Should Scottish Mortgage pay an extra Covid tax?

The success of Scottish Mortgage during the pandemic has attracted the attention of a campaign group. 

One of the best performing investment funds or trusts since the start of the pandemic has been Scottish Mortgage (LSE:SMT). The trust has a global portfolio heavily concentrated on tech and growth stocks, which have been some of the market’s biggest winners of the pandemic.

The portfolio, managed by Tom Slater and James Anderson, was well positioned going into the pandemic. As data from FE Analytics shows, since the start of March 2020 to 28 September 2021, Scottish Mortgage has returned 159%. In comparison, the AIC’s Global sector had an average return of 29.3% and the FTSE All World index 35.7%.

The success of Scottish Mortgage during the pandemic, however, has attracted the attention of the campaign group Tax Justice UK in a new report entitled “Pandemic Profits: who’s cashing in during Covid”.

The report accuses several UK companies, including Scottish Mortgage, of profiting from the pandemic based on profit increases over the past 18 months. Scottish Mortgage in particular was singled out for growing its profits by 801% compared to the average over previous years.

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According to the authors of the report, such an increase in profits is indicative of how the pandemic exacerbated inequality. Whereas many saw cuts to their income or job losses, some businesses, such as Scottish Mortgage, Rio Tinto (LSE:RIO) and ASOS (LSE:ASC) saw profits balloon. As a result, the activist group, which also targets AstraZeneca (LSE:AZN), Tritax Big Box (LSE:BBOX) and Serco Group (LSE:SRP), has called for a Covid surcharge tax on “excess profits”.

It wants a one-off windfall tax on “excess profits” made during the pandemic. It says “a 10% corporation tax surcharge on global profits made that exceed pre-pandemic levels could raise up to £1.6 billion on just the six companies in this report. A 50% tax could raise up to £8 billion.”

The great tax debate

Putting to one side the wider debate about taxation, inequality and profit incentives aside - and who can argue against everyone paying their fair share? – Scottish Mortgage has good reason to reject calls for it to pay a Covid profit surcharge.

First, these profits were not gains realised by Scottish Mortgage’s shareholders, who saw a return of around 160%. Nor was it the money accrued by Baillie Gifford for running the mandate. In the financial year ending March 2021, the asset manager made £42million from investment management fees charged by the trust. That was roughly double what it earned in previous years owing to the trust’s strong performance.

The 801% “excess” profit increase mentioned in the Tax Justice UK report refers to capital gains made by Scottish Mortgage from selling its shares that had gone up in price.

As the report notes: “At the start of 2020 nearly 10% of its assets (equivalent to £800 million) were invested in electric car maker Tesla Inc (NASDAQ:TSLA), whose share price soared by 700% over the course of the year. SMT sold around 80% of its Tesla shares during the year to maintain diversification in its portfolio and prevent Tesla from dominating the fund’s performance, which is the primary reason for its spectacular profits.”

The report also cites the trust’s big holdings in Amazon (NASDAQ:AMZN), DeliveryHero (XETRA:DHER), and Netflix (NASDAQ:NFLX). These companies also saw big share price gains in the pandemic, resulting in Scottish Mortgage selling holdings for diversification reasons.

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Authors of the report are asking Scottish Mortgage to pay a surcharge tax on the capital gains made from the sale of these shares. As an investment trust, Scottish Mortgage doesn’t pay capital gains on the sale of shares in its portfolio – instead, the owners of shares in Scottish Mortgage pay capital gains, assuming they aren’t using a tax wrapper.

Did Scottish Mortgage cash in on Covid?

There's also the allegation that Scottish Mortgage “cashed in” on the pandemic. The implication is that the trust was able to take advantage of the pandemic, which for many others in the country has been less lucrative. But, while the share price rise of DeliveryHero, Amazon and Netflix definitely can be directly linked to the pandemic, it is less clear when it comes to Tesla.

The electric car maker’s share price did enjoy a bump due the market backdrop favouring “growth” companies, while the pandemic also saw a growing interest in renewable energy. But the share price also surged because of financial fundamentals and its long-awaited inclusion in the S&P 500.

The report also notes that the share sales and therefore capital gains (or profit) were the result of portfolio management decisions. It was the trust attempting to keep sufficiently diversified after some of its big long-term holdings saw large share price rises. It was not the result of some sort of predatory business practices.

There's also the question about where the “excess profit” goes.

When a company makes a profit, they can either reinvest it, give it back to shareholders or let it sit in cash. Investment trusts are no different. Scottish Mortgage could have decided to distribute these profits (or capital gains) to shareholders through higher dividend payments. Looking at their dividend policy for 2020/2021, they did not.

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Instead, as a trust committed to capital growth, it reinvested much of this in other companies. Some of these may be in relatively big, listed tech companies. However, many will also be earlier-stage companies, often unlisted. As followers of the trust will know, Scottish Mortgage has shown itself to be a committed investor in unlisted companies, both in the UK and abroad. For these smaller and unlisted companies these cash injections can be vital for their success as a business.

The track record of Scottish Mortgage shows its managers to be skilled capital allocators, providing much needed money to early-stage and unlisted companies. The ability of such companies to grow is broadly a positive thing. A surcharge on the trust’s “excess” profits will eat into its ability to do this.

Many will argue that the potential societal benefits of Scottish Mortgage being able to invest in, and help grow, cutting edge new companies probably outweighs the benefits of giving the Treasury a windfall in tax receipts.