Educating The Next Gen

We understand that one of our primary responsibilities is to help equip future generations with the skills,experience and perspective to manage their responsibilities as well as the challenges and opportunities they will face.

Additionally we appreciate that each generation may require support in communicating

their concerns and aspirations as they wrestle with the responsibilities associated with being custodians of wealth.

We offer a variety of opportunities to our clients as demonstrated below which not only strengthen our relationship with them, but also offers the opportunity to develop new relationships within the family.

 

Next Gen Courses

Our engagement with the Next Gen is calibrated to the specific challenges they will face at various stages of their lives and in the process of inheritance. Whether we provide training, experience and peer group discussion alone or in conjunction with professional partner firms, feedback from participants and often their parents evidences the tangible benefits that accrue.

“I learned a lot about the business world, the family business world and most unexpectedly about myself. Each lesson was well organised and interesting”
“Thanks so much to you and your team for organising such a stimulating and motivating programme. It has certainly provoked much thought and already created much debate. Absolutely brilliant!”

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Matthew Fleming

Partner - Head of Family Governance & Succession

e. Matthew Fleming

Ari Tatos

Managing Partner

e. Ari Tatos

Lucy Birtwistle

Director – Family Office

e. Lucy Birtwistle

 

 

Steinhoff: lessons for the long-term Investor

CONCENTRATION RISK

Unfortunately it seems to take major corporate failures to highlight the virtues and merits of a diversified portfolio. Naturally, investment managers who potentially held such a failure in client portfolios, also choose to trumpet the benefits of a diversified portfolio at such times.

The subject of diversification also raises the active versus passive debate. One of the growing arguments against passive (or index tracking) investing is the inherent concentration risk in particular companies. In the case of the JSE All Share Index, it is Naspers at nearly 20% of the index (with Naspers, Richemont and BHP Billiton together constituting 34% of the index). Certain longer-term investors may be comfortable with such a concentrated exposure, but index investors need to be aware that although they may no longer be at risk of underperforming a particular index, they may be significantly increasing concentration risk.

LONG-TERM ORIENTATION

When investing in a listed company, investors are implicitly placing both their capital and their trust in the company and most importantly, in the company’s management team. Management are ultimately the stewards of shareholder capital and have a critical role to play in determining either the success or lack thereof of a particular investment.

In this regard, shareholder and management interests should be aligned in achieving long-term success. In a short-term oriented investment environment fixated on short-term peer rankings, industry awards and the pressures of chasing fickle inflows, achieving such alignment is increasingly difficult.

One important flag in the Steinhoff saga was of a culture of risk. Key management and executives entered into significant derivative positions and/or leverage to benefit from an increase in the company’s short-term share price movement. Although the argument can be made that management had material ‘skin in the game’, we view this as a misalignment of interest. Management stood to benefit from an increase in the short-term share price, despite potentially exposing shareholders to excessive risk or value destructive deals over the longer-term.

UNDERSTANDING COMPANY CULTURE

It takes time to understand a listed company’s culture. As outsiders, investors are reliant on management interaction, company disclosures or press reports and often an investor’s opinion on a particular company’s culture is based on accepting the status quo.

Paying close attention to a management team’s response to/or treatment of a poor set of results, a particular deal that may not have gone as planned or potentially unethical internal behaviour can often give good insight into the company culture. One notable example was Steinhoff management and executive team’s trading in Steinhoff shares leading up to the announcement of the acquisition of Pepkor from Brait in 2014. When later questioned on why the company was not under ‘cautionary’, Steinhoff’s response was that the ‘advice received was that no cautionary announcement was necessary’. To remain beyond reproach, and specifically to avoid after the fact questioning and insinuations, we would prefer management and companies to always take the most conservative option possible in such instances.

The ideal for the long-term investor is to find a company with a shareholder (both large and small) centric culture who understand and respect that they are ultimately custodians of all shareholders’ hard earned capital.

An even more recent example is the case of a JSE-listed retailer’s write-down of a recent overseas acquisition. Whilst the write-down was expected, the company recently altered their remuneration policy to incorporate ‘return of capital employment’ as a key metric. The write-down has the effect of boosting return on capital employed even if the company profits remain flat. Although the introduction of this metric may well be warranted on a longer-term view, the timing of the introduction in conjunction with the write-down is unfortunate. We have consequently placed our investment recommendation on the company under review.

