FT Tax Efficient Investment Seminar
2 October 2014
Talk by Paul Jourdan
Amati Global Investors is a specialist investment management company, focussed entirely on investing in UK Smaller Companies, through VCTs, through an open ended smaller companies fund, and in offering an AIM Portfolio service for Business Property Relief on Transact. We are based in Scotland, a place where exactly two weeks ago today, as everyone here I'm sure, will know, a historic vote was held. I'm pleased to be able to report that on the 18th September, with a high turnout, and a near unanimous ballot, the R&A golf club voted to end its 260 year prohibition on women members. Of course, there was another vote being conducted on the same day, which became known affectionately as the Indy Ref, which sounds a bit like what you might call a football official making an album on an non-mainstream record label.
The referendum itself was, broadly speaking, not an affectionate matter. It was hard-core politics. It was also democracy at work in the 21st Century. There are two important bi-products of this. The first is that the political energy of the 45% who voted "YES" needs somewhere to go now. This was too highly charged to dissipate. The second is that the Referendum made most of us in Scotland do something that we will normally go to great lengths to avoid doing: it made us think. And one of the topics that it made me think a lot about was Government Revenue, or to put this another way relevant today's seminar, it made me think hard about taxation.
So I want to break with precedent here for a few minutes, and do something distinctly counter-intuitive for the manager of tax efficient investments standing in front of an audience of sophisticated professional investors considering tax efficient investment. I want to begin by looking not at the ways of avoiding tax bills, but at the reasons for paying them. I am doing this because I want to suggest to you that there are ethical considerations to bring to bear when it comes to advising your clients about tax efficient investment. Some in the "tax efficient" industry will deny all knowledge of this. But there is a bigger picture, beyond the usual considerations of optimising risk relative to reward.
For the purposes of today, I want to characterise this bigger picture in terms of two disappearing acts. "In this world," wrote Benjamin Franklin in 1789 (the year of the French Revolution), "nothing can be said to be certain, except death and taxes." Were he writing this today he might not be so sure about the latter. Recall Leona Helmsley, the New York hotel tycoon, who famously said: "We don't pay taxes. Only the little people pay taxes." For her, it was a short step from being an abusive employer (she was dubbed the "Queen of Mean") to becoming a tax fraudster. She was given a 4 year prison sentence in 1989. I am raising this to highlight a mentality of disowning all responsibility for the state. 25 years later it is one that has more resonance now, not less.
Sebastian Faulks' 2010 novel, A Week in December, about the jigsaw of contemporary London Life, confronts this issue during the dinner party hosted by the socially ambitious wife of a Conservative MP, which brings all of the narrative strands around which the novel is based together. One of the characters, Roger Malpasse, has a rant about the financial crisis and the financiers who made money from it.
Turning to John Veals, the emotionally frozen, billionaire hedge-fund manager who has discovered, with some clever, but dubious means, the imminent downfall of one of the world's largest banks, and shorted it having first puffed it up with a well placed takeover rumour,
Roger says: "And [the money that disappeared in the financial system] won't be paid back by people like you, John, you or the bankers, because I don't suppose you pay tax, do you?"
"I pay what I'm legally required to pay."
"I think we can take that as a no," said Roger."
From a global perspective, tax-paying has a curious inversion; at the upper end of the scale, it simply does a disappearing act. It is virtually impossible to know how much financial wealth globally is siphoned out of "onshore" economies to find its way to the safety and anonymity of tax havens. The current best guess of private wealth held offshore is between $21 and $32 trillion, and this estimate is 4 years old. This is on top of Profit Laundering, where corporations shift profits out of the taxable jurisdiction where they are made, to low tax territories, which was estimated in 2005 to amount to $1 trillion per year, half of which was siphoned out of developing nations. These figures are conservative estimates, and they are ballooning. It's not just that this constant movement of capital to zero or very low tax environments offshore deprives nations of an adequate ability to raise taxes, it's also the fact that this movement breaks down the relationship between that capital and the locality which fostered the success upon which it was built. It de-localises and de-personifies that capital. In doing so, it prevents the natural recycling of capital into the local economy.
The other disappearing act is at the opposite end of the spectrum. It is described eloquently by Saskia Sassen, who spoke about her most recent book, Expulsions, at the Edinburgh Book Festival over the summer. It is a direct function of major economies, including our own, not being able to balance their books.
"The language of low growth, unemployment, inequality, poverty, is not enough to capture what is going on in the current phase of capitalist political economies. All of these are present, but then they always have been part of capitalism. There is a specific difference I want to capture: something far more brutal and acute that we cannot capture with the usual language. Further, I want to argue that these dynamics are not only hitting Greece, Spain and Portugal, but in fact are present throughout Europe, including Germany and the much admired Scandinavian countries.
I think of this stripping bare as systemic expulsions, and in being expelled these extreme conditions become invisible to our standard measures and categories. The unemployed who lose everything - jobs, homes, medical insurance - easily fall off the edge of what is defined as 'the economy' and counted as such. So do small shop and factory owners who lose everything and commit suicide. And so do the weakened and ill newly poor who can no longer access basic medical services. All are stripped from what gets measured as 'the economy."
