being abused.”

If a company buys back its shares, then it will increase the earnings per shares (EPS) because the same profits will be spread over fewer shares. But EPS is often an element in the calculation of performance related bonuses, e.g. in LTIPs. So effectively management can earn bonuses by simply deciding to buy back shares rather than really improving the underlying performance of the business.

Obviously cash has to be used to buy back the shares, and another concern is that this is money that should be used to develop new products, services or markets. In other words, it contributes to the lack of investment in the UK economy. In extremis companies can borrow money (i.e. gear up) to provide the funds to cover the buy-back which increases the risk profile of the company.

There is also the suspicion that some companies undertake large scale buy-backs to support their share price, often encouraged by institutional investors who wish to exit. The directors always deny this, but one can see the sub-conscious motive to “clear-up a share over-hang” that may be present. In practice, share buy-backs may benefit shareholders who are departing more than they benefit shareholders who remain.

In theory, if a company cannot find a good use for surplus cash, i.e. cannot reinvest it in the business profitably, then buying in shares where the per share intrinsic value of the company is more than the market share price should make sense. But determining what is the “intrinsic value” is not at all easy.

There are also tax issues to consider. Some investors think it’s best to retain the cash in the business because paying it out in dividends might incur more tax, and sooner, than the capital value growth that might otherwise be obtained.

You can see there are many complex issues around this topic that could fill a book, or at least a pamphlet. But here are some comments on the approach I take:

  1. I always vote against share buy-backs unless there are very good justifications given by management (and that’s about 1 in 20 votes in practice).
  2. The only general exception I make is investment companies (e.g. investment trusts) where it does make logical sense and can be used to control wide discounts.
  3. I prefer management to reinvest in growing the business if they have surplus cash (and as I rarely invest in no-growth businesses, you can see why the above rules are easy to apply).

If the advisors to the Government determine that share buy-backs are being undertaken for the wrong motives, what could they advise the BEIS to do about it? Reading the minds of directors about their motives for share buy-backs will not be very practical. If they simply wish to stop the abuses related to incentive schemes they could insist that all such schemes (including all share options) should be adjusted for the buy-back – they often are not at present. But would it not be simpler just to revert to the old regime and outlaw them except for investment companies? I do not recall it created any major practical problems.

If a company’s shares consistently trade below “intrinsic value” then someone will buy them sooner or later – after all many people believe in the perfect market hypothesis and it’s probably true to a large extent – particularly with large cap companies where share buy-backs are the most common. So simply banning share buy-backs should not create significant problems.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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