THE ROLE OF INVESTMENT MANAGERS

In the same way company management are custodians of shareholder capital, investment managers fulfil the same role for clients’ capital. Just as company management are held accountable in cases of corporate failure or poor allocation of capital, investment managers should also be held accountable for poor decisions. All investment managers make mistakes. When mistakes are made, Stonehage Fleming Equity Management spend time examining what investment process refinements could be made or what may have been missed. Accepting that a particular investment decision was a mistake is, in our view, the most difficult acknowledgement for the long-term focused investment manager (even more difficult than a decision to allocate investor capital to a particular company). Analysing and assessing the merits of a new investment is a methodical and process-driven decision, accepting a mistake and taking the appropriate action requires accepting short comings in one’s research or process.

We do not agree that a failed company’s management team or lack/quality of disclosure should be blamed when investment decisions do not work out. The responsibility of the long-term investor is to understand the company where they are allocating client’s capital. As investors, we are quick to judge a management team for a poor deal and would not tolerate an excuse of ‘lack of trustworthy information’ and should therefore be held to the same set of standards as company management teams.

FOCUS ON ORGANIC GROWTH AND CASH FLOWS

We believe it is essential to differentiate between organic growth and cash flows as opposed to ‘engineered’ profit growth. Companies are able to grow short-term profits through one, or multiple, acquisitions which may or may not make strategic sense or be in the best interest of the long-term shareholder. The low interest rate environment experienced over the recent past has been particularly friendly towards acquisitive companies. When companies embark on corporate activity, our preference is for management to have a track record of successful activity and for the acquisition to fall within the acquiring company’s ‘core competency’ (whether this competency is operational, technical or even regional related).

In Steinhoff’s case, the company embarked on a series of global acquisitions over the past five years. The acquisitions, in conjunction with changes in segmental reporting and a change to the financial year end in 2016, made consistent analysis of underlying ‘organic’ growth near impossible. Further to this, it now appears very likely that cash flows and even profit numbers were inflated over the past few years.

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Taxation, Lifestyle and Morality

George Osborne’s 2015 “Summer Budget” raised some challenging questions for those who are resident but not domiciled in the UK. For centuries the UK has welcomed wealthy foreigners’ contributions to our economy, allowing them to maintain unremitted offshore income and gains outside the UK tax net. The problem is that, economic arguments aside, it is now generally considered unacceptable for such special treatment to be enjoyed indefinitely by people who have become long- term residents, particularly if actually born here.

The clear message to the Resident, Non-Domiciled (RND) community is not only that they will have to pay substantially higher taxes, but that the historic arrangements are becoming increasingly difficult to justify, morally. The implication is that these individuals have a social duty to make a larger contribution to their adopted country.

It is never easy to have a privilege removed, and in this case the proposed changes may have a profound impact on the financial, business and lifestyle arrangements of many wealthy families, particularly those with widespread business interests. For some, the issue is far more than financial, as increased taxation (particularly inheritance tax) may jeopardise their ability to retain control of family businesses that have been built up over decades.

The responses of such families to the changed environment have been varied, but surveys conducted by this firm provide evidence that attitudes are changing:

  • Whilst reasonable measures will be taken to mitigate tax, many RNDs accept they will have to pay more.
  • Some, particularly the younger generation, accept that there may be a moral obligation to make a bigger contribution.
  • Some of those whose initial response was to leave the UK have yet to find an alternative which both has sustainable tax benefits and an agreeable lifestyle. The UK remains attractive relative to most alternative locations.
  • Many RNDs have established deep roots and family ties in the UK and have concluded that very substantial savings would be required to justify relocation.
  • Those who have already decided to leave are mainly those whose lifestyle is essentially international and whose residence can be changed by a relatively minor adjustment to the time they spend in the UK.

Most families affected will already be exploring their options, but changing attitudes may need to be reflected in the brief they give to their advisers.

Tax planning is no longer an exercise in outwitting the authorities, but rather finding a more balanced approach which takes account of increasing risks and changing social attitudes.

Artificial schemes, which operate within the letter but not the spirit of the law, are increasingly unlikely to succeed. They can also open an individual up to a wider investigation of their affairs, which is usually expensive to deal with, even where there is no wrongdoing.

Now is an ideal time for families to develop an agreed approach and set of guiding principles, accepted by all relevant family members. In particular, the younger generation may take a different view from their parents and, bearing in mind that tax planning spans generations, it is desirable that the arrangements put in place now are acceptable to those who may have to deal with the consequences in years to come.

