Post on 13-Jun-2018
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The ABI’s Response to: Life Insurance Companies: A New Corporate
Tax Regime
1 Introduction
1.1 Approach to our response
This document contains a section for each chapter of the above Consultation
Document. The key points are extracted and summarised at the beginning of each
section. Please note that the numbering system is similar to but does not
correspond precisely with the numbering system in the Consultation Document.
A number of points and themes are particularly important and pervasive and these
are summarised in this opening section to our response. But running through our
response is a force towards, where there is a choice, aligning the life tax regime with
the regime applicable to companies more generally in the UK, and aligning towards
the accounts.
We would like to record our continued appreciation of the positive engagement by
the HM Treasury (HMT) and HM Revenue and Customs (HMRC) teams and we look
forward to working together in the same vein in the coming months.
1.2 Summary of key issues and themes
(i) Transition. The potential size of the transitional adjustments on the move
from the regulatory to the accounts basis makes this a key issue for
companies, and we very much welcome the proposal to spread “residual
adjustments” over 10 years. However companies are also very conscious of
the anticipated accounting changes, and do consider that if such changes do
take effect in 2013 and/or in early subsequent periods the resulting
transitional adjustments should be spread over the remainder of the period to
2022 (when the 10 year spread on the tax transition will cease). Should the
accounting changes take effect only in later accounting periods, the industry
would wish to discuss more targeted transitional measures.
(ii) Apportionments. It is a very significant change to move from a formula
based approach to a business-based approach, and it is even more
significant (in a positive way) that industry and HMRC are aligned in
recognising this as the way forward. Against the backdrop of such a change,
we believe that it is important that there is a flexible and enabling process for
companies to agree the commercial allocation basis with their Customer
Relationship Manager (CRM) as the new regime commences. We also
believe that it is consistent with the business-based approach that the regime
should respect how with-profit funds operate, and in particular the allocation
of the Fund for Future Appropriations (FFA) or Unallocated Divisible Surplus
(UDS) should (where the with-profit fund works in a conventional manner)
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ensure that the shareholder profit from conventional with-profit business is
split in proportion to the split of declared bonuses.
(iii) Policyholder tax deduction. Industry and HMRC are aligned on the
deductibility of I minus E policyholder tax in determining basic life assurance
and general annuity business (BLAGAB) trade profit based on the tax paid
on the policyholder share of I minus E profit. However, it is critical in the
industry‟s view that BLAGAB deferred tax provided at the 20% rate is
allowable in the computations, permitting the actual split of shareholder and
policyholder tax to be determined in an actual annual computation on real tax
principles. This is the most compelling way of reconciling the move to
accounts-based taxation and the determination of policyholder tax on a
computational basis (as opposed to an economic basis).
(iv) The use of brought forward losses. The industry believes that historic
Gross Roll-Up Business (GRB), Pension Business (PB) and Permanent
Health Insurance (PHI) losses should be set against profits of the new
category (all existing GRB and PB, all existing PHI and new Protection,
collectively called GRB - PHI) without restriction. This is the most compelling
from a simplicity perspective and places life assurance on a par with other
financial sector industries where all similarly associated activities are taxed
as one trade. We believe that the value for the Exchequer in maintaining
existing streaming or introducing new streaming rules now would not be
significant. In relation to brought forward life assurance trade losses, we
believe that most companies will be able to determine the BLAGAB element
on a factual basis, and it is consistent with the new regime to require this
determination as a starting point.
(v) I minus E volatility. The critical point at the heart of the industry‟s concern
is the fact that the gilt and bond market can spike at 31 December and
reverse on 1 January but the two cannot offset, and this can cause
permanent increases in tax payable. We simply ask for an effective 1-year
carry-back (unlike the current limited carry-back) to eliminate such short-term
timing differences. This is consistent with the position of other companies in
the UK and ought not to cost the Exchequer as against any modelled basis,
on the basis that such short-term volatility is unlikely to be priced into any
models, as it is not priced into those of insurers.
(vi) Transfers of business. Companies undertaking transfers of long-term
insurance business need lead time and certainty. We agree that it is
sensible to adopt different approaches to connected and unconnected party
transfers, and to legislate for the treatment of the Value of In-Force Business
(VIF) on transfer where there is uncertainty today. We would advise that we
monitor emerging accounting rules and retain flexibility as such rules
become clear.
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Chapter 2 Trade Profits
2.1 Starting Point
Key points:
As is true for companies in other industry sectors, there could be differences
between companies applying UK Generally Accepted Accounting Practice (“GAAP”)
and those applying International Financial Reporting Standards (“IFRS”), since the
measure of profits will be different between those two bases.
Under IAS12, all corporate tax (including current and deferred tax items calculated at
the policyholder rate) should be treated as income tax and it should be included in
the income tax line.
Under UK GAAP, some items may be dealt with as a component of the technical
provisions rather than deferred tax, for example, that on unrealised BLAGAB
investment gains. For such items, it would still be appropriate to follow the accounts
treatment.
UK branches of overseas life assurers should not be subject to rules that require
them to produce accounting figures, solely for the purposes of their UK tax
computations
UK branches should compute their taxable profits, for both general and life
assurance, in either GAAP used by the entity or under IFRS, if adopted at either
entity or group level.
2.1.1 Are any practical difficulties anticipated in identifying the trade profits
starting point? If so, how could they be addressed?
2.1.1.1 Both UK GAAP and IFRS financial statements will disclose a profit for the
year before tax.
2.1.1.2 In the case of UK GAAP this figure will appear in the non-technical account
and will be net of the excess of the tax charge in the long-term business technical
account over that in the non-technical account relating to the transfer from the long-
term business technical account. Because one, or both, of these figures may be
negative, care will be needed in adjusting the profit before tax in the non-technical
account to provide a profit before all corporation tax deductions.
2.1.1.3 A further aspect not yet addressed, is the potential application of the tax regime for property income at part 4 of the Corporation Tax Act (“CTA”) 2009 to the real estate investments of companies writing long-term business. Such investments are often significant in their own right as well as forming a material segment of the
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investment activities of the companies concerned. Historically, the regime for property income has only been applied in full to assets outside the long-term fund. For assets of the long-term fund it is used to determine profit for I minus E, which should not be affected by the change to the new regime, but not life assurance trade profits.
