Tony Mudd: All change again for dividend taxation

In 1973, the UK had an imputation system for dividend taxation. This was a method of giving credit to the recipient for the tax paid by a company making the distribution. It always felt appropriate and in line with many other tax systems around the globe.

However, that has not stopped numerous chancellors from mucking about with it. Whether this has been on the promise of creating a fairer tax system or for the benefit of the exchequer is open for debate.

What cannot be disputed is that from the first step taken by Norman Lamont in 1993 through to Gordon Brown severing the link between tax credit and corporation tax paid, the imputation system has been eroded.

Finally, we have a chancellor in Mr Osborne who has, arguably, taken the logical decision to scrap tax credits completely. This ends the imputation system. While he could have left matters there, he also announced:

• A £5,000 dividend allowance from 2016/17
• New rates of tax above this allowance of 7.5 per cent, 32.5 per cent and 38.1 per cent for basic rate, higher rate and additional rate taxpayers respectively.

According to the Treasury, 85 per cent of individuals in receipt of dividends will either be better off or no worse off at all. If we assume that the average dividend yield on a portfolio of equities is 3 per cent, this leads us to the conclusion 85 per cent of investors have portfolios of no more than £166,000. For those with portfolios in excess of this level, the position from 2016/17 is very different to where we are now.

The question is, who are the taxpayers that will benefit from this? The answer is arguably perverse:

• For investors paying tax at the higher rate, the £5,000 allowance is worth £1,250 (£5,000 x 25 per cent)
• For investors who pay tax at the additional rate, the allowance is worth £1,527 (£5,000 x 30.55 per cent)
• For investors falling within the basic rate, the allowance provides no benefit whatsoever

The bad news for basic rate taxpayers does not end there. While they currently would not pay any tax until their income fell into the higher rate threshold from 2016/17, they will now pay 7.5 per cent tax over the allowance.

These changes could also have knock-on effects to some of the standard tax advice around normal portfolio construction. The end to grossing up dividend income will have a material effect on those investors selecting tax wrappers based on ensuring income does not take them into the next threshold for income tax. Furthermore, for many clients, the value of stocks and shares Isas will now only be in terms of capital gains tax, which few investors are liable for in any case.

We also have the issue of investment bonds. On the face of it, over and above the dividend allowance tax rates of 7.5 per cent, 32.5 per cent and 38.1 per cent does not compare well with onshore bond gains taxed at 0 per cent, 20 per cent and 25 per cent. Unfortunately, we do not yet know whether, or to what extent, these changes will affect the rate of tax levied on dividends within life company funds, although it is something all of us will be looking carefully at.

A further interesting twist, with corporation tax itself reducing to 18 per cent by 2020, is whether this will result in higher net dividend yields and further changes to the effective rate of tax on dividend distributions. Changes that, frankly, the majority of investors do not understand. But perhaps that is the point.

Tony Mudd is divisional director, tax and technical support, at St. James’s Place

Profile: Bravura’s Tony Klim on technology in the new pensions era

Bravura Solutions group chief executive Tony Klim was lucky enough to work through the “golden age” of UK software in the 1980s and 1990s, when banking was becoming hi-tech with the introduction of credit card systems, online payments and secure networks. Now he is anticipating another exciting era in financial services technology, as pension freedoms create a need for product innovation.

“While the pension reforms have caused much strife across the industry, they will also result in product innovation, which is something we have not seen for some time. People do not need to buy an annuity so companies are looking at how to hold on to assets through flexible and guaranteed models.

“We are already working on some interesting new models around guaranteed products and flexible drawdown. It is great for us because technology is needed to support the new products.”

Klim admits keeping up with the pace of change in the rules and regulations is no easy feat. But the move towards greater individual responsibility for retirement planning came as no surprise to him.

Back in 1999, in his early days at Marlborough Stirling, Klim predicted this shift would create huge growth opportunities and demand for software solutions. “One of the main problems is the rate of change and our clients need to react reasonably quickly,” he says.

Bravura, an anglo-Australian firm providing software services to wealth managers, fund managers and insurance companies, believes the platform industry is the logical place to deliver the product innovation needed for the new pensions environment.

Klim says Bravura and its clients are particularly happy with the scale of opportunity that lies ahead, although the need to offer attractive and innovative new products is also challenging, not least for platform providers.

“Platforms will encompass traditional life and pensions, and possibly even banking, across multiple delivery channels. Far too many people focus on platforms as a business model. In reality, we are just talking about the infrastructure for the next generation financial services business,” he says.

