How goverments piled costs onto pensions during the good times

bowlhead99

zagfles wrote: »

Post 1999 dividends were still paid with a tax credit, which reflected part of the corporation tax just like ACT did. For unwrapped investments, basic rate taxpayers could use that tax credit to offset their tax liabilities completely, and higher rate taxpayers could use it to partially offset tax.

Yes, dividends today are still paid with notional tax credits which reduce the burden of income tax for those taxpayers who take large investment risks to receive investment income from equities rather than investing in fixed interest products or earning known salaries for known amounts of work.

Higher rate taxpayers get a break too, via the mechanics of the notional tax credit, but it isn't enough to reduce their liability to zero. They still end up paying some tax, but have had a bit of it reduced compared to the rate they would pay on bank or bond interest or on salaries.

Potentially, if we didn't offer those tax incentives, individuals may be less inclined to go and invest in UK companies, because a basic rate taxpayer for example would have to pay income tax in the year when he makes 5% or 10% dividend on his capital employed, but gets no compensation if he makes zero dividend on his capital employed and if his investment tanks he might lose tens of thousands of capital without ever making enough income or gains in the future to make up for it. So the government is incentivising risk capital by saying you can have an annual CGT allowance and you can also have a break on your dividend income from investments.

People who do not pay any tax at all, such as low income groups or pension funds, cannot access this incentive. Because they are already fully incentivised to go out and earn money from investment because they will not pay a single penny of tax on their earnings from that endeavour. They are as incentivised as they can be, without actually paying them to go out and invest.

And until 2004, ISAs could reclaim the tax credit. Were ISAs claiming relief on something which "no longer existed" :rotfl:

Sounds like, through a quirk of how it evolved, HMRC were making it relatively more attractive to always invest in S&S through an ISA rather than outside an ISA. A nice perk which no longer exists. You were getting something for nothing. Effectively the company had paid some corporation tax over its history and those revenues were being shared with you to say thanks for participating in our special ISA scheme which incentivises people to go out and invest in risky assets for long term gain so they don't have to be reliant on the state.

That no longer exists and so as of today, if you are a basic rate or nil rate taxpayer considering investing in a share or an equity fund it is no more attractive to invest small amounts via an ISA or a SIPP than unwrapped (disregarding the SIPP's general benefit of potentially getting more tax relief on the way in than on the way out, if you can afford to lock up the cash for long long term).

They feel that the ISA wrapper gives you enough incentive, by not making you pay a single penny of tax on the dividend that the company declares, however much it is, and never paying any tax on your capital gains, however much they are, and never needing to report the investment activity on your tax return, however active you are. They limit the incentive by saying that as an individual you can only put £15k net into an ISA or £40k gross into a SIPP.

As a pension fund, the incentive is not limited to a yearly amount. It can invest as much of its assets as it wants whenever it wants into high risk assets like shares or medium risk assets like bonds or low risk assets like cash, and not pay a penny of tax on any of the proceeds that the companies or banks pay them out. This 'all of my returns are tax free' is quite nice. Do you think they should get all of the returns tax free and then get some extra cash on top for free? How would HMRC fund that?

Situation today: If a company makes £4 of profit on its £100 of assets it might now pay (say) £1 of tax, reinvest £1 and pay £2 of dividends.

Individuals other than high rate taxpayers, high rate taxpayers using ISAs, and personal or corporate or government pension funds, would all receive the entire £2 scot free with no income tax to pay. That sounds nice.

Contrast with the old days, the company making £4 of profit might pay £1.40 tax, only afford to reinvest £0.80 and only be able to afford £1.80 of dividends before they're out of cash. The £1.80 of dividends could have been grossed up to £2 with the few pence reclaimed. The loss of long term value from only reinvesting £0.80 was expensive for the investors but hopefully the government spent their extra tax revenue on something good.

Now we have a different system where the company can afford to reinvest its whole £1 not just £0.80, and the pension funds and ISA investors are still getting £2 out. The government's tax take is lower so we don't need to worry about them hopefully spending it on something worthwhile, because they are not taking it from us in the first place...

I don't think there is any point on getting hung up on the fact that there was a timing difference for a few years here between ACT stopping being paid by companies and tax credits stopping being reclaimable in pensions or ISAs, whether the first thing followed the other or led to the other. "Can't we all just get along?".