2.1.2 Could the approach set out above give rise to material inconsistencies
between companies?
2.1.2.1 There could be differences between companies applying UK GAAP and
those applying IFRS, since the measure of profits will be different between those
two bases. The same is true for companies in other industry sectors – namely that
UK GAAP and IFRS profits measures may be different.
2.1.3 What is the nature and extent of income, gains, expenses and losses
included in statements in the accounts other than the income statement or
profit and loss account?
2.1.3.1 For IFRS these are:
Available for sale gains and losses less recycling on realisation less “shadow
adjustments” under IFRS 4 paragraph 30.
Gains and losses on a hedge of a net investment.
Gains and losses on cash flow hedges less reclassification to profit or loss.
Exchange differences on translation of foreign operations.
Actuarial gains and losses on defined benefit pension schemes.
Restatements arising from changes in accounting policy or corrections of
fundamental errors.
Interest on hybrid debt treated as dividends for accounting purposes.
Income tax effect of all the above.
2.1.3.2 For UK GAAP these are:
Unrealised surplus on revaluation of investment properties.
Currency translation difference on foreign currency net investments.
Currency translation difference on related borrowings [this and prior item are
equivalent to the IFRS net investment hedge].
Actuarial gains and losses on defined benefit pension schemes.
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Restatements arising from changes in accounting policy or corrections of
fundamental errors.
Interest on hybrid debt treated as dividends for accounting purposes.
Tax effects of all the above.
2.1.4 What is the nature and extent of any tax elements not included in the tax
lines in the accounts?
2.1.4.1 Under IAS12, all corporate tax (including current and deferred tax items
calculated at the policyholder rate) should be treated as income tax and it should be
included in the income tax line. (Other taxes that do not meet the income tax
definition under IAS 12 will be classified as expenses and not within the income tax
line. Examples of these would be stamp duty or irrecoverable VAT. This is, of
course, the same for insurers as for all other companies.)
2.1.4.2 Under UK GAAP, some items may be dealt with as a component of the
technical provisions rather than deferred tax, for example, that on unrealised
BLAGAB investment gains. Paragraphs 188, 189, 197 and 209 of the ABI SORP,
permit such treatments. For such items, it would still be appropriate to follow the
accounts treatment. Thus there would be no adjustment in respect of such items,
neither would there be any separate deduction for them as policyholder deferred tax.
2.1.5 Are there any specific considerations in relation to UK branches of
overseas companies if, for example, these companies do not prepare
accounts under either UK GAAP or IFRS?
2.1.5.1 There are some specific points to consider in the case of UK branches of
overseas insurers.
Current Taxation Basis for UK Branches of Life Assurance companies
2.1.5.2 UK branches that currently prepare FSA returns will need to determine the
appropriate basis for preparing their tax computations, once those FSA returns
cease to exist. Under current law, applicable to non-life assurers, this will require
them to prepare their tax computations using UK GAAP, unless the entity of which
they form part, prepares its financial statements using IFRS, in which case these
profits can form the basis of their UK tax computation.
2.1.5.3 Certain UK branches of life assurers are not obliged to file a UK FSA Return.
These insurers form part of entities that are regulated elsewhere in the European
Union. Several of these life assurers are part of composite UK branch enterprises,
who currently perform a separate computation of their general insurance business.
2.1.5.4 If the parent entity of which the branch forms part prepares IFRS Financial
Statements, the branch will prepare life assurance, PHI and general insurance tax
computations using IFRS.
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2.1.5.5 If however the parent entity does not prepare IFRS Financial Statements, the
insurers need: to prepare UK GAAP figures to compute their PHI and general
insurance results. These are reported for tax purposes only, resulting in
administrative inconvenience. Typically these figures are not audited, albeit most
tax departments will perform reconciliations to ensure that those figures are
accurate. 2.1.5.6 Local GAAP figures, if drawn up under the Insurance Accounts
Directive, will be used to compute life assurance trade profits. Two of the major
branches are pure reinsurers who do not produce I-E computations
2.1.5.7 Certain jurisdictions do not permit local insurance companies to produce
financial statements using IFRS, and are not expected to permit the use of IFRS in
future periods, including 2013. Examples are Germany and Luxembourg, which are
the home states for a number of UK insurance branches and a major UK branch
reinsurer respectively.
Impact of the introduction of Solvency II
2.1.5.8 If the overseas life assurance company (“OLIC”) rules were abolished as of
31 December 2012, but with other relevant legislation remaining in situ, so that UK
branches of life assurers were taxed in the same manner as other non-insurance UK
branches, UK branches of insurers would have to compute both their life assurance
and general insurance profits using UK GAAP or IFRS
2.1.5.9 Certain overseas groups with UK branches either currently adopted IFRS for
group reporting purposes or intend to adopt IFRS by 2013. However, current
indications are that Luxembourg and Germany will still require their resident insurers
to prepare their own entity financial statements using local GAAP, and will not permit
the alternative option of using IFRS.
2.1.5.10 Hence, if the OLIC rules were abolished, so that UK branches of life
assurers were taxed in the same manner as other UK branches, including general
insurance branches, such UK branches would have to compute their entire profits
using UK GAAP, even though the same operations would have computed their
accounting results under IFRS, albeit for group purposes. The figures produced for
UK GAAP would serve no purpose other than to compute UK taxable profits for
accounting periods up to the date when UK GAAP ceases to exist. Such figures
would remain unaudited and their compilation would require considerable extra
manpower.
2.1.5.11 It would therefore be preferable to allow either:
the adoption of IFRS by such UK branches for computing taxable profits for
2013, so UK branches can use the figures they report for consolidation
purposes (prior obviously to consolidation journals). Any introduction of IFRS
should fall to be taxed in accordance with the normal principles of taxing the
transition to IFRS; or
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to allow UK branches to continue to use local GAAP to compute taxable
profits of life assurance business, and potentially extending this to general
insurance business too.
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2.2 Loan Relationships and derivative contracts
Key points:
The basic principle of the loan relationships rules is that the debits and credits
brought into account for tax purposes follow those in the company accounts. Given
that under the new rules the calculation of a life company‟s BLAGAB trading profit
and its aggregate non-BLAGAB result will also be based on the accounts prima facie
there should not be a fundamental difference between the tax position of a
company‟s interest income and expenses under the loan relationships rules
compared to the rules governing the calculation of life company trading profits in the
current section 83 of the Finance Act (“FA”).
