May 2008

Welcome to the May 2008 edition of our Professional connection e-bulletin.

We hope that you enjoy these e-bulletins. If you have any queries, or would like to discuss any of the issues raised with one of our advisers, please call us on 0845 788 9933.

The Budget and its implications

At 270 pages, this year's Budget Notes were something of a record although most of it built on previous announcements. This article highlights some aspects that might be of particular interest to professional advisers.

Capital Gains Tax - Investment Structures and Tax Efficiency

The changes to Capital Gains Tax and the new entrepreneur's relief are well known as there was nothing in the Budget to alter previous announcements. What the changes mean is that in general the tax scales now favour investments that will be subject to CGT against those that will be subject to income tax. The advantages are using the personal CGT exemption (£9,600 in 2008/9) with any gains in excess being taxed at only 18%, whereas income tax still bites at up to 40%.

As a result of these changes all investors and trustees should be reviewing their plans and existing arrangements, from a tax perspective as well as the asset allocation and risk management aspects.

Inheritance Tax - Transferable Nil Rate Bands and Trusts

Last October's announcement of transferable nil rate bands appeared largely intended to take the wind out of the Conservatives' proposals. It was therefore a surprise to find that it also extended to situations where the first death occurred before 9th October 2007, however far in the past that occurred. Widows and widowers might wish to check the papers relating to their spouse's estate to make it easier for their own executors to claim this relief in due course.

Despite the cost to the Treasury from the introduction of transferable nil rate bands, the forecast IHT yield is expected to be £3.9bn in 2007/8, an increase of 8.5% on the previous year and an additional £0.75bn of assets caught by Inheritance Tax. This underlines the importance of sound IHT estate planning.

Regulations on the IHT reporting rules for chargeable lifetime transfers were also published. The existing limits of £10,000 chargeable lifetime transfers in any tax year or £40,000 cumulative over ten years were woefully low, resulting in additional work for clients, advisers and HMRC. The limits have been substantially increased and also apply from 6 April 2007, although they are not as straightforward as one would like. Please let us know if you would like a copy of Towry Law's briefing on this topic.

Among the other changes affecting trusts, interest in possession settlements established before 22nd March 2006 now have until 5th October 2008 to reorganise the beneficiaries without being subject to the discretionary trust tax regime. Of course it is still necessary to take into account the possible impact of the gift with reservation provisions.

Income Tax - Pension Contributions and Gift Aid

The replacement of the 10% and 22% tax bands with a 20% tax band means that basic rate taxpayers will receive less relief on pension contributions. A basic rate taxpayer making a gross pension contribution of £100 will find that the cost has increased from £78 to £80 and the tax relief reduced from £22 to £20. For higher rate taxpayers the overall effect is neutral.

The Budget also introduced some more technical changes on pensions covering the commutation of trivial occupational pension schemes, simplification of the lifetime allowance test for pension increases, changes to the IHT treatment of unauthorised lump sums in respect of those aged over 75, and overseas pension schemes.

Transitional arrangements are introduced for Gift Aid donations to enable the charity to reclaim tax at 22% for the next three years to save charities from losing out.

'Alternative' Investments

The Budget also included some changes to 'alternative investments' such as Enterprise Investment Schemes (EISs), Venture Capital Trusts (VCTs) and film partnerships. The most significant was that EIS investors can now claim Income Tax relief at 20% on an investment of £500,000 (previously the maximum was £400,000).

EIS investments are eligible for CGT deferral. This may be particularly attractive to clients who have already made a disposal and would benefit by deferring a liability into the 18% CGT regime.

Because of the risks involved, Towry Law's approach to alternative investments is that they are only recommended where they are clearly appropriate. We have a training and licensing system for selected advisers so that they are able to advise clients in this specialist area.

Domicile and Residence

Despite the fact that this was the area with the most concessions on previous announcements, it still represents a radical upheaval for those who are affected.

The main changes affect people who are resident in this country but not UK domiciled - because it is not their permanent home – called 'non-doms' for short. Previously non doms were only taxed on foreign sourced income and gains only if the money was brought into the country (the remittance basis). If they want to continue being taxed on this basis, they will have to apply for the remittance basis to continue and will lose their personal tax allowances and the CGT exemption. In addition, if they have been resident here for seven or more years, they will have to pay a £30,000 annual charge to qualify for the remittance basis.

All non-doms will need to consider whether they have sufficient foreign income and/or gains to justify applying for the remittance basis in view of the loss of UK tax allowances. Those who have been here for over seven years will need fairly substantial foreign income and/or gains to justify applying.

The additional concessions in the Budget included defining the £30,000 charge as a tax which is very important for US nationals working here, exempting children from the charge and introducing a threshold of £2,000 foreign income below which the changes will not apply.

The existing rules on how many days you need to spend outside the UK in order to be 'non-resident' for tax purposes were altered. As a result, some people who were previously non-resident may now become UK resident and be subject to UK tax.

