UK Funds Risk Tax Hit By Slow Investment At Home, Official Warns

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(Bloomberg) — The UK could claw back pension tax breaks from asset managers that fail to invest enough domestically, the head of the British Business Bank said in a warning about the stakes for the industry as the government pursues a key growth initiative. 

Louis Taylor, effectively a government official in his role as chief executive of the state-owned lender, insisted that he was not endorsing the idea but pointing out how the government can boost funding for growth-enhancing projects at no cost to taxpayers and without resorting to full compulsion. The industry prefers Australian-style tax reliefs to incentivize investment.

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Prime Minister Keir Starmer is counting on the private sector to deliver the rapid growth his new administration has promised. Funds considered to be the least expensive investment in the UK are under scrutiny because they already receive tax relief from employee pensions, which boost assets under management.

So far, the government has refrained from imposing a minimum dividend on UK assets but Pensions Minister Emma Reynolds this week refused to rule out tougher alternatives.

“Right now we’re not talking about it, but let’s see where we end up,” Reynolds told the Financial Times when asked about the controversial approval move. “Investment in pensions, as you know, is provided for free in terms of tax exemption.”

In an interview with Bloomberg before Reynolds’ comments were published, Taylor said that instead of giving more tax breaks, the government could strip funds of some of the benefits they currently receive.

“It is open to the fund manager that, unless your scheme invests some part in the UK, we will give you back the tax benefit you have. You can put it back into the pension plan,” he said. “That would be good for the Treasury – in the sense that the deduction is happening anyway, but whatever they say they get back is fine.”

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Pension contributions are deducted from earnings before they are taxed, a gain worth around £50 billion ($63 billion) a year at a time when public finances are stretched. For a basic tax payer, it is 20% exemption from the fee and 45% for a higher tax payer. The fee paid to pension funds that invest less in the UK will not be equal to the mandate because they can still invest overseas if they see that doing so will exceed the cost of higher taxes.

Starmer is committed to delivering sustained growth of 2.5% a year and improving living standards, a challenge for an economy plagued by sluggish productivity since the global financial crisis of 2008-09. The decline is largely blamed on chronic underinvestment in infrastructure and startups.

Ministers would like pension funds to contribute at least 5% of their assets to the UK and hope that the disclosure regime will be sufficient to ensure it is carried out voluntarily. Taylor said the threat of tax reform would encourage investment in infrastructure and capital but would also damage “the UK’s image among international investors in an open economy where there is a lot of freedom.”

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He continued: “This is difficult for the government. There are no easy answers here. It should be gradual. But it has the potential to change the rate of economic growth. Venture capital needs a little patience, infrastructure investment needs patience, and pension money is patient money.”

BBB, an independently owned development bank designed to help small and medium-sized businesses, has £7.9 billion to invest in partnership with private sector partners. It also manages the government’s loan guarantees and the emergency Covid business loan portfolio, including a revolving loan program for small companies.

For now, the government is treading carefully. Last week, Chancellor of the Exchequer Rachel Reeves promised new rules to unify the UK’s fragmented pension fund industry into fewer, larger players with a scale to invest in bigger projects and riskier companies. He hopes the move will unlock £80 billion of productive capital for domestic investment. In an interview with Bloomberg TV, he said the government “is not looking to authorize pension funds.”

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Taylor said UK pension funds are less efficient than those in the US, Canada and Australia because they are managed in a “higher risk-taking manner.” Canadian funds invest 15 times more in private equity and start-up venture capital than their UK counterparts and deliver better returns to program members, according to BBB analysis.

“We have the second largest amount of pension money in the world, and we are not investing it in productive assets in our economy,” said Taylor. “You’ve got to want to be overweight in the UK, because it’s an equally powerful ecosystem for innovation.” UK pension funds only account for 4.4% of UK stocks, compared with 50% at the turn of the millennium, according to think tank New Financial.

Not all investors are opposed to accreditation, Taylor said. Trustees face tougher oversight of fees that drive money into safer asset classes that are cheaper to manage. “Some feel that if they are authorized, the question of whether or not they enter the business is removed. Just how they fit into it. They may feel that would be a good thing. Some may find that strange. They told me what I should invest in,” he said.

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