The loan relationship rules should be used for the purposes of calculating life
assurance trading profits in respect of non-profit funds. This would help to bring the
life assurance industry in line with other businesses in the financial services sector.
While the use of the loan relationships provisions should be the general rule,
applying them to the calculation of trade profits for with-profit funds could create
unnecessary complexity. Accordingly, for such funds, any investment returns from
loan relationships should be taxed on a quasi-section 83 basis – i.e. the measure of
trading receipts/(expenses) be based on the unadjusted accounting figures.
Given the same accounts-based principles apply to the taxation of derivatives as to
loan relationships, there is in theory no reason why the standard derivative contract
taxation regime should not generally apply to contracts held within non-profit funds.
However some departures from the rules will be required in relation to contracts that
might otherwise be within the scope of section 641 CTA 2009.
Whether or not the loan relationship and derivatives rules are adopted for life
companies‟ trade profits calculations, the treatment of creditor and debtor balances
should be made symmetrical.
2.2.1 Given that investment returns are integral to a life company’s trading
profit, and given that loan relationship rules are founded on accounting
treatment, might it be feasible to continue to disapply those rules in
computing life company trade profits, and rely purely on the accounting
results to capture the relevant income and gains?
2.2.1.1 The basic principle of the loan relationships rules is that the debits and
credits brought into account for tax purposes follow those in the company accounts.
Given that under the new rules the calculation of a life company‟s BLAGAB trading
profit and its aggregate non-BLAGAB result will also be based on the accounts
(rather than the FSA return as previously, PHI business excepted), prima facie there
should not be a fundamental difference between the tax position of a company‟s
interest income and expenses under the loan relationships rules compared to the
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rules governing the calculation of life company trading profits in the current section
83 FA 1989. The loan relationship rules would apply to both the BLAGAB and the
aggregate non-BLAGAB trading profit calculations.
2.2.1.2 Under the current tax regime for life companies any debtor (i.e. liability) loan
balances are already subject to the loan relationship rules – resulting in a
discrepancy between the treatment of a company‟s creditor relationships (i.e.
assets), which are taxed under section 83, and its debtor relationships, to which the
loan relationships rules apply.
2.2.1.3 Whether or not the loan relationship rules are adopted for life companies‟
trade profits calculations, the treatment of creditor and debtor balances should be
made symmetrical. This would reduce the possibility of both arbitrage-style planning,
and disadvantages to companies due to asymmetric tax treatment.
2.2.1.4 While it would be feasible to continue with a system analogous to the current
section 83 (i.e. for the taxation of loan relationships simply to follow the accounts) it
would be preferable to adopt the loan relationship rules for calculating life assurance
trading profits (both BLAGAB and aggregate non-BLAGAB) in respect of non-profit
business. This would help to bring the life assurance industry in line with other
businesses in the financial services sector (for example banks) who apply the loan
relationship rules to loan balances held for trading purposes.
2.2.1.5 One impact of adopting the loan relationship rules for loan balances in the
life assurance trading profits calculation would be the effect of the connected party
rules in Chapter 6, Part 5 CTA 2009. Many life companies within groups have loans
to or from connected companies; the impact of applying the loan relationships rules
to life companies would be that future write-offs of these loans would, under normal
circumstances, be non-deductible/non-taxable in the life companies. It may be
possible to grandfather existing intercompany loans so that they remain outside the
scope of the loan relationship rules if these are introduced for life companies.
However this would potentially leave in place the discrepancy between the treatment
of debtor and creditor balances as discussed above. As noted, there should be
consistency of treatment of debtor and creditor balances whether or not the loan
relationship rules are implemented.
2.2.1.6 For life companies which invest in index-linked gilts, adopting the loan
relationships rules would result in a reduction in fair value gains (or an increase in
losses) as a result of applying indexation in accordance with section 399 CTA 2009).
Since 2005 other corporates with holdings of index-linked gilts have been able to
claim indexation relief for the purposes of calculating their trade profits. It would be
unfair if this relief was not extended to life companies. The reasons why index-
linked gilts are held by life companies are similar to the reasons why they are held
as investments by other financial companies – specifically as a hedge against the
potential impact of inflation on both their cost base and the level of future liabilities to
their customers, whether these be holders of, for instance, index-linked ISAs or
holders of index-linked annuities. There is no clear reason why the after-tax cost of
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hedging for life insurance companies should be higher than the cost for other
financial corporates such, as for instance, banks and general insurers.
2.2.1.7 Although there are benefits from the general extension of the loan
relationship rules to life assurance trade profit calculations, it appears that the
application of the rules to the calculation of the profits of with-profit funds could
cause unnecessary complexity and potential distortions. As outlined at 3.1.7.3, the
trading profit for 90:10 funds should be based on the level of shareholder transfers.
While some fiscal adjustments might be required (such as, for instance, those
relating to disallowable expenditure) for such funds, there is a risk that the full-scale
application of the adjustments required under the loan relationship rules could
produce a trading result that diverged radically (and inappropriately) from the
quantum of shareholder transfers. Consequently, it would be preferable to retain a
quasi-section 83 approach for loan relationship assets held within with-profits funds.
2.2.2 Could such an approach also apply to derivative contracts?
2.2.2.1 Given the same accounts-based principles apply to the taxation of
derivatives as to loan relationships, there is in theory no reason why it should not.
Indeed, for the reasons outlined in 2.2.1.4 above the derivatives rules should be
extended to contracts held within non-profit funds (although not for those held within
with-profit funds.)
2.2.2.2 However, there is a potential issue for life companies where the tax
treatment prescribed by the derivatives rules departs from the accounting treatment
– in particular this is the case for those derivatives which Part 7 of CTA 2009 (and
specifically section 641) requires to be taxed on a chargeable gains basis, even
where the derivatives themselves are held as trading stock.