Towry Law has a training and licensing system for selected advisers so that they are able to work with solicitors and accountants to assist clients in this specialist area to review their financial affairs in the light of these changes.

Business Taxation

Following the Arctic Systems case and the threat of legislation to close what HMRC call the 'income shifting' loophole, it was a relief that the legislation has been postponed to 2009 for a further period of consultation. It was feared that the legislation would impose onerous requirements on owner/directors where both husband and wife are shareholders, so hopes are riding on the consultation to produce something more straightforward.

On Corporation Tax, the main rate is reducing from 30% to 28% but the small companies rate is increasing from 19% to 21% and due to increase further to 22% next year. The Government's reason for this increase is that they want to provide a more level playing field. This means that there is less of a tax bias between:

• Trading as a small company or trading as a sole trader or partnership
• Drawing value from one's own company as dividends or salary.

Finally for businesses, Capital Allowances were reformed with the introduction of a new £50,000 Annual Investment Allowance covering most businesses regardless of size and giving 100% relief on qualifying capital expenditure of up to £50,000.

Towry Law welcomes opportunities to work with other professional advisers of small businesses to ensure they are not paying too much tax and to maximise long term value, taking into account both business and personal needs.

Investment Management in volatile markets

We've lost count of the number of occasions, since the beginning of the year, we have been asked whether "now" is the right time to sell or indeed buy. Equities are probably more risky than many investors realise and certainly are if said investor is not prepared to be patient, or gets worried out of a sensible strategy by market noise.

The mundane and sadly prosaic answer to the original question is that if you have a properly constructed and diversified multi asset class portfolio, then you should keep your head down and ride out the troughs, as you do the peaks. The point being that if your portfolio was correct for you a year ago and a month ago, then it probably still is now.

We have never come across anyone who can predict the future, and especially the tops and bottoms in financial markets. For example, who would have guessed that Saddam Hussein would invade Kuwait in 1990, or that Russia would default on its debt in 1998? Even assuming you could assimilate all the millions of factors that are available, the most rational of predictions can still get wiped out by a stampede of, often irrational, sentiment from investors, whose mania and mob mentality can lead to large swings from depression to over confidence.

Studies in the US often show the incredible fact that average investor returns, over time, are rarely in the same postcode as the market or even the median mutual fund. The obvious conclusion is that investors are consistently interfering with their portfolios and following the observed behavioural issue of buying high and selling low.

It was only a year ago that investors were buying commercial property funds in vast quantities, after several years of strong and sustained performance. One year on and we are facing an entirely different landscape with sentiment being one of 'doom and gloom', fund prices falling and fund managers imposing additional exit penalties and/or time delays before investors can withdraw their funds. Despite the fact that for most historic holding periods commercial property has produced very solid annualised returns, we are now seeing investors coming out and taking a 20 per cent loss.

We should also not forget the lessons of the 2000-2003 equity bear market. In early 2000, the FTSE stood at 6,900. This was at the height of the technology boom and many investors increased their weighting into the equity markets. Then the markets started to fall. As they fell, investors did not look for buying opportunities, instead they became more and more nervous, selling many of their equity holdings for ever bigger losses while increasing exposure in safer assets. As the market bottomed at 3,300 in early 2003, by far the biggest selling investment sector was fixed interest.

Trading a portfolio when uncertainty is great and emotions are running high seems destined to lead to disappointment. Instead, consistently and systematically rebalancing a multi asset class portfolio back to its original target weights, by consistently taking "profits" out of the areas that have done well, and redirecting them into asset classes that have lagged and hence are "cheaper" in relative terms, essentially averages down your relative cost price in that asset class. One manages to avoid the buy high and sell low issues that tend to plague the average retail investor.

The bad news is that, unfortunately, it remains just as difficult to predict where different asset classes will go from here; of course this will not stop many industry experts from trying. In the words of renowned economist, JK Galbraith, "We have two classes of forecasters; those who don’t know and those who don’t know they don’t know."

The better news is that you don't need to be able to predict the future or time market peaks and troughs, to be able to invest productively. Risk can be diversified, especially via multi asset class investing, which itself is based upon correlations, or the way asset classes move relative to one another. Critics say that correlations can be unstable, and this is sometimes true of the short term, but over any meaningful investment period they are actually remarkably robust. When did we last come across a period of time when Wall Street went down and the FTSE went up, or vice versa? Something else that can usually be relied upon is the order of volatility in asset classes. That is to say smaller companies are usually more volatile than blue chips, equities more volatile than bonds, and so on.

So, we are able to create an optimised portfolio that blends different asset classes that should shield investors from large lurches in the markets, and without the need for subjective interference, which so often can go wrong.

Scottish Business Insider Accountancy Awards

This year sees the launch of the first Scottish Business Insider Accountancy Awards and Towry Law is delighted to be a sponsor of the event.

As a fast growing firm ourselves, it is logical that we have decided to sponsor the 'Fastest Growing Firm' award at the ceremony, which will be held on Thursday 22nd May 2008 at the Hilton in Glasgow.