Bravura has spent a huge amount of money on developing its Sonata technology as the “next generation” platform across investments and life and pensions globally.

Sonata is Bravura’s life and wealth management administration system that enables the firm’s clients to be more efficient and reduce running costs by connecting and engaging with their clients through a range of devices including a desktop or laptop computer, tablet or smartphone.

“As with all major step functions in technology, it has taken longer and cost far more than we initially envisaged but we are now getting significant traction on both sides of the world.”

“Unlike some of the other players in the market, our focus is solely on software and software as a service rather than administration. This means we are able to service both administrators and product providers alike. It is a business model that we have successfully deployed across the fund management industry for many years.”

Klim started his career with his feet planted firmly in the technology side of financial services. He got into software development once he realised his teenage ambition of becoming a rock guitarist was not to be. “I know it sounds corny but I so wanted to be a rock star,” he says. “My air guitar skills didn’t make the grade but I did graduate to a real guitar. I became a blues and jazz guitarist. I got to the point where I was practising three hours a night and ended up in an amateur rock band but I still didn’t make the grade,” he says.

At school, Klim shone at mathematics and, after graduating from university with a physics degree, became an analyst/programmer at Software Sciences, now IBN Data Sciences, working on defence systems. He then joined Systems Designers, now EDS, working in secure communications networks. “In the early 1980s, these skills became very much in demand in banking with the emergence of card technology and online payments,” he says.

In 1985 Klim joined The Software Partnership and moved into the business side, encompassing distribution. “The Software Partnership was an amazing business that was set up by a group of like-minded entrepreneurial individuals. It went on to be a pioneer and market leader in online banking technology before eventually being acquired by a very large US corporation.

“I learnt a huge amount about high growth companies and international business at that time through working with partners across the US and in Asia. We got a number of major banks using our system in the pre-internet banking era.”

Klim joined Marlborough Stirling in 1999 and led the integration of the Exchange portal, which Marlborough Stirling acquired in 2001. He left the group in 2004 due to an internal restructure and spent the four years prior to joining Bravura Solutions as an independent consultant.

“I worked as an independent consultant with a variety of financial services businesses and private equity companies. A key theme was the changing UK value chain in financial services distribution and the emergence of platforms. This was an area of interest that I had started to develop when working with the Exchange IFA portal at Marlborough Stirling. Platforms were almost a logical extension of the portal.”

For Klim, the future of the platform industry lies in its supporting technology. “Technology is very much on the agenda again as modern platforms need to cover multiple channels: advised, discretionary, execution only and potentially online advice.

“Scaleability and admin efficiency will become even more important with the continuing squeeze on the overall value chain. Shaving a few basis points off the admin cost model through use of modern technology can make a significant difference to the profitability of a platform. Multi-channel servicing and admin efficiency is the key to how platforms will make money.”

Five questions

What is the best bit of advice you’ve received in your career?

Don’t sell technology; sell the business benefits of technology.

What keeps you awake at night?

The fact we have over $2trn of assets managed on our technology platforms. More seriously, my two daughters finding their way in life.

What has had the most significant impact on financial advice in the last year?

It has to be the changes to the pensions/annuity rules in the 2013 Budget.

If I was in charge of the FCA for a day I would…

Openly encourage more innovation in online advice.

Any advice for new advisers?

Embrace technology to make your job easier.

CV

2008-present: Group chief executive and previously chief executive for Europe, Middle East and Africa, Bravura Solutions

2004 -2008: Independent consultant working with various financial services businesses and private equity companies

1998-2004: Managing director of UK Operations, chairman of Marlborough Stirling subsidiary Exchange FS and director, group strategy, Marlborough Stirling

1994-1998: Director of International Marketing and Product Management, Deluxe Data Corp.

1985-1994: Director of international business development, managing Director, Open Systems Division and director, Consultancy Services, The Software Partnership

1981-1985: Technical Consultant/Senior Systems Engineer. Systems Designers, now EDS

1979-1981: Analyst/programmer, Software Sciences, now IBM Data Sciences

Strong sterling cools BoE inflation forecast

The strength of sterling has played “a significant role” in the Bank of England’s thinking over inflation projections, says Axa’s David Page.

The Bank said today the stronger pound trajectory over the past months could cause a delay in the rise of inflation in the UK.

In its latest inflation report, released today, the Bank stressed the fact sterling has appreciated by 3.5 per cent since May, as well as rising in the past couple of years, will likely push inflation down in the near term.

The MPC minutes say: “In light of the reduction in oil prices and appreciation of sterling over the past three months, it appeared that the increase in inflation over the following year would be more gradual than had previously been supposed.”

