Officials at the Treasury “more or less fell about laughing” when Richard Buxton suggested that current UK tax rules need changing in order to prevent financial instability, the fund manager has said.
In a webinar from the Smithfield Group last week (April 30) called 'The Outlook for UK plc post Covid-19' Mr Buxton, head of UK equities at Merian Global Investors, noted under current rules debt interest is deductible against a company's corporation tax bill.
He said this encourages companies to borrow more, and in some cases the borrowed money is used to buy back the company’s own shares, boosting the share price but doing little to stabilise the company.
Mr Buxton said: “Companies are using the tax deductible debt to juice the returns to equity holders via buybacks, but then every decade or so we have a major financial collapse that requires government intervention.
"For example, in the US, the airlines have spent $45bn (£36bn) on share buybacks over the past decade, and now have gone cap in hand to the government for a $50bn (£40bn) bailout. We cannot keep privatising profits and nationalising losses.
"Post the financial crisis, I did try to get a debate going on this, I went to see the Treasury for example. But the Treasury officials more or less fell about laughing when I suggested trying to amend that.”
The remuneration of many company chief executives, particularly the bonus element, is calculated based on the growth of earnings per share (eps).
There are two ways this number can grow, the first is by increasing the earnings (profits) of the company, and the second is by reducing the number of shares by buying them back, so the profits achieved are spread across a smaller number of shares, and so the earnings per share is higher.
In this way, it can be in the interests of company chief executives to buy back shares, and to borrow money to do it, and by borrowing the money, there is a tax advantage to the company.
Mr Buxton acknowledged that it can be in the interests of fund managers such as himself that companies do share buybacks, as this means share prices rise, and so would the performance of his fund if he held those shares.
But he said he would prefer “a more stable economic cycle” brought about by there being less debt in the financial system.
He said changes to the financial system that may come as a result of the Covid-19 crisis may mean that companies prioritise having “prudent” balance sheets in future, rather than “efficient” balance sheets which have lots of debt.
Mr Buxton said US investors tend to want companies to take on more debt, while in the UK investors are more cautious.
david.thorpe@ft.com