2.2.2.3 There is a risk with regard to life assurance trading profit calculations
(whether BLAGAB or aggregate non-BLAGAB) that an accounts-based tax
treatment of, for example, an investment might differ from the treatment of a
derivative hedging it. Applying the chargeable gains rules to derivatives could in
some specific circumstances have a distorting effect, in that hedges which would be
effective from a commercial and accounting perspective might not be so where tax
is concerned.
2.2.2.4 If therefore, life assurance trade profits calculations are brought within the
general scope of the derivatives rules, there would need to be a specific
disapplication of section 641 for these purposes. Rather than being taxed under
the chargeable gains rules, any gains or losses on these contracts would be treated
as either trading receipts or expenses. In the interests of simplicity, the
measurement of these receipts or expenses should be based on the unadjusted
accounting figures. For the avoidance of doubt, the disapplication of section 641
should only apply for trade profit calculations – i.e. these contracts should continue
to be taxed under chargeable gains rules within the I minus E.
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2.3 Intangible Fixed Assets
Key points:
The exclusion of intangible assets relating to life assurance business is appropriate
whilst the trade profits of that business are computed by reference to regulatory
surplus. The new regime is based on accounting profits and intangible assets will be
recognised on acquisition in the balance sheet at fair value and amortised
appropriately. For intangible assets acquired after the start of the new regime, this
amortisation should be deductible in the same way as for similar assets held in
connection with other trades.
If this approach is followed post Solvency II, it will be important that where intangible
assets are held as fixed capital, relief is available for non-trading as well as trading
debits.
The removal of the restriction should apply to separately identifiable intangible
assets held on fixed capital account including brands, customer lists, software of
various kinds and goodwill.
The exclusion from the intangible assets rules should continue to apply to
“intangible” assets which represent the recognition of future trade profits or the
deferral of revenue expenditure as these are in essence adjustments to the timing of
the recognition of profit not assets of enduring benefit to the business. They would
include the value of in-force business and deferred acquisition costs which would
each be addressed on normal trading principles.
2.3.1 Under the new accounts based regime, do you think that the exclusion
from the provisions of Part 8 of CTA 2009 of intangible fixed assets held by an
insurance company for the purposes of its life assurance business should be
removed, and, if so, why?
2.3.1.1 The exclusion of intangible assets relating to life assurance business is
appropriate whilst the trade profits of that business are computed by reference to
regulatory surplus. Such assets are generally inadmissible for the purpose of pillar I
of Solvency I and relief is available in the trade profit computation for any resulting
write down in the value of such assets brought into account through Form 40 line 13.
The new regime is based on accounting profits and intangible assets will be
recognised on acquisition in the balance sheet at fair value and amortised
appropriately. For intangible assets acquired after the start of the new regime, this
amortisation should be deductible in the same way as for similar assets held in
connection with other trades. In this context, it will be important that where
intangible assets are held as fixed capital, relief is available for non-trading as well
as trading debits.
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2.3.2 What implications, including fiscal impacts, would you expect to arise if
the exclusion were removed? What types of assets would be affected?
2.3.2.1 The removal of the exclusion would substitute relief for accounting
amortisation for the current relief for the admissibility restriction where new regime
intangibles are held by the long-term fund. Relief for accounting amortisation for
such assets would become available where these are currently held by a company
writing long-term business as assets of the shareholder fund.
2.3.2.2 The removal of the restriction should apply to separately identifiable
intangible assets acquired on fixed capital account under the new regime. These
would include brands, customer lists, software of various kinds and goodwill. The
exclusion from the intangible assets rules should continue to apply to “intangible”
assets which represent the recognition of future trade profits or the deferral of
revenue expenditure as these are in essence adjustments to the timing of the
recognition of profit not assets of enduring benefit to the business. They would
include the value of in-force business and deferred acquisition costs which would
each be addressed on normal trading principles.
2.3.3 What transitional issues would arise?
2.3.3.1 The difference between the value of aggregate intangible assets in Form 13
of the FSA return and the balance sheet in the financial statements should be dealt
with in a manner similar to that for deferred acquisition costs (“DAC”). There would
be no credit to the transitional adjustment to trade profits. Relief will implicitly be
given for any accounting amortisation between acquisition and the date of transition
to the new regime. This should not be reversed. Future amortisation of these
assets would be disallowed.
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2.4 Policyholder Tax
Key points:
The deduction for policyholder tax should comprise current policyholder tax
(defined as corporation tax at the policyholder rate as set out in the submitted
computation for an accounting period) and the movement in the year in deferred
tax recognised at policyholder rate.
A deferred tax deduction is required to match the incidence of tax allowances in
contract liabilities and to mitigate unwanted volatility. Not to give an adjustment
for policyholder deferred tax will result in a fundamentally distorted and
unrealistic figure of taxable shareholder profit in many cases.
The deferred tax items qualifying for a policyholder tax deduction will always be
set up and reversed at policyholder rates, their ultimate marginal impact on
current tax also being at policyholder rate.
Transitional adjustments may be required where companies do not currently
obtain a policyholder deferred tax deduction, and/or where the current tax
deduction is based on an accounts rather than computational amount.
2.4.1 Is it possible to identify an accounts-based method of computing
policyholder tax deductions, which is simple, consistent, transparent and
linked to tax actually paid at the policyholder rate?
2.4.1.1 The policy decision of giving a deduction for policyholder tax in the
Consultation Document is welcome but that cash tax payable at the policyholder
rate is not a sufficient basis of calculating the policyholder tax deduction for the
following reasons:
It does not take into account deferred tax (discussed further below).
It is not consistent with an accounts based approach to determining the tax
charge.
The cash tax paid at the corporate level is not consistent with the incidence
of tax allowed for in policyholder liabilities.
2.4.1.2 In respect of policyholder current tax, the tax adjustment should be for the
corporation tax at the policyholder rate as set out in the submitted computation for
an accounting period.
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2.4.1.3 There should be a deduction for policyholder deferred tax for the following
reasons:
It is included as an expense in the accounts as tax which relates (dependant
on the definition used) to policyholders and it is right that it is deductible as
an expense of the trade. There is a distinction between “tax expended by a
life company on behalf of its policyholders” and “tax borne by policyholders”.
This is a critical distinction and it could influence the calculation of the
policyholder tax deduction.