Axa Investment Managers senior economist Page says sterling has played “a significant role” in the Bank’s thinking over inflation projections.

He says: “Sterling is clearly having a significant role in the bank’s thinking about the development of inflation. They’ve suggested they’ve downgraded to some extent the path of inflation over the near term…they think that is a more accurate way of treating the situation and we will see how that goes through.”

The MPC report also says: “To the extent that the appreciation of sterling could be expected to weigh on inflation for a persistent period, the corresponding pickup in domestic costs necessary to return inflation to the target within three years would be greater.”

“The movements in sterling over the course of 2015 had been correlated with changes in the interest rate differentials paid on sterling and foreign currency assets, although the scale of the change in the exchange rate had been much larger than implied by the change in interest differentials alone,” the MPC minutes state.

“The recent appreciation of sterling was therefore likely to represent an additional tightening in financial conditions over and above the steepening of the sterling yield curve over the past few months.”

JP Morgan Asset Management chief market strategist for Europe Stephanie Flanders says, unlike many major economies, “the UK is not trying to recover on the back of a weak currency, but the Bank does not want investors to think sterling is a one-way bet”.

BoE governor Mark Carney pointed out in his press conference on the UK outlook today that sterling has risen 20 per cent on a trade-weighted basis since March 2013.

Flanders says: “With monetary policy still extraordinarily loose in the major developed economies, the upward move in sterling in the past two months shows how even a modest move in rate expectations can have a dramatic impact on the currency.”

The inflation report had had an immediate impact on sterling with the British currency falling 1 per cent against the dollar and the euro today.

Flanders says: “However, we do not believe this is the start of a sustained move down in sterling given the broadly upbeat tone of today’s statements about the economy.”

Dennis Hall: When a provider relationship turns sour

I recently advised one of our clients to use the new pension freedoms to close her pension with AJ Bell and withdraw the entire sum as a lump sum. It formed part of a much larger portfolio of investments but the pension pot was relatively small.

For our involvement we agreed to charge the client about £500, paid from the pension fund before it was finally paid out. We submitted all the paperwork to AJ Bell making this very clear. You already know what’s coming.

At this point AJ Bell paid the client without deducting our fee. Several days later we received the paperwork and noticed the fee had not been deducted, so we asked AJ Bell what they would do about it.

After some to- and fro-ing they said they would write to the client asking for the money back and thanking us for highlighting a training issue. When will product providers stop spouting platitudes and instead pay for their mistakes (financial pain being the only pain they feel)?

I do not want AJ Bell to go back to my client asking them to return the money – it is not as though the sum was significant enough for them to notice. As far as they are concerned they received a net payment. Anything I have read about behavioural economics or the psychology of loss tells me the pain of losing money is twice as painful as gaining it.

My clients would feel a sense of loss far greater than the £500 they had agreed, which would impact on our relationship, and so for the sake of £500 I am left wondering whether I bear the loss or make the clients feel as though it cost them £1,000. AJ Bell on the other hand has not have suffered any loss, and although it has discovered a weakness in their processes it has suffered no pain.

By last week I believed we had reached an impasse. This is not the AJ Bell I started out dealing with more than 10 years ago – back then when something went wrong they held up their hands and fixed it. It was so refreshing, and it shaped my own attitude to handling clients complaints – we even have a ‘no quibble’ guarantee on our website.

So when I tweeted on Friday that my long running association with AJ Bell had sadly come to an end it triggered a response that I was not expecting.

One of the senior management team picked up the tweet whilst on holiday in Florida, and immediately called me. It is hard not to take anyone seriously when they interrupt their downtime to try and save a relationship. That is the AJ Bell I had experienced in the past.

With senior management involvement there was a thawing of the ice. We still did not reach the ideal solution from my perspective, but we got halfway there. And for that I am satisfied.

They still don’t quite ‘get’ where I am coming from – but then I am not a multi-million pound provider. I can care that little bit more, and I treat my clients in exactly the same way I would wish to be treated – and I live in a fantasy world where I believe providers should do the same.

Dennis Hall is managing director at Yellowtail Financial Planning

AJ Bell declined to comment

Brooks Macdonald appoints deputy CEO

Brooks Macdonald has promoted Andrew Shepherd to be deputy chief executive, a newly-created role “to broaden the senior management team”.

Shepherd, who joined the wealth manager in 2002, was an executive director of the group and joint managing director of Brooks Macdonald Asset Management with Nick Holmes.

After Shepherd’s appointment, effective from today, Holmes will be the sole managing director of the asset management division.

