The Budget 2016 - An investor's perspective

Thursday, 17th March 2016 09:33 - by David Harbage

Most budgets contain a surprise or two, and Chancellor George Osborne’s latest set of measures may well in future years be best remembered for the introduction of a ‘Sugar’ tax on soft drinks.

Plans to bring in such a levy in 2018, primarily to counter the rising trend of obesity in children, are likely to adversely impacted A.G. Barr (the makers of Irn Bru) and Britvic – whose shares fell 2.5% and 1.4% respectively, on a day when the UK equity market rose 0.5%.

By contrast, the macro news did not surprise: domestic economic activity is being hampered by a slowdown in other parts of the world and weaker productivity. That we are expected to perform better than most other major advanced economies is small comfort, with the pace of UK growth over the next five years likely to lag the longer term trend rate of expansion in output (2.4% per annum). The Office for Budget Responsibility (OBR) predicts GDP growth of 2.0% in calendar year 2016 - down from November 2015’s forecast 2.4% - and lower than the consensus of City expectation. Less pronounced reductions in GDP, within a range of 2.1%-2.2%, is predicted for the following 4 years. 

Although the Chancellor has missed his own forecasts of public debt and the current account deficit (the difference between HM Government’s receipts and payments), both are likely to reduce and improve – with Mr Osborne predicting that the deficit is eradicated by 2020 (OBR put a 55% likelihood on that eventuality). One increasing contributor to the overall coffers can be corporation tax, as receipts should rise from further efforts to target multinationals (who seek to avoid paying UK tax, via domicile), accounting restrictions on allowing all interest costs to be expensed against pre-tax earnings (reduced to a 30% deduction) and applying less scope to use previous years’ losses to reduce the current year’s taxable profit (flexing to only 50%, instead of 100%, applied – with banks being restricted further to use just 25%).

The balance sheets of pub companies such as Enterprise Inns and Punch Taverns carry significant debt – to the extent that the interest charge exceeds 50% of EBITDA (earnings before interest, depreciation and amortisation) – with other highly geared (financially) industry sectors including private equity, venture capital, water, electricity, power and retail. However, measures to reduce the burden of business rates on property – in particular via a 150% increase in small business rate relief to £15,000 – could cushion the blow. As regards the latter, banks like RBS and Lloyds Banking Group that have built up the biggest losses since 2008/099 will be hardest hit by this measure; with the Treasury set to collect a further £2bn tax as a consequence. The banking sector is set to provide further exceptional windfalls to reduce government debt, as the remainder of HMG’s stake in Lloyds is offered to retail investors and mortgage loans from the publically owned Bradford & Bingley are put up for sale.

In terms of the wider taxation measures, much of the working and middle classes will feel better off as a result of above-inflation increases in the personal income tax allowance (to £11,500 in April 2017), the higher rate income tax threshold (to £45,000 next year) and the freezing of duties on fuel, beer and spirits (if not wine). The ‘takeaway’ from an investor’s perspective is that a focus on the domestic consumer is likely to prove more beneficial than exposure to an overseas opportunity.

Beyond the prospect of the freeze on fuel duties being opportunistically lifted (as oil prices had reduced the price of petrol at the pump), commentators in the media had speculated about further taxation hits on the insurance and the gambling sectors, with stocks such as Aviva and Ladbrokes coming under pressure ahead of the Budget. As it turned out, IPT (insurance premium tax) was only increased by 0.5% to 10% (some suggested 12.5% was probable) and no further taxes were applied to the gaming industry – where many had forecast a hike in the machine games duty – prompting relief rallies within these sectors. The other ‘non-event’ surrounded the well-publicised withdrawal of proposals to stifle – if not remove – income tax relief on pension contributions (deemed politically inexpedient, given the current turbulence within the Conservative party ahead of the imminent EU referendum).

Besides the ‘sugar tax’, this Budget will probably be remembered for its encouragement of savings. The annual allowance for investment into an ISA (£15,240 in the current, and imminent, tax year) is to jump to £20,000. Within this allowance, those under 40 years of age can invest up to £4,000 into a Lifetime ISA – which will benefit from a 25% bonus, limited to £1,000, from HMG – per annum, until they are 50 years old. Monies can be withdrawn to buy a first home, upon reaching 60 years of age or in exceptional circumstances (such as becoming terminally ill) – otherwise withdrawals will incur a 25% charge. Added to a reduction in the rates of stamp duty on commercial property (akin to that introduced last year on residential property, but slightly different bands apply), house builders Berkeley Group, Barratt Developments and Taylor Wimpey featured in the top ten risers within the FTSE100 index.    

Another industry segment which benefitted from the Chancellor’s attention was oil and gas exploration – in particular operators in the North Sea, which typically feature high extraction costs – with Tullow Oil (aided by good news from its Kenyan field) and Cairn Energy topping the risers in the FTSE250 index. Petroleum revenue tax was effectively abolished, via a 0% rate, and the supplementary charge on oil & gas halved to 10% as government support measures to North Sea operators are set to exceed taxes raised by circa £300m this year. In addition, the construction and building materials sectors should benefit from the announcement of plans to spend more on the country’s infrastructure; projects include a number of new or widened roads in the north of England, including a tunnel from Manchester to Sheffield, high speed rail link between Leeds and Manchester, a Crossrail 2 going north-south in London and – from the additional IPT - more flood defences. Companies such as contractor Kier Group and provider of aggregates Breedon appear well positioned, although this week both the CEO of Balfour Beatty and the leader of the Labour party, Jeremy Corbyn, highlighted the dislocation between the promise of new works and signed contracts.      

In addition to increasing the tax shelter which is the ISA (although not pension plans, as the lifetime allowance is further reduced - from £1.25m currently to £1m with effect from 6 April 2016), the rate of capital gains tax is to be significantly cut next month. After taking account of the annual allowance of £11,100, gains in excess of this are added to taxable income to assess the rate of capital gains tax payable: if the total falls within the basic rate tax band then 18% is payable in the current tax year, if falling into the higher or additional rate tax bands, then 28% becomes due. In the next tax year, these tax rates fall by 8%, to 10% and 20% respectively. There is an exception, however, in that gains made on a second or buy-to-let property (that is not the principal residence) will incur the 18% or 28% rate of tax. A lower rate of CGT typically results in higher transactional activity in certain assets – notably stocks and shares – while the higher ISA allowances should represent a boon for private client stock brokers, advisors or fund providers like Hargreaves Lansdown, St James Place or Legal & General.  

In summary, this would appear to be a steady and an unspectacular Budget that should please tax payers and investors. Notwithstanding that the UK stock market represents a barometer on prospects for the world – rather than our domestic economy – the writer believes that the FTSE100 can make further progress in the short term, with this blue chip index challenging and revisiting the 6,250 level that it began 2016.

Written by David Harbage for lse.co.uk on the 17th March 2016