It reflects commercial reality. From 2013 the starting point in the BLAGAB
trade profits computation will be the profit before all taxes from the financial
statements. That profit will reflect movements in the actuarial liabilities and
the fund for future appropriations (UK GAAP) or unallocated divisible surplus
(IFRS) (“UDS - FFA”) which in turn will reflect charges in respect of tax made
to unit linked (“UL”) and with-profits (“WP”) funds. The other side of that
adjustment is the tax (both UL and WP) which will be included as part of the
overall income statement tax charge. That tax will include both current and
deferred tax. If a tax deduction were not given for the other side of the
actuarial liability movements, the taxable profit would not reflect the
commercial profit from writing the business as both elements relate directly
to policyholders.
It is recognised that deferred tax can be a large number which may never
turn into cash tax purely because equity markets might reverse or a tax
asset, such as excess expenses of management (“XSE”), is utilised.
However in such cases the deferred tax provision would always reverse, and
reverse at the policyholder rate, (giving a taxable credit) and so will give a
matched result over time.
It is further recognised that in some circumstances a deduction for
policyholder tax could lead to a significant tax credit e.g. from a large market
shock.
2.4.1.4 A straightforward balance sheet approach should be the most appropriate
basis satisfying all of the Government‟s criteria for policyholder tax. Other options
have been examined and dismissed as follows:
The deduction for policyholder tax could be based on the tax disclosed in the
income statement or notes to the financial statements as “policyholder tax”.
This approach is problematic as it is considered opaque because of different
approaches to calculating this amount (if it is disclosed at all) and the lack of
a specific accounting standard governing this disclosure for IFRS purposes.
Alternatively, the deduction for policyholder tax could be based on the actual
charge made against policyholder liabilities (via unit pricing for UL contracts
and asset shares for WP contracts). This charge would cover both current
and deferred tax, reflecting the economic impact of tax on income and
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expense items arising to policyholders. However, this basis requires data
from underlying actuarial calculations and does not provide a transparent,
accounts-based methodology. There is also a risk of material inconsistency
between companies.
2.4.2 If so, how would it work in practice?
2.4.2.1 The policyholder deferred tax would be defined as the movement between
the opening and closing deferred tax amounts in the balance sheet which have been
calculated at policyholder tax rates.
2.4.2.2 Companies calculate deferred tax at each balance sheet date on
temporary/timing differences relating to BLAGAB I minus E items at the policyholder
rate of tax. At subsequent balance sheet dates, such timing/temporary differences
are reassessed such that the prior year amount reverses at the same rate of tax.
2.4.2.3 A key attraction of this approach is that it is accounts-based and reflects the
actual numbers within the tax charge in the accounts. As the basis of the tax
computation moves towards an accounting measure then it seems entirely
appropriate to use an accounts measure of deferred tax. Furthermore this is a
relatively straightforward way to identify policyholder deferred tax and is widely
available as each company has to undertake this calculation and there is
consistency across companies as to how the calculation is undertaken.
2.4.2.4 Government may be concerned that a deferred tax item, once the related
timing difference reverses, may be taxed at the shareholder corporation tax rate.
This is not the case for a company that has an excess of income and chargeable
gains over BLAGAB trade profits (“is XSI”), or even for one that has XSE temporarily
but will return to being XSI. This is because the marginal impact of such an item will
either be to increase tax in the period it crystallises at 20%, or decrease XSE carried
forward which is deductible ultimately at 20%. The following example illustrates this
effect (see next page).
16
Policyholder tax example (from paragraph 2.4.2.4)
Company A has:
I minus E per annum 400 BLAGAB trade profit per annum 200
XSE carried forward 600
No BLAGAB dividends
Tax in next 3 years would be:
Year 1 2 3 Total
I minus E 400 400 400
XSE (600) (400) (200)
Excess BLAGAB trade profit 400 200 0
Total I minus E 200 200 200
BLAGAB trade profit 200 200 200
Minimum Profits 200 200 200
Profits
Shareholder 200 200 200 600
Policyholder 0 0 0 0
With a realised gain of 500 in year 1, the tax profile would change to:
Year 1 2 3 Total
I minus E 900 400 400
XSE (600) 0 0
BLAGAB trade profit 0
Total I minus E 300 400 400
BLAGAB trade profit 200 200 200
Minimum Profits 200 200 200
Profits
Shareholder 200 200 200 600
Policyholder 100 200 200 500
17
2.4.2.5 The above example apparently shows the additional 500 of gain only
producing an additional 100 policyholder profit in year 1. In fact, the faster unwind of
XSE illustrates that the full 500 marginal increase is taxed at policyholder rate. This
effect applies to any policyholder (i.e. I minus E impacting) deferred tax attribute in
any company that ultimately is XSI. Therefore, the Government‟s concern that
deferred tax items will be taxed at shareholder rate is misplaced.
2.4.2.6 As companies have employed different policyholder tax methodologies prior
to 2013, there would also need to be an appropriate transition mechanism to allow
for variations in deferred tax treatment (including where currently a company does
not get a deduction for policyholder deferred tax).
2.4.2.7 Policyholder deferred tax in respect of unit-linked business is normally
incorporated within mathematical reserves under regulatory reporting, but is a
deferred tax item under IFRS. Certain companies may still retain unit-linked deferred
tax within investment contract liabilities under UK GAAP. For simplicity, no
adjustment to liabilities would be made in these circumstances nor would the
deferred tax form part of the policyholder tax deduction. Implicitly this gives the
same answer as if the adjustments were made.
2.4.3 What are the implications of restricting relief to amounts payable in
respect of a particular year?
2.4.3.1 Including deferred tax within the definition of policyholder tax is essential to
preserve a matched position relative to the allowance for tax in both UL unit prices
and WP asset shares, both of which translate into either policy charges in the
income statement (for investment contracts) or insurance contract liabilities/UDS -
FFA in the balance sheet.
2.4.3.2 Restriction of relief to actual amounts of cash tax in a particular year is likely
to create volatility in the BLAGAB trade profit measure. For example, take a case
where a unit linked book of business of £7bn is invested entirely in collective
investments and the market growth in the year is 15%. In this scenario, ignoring any
discount, the fund deduction from income would be £210m (£7bn x 15% x 20%).
