08 Oct The market impact of concerns over tax changesRead Time: 5 minutes
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Having concluded that CGT changes were at least a viable possibility in the near future, the client’s next question was whether they might have an impact on the stockmarket. Their thinking behind this is that, particularly if the change were to be announced with a future effective date, there might be a rush to liquidate assets and pay tax at the lower rate. If such a move were to be widely anticipated, there might even be a sell-off in advance of the expected announcement, lest the changes take effect immediately.
This is an interesting question and one which is worth considering. However, to do so we need to look at both the distribution of the tax and of the underlying assets on which it is paid.
The somewhat uneven distribution of CGT across a minority of taxpayers was addressed last time. To consider the extent to which the sort of assets that are liable to it might be affected, we need to dig around elsewhere. Fortunately, as well as cat videos, the internet has plenty of useful information that we can use, even if some of it is a few years old (no doubt it takes a while to gather and collate the data). Governments love to collect data and there is much of it to be found on UK government or Office for National Statistics (ONS) sites.
Who owns the UK stockmarket?
As we are concerned with the stockmarket (rather than property or works of art), a good starting point is to look at how the UK stockmarket is owned. Obviously many (hopefully most) investors will hold a diversified portfolio and not be exposed entirely to the domestic market. However there are undoubtedly some who hold only UK shares.
Perhaps surprisingly, more than half the UK market at the end of 2018 (the most recent figures available) was owned by overseas investors, a group whose market share has significantly increased over the last few decades. At the start of the 1980s, it was a mere 4%. Although some of these will be subject to tax, that is likely to be in their own jurisdictions and since their decisions to buy or sell will not be influenced by most changes to UK tax, we can ignore them here. There are also some categories of domestic investor which we can disregard. These include assets owned by corporations, as well as various institutional investors, such as unit trusts, insurers, pension funds, banks, charities and the like. They account for just under a further third, leaving a mere 13.5% owned by private individuals, amounting to £254bn.
Some of those individually owned holdings will themselves be within wrappers which are exempt from CGT, such as individual savings accounts. Government statistics also reveal the extent to which ISAs are in use. At the end of 2018/19, £584bn was invested in adult (i.e. non-junior) ISAs, of which £314bn was in stocks & shares ISAs. Clearly some of that will have been held in pooled funds (some of which were invested in the UK equity market) and the same report reveals that actually more than half of that total was – only around £30.5bn of it was directly invested in UK shares.
Deducting that figure leaves maybe £225bn of UK shares owned by individual investors in a form which makes them subject to CGT. Given a UK market capitalisation of £1,884bn, that amounts to around 12% of the market owned by those individuals. This gives us an upper figure for the value that could potentially be sold. However, that does not mean that around 12% of the market is likely to be dumped with the inevitable fall in prices that such a sell-off would entail. There are several reasons for this:
- A certain proportion of any population of investors will be substantially passive, in that they will retain their holdings from year to year and either spend or reinvest the dividends. They may liquidate some stock at times to meet specific cashflow needs but they are not managing their portfolio or paying anyone else to do it for them. Consequently they may not have a trading account as they rarely have the need to carry out transactions. The additional hassle of arranging a disposal (and then a repurchase) may be more than this cohort would be willing to undertake simply for the possibility of a tax saving.
- Others will have portfolios (or rather holdings, such as those acquired from privatisations and demutualisations) which are so small that even if they were to sell the lot, they would not incur CGT. Such individuals quite possibly have no awareness of CGT anyway. If you don’t think you’re going to pay tax on something, you have no incentive to take any action to avoid it.
- Some (probably those with higher value portfolios) will have their portfolio managed professionally by a third party. This is likely to have a couple of consequences. One is that it will be (or at least should be!) more diversified across more than just the UK equity market. Considering that the UK represents under 10% of the value of the global equity market, a diversified portfolio should have a substantial part of it invested in markets outside the UK. In most cases, some will also be invested in asset classes other than equities. Even if the manager were to decide that it would be worthwhile to realise gains at the current rate of tax in anticipation of it being increased, any disposal would likely be across more of the portfolio than just the UK equity element. If they were to make such disposals for tax reasons, these would invariably be a temporary measure and the same assets (or at least similar ones) would be bought back within a matter of weeks so as to maintain the portfolio’s target exposure.
- Even where individuals have gains to realise, are motivated to do so and have the means to liquidate their UK holdings easily, it is unlikely that they would all do so at the same time. Some will be better organised than others, some will leave it to the last minute and others will be somewhere in between. This would serve to reduce the prospect of a sudden ‘wave’ of disposals of the sort which might move prices.
- Disposals by those who are willing and able to take action in anticipation of an adverse change in their CGT liabilities would be purely for that tax reason. However, there is no particular reason to assume that they would also simultaneously decide that investing in UK shares is no longer attractive to them. Consequently, any disposals of UK assets are likely to be temporary and even if they did not buy back exactly the same assets immediately (to avoid the 30-day rule), they would likely opt for those with similar market exposure. While HMRC cares if someone sells index fund A and buys index fund B instead because they are different assets for CGT purposes, the market doesn’t.
- Some investors who would be willing sellers will not have unrealised gains large enough to make it worth their while to sell (or they might have unrealised losses).
Hopefully from this it should be apparent that a combination of the relatively low proportion of the UK stockmarket that is actually owned by taxpayers who are subject to CGT, are aware of the fact and have the means and inclination to take action will be likely to limit the amount of CGT-driven disposals. Even those who are knowledgeable enough to make them can be expected in most cases to repurchase similar assets shortly afterwards to maintain their portfolio compositions.
While we can observe the pattern of daily trades and the movements in prices, even the most insightful commentator can only speculate as to why thousands or millions of investors are making the buy/sell decisions that they are. Although a sudden rush of disposals (for whatever reason) can be expected to move markets, if the volume of trades is modest, it could easily be lost in the normal day to day trading activity anyway. Consequently it can be very difficult, even after the event, to determine whether the fears (or knowledge) of an imminent tax change were actually responsible for a given price movement or whether it was due to something else entirely. Free markets don’t claim to know what causes participants to buy and sell; they just reflect the impact of those transactions on asset prices.