On 1st August 2017 H.M. Treasury launched a consultation on the subject of financing growth in innovative firms (a.k.a. The Patient Capital Review), which can be found here. ShareSoc and UKSA submitted a joint response to this consultation on 22nd September: ShareSoc -UKSA Patient Capital Patient Capital Review – FINAL VERSION 20170924
Our response included the following comments:
- Individual shareholders are the archetypal long-term investors. They tend to invest for retirement, to fund care in later life and to pass on wealth to future generations, as well as for growth and income.
- The FCA Asset Management Market Study has highlighted the high fees (and other charges and forms of remuneration) and the anti-competitive behaviour that occurs in this industry. This effectively increases the cost of capital for innovative growth firms and reduces the supply of investor capital. Walker and Kay also identified this issue. Sorting out the excesses of the financial services industry is proving difficult.
- The banks’ behaviour since the 2007/08 financial crisis, when they squeezed their customers, withdrew facilities and demanded much higher and more onerous terms has resulted in a huge decrease in the confidence of their customers in the banks . This will take a very long-term to correct.
- The taxation treatment of debt versus equity is not equal. Interest on debt is tax-deductible, whereas payments of dividends to shareholders come out of after-tax profits.
- As a consequence of points 3 and 4 above, many companies take on debt and have a very short-term orientation.
- Capital gains tax has been subject to a huge number of changes over the past 40 years. Government should not expect a long-term perspective from companies and their owners if it keeps changing the rules. In future, Government should only make changes infrequently and only when they are clearly necessary. Presently, there are two main issues:
- Capital gains tax taper relief over 10 years should be reintroduced. The idea that the longer you hold an investment the lower the tax rate will be a huge factor in increasing long-term thinking. The removal of this taper relief (and prior to that, its reduction from 10 years to a shorter period) has been instrumental in stimulating a short-term focus and culture.
- Capital gains tax for individuals is assessed on each individual investment , so if an investor wishes to take a profit which is then reinvested in another growth or innovative company, the investors’ capital is reduced by a taxation charge. The investor has not at this stage had access to his capital to spend it, so it is illogical to tax him or her at this time. This contrasts with investments held in an investment trust, where no capital gains tax is levied on gains within the trust; only on amounts that are taken out of the trust.
- We, in Britain, need to create a culture of long-term thinking. Patient capital is needed. We need a culture whereby we think about accumulating wealth gradually. The get rich quick culture of the early 2000s served to create a large social imbalance.
- The UK markets give lower valuations than US markets to growth companies and innovative companies. This creates an opportunity for US based companies to acquire UK companies cheaply. This is one reason why the UK has failed to produce large successful innovative growth companies on the same scale as the US.
- We can see no representative of individual investors on your steering committee. This is a shameful major omission, and is evidence of the way in which individual investors continue to be ignored and underestimated. Direct individual investors make up 12% of the UK stock market, and with indirect individual investors via funds represent 30%. Your steering committee comprises representatives of fund managers rather than underlying asset owners. We note also that successful ‘hands-on’ entrepreneurs such as Luke Johnson and James Dyson are not represented on your panel.
- The current VCT tax reliefs are justified by creating incentives to invest. There is no evidence of excessive profits for individuals investing in VCTs. The VCT regime seems to be working satisfactorily. Government should resist the temptations to significantly change something which is working. (Minor changes to stop abuse should be implemented, but only after careful consideration of other consequences.)