The current tax liability (ignoring expenses and the interaction with the BLAGAB
trade profit) would be £30m (£210m / 7) and the deferred tax charge would be
£180m. If no deduction is taken for deferred tax, shareholder taxable profit of
£180m is higher than the accounting profit .
2.4.3.3 Use of the policyholder tax charge/credit as per the tax computation finally
agreed for a period will mean that there is no deduction required for prior year
adjustments in respect of post 2012 periods, or for prior periods for companies
whose current methodology also follows a computational approach. A transitional
measure will be required to address prior year adjustments made in 2013 or later in
respect of current tax provided in 2012 by companies whose current methodology
does not use a computational approach.
18
Chapter 3 Other Technical Issues
3.1 Allocation of profits, income and gains
Key points:
The ability to determine and allocate accounts profit to specific lines of business will
depend upon the internal systems and procedures of each company rather than the
identity or nature of the lines of business. It should be expected that companies will
be able to identify separately the accounts profit arising from with-profit business,
unit-linked business and non-linked non-profit business.
For with-profits business, it is the trading profit of each with-profit fund and before
fiscal adjustments (e.g. in respect of loan relationships) that is being apportioned.
Any individual company will need to agree with its CRM an allocation methodology to
be used in the tax computation which reflects the manner in which it runs its
business; different companies may thus use different methodologies..
Non profit business written within a with profit fund should be allocated in proportion
to with-profit bonuses, except where a mechanism other than bonus declaration is
used to pass profits to shareholders in which case direct attribution based on the
computation of profits to pass to the shareholder should be used.
For the purpose of tax on chargeable gains, assets which are not directly allocated
to a category of business should be allocated to a different pool from those which
are. Direct attribution will be possible for some lines of business. For other lines of
business, “hybrid” pools may support both basic life assurance and gross roll-up
business. Chargeable gains should be allocated in the same way as other income
and gains. A liabilities based approach might be appropriate for some chargeable
gains.
The I minus E and trade profit allocation methods can be reconciled by the
mechanism described in paragraph 3.1.10 below. Equity and property gains will be
chargeable gains in I minus E but market value movements and realisations for trade
profit purposes. No special measures seem necessary beyond extending the boxes
in section 440(4) of the Income and Corporation Taxes Act (“ICTA”) 1988 where
relevant.
As was discussed at the Open Meeting on 29 June, it is not considered necessary
for there to be an alternative statutory method provided that it is recognised that
different companies will commercially use different methodologies. For some
companies, a method akin to the existing formulaic approach may be suitable. There
is no need for an election.
19
3.1.1 For what lines of business can the accounts profit arising on that
business be directly determined and allocated?
3.1.1.1 The ability to determine and allocate accounts profit to specific lines of
business will depend upon the internal systems and procedures of each company
rather than the identity or nature of the lines of business.
3.1.1.2 In any event, it should be expected that companies will be able to identify
separately the accounts profit arising from with-profit business, unit-linked business
and non-linked non-profit business.
3.1.2 To what extent will current internal accounting and actuarial procedures
enable companies to allocate directly a substantial part of the income and
gains arising on assets held for the purposes of its life insurance business?
What will be the cost of introducing new systems and/or adapting existing
systems?
3.1.2.1 It should be expected that companies will be able to identify separately the
income and gains attributable to policies to which an asset share methodology is
applied as well as to unit-linked policies. Attribution to non-linked non-profit
business will also be possible if the assets are managed in pools specifically
matched to the different types of such business.
3.1.2.2 For clarification for with-profits funds, it is the trading profit of the funds as a
whole and before fiscal adjustments (e.g. in respect of loan relationships) that is
being apportioned.
3.1.2.3. Any individual company will need to agree with its CRM an allocation
methodology to be used in the tax computation which reflects the manner in which it
runs its business; different companies may thus use different methodologies.
3.1.2.4 The cost of separately identifying for tax purposes the income and gains
attributable to lines of business where this is currently not required for those
purposes will vary from company to company.
3.1.3 What bases might be acceptable and/or possible for the allocation of
assets which are not directly allocated to products or lines of business?
3.1.3.1 It is assumed that this question is intended to refer to income and gains
arising from assets rather than to the assets themselves. In so far as it relates to
assets, assets which are not directly allocated to a category of business should be
allocated for the purpose of tax on chargeable gains to a different pool from those
which are.
3.1.3.2 Direct attribution is already used with sub-apportionment for business linked
to more than one category. Other major lines of business, such as with profit
business, are similarly matched to specific pools of assets including real estate and
equities as well as loan relationships. These pools may support both BLAGAB and
20
GRB in a manner analogous to a property linked fund linked to more than one
category. Investment return from these “hybrid” pools could still prima facie be
capable of direct attribution if investment return is attributed directly to policies by
reference to asset shares, but the assets will not themselves be segregated and
there will be no direct matching of specific assets to specific liabilities. A mean
liability approach by reference to the liabilities matched to the hybrid pool might be a
suitable way of addressing the attribution of investment return in these
circumstances. It is understood that individual ABI members are already discussing
with HMRC approaches which may be suitable in their own circumstances.
3.1.4 Will companies always be able to compute the accounts profit of a with-
profit fund?
3.1.4.1 Companies should always be able to compute the accounts profit of a with-
profit fund. This will be the case whether or not the profit is determined by reference
to bonuses declared or because it is derived through the charging of management
or guarantee fees to the with-profit fund.
3.1.5 Is allocation by bonuses always representative of the actual allocation of
assets to the different categories of business?
3.1.5.1 Bonuses in this context are the aggregate of reversionary and terminal
bonuses declared. Allocation by bonus is affected by the mix of policies terminating
in any period. Reversionary bonus policy can also vary from product to product.
There could thus be a persistent bias in using allocation by bonus for the allocation
of income and gains in favour of products where reversionary bonuses are declared.
3.1.5.2 A bonus based apportionment of income and gains for BLAGAB I minus E
will not reflect the underlying allocation of income and gains to the extent that there
is business in the with-profit fund where income and gains pass either to
policyholders or shareholders other than by way of a share in the cost of bonus. For
example, if there were unitised with-profit business where the shareholder profits
were derived in a non-profit fund from charges made to the with-profit fund, the
allocation of income and gains to BLAGAB I minus E would not reflect the
proportions of unitised with-profit business but only the bonus proportions of
conventional with-profit business. Similarly, if there were non-profit annuity business
in a with-profit fund, income and gains would pass to the relevant policyholders by
way of annuities not bonuses. Also where BLAGAB is running off faster than
pension business where pension business is written in the same fund bonuses will
not reflect the underlying allocation of income and gains.