The following are some thoughts which might help with deliberations:

1. WHAT IS FAIR, AND WHAT IS NORMAL

The question of what is fair is a tricky one. It can be argued that it is fair that everyone should pay the same rate of tax. Equally, it can be argued higher earners should pay a higher rate of tax, following the mantra “from each according to his ability, to each according to his need.” Further still, it can be argued that as an immigrant to the UK, one should only have to pay tax on income arising in the UK: why should the UK government have the right to tax monies hard earned elsewhere in the world?

In this context, it is helpful to look at where the UK falls in comparison to other major economies. Resident non-domiciliaries have, for a long time, been generously treated under the UK’s tax regime and the question is whether, following the tightening of the legislation, they are still better off than they might be elsewhere?

COUNTRY INCOME TAX CAPITAL GAINS TAX INHERITANCE TAX OTHER
United Kingdom 20/40/45% (10/35/42.5 on dividends). 18/28% Spouse exempt, £325,000 tax free, otherwise 40% Non-domiciliaries can for up to 15 years claim a) the remittance basis - no tax on unremitted income and gains and b) exemption from IHT in respect of non-UK assets.
United States Progressive rates up to 39.6% Generally taxed at 20% Subject to a current exempt amount of US$5.34 million, tax is charged at 40% US residents are taxable on their worldwide income and gains. Only very limited provisions allowing short-term residents to shelter foreign assets from tax.
Germany Progressive rates up to 45% 25% Rates vary depending on the relationship between donor and done, as does the tax free amount, and apply to lifetime gifts as well as testamentary giving. While the principle of testamentary freedom applies, a disinherited heir may claim 50% of the amount they would have been entitled to in intestacy. German residents or those with a habitual abode in Germany are subject to the tax on their worldwide estates.
France Progressive rates up to 45%. Additional rates of 3% - 4% for income up to/over EUR 1million in certain circumstances. 19% Spouse exempt, child sibling 45%, other 60%. Forced heirship also applies to certain assets. Wealth tax payable on assets of over €0.8 million. Heavy social security payments.
Australia Top rate of 45%. Taxed at income tax rates. Rate is reduced by 50% for assets over a year old. None. Temporary residents taxed on Australian source income and gains only.
South Africa Progressive rates up to 41% on worldwide income. Maximum effective rate of 13.65% on SA resident individuals on worldwide gains. Testamentary freedom. R3.5 million can pass tax free, otherwise 20%. Spouse exemption exists. Temporary residents / immigrants can shelter foreign income and gains provided they do not fall within the definition of tax resident in South Africa.

SOURCE: Private Client Tax, Third edition 2015, John Rhodes, Stonehage Law Limited

As can be seen, the UK still has a broadly favourable regime compared to many other major jurisdictions. It is reasonable to conclude therefore that the UK’s current regime is relatively fair and normal, and indeed still likely to be more advantageous to RND’s than most comparable alternatives.

2. WHAT ABOUT TAX HAVENS

A tax haven is defined by the OECD as having three key identifying criteria: 1) Nil or nominal tax rates; 2) Protection of personal financial information; and 3) Lack of transparency. On the face of it, these are an attractive proposition for a wealthy individual looking to keep his affairs private and reduce his global tax liability.

The immediate benefits of living in one of these jurisdictions are obvious: little to no income, capital gains, or inheritance taxes and a perceived higher level of privacy and anonymity with regards to assets.

However, for most people, the sheer levels of life upheaval and lifestyle changes required are often the deal-breakers. The day counting; the constant travel; the time spent away from one’s family: these things can be, or can become, too much of an additional burden.

It is also clear that the days of secrecy and privacy are over. The Foreign Account Tax Compliance Act (FATCA) is already well under way and the Common Reporting Standard (CRS) has effectively been with us since the start of 2016. This means that most account holders will have details of their holdings and income reported to the tax authorities of their home jurisdiction. Most of the major tax havens have reluctantly already signed up to these arrangements, under pressure from the international community.

Perversely, the only major jurisdiction not currently participating in CRS is the USA, which is relying on FATCA to provide all of the information they need, having forced the world to comply with their legislation!

3. THE MORALITY DEBATE

We must distinguish the morality of the individual from the morality of the law. People increasingly criticise the wealthy even for taking advantage of tax breaks deliberately created by the government and politicians are often keen to exploit this misplaced public ire for a short-term win.