The big picture is that now this has all shaken out, the companies are no longer paying as much tax as they were, leading to them being able to pay a greater proportion of their net incomes directly out to the equity investors.

Whether those investors are high rate taxpayers using wrappers, or low rate taxpayers, or pension funds, no tax is being paid by the recipients who take the investment risks. Only high rate taxpayers not using wrappers are actually going to pay any tax on the divs they receive, which I suppose is fair because if we have enough spare money to live our lives and max our allowances and still keep investing unwrapped, making better long term returns than low income people can dream of (for whom staying out of overdraft may be considered a success), then we can probably afford some tax.

BobQ

hugheskevi wrote: »

HMRC (as they are known now) were concerned that corporates were avoiding tax by making excessive contributions to their occupational pension fund, which in future would be returned as surplus to the employer by the trustees. Therefore, limits were in place to limit the amount of surplus which could be built up in pension funds. With the benefit of hindsight about longevity, future inflation/yields, etc, those surpluses were either far lower or never existed, but they were calculated on best estimate at the time.

As Royal Mail say:

A very good example. Were they saying that all of the surplus would have gone to tax?

More relevant is that 20 years later the fund was not strong enough to enable the Royal Mail to be privatised without the Government underwriting the pension fund.

jamesd

zagfles wrote: »

Post 1999 dividends were still paid with a tax credit, which reflected part of the corporation tax just like ACT did.

ACT required companies to pay the equivalent of basic rate tax tax on the amount they distributed to shareholders, just as banks today have to deduct basic rate tax on interest. Though it wasn't always exactly the same as basic rate tax. That whole system was abolished: companies from 1999 could distribute their dividends and did not have to pay the anticipated basic rate tax of the recipients when they did so because ACT was gone.

The 10% tax credit on dividends isn't paid for by the company paying 10% tax in advance. It's just a tax break for the eligible recipients.

zagfles wrote: »

And until 2004, ISAs could reclaim the tax credit. Were ISAs claiming relief on something which "no longer existed" :rotfl:

They were claiming the 10% but that 10% wasn't paid for in advance by the company paying the dividend, which is what ACT required.

There's still a tax credit for dividends but the company doesn't have to pay your or my income tax in advance on it just in case we're tax payers.

All the company has to do these days is pay the Corporation Tax and distribute what it decides to pay out as dividends, leaving it to us to pay the tax and use the notional tax credit for a tax that the company hasn't actually paid.

jamesd

BobQ wrote: »

"Contribution Holidays" as I understand them were not illegal but the rationale for allowing them escapes me unless it was to undermine the stability of the pension funds. I do not claim to be an expert in pension funds but what other interpretation can their be? It cannot help an employee or a scheme pensioner to weaken the financial strength of a scheme.

The holidays were OK then and today. The justification for them is that the scheme appears to have enough money to meet its liabilities, so there's no point in requiring the employer to pay in more. If the scheme doesn't appear to have enough, no holiday for the employer.

hugheskevi explains a bit about how pensions were a tax avoidance scheme for employers at various times and how that led to caps on how much could be paid in to limit the scope for avoidance. Assorted changes have, I think, closed the relevant tax loopholes.

BobQ wrote: »

In the 1990s it was commonplace for firms to take holidays to access perceived surpluses of contributions based on all sorts of assumptions about future commitments. Today, the lack of these surpluses mean than benefits gave been scaled down and schemes closed.

Right. But at the time and I suppose even for some schemes today the funding could appear good enough to allow a holiday. If it turns out not to have been the company isn't off the hook but has to pay later instead.

zagfles

jamesd wrote: »

ACT required companies to pay the equivalent of basic rate tax tax on the amount they distributed to shareholders, just as banks today have to deduct basic rate tax on interest. Though it wasn't always exactly the same as basic rate tax. That whole system was abolished: companies from 1999 could distribute their dividends and did not have to pay the anticipated basic rate tax of the recipients when they did so because ACT was gone.

The 10% tax credit on dividends isn't paid for by the company paying 10% tax in advance. It's just a tax break for the eligible recipients.

They were claiming the 10% but that 10% wasn't paid for in advance by the company paying the dividend, which is what ACT required.

There's still a tax credit for dividends but the company doesn't have to pay your or my income tax in advance on it just in case we're tax payers.