3.1.5.3 Allocation by bonus would thus only fortuitously be representative of the
actual allocation of income and gains in a particular year.
21
3.1.6 What special considerations are there where non-profit business is
written within a with-profit fund?
3.1.6.1 There are two possible circumstances here: in the first, the profits of the non-
profits business are part of the profit pool in which both policyholders and
shareholders share; in the second, the profits of the non-profit business pass to the
shareholder by some legal mechanism agreed with the regulator and the with-profits
actuary. In the first circumstance it will be necessary to allocate income and gains
relating to the non-profit business. This would be done directly if there were a
specific pool of assets for the business or through an agreed method for the with-
profit fund asset pool as a whole. In this circumstance however, the profit from the
non-profit business will only inure to shareholders through the bonus declaration
mechanism and no specific tax adjustment will be required. In the second
circumstance, both the allocation of investment return and profit should be capable
of direct attribution based on the computation of profits to pass to the shareholder.
3.1.7 This document focuses on the allocation of investment income and
gains. Are there other types of income or expenditure which could not be
attributed to categories of business by reference to internal accounting
systems?
3.1.7.1 Direct attribution is already widely established in the allocation of the
components of trade profits from life assurance business. Indeed, it is used for
premiums, benefits, expenses, tax deductions, and movements in liabilities to
policyholders. Looked at in this way, investment return is the exception rather than
the rule.
3.1.7.2 There is however one specific and important item where direct attribution is
unlikely to be possible. Financial statements, whether under IFRS or UK GAAP, do
not permit a "book value" election. They do however currently contain a mechanism
for providing an additional liability for what would otherwise be profits of a with-profit
fund but which have not been allocated between policyholders and shareholders.
This liability is the UDS under IFRS or the FFA under UK GAAP. An allocation
mechanism will be required for the movement in the UDS - FFA. As this is the
movement in a liability, direct attribution would be the normal approach but, given
that the amounts are specifically unallocated, is unlikely to be practicable.
3.1.7.3 However, as discussed at 3.1.10.2, bonuses are the correct and appropriate
way for allocating trade profits of a with-profit fund.
3.1.8 How should chargeable gains be allocated?
3.1.8.1 Chargeable gains should be allocated in the same way as other income and
gains, by direct attribution, allocation by reference to the liabilities matched to a
hybrid pool or mean fund apportionment.
3.1.8.2 One obvious development however would be to include assets matched to
only one category in the relevant linked pools for section 440 ICTA 1988. A
22
transitional provision would be needed if assets changed category as a result at the
date of transition.
3.1.9 Would retaining a liabilities based approach for chargeable gains be
appropriate?
3.1.9.1 Chargeable gains should be allocated in the same way as other income and
gains, by direct attribution, allocation by reference to the liabilities matched to a
hybrid pool or mean fund apportionment. A liabilities based approach is thus
appropriate for some chargeable gains.
3.1.10 If I-E allocation does not follow that used for trade profit purposes are
there any mechanisms that could protect against significant under or over
allocation?
3.1.10.1 The I minus E and trade profit allocation methods can be reconciled by the
mechanism described in the paragraph below. The measure of loan relationship
and derivative gains and losses will be the same. Equity gains will be chargeable
gains in I minus E but market value movements and realisations for trade profit
purposes.
3.1.10.2 It is implicit in allocating trade profit of with-profit funds that the UDS - FFA
should be allocated in such a way as to secure that the shareholder profit from
conventional with-profit business was split in proportion to the split of declared
bonuses for the year. The allocations of investment return to unitised with-profit and
other business within the with-profit fund but where shareholder profits are derived
by way of fees not as a proportion of bonuses would however still reflect the
investment return out of which the fees were borne, and so the profits made, rather
than an allocation by reference to bonuses from another part of the business of the
fund. Direct allocation in respect of non-profit business within a with-profit fund
would also be unaffected. The approach consistent with the current regime would
be to allocate the movement in the UDS - FFA in such a way as to secure that the
shareholder profit from conventional with-profit business was split in proportion to
the split of declared bonuses for the year. This seems an appropriate way to deal
with profits from such business as the shareholder profit is a proportion, frequently
one-ninth, of such bonuses. The allocation of the UDS - FFA would not affect the
direct attribution or apportionment of the income and gains of the with-profit fund as
a whole and would have no impact on I minus E. The allocation basis applied to
income and gains would be consistent between I minus E and trade profit.
3.1.10.3 To summarise the specific issues here, no special measures seem
necessary beyond extending the boxes in section 440(4) ICTA 1988 where relevant.
The use of the bonus allocation is appropriate but only for the movement in UDS -
FFA to give a consistent allocation of the profit from conventional with-profit
business.
23
3.1.11 What would be an appropriate process for reaching agreement with
HMRC and ensuring fairness between companies?
3.1.11.1 The agreement of the details of a factual allocation method should be part
of the self assessment process through discussion between a company and its CRM
in line with the high level principles to be set up in legislation and HMRC guidance
and reflecting the facts and circumstances of each company‟s specific
circumstances.
3.1.12 In what circumstances should any election for factual allocation be
revoked/revocable?
3.1.12.1 As was discussed at the Open Meeting on 29 June, it is not considered
necessary for there to be an alternative statutory method provided that it is
recognised that there are a number of different methodologies which may be
appropriate. For some companies, a method akin to the existing formulaic approach
may be suitable. There is no need for an election.
3.1.13 What would be an appropriate basis for the single apportionment rule?
3.1.13.1 There is no need for such a rule.
24
3.2 Combining GRB and PHI
Key points:
Both PHI and GRB transitional losses, and historic pension business losses, should be
permitted to be used against the new category (“GRB-PHI”) without restriction.
It should not be difficult initially to stream transitional losses against GRB and PHI, but
given the significant level of GRB losses in the industry, it may be that the losses last
much longer than the underlying rationale for streaming GRB-PHI profits using historical
category definitions.