The morality of the law is debateable. One can easily argue that the UK government has no right to tax funds that have been earned overseas, without any reference to the UK. On the other hand, it can equally be argued that if you are a long term resident of the UK and enjoy all the benefits that come with that, you should pay tax in the same way as any other “normal” UK resident.

Recent government policy changes and announcements are consequently designed to ensure that once you become a “long-term” resident, you should be treated for tax purposes on the same basis as those who are UK domiciled. For the time being, the government has determined that 15 years is the “long-term” watershed; less than the 17 years previously set for IHT in 1974, but much longer than any similar initial period in other countries such as Spain or even Israel.

More broadly, objections are frequently raised when wealthy individuals try to use ‘artificial’ schemes to gain tax advantages that were not intended. A notorious example is the film schemes which took advantage of an intended tax break, but pushed the boundary too far by removing most of the risks which the legislation was designed to encourage. It is not always obvious at what point the line is crossed between an intentional tax break and ‘an artificial scheme’.

FOCUS ON FILM SCHEMES
Gordon Brown originally enacted this legislation in 1997 in order to provide a boost to the British film industry, initially for 3 years, although it was ultimately extended a number of times. Initially, this appealed to many as an interesting alternative investment, but eventually people found ways to financially engineer products such that the benefits could be enjoyed by investors with significantly less risk. It is difficult to know when these schemes began to cross the line of acceptability and this may well not have been clear to investors at the time investments were made - it is easy to be caught out when one thinks there is a genuine investment opportunity.

No one is obliged to leave their affairs in such a way that the taxman will get the maximum possible share, but anything done to decrease that share constitutes tax avoidance. It quickly becomes apparent that tax avoidance is a vast grey area and what might or might not be immoral is a subjective question - one man’s “morally repugnant” tax avoidance is another man’s ISA, or duty free shopping basket. An individual’s approach to tax avoidance or mitigation must be based on their own level of comfort.

There have been high profile cases in recent years of people and corporations being exposed for engaging in various degrees of tax avoidance schemes. These range from companies such as Starbucks and Google transferring profits to lower tax jurisdictions and the “K2” scheme (used by individuals to move income offshore), to the swathes of people caught out by the ultimately failed film schemes. These have all been met, rightly or wrongly, by a strong, negative public reaction which has often been reinforced by criticism from the very top of government.

Whether or not you consider these schemes immoral (note that they were all legal), there is another matter to consider here - the issue of reputational damage. It is difficult to put a price on this but for many entrepreneurs, who hold the majority of their assets in their business, the impact of this has the potential to be significant; tarnishing both the name of the business and indeed the family name, which can be a brand in itself.

An individual is entitled to take advantage of tax legislation to whatever extent and in whatever way they are personally comfortable with, so long as they remain within the bounds of the law.

Some may take advantage of all legal means to minimise tax and others only of tax breaks which were clearly intended by the authorities. Some will always seek tax minimisation, whereas others will aim to keep their overall tax bill to a ‘reasonable’ level, an objective which needs to be defined and discussed with tax advisers.

It is important to note that those with fiduciary obligations such as company directors or trustees have to justify their decisions to their beneficiaries. Bearing in mind their effective obligation to maximise profits, a strong case will have to be made if tax minimisation is not one of their main objectives, particularly if personal moral values are coming into the equation.

4. ANTI-AVOIDANCE

Historically, offshore structures, while often used for tax avoidance, are also used for matters entirely unrelated to tax, including the mitigation of political and/or personal risk, and succession planning. In these matters, the tax consequences are often a secondary consideration.

In some countries, wealthy individuals can face imprisonment and the confiscation of their assets simply for having a difference in opinion with the ruling party. Transferring assets out of your own name and out of the country is thus an obvious way to mitigate this risk.

The relative anonymity of an offshore discretionary trust can also be put to good use in reducing risks for wealthy families. Kidnapping, for example, is a real threat.

Testamentary freedom may seem like a given to many, but there are a number of countries that restrict, to a greater or lesser extent, the ability to decide how one’s assets should be divided on death. Several offshore jurisdictions have laws that specifically do not recognise forced heirship and placing your assets into trust can allow you to pass on your estate freely.

In all of these scenarios, the avoidance of tax will be a likely by-product, rather than a driving factor in the planning. Do moral arguments against tax avoidance still stand up here? Even British legislation recognises that anti-avoidance provisions will only apply where tax avoidance is “the main, or one of the main” reasons for the planning.