Towry Law has built strong relationships with a number of the pre-eminent firms of accountants in Scotland and is very pleased to help support excellence in professional services. The financial services sector in Scotland is one of the most buoyant in the UK and has seen significant growth in recent years. It is also an extremely important region for Towry Law; we have offices in Glasgow, Edinburgh, St Andrews and Aberdeen.

Award success for Towry Law

Towry Law celebrated award success in recent weeks and has been accredited as one of the Sunday Times Best 100 Companies to Work For. This follows entries from 868 UK companies and is based on the response of an extensive staff survey, as well as financial and other information. Towry Law's ranking within the Top 100 Companies therefore confirms the positive perception that Towry Law employees have of the company. In particular, the leadership skills of Chief Executive Andrew Fisher, and the firm's management team, were held in very high esteem.

Towry Law is one of only five financial services firms to make the final list, and the only firm offering fully fee-based private and corporate wealth advice.

Andrew Fisher, Chief Executive, Towry Law, said:

"We are proud to be included in the Best 100 Companies list, which recognises the importance we place on employee engagement and, in particular, the wellbeing of our employees. Our aim is to become the leading provider of private and corporate wealth advice in the UK and we will only achieve this by attracting and retaining the most talented people in our industry."

April Market Commentary

Volatility continues to be a feature of markets in the first quarter of 2008 but a major crisis in the financial markets appears to have been averted by the rescue of Bear Stearns. The Central Banks have been very active in reducing interest rates and supplying liquidity to the markets but such action often incurs a time lag before feeding through to improved equity returns. As John Maynard Keynes observed, monetary policy is something of a blunt instrument, and at times it can be like pushing on a piece of string.

The US economy appears to be headed towards a recession lead by the downturn in residential property prices and the continuing seizure of activity in the credit markets, which is temporarily choking off normal financial activity, that economies rely on to grow and prosper. Banks are increasingly reluctant to lend in the mortgage markets having been badly burned as a result of imprudent policies. Now lending criteria are being tightened and in the UK 100% mortgages are now a thing of the past; arguably they should never have existed in the first place.

For a time in March there seemed to be some respite from ever rising energy and basic material prices but the upward trend in both has resumed and the latest "problem child" is food. Many exporting countries have put an embargo on rice sales, further exacerbating the issue. Another contentious issue is the planting of crops to produce ethanol instead of food, all of which adds to the costs of feeding the family.

Uncertainty will always add to equity market turbulence – our own FTSE All Share index is down 9.9% so far this year; 7.7% over the last 12 months. Emerging markets have fallen more than FTSE so far this year at minus 11.7% but are still up 16.0% over 12 months. Other asset classes have experienced quite different results. Oil (in sterling) is up 8.8% so far this year and 46% over the last 12 months. This has had an effect on the inflationary outlook as higher energy costs should be passed on to the consumer. In the highly competitive traded goods sector this is not necessarily the case with manufacturers trying to stay competitive by keeping price increases down. One might argue that higher energy prices are in fact more like a tax on the consumer and hence deflationary. Energy as a percentage of household outgoings is rising so there is less to spend on other consumables. Demand falls and so in theory should prices.

Government bonds – gilts in the UK – are also doing well mainly as a result of the flight from non investment grade sub prime debt. The FTSE All Stocks Gilt index is up 1.4% this year and 7.6% over the last 12 months. As a result the reduction in gilt yields (the UK 10 year gilt now yields 4.4%) has begun to put a prop under commercial property prices where rental yields are now over 6%. This makes property more attractive to institutions than gilts.

The outlook is still far from clear; so more volatility will be high on the agenda with the Central Banks doing their best to calm the troubled waters. What is key for investors at this time, and in fact at any time, is to acknowledge that the future is uncertain and to position their portfolios to benefit from multi asset class diversification, so that no matter what happens they have the best opportunity for meeting their objectives.

This Market Commentary is solely for information purposes and is not intended to be, and should not be construed as investment advice.

Whilst considerable care has been taken to ensure the information contained within this commentary is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.

The opinions expressed are those of Towry Law Investment Management Limited on behalf of Towry Law Financial Services Limited and are made in good faith, but are subject to change without notice.

IMPORTANT NOTICE: Towry Law Financial Services Limited. Registered in England No. 607039. Towry Law Investment Management Limited. Registered in England No.793636. Towry Law Trustee Company Limited. Registered in England No. 1151146. Towry Law Pension Trustees Limited. Registered in England No.781047. All of the above firms are authorised and regulated by the Financial Services Authority. Towry Law Holdings Limited. Registered in England No.4773122. Towry Law Nominees Limited. Registered in England No.2988101. Towry Law Services Limited. Registered in England No. 5169111. The Registered Office of all these companies is Towry Law House, Western Road, Bracknell, Berkshire, RG12 1TL. Telephone 01344 828000.

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