Brooks Macdonald chief executive Chris Macdonald says Shepherd’s appointment will give him more time to focus on “delivering the group’s growth ambitions”.

He adds: “I am looking forward to working alongside Andrew in his new role as deputy chief executive. He has been a core part of the group’s management team for the last seven years.”

Asset allocation: Property is bright spot for Canada Life’s David Marchant

Property is the golden child currently for David Marchant, chief investment officer at Canada Life, delivering solid yields and growth for his range of risk-targeted model portfolios.

The risk-rated 3 version of the fund, which has £16.1m in assets, has an 8 per cent allocation to property, which Marchant says has done “fantastically well”. In June it was the only positive contributor to returns for the fund “as sustained investor demand in the sector translated into a continued rise in capital values”.

“The commercial property market came off 50 per cent in the financial crisis and has had a good recovery since then, in particular in London and the South-east but now spreading out to the regions,” he says.

“The overall yield on the property portfolio is in the region of 5 per cent or so, which is excellent, rent is growing, capital values have some room for further upside.”

The Canada Life Portfolio range consists of five funds, with CanLife Portfolio 3 being the lowest risk version of the range and Portfolio 7 being the highest. All the funds are risk-targeted to the Distribution Technology risk rating tool and the asset allocation is determined by DT’s target asset allocation.

Marchant chooses not to put his own tilt or tactical allocation overlay onto the DT asset allocation, believing that doing so inevitably means that clients will be taking more or less risk than they intend.

“We don’t have a deviation against the risk allocation, no tactical tilts. If DT make a recommendation we will stick to it, so there are no surprises for advisers,” says Marchant.

“If you’re an investor and risk profile 3 reflects your attitude to risk you don’t want to find it’s gone to [risk profile] 4 or 5 three years down the road.”

However, he says the asset allocation team at Canada Life sense check the DT allocations and question whether they make sense, sometimes going back to DT to query anything they don’t agree with.

The team will also take their time making any changes to allocations prescribed by DT, waiting until the pricing is right and they are ready to move out of other areas.

Performance of the Portfolio 3 fund has been patchy, ranking third quartile over the short term – one and three months – but first quartile over a year. The fund was only launched at the end of 2013, so longer term performance is not available.

The most recent change on the fund was the introduction of high-yield bonds, which now make up 6 per cent of the Portfolio 3 fund, having previously been no allocation. The money for the new allocation was taken “across the board, from small tinkering” with other allocations, says Marchant.

“The benefit of high yield is it adds an extra element of diversification, which these funds are suppose to achieve,” he says.

However, Marchant was careful with the timing of the move into the asset class. “High-yield has already had a relatively good run, we did finesse the implementation and didn’t go into it until mid-December, which was pretty close to the lows in prices,” he says.

For the high-yield allocation Marchant invested in the Putnam World Global High Yield Bond Fund. The range of model portfolios has a skew to internal funds, always using a Canada Life fund if it is available.

If Canada Life doesn’t have a suitable fund, as with the high-yield allocation, Marchant will look among the group’s partners for a suitable option.

“We have not got high-yield expertise in house, Putnam is part of our group of companies and has experience and a long record of managing high-yield bonds, so we use their portfolio to provide asset allocation,” he says.

Only if this search among Canada Life’s partners turns up blank will Marchant look to other fund managers. The only instance of this occurring is in the allocation to the BlackRock ICS Sterling Liquidity fund, which has 9.8 per cent of the fund.

The benefits of using internal funds are multiple, says Marchant. “We benefit from being close to the fund manager, we know exactly what they are implementing with no surprises and it also is cost effective using our own internal managers.”

This selection process limits the choice of funds available, often driving it to just one option for each asset bucket. Marchant admits the size of Canada Life’s fund range means he has “not got a vast array of funds to choose from”.

The only area where this isn’t the case is in its UK equity allocation. Here the fund has the allocation split between two funds: the CF Canlife UK Equity Fund at 12.4 per cent and the CF Canlife UK Equity Income Fund at 3.2 per cent.

“I like the idea of income funds and recognise the importance of income, “ he says, leading him to put 20 per cent of the UK equity allocation in the income fund and 80 per cent in the core UK equity fund, although he says “that can change over time if required”.

Marchant is very positive for the prospects of the UK equity sector generally, predicting a boost in consumer spending will help to drive the economy up.

“There is rising employment, real wages are going up, consumer sentiment is at relative highs and oil prices are low and weakening more recently, so the outlook for the UK consumer is pretty good,” he says.

Portfolio Research and Consulting Group: Helping to manage risk and build more durable portfolios