All the company has to do these days is pay the Corporation Tax and distribute what it decides to pay out as dividends, leaving it to us to pay the tax and use the notional tax credit for a tax that the company hasn't actually paid.

Fact is, the govt could have allowed pension schemes to continue to claim dividend tax credits, ACT or no ACT, just like they did with ISAs for a few years.

Fact is, they didn't.

Fact is, this had a negative impact on pension schemes and was one of the factors in the decline of private sector DB schemes.

Fact is, I'm past caring whether you agree or not.

Ta ta.

bowlhead99

It's always interesting to watch how someone who wakes up to the fact that they might have not been seeing both sides of the story, decides to bow out gracefully . Grasp at a few straws on the way out, but knowing that those arguments don't really 'win', simply declare you've had enough of the other person not understanding you and are past caring so you won't participate any further.
:beer:

I think the 'facts' as established were:

1) Government stopped pension funds recovering a slice of the corporation tax paid by companies, and, over time, simply reduced the tax paid by corporations anyway.

2) Government, for a limited period, allowed individuals holding S&S Individual Savings Accounts to continue to take a tax incentive where they could claim a notional dividend credit - free cash from the taxman to boost their returns and receive in total more pence per share than the headline dividend that was declared by the paying investee company.

In 2003-4 and 2004-5, the number of people who actually opened a mini shares isa or maxi isa was only 2.5-2.9 million, with average year end balances of £1k for mini isas and £4k for maxi isas. So, while there might have been £30-40bn in total invested in S&S through ISAs, people were not able to stash monster amounts of new cash away to take advantage of this nice little perk you could get as an individual investing in this product.

Because it was a pure perk (i.e., having the tax man send you cash that the company hadn't even declared as dividend), it is not something that by any stretch of the imagination ought to be extended to the billions invested through pensions. After a while, the government got around to cutting out that break from ISA investments, so they got no special treatment ahead of what the institutional pension funds got. Both simply now receive all the dividends declared by the company and pay 0% tax on them.

In the old world, the government allowed a pension fund to effectively take more than 10p from a company that had paid a 10p dividend - because it simply handed the pension fund some of the corporation tax that the company had paid along the way. This allowed the pension fund to participate in the gross profits from the company's trading; effectively the company paid high corporation tax but the government kicked a big chunk of it right back to the investors.

No doubt, the removal of this [perk / strange state of affairs] played havoc with the expected returns of pension funds when they heard this was going to happen. A one-off 'bit of a shock' because they had thought that all their investee companies were going out running businesses with a low effective rate of tax (from the kickback) and all of a sudden there was no kickback and their investees had paid real tax. This put some of them in a quandary - how would they meet their projections if the companies they were relying on to generate income were effectively having to pay more tax by the time the dividends get back to the shareholder?

The answer of course was that tax rates came down to be globally more competitive and their companies are not paying the same high tax rates any more, so by the time the dividends get back to the shareholder for a given pound of corporate revenues, the dividends are just as good as the old 'dividend plus tax kickback' used to be.

Not knowing how much they could rely on the government to go through with reducing corporation tax, the pension funds were understandably nervous about whether there would be as much net return from an equity investment in a profitable business as there had been in the past. Some may have thought that this would compromise their future ability to generate the long term IRRs required to pay out all the retirees, and they woke up to the fact that they were taking on monster risks to fund everyone's retirement and perhaps they should just do DC schemes instead and put the risk in the employee's hands.

Still, that's about perceptions of how profitable a portfolio of investments might be, given a bunch of assumptions on how the assets might perform and what dividends might be available. It doesn't mean that the net dividends that ultimately were available from risk capital have actually declined following the populist 'raid on pensions' headline.

jamesd

Bowlhead99, agreed but I think it's even easier to understand what really happened.

Under ACT a company had to pay the approximate basic rate tax that the recipient of the dividends would have to pay, much like banks having to deduct tax on interest at source. Eligible dividend recipients could reclaim that.

When ACT was abolished the companies no longer had to pay that basic rate tax equivalent and could instead increase their dividend payments so recipients effectively changed from net to gross dividend payments. Since the payments effectively became gross there was no tax "relief" for pension funds to claim because there was no longer any tax being paid at source.

Far from a raid on pensions, the combined 1997 and 1999 changes just meant that they no longer needed to make refund claims any more.

There was, of course, an effect between those years when there was still a deduction but no way to claim relief.