5. WHAT SHOULD I BE DOING?

In light of the major changes coming, it is a good opportunity to take a step back and look at the bigger picture: to assess one’s priorities and consider what level of tax risk one is willing to accept. No-one can predict specific future changes to the tax system with any confidence, but the direction of change is clear. Families can take the opportunity to put in place structures that are reasonably futureproof. The alternative is to adopt a more reactive approach, and try to adapt as the legislation is announced.

Given the constant changes, and the upheaval that they can cause, many families find it useful to agree a strategic framework and set of guiding principles, which help define their approach and philosophy. These provide a benchmark for individual decisions, as well as being a useful guide for the family’s tax advisers, in developing their proposals. It is also an important benefit of drawing up such ‘policy documents’ that the process helps identify and reconcile differing views between family members. The younger generation, for example, often has a slightly different attitude to tax avoidance and, given that they ultimately have to live with the result of any long-term planning, an agreed philosophy makes obvious sense.

WHERE IS MY RISK?

There are a number of areas where an individual taxpayer faces risk. Investment selection is self-explanatory and the closer one pushes the tax boundaries the greater the risk, naturally. However, it is also worth noting that having an excessively low tax bill can also add risk. Not only do you make yourself more of a target for HMRC, you are also likely to receive less leniency and a more thorough investigation in the event of an enquiry.

Such a framework will be particularly helpful to those considering the implications of the changes to the UK RND rules, given the many complex alternatives which could be explored. It will promote sounder, more consistent and more ‘joined up’ decision making. Greater clarity of purpose will reduce unnecessary debates and thus reduce the costs of professional advice.

6. CONCLUDING THOUGHTS

Ultimately, deciding an approach to tax is a personal issue. There is a danger that personal advisers have engendered a mind-set of minimising tax at all costs, with little regard for anything else.

Individuals need to ask themselves: do I have an idea of the level of tax that I would consider to be acceptable? Am I able to achieve this level of minimisation within the bounds of moral decency? Am I willing to accept a higher level of tax payable in order to reduce the level of risk faced and to continue to enjoy the quality of life I have achieved in the United Kingdom?

With the direction of tax changes undeniably in favour of tighter legislation, fewer legal loopholes and a more focused approach on tax avoidance, there is an opportunity to consider a new, sustainable philosophy and approach, with some clear guiding principles.

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Cyber security - simple scepticism is a good start

91% of cyber-attacks still start with a phishing email ¬– a fraudulent email designed to obtain sensitive information, deliver malware or extract payment ¬– and they are becoming increasingly targeted, sophisticated, and harder to detect, according to Roddy Priestley, Director of Cyber Security at global risk management consultancy, S-RM.

“We have seen a shift in the way that hackers approach an attack. They are patient and persistent in their approach to stealing data.”

“They build a profile around a target, looking at social media, the news and information on Companies House to understand their working and personal habits,” he told delegates at our 2019 Next Generation Seminar, hosted by Matthew Fleming, Head of Succession and Governance. The seminar – focused mainly on family, communication and governance - takes the opportunity to engage with the next generation of our client families and open their minds to the challenges and responsibilities they are likely to face, including the more practical issues surrounding wealth.

A successful phishing email is unobtrusive, authoritative, and appears to come from a reputable source. Often hackers will instil a sense of urgency in order to prompt their target to act. “We want to lift the veil on how a hacker thinks and understand the psychological tools they might look to exploit their victims sensitivities” explained Roddy.

“Understanding what they are trying to achieve at each stage of the cyber-attack will ultimately reduce risk.”

Roddy brought one of S-RM’s team of ‘ethical hackers’ with him, James Jackson. It is James’s job is to legally exploit vulnerabilities in systems for businesses and private clients, then recommend taking remedial measures to prevent cyber-attacks. During the seminar, James carried out a live hack, demonstrating to guests the process of information gathering and highlighting the level of sophistication a phishing attack requires.

Roddy added, “It is effectively impossible to be 100 per cent secure. We don’t talk about how to make things impenetrable, but how to make the level of sophistication and resources required by the hacker so high that you will not be a target.”

People are inherently trusting, explained Roddy, so a healthy dose of scepticism is a good thing when protecting yourself against cybercrime. He offered some simple tips: be wary if someone contacts you unexpectedly, don’t be pressurised into taking urgent action or giving confidential information. Be vigilant with security, setting up encrypted passwords and multi-factor authentication will deter hackers. “There are often tell-tale signs and common methodology behind attacks. At each stage there are things you can do to defend yourself,” said Roddy. In short, he warned: “Be suspicious.”

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