When US hedge fund Elliott Management moved to buy a stake in BP last year, there was more to the purchase than met the eye.
On the face of it, the fund had acquired about 800,000 of BP's publicly traded shares for £3.8bn. But on closer look, it emerged that Elliott had in fact bought only about 100 BP shares, worth a measly £360.
How had Elliott managed to acquire £3.8bn of BP and spend just £360? The answer was that most of the shares had been bought by an investment bank on Elliott's behalf using complex derivatives.
This gave Elliott artificial ownership of the BP shares – drastically cutting its tax bill.
Buying such a large stake in a FTSE 100 giant would normally incur a hefty stamp duty tax liability.
But by using a derivatives contract with a bank known as an equity swap, no shares changed hands, meaning Elliott probably paid just £1.80 in stamp duty – and saved £14.5m in tax.
Elliott is far from alone in spinning together complex deals to avoid stamp duty, a practice that is entirely legal.
While stamp duty has been billed as a tax on the City, it's almost entirely paid by ordinary pensioners and savers, while the most sophisticated investors employ heavy use of derivatives to avoid it.
According to the London Stock Exchange Group, just 14pc of trades on London markets in the first quarter of the year were subject to stamp duty, while only 11pc of trades paid stamp duty in the same period last year.
The contrast between high-rolling hedge funds avoiding stamp duty and pensioners having to pay is, for some, another damaging example of how London's stock market has been left to wither on the vine by the Treasury.
Flows in UK stock market funds have been negative for years. In the past 12 months, £14bn flowed out of funds, according to Calastone.
Leaving London
Companies are also leaving London at a record rate, and coupled with a dearth of new listings, the centuries-old market is lurching into a death spiral.
Stamp duty has been blamed for fuelling the decline, gumming up the stock market and suppressing liquidity.
The tax, which is charged at 0.5pc, is overseen by the Treasury. It brought in £4.3bn to the exchequer in 2024, up roughly a third from the year before.
Although the Treasury has made some small changes – Rachel Reeves announced last year that stamp duty would be exempt for companies listing on the stock market – the Government has been unwilling to go further.
Without action, many in the City fear that stamp duty will further dampen enthusiasm for the stock market, all the while making it more attractive to overseas funds looking to lure away the best of Britain's public companies.
Richard Wilson, the boss of Interactive Investor, says: "Stamp duty on shares is a globally uncompetitive and irrational tax that cuts the value of UK companies, which is why the good ones who can leave go elsewhere, and the good ones that don't leave get bought anyway.
"To make matters worse, the burden increasingly falls now only on retail investors."
The self-harm is most stark when hedge funds use Elliott's tax-loophole tactics to buy shares in British companies and then demand they move abroad.
Sparta Capital, another hedge fund, campaigned for years for struggling British engineering company Wood Group to abandon the UK.
In a scathing letter in 2024, Sparta blamed Wood's struggles on the "apparent indifference" of British public markets.
Ultimately, the business succumbed to investor pressure and sold itself to Sidara, an engineering firm based in Dubai.
When the takeover was complete, it became apparent that Sparta's entire stake in Wood Group had been built through derivatives – meaning it didn't own most of the shares.
A 'competitive disadvantage'
The hedge fund, which was contacted for comment, probably saved hundreds of thousands of pounds on stamp duty during its years-long campaign to expel Wood from London.
Piers Hillier, the chief investment officer at Jupiter Asset Management, says: "Stamp duty reduces the transparency of shareholder registers and the integrity of listed securities.
"The number of UK companies moving their listings elsewhere, particularly to the US, is another sign of the competitive disadvantage the stamp duty brings."
In many ways, the fact that hedge funds can use complex derivatives to reduce stamp duty tax is itself an example of Britain's financial ingenuity.
These derivative products generally work by having an investment bank, probably in Canary Wharf, buying shares on a hedge fund's behalf.
The hedge fund pays the bank a financing cost for doing so. In return, the hedge fund receives the economic return on the shares, including any gains or losses in their value.
However, the key detail that underpins the whole thing is that the bank doesn't pay stamp duty either.
These banks qualify for a "broker exemption", since they are buying shares on behalf of their client.
If the shares fall in value, the hedge fund owes the bank the loss. If the shares rise in value, the bank pays the hedge fund the corresponding gain, minus the financing cost.
Any investor buying such products does not receive voting rights in the shares they hold, but in practice this rarely matters.
Even a small holding of shares – say Elliott's £360 worth of BP – gives an investor the rights of any other shareholders to attend meetings and vote.
It means they can still use their heft to lobby a company's management to change course, as Sparta Capital did, or corral other shareholders to their cause.
Investors' demands
The threat that they might convert their financial contracts into actual shares also means that companies need to take the demands of such investors seriously. Elliott, which declined to comment, has been engineering change in the background at BP for months.
There are other advantages to using a derivative contract rather than buying shares outright. It requires less upfront capital and requires less public disclosure, but tax efficiency is one of the main selling points.
"Each fund is different ... but effectively, they'll invest in the most economically efficient way. They will minimise the amount they put in, and the stamp duty is a factor in that," says one City lawyer.
"If you're taking 5pc in a multibillion-pound company, then half a percent adds up."
The Treasury, which was contacted for comment, is straining every sinew to meet Andy Burnham's cost of living push. Some say cutting the tax ordinary Britons pay on shares could be a start.
"At a time when all policymakers want more people investing for the long term and more capital flowing into UK companies, stamp duty has the diametrically opposite effect," Wilson says.
"It is self-harm. It has to go."