Of course, I'm just hinting at the outline of some very complex topics here. To circle back to where I started, the point is this. Tax is a hugely potent political and ethical issue today. The globalisation of tax exempt networks are reducing governments' ability to remain solvent.
This is the backdrop against which the UK government has put in place a number of onshore tax-incentivised investment schemes. It has done so because it understand the importance of getting capital to flow into small companies whilst they are still risky propositions, so that they can make the long and difficult journey from being pipedreams to joining the engine room of the national economy. Unlike offshore tax havens, which siphon away taxable revenues pretty much without limit, these schemes represent a conscious investment in future growth. They should produce a return on this investment. In advising clients about tax efficient investments relating to these schemes, there are always going to be responsible and irresponsible pathways to take. For me, the responsible pathway does not involve some kind of disappearing act (i.e. don't try to over-optimise your tax bill); and it does not involve taking part in exploiting the schemes such that you take the tax relief without taking any of the additional risks involved in supporting genuine and ambitious new enterprises, which can become the dynamic creators of wealth and employment in the years to come. Because legislation is never perfect, you are likely to have a choice to make here. You can go with secured property loans dressed up as VCTs or EISs if you want to. There will always be products which just aim to exploit the loopholes. This is to take a free ride on the back of others' efforts. It may seem clever, but it's also corrosive.
What I am advocating is this. When you consider a VCT or an EIS proposition, in addition to the questions you will ask about what returns it may give your clients, ask yourself this question too: does this proposition give enough return to the tax-payer to justify the relief being claimed against it?
In what follows I want to portray the act of investing in new enterprises as something not to be feared, but rather, as something to be embraced. In the Amati VCTs, the field of new enterprises we look at is defined largely by the boundaries of the AIM market, so this where I will focus. At this point it would be tempting to give you the full presentation about our investment process at Amati: how we choose stocks; how we define what we mean by "quality" in a business; what our "red flags" are in stock picking; how we structure some of our investments as convertible loans to manage risks; how the we seek to create a well diversified portfolio across industry sectors, geographies, and business maturity profiles; and about how we were the first VCT manager to drop performance fees. But you can see all of this information just by asking us for a download of our VCT presentation, or by looking at some of the videos on our website. These things are important in relation to the specifics of what we do, but I don't expect them to be novel to you as a group of seasoned professional investors.
Instead, the point I most want to convey to you in the last couple of minutes, is how VCT and EIS schemes, when used in the way they are intended, keep alive the human face of investment. They are not about financialisation and unitisation. They are not impersonal. There is a short chain between your client as the end investor, and the investee company which benefits from opportunity created by their capital. Whilst AIM, like any large pool of companies, contains the good, the bad and the ugly all under one roof, we find that there are ample opportunities to invest in vibrant, and highly promising enterprises, run by some extraordinary entrepreneurs, covering a huge spectrum of life.
There is Mike Goddard, who set up a lettings business in 1995 when he left the RAF, embuing the business with core principles of professionalism, customer service and specialism, floating on AIM in 2012, raising capital for expansion, Belvoir now has over 140 branch offices. There is David Braben, who wrote a space game called Elite in 1982, reckoned to be the first computer strategy game to use 3D graphics, whilst he was studying at Cambridge University, going on to set up his own games development business in 1994, and nineteen years later raising external financing for the first time through an AIM flotation to help finance a major re-release of Elite using modern 3D graphics, based around a full model of the known stars of the Milky Way. This game is now just a few weeks away from full scale launch, having already achieved £6m of sales for pre-release Beta versions to around 100,000 users.
There is Chris Macdonald, who has overseen the creation of Brooks Macdonald as a national discretionary wealth manager now running £6.5bn. At the cutting edge of science there are people like Graeme Purdy and Brian Hayden at Ilika, who have built a remarkable materials discovery process based on thin-film technology at Southampton University, and whose look set to be the first to produce a commercially viable solid-state battery. Similarly the inventors at Microsaic have developed a miniaturised liquid mass spectrometer based on semi-conductor manufacturing techniques, which is becoming close to realising a 10 year vision of reaching widespread market adoption.
There is Keith Neilson, who founded Craneware, based in Edinburgh, now one of the dominant suppliers of revenue integrity software to US hospitals. And Tom Burnett, who has radically transformed Accesso, a company which started life selling electronic queue management systems to a few theme parks, and which has now extended both its product range and its customer base, to become an essential partner to many of the worlds' largest theme park operators.
I could go on, in fact I've barely started with this list. The people we back are people we get to know well. We regard them as our friends. The investments we make are important to them, and the success of their businesses is important to us. For us, investment is not just about share price graphs, due diligence reports, and sets of accounts. It is about companies that we are excited about. It is about dreams we are helping to realise. It has a human face. The investments facilitated by the Amati VCTs make a big difference to real people, and in turn if they succeed, this investment pays back many times over to the wider economy.
To attempt to summarise all I have said here: when you consider the many choices you will be faced with in advising your clients about tax efficient investing, have the courage to ask, in addition to all the usual questions, what difference will this investment make, and to whom?