The restriction on the utilisation of pension business losses has not in practice placed any
significant restriction on the use of losses, and it would not cause a significant loss to the
Exchequer for this restriction to be abolished.
Simplification is best achieved by avoiding any need to track historic differences into the
future. It is inefficient to open up what this simplification has meshed together.
3.2.1 Use of losses (including transitional losses)
3.2.1.1 It is appropriate to permit both PHI and GRB transitional losses, and historic
pension business losses, to be used against the new category without restriction. It
is recognised that this is the most generous relief, but it is also consistent with
simplification that companies should not be required to continue to maintain records
in respect of the historic categories for what may be many years.
What levels of unused GRB and PHI losses might exist at 31 December 2012?
3.2.1.2 Some groups are expected to have significant levels of unused GRB losses
at 31 December 2012, as is consistent with taxing on the FSA basis, where new
business strain was written off immediately. It is understood that there are much
less significant levels of unused PHI losses, where the tax basis has followed the
accounts.
Transitional loss streaming
3.2.1.3 It should not be difficult initially to stream transitional losses against GRB
and PHI. But given the significant level of GRB losses in the industry, it may be that
the losses last much longer than any meaningful recollection of the underlying
rationale for streaming GRB-PHI profits using historical category definitions. On an
ongoing basis there would be a systems challenge in identifying the profits arising
from particular historic categories. Neither of these points would seem to be
consistent with the concept of simplification.
25
Other than unrestricted use against new GRB/PHI profits and streaming, what
approaches to transitional loss use might be feasible
3.2.1.4 Allowing use of transitional losses against profits of GRB-PHI should not
cause particular concern for HMRC, as long as it is clear that losses which convert
into full corporation tax rate losses on transition should not be available for
surrender as group relief to other companies in the year of conversion, or by way of
offset in that year against the shareholders share of BLAGAB I minus E.
3.2.1.5 There are other possible methods of restricting loss utilisation. For example,
one might spread the losses over 10 years which is consistent with the rule for
transitional adjustments. This does not give a reasonable result if profits naturally
emerge against which the losses would have been usually offset. The losses do not
arise on transition – they arose historically and should be available against profits
whenever they emerge. A alternative approach therefore would be to offset losses
on transition against profits arising on transition before any net profit is spread. This
could have the effect of matching the losses against the reversal of the items giving
rise to them and would be simpler to administer if all the losses were offset, but, to
the extent that losses were offset in this way, it would be equivalent to spreading
them as they would reduce the amount which would otherwise be spread.
Companies should therefore be able to opt for either a simple carry forward or this
treatment.
3.2.1.6 If there was a wish to stream, HMRC might consider approaching this on the
basis of liabilities. However this brings difficulty. Both protection and PHI business
routinely use negative reserving, which would tend to over-allocate to GRB under
current law. It is not clear what would happen under IFRS Phase II but negative
reserving is expected to be a significant feature on Solvency II.
3.2.1.7 A more prosaic example may assist. It is commonplace to undertake
reinsurance on a “fund only basis” which passes liabilities to a counterparty but
leaves the profit to emerge in the same place as it did before. A mean liability basis
may therefore apportion profits to PHI (say) where the profits are really GRB and
this might deny the utilisation of losses attributable to this business. This would not
be consistent with the direction of the consultative document towards a commercial
and factual basis, not an arithmetic calculation which gives an uncommercial
answer.
3.2.1.8 The factual./commercial direction of the life tax changes together with
simplification objectives point strongly towards a conclusion that there should be no
streaming or other restriction on the use of historic losses in the GRB-PHI category.
Streaming of PB losses up to 2006
3.2.1.9 On amalgamation of the “5 into 1” categories as a result of the last
consultation exercise, streaming was introduced to restrict pension business losses
so that they were restricted and not permitted to be offset against profits of other
GRB categories. This restriction does not appear to have placed any significant
26
restriction on the use of losses, and it would not cause a significant loss to the
Exchequer for this restriction to be abolished.
What levels of streaming exist now, and what might remain at 31 December 2012?
3.2.1.10 Significant levels of streaming do not appear to exist in the industry.
Is there likely to be any difficulty in practice in identifying PB profits within a new
GRB/PHI category?
3.2.1.11 Please see 3.1.2.3 above.
To what extent will PHI business be backed by equities with dividends being
allocated to PHI on a factual basis?
3.2.1.12 PHI is usually backed by fixed interest securities, but fixed interest
securities may include preference shares which are regarded as fixed interest by
investment teams.
3.2.1.13 Where a company has not elected to make allocations on a factual basis,
the identification should be consistent with the basis of allocation generally used in
that situation.
3.2.2 Taxation of dividends
3.2.2.1 See responses above which are relevant.
27
3.3 Shareholder Fund (“SHF”) Assets
Key points:
In addition to the investments held as circulating assets to support its
insurance trade, a life company may hold an investment portfolio which
represents a separate investment business within section 1219 CTA 2009.
Grandfathering of existing SHF and structural assets over transition should
be available at the option of the company.
Transitional measures will be required for long-term fund (“LTF”) assets
which fall to be treated as capital assets.
The segregation of assets between circulating and capital should be agreed
with HMRC using the same process as for the basis of allocation of
investment return (section 3.1.2.3 above).
Capital introduced to a life company by means of a capital contribution
should, as for other traders, be treated as a transaction on capital account.
3.3.1 What practical difficulties are foreseen with the approach outlined in
paragraph 3.26? How might they be addressed?
Introduction
3.3.1.1 At the Open Meeting on 20 June 2011, HMRC suggested that assets of a life
insurance company should be segregated between three categories:
Circulating assets held to support the insurance trade
Fixed assets held for the purposes of the insurance trade
Assets held otherwise than to support the insurance trade (hereafter, capital
assets).
3.3.1.2 Taxable amounts in respect of circulating and fixed assets would be
allocated as between BLAGAB and GRB-PHI and reflected appropriately in the
relevant computations. Taxable amounts in respect of capital assets would be taxed
otherwise than as part of the BLAGAB I minus E profit and the GRB-PHI trading
profit.
3.3.1.3 Practical issues may arise in respect of the classification of assets between
these categories. There may also be transitional issues, in particular where assets
28
of the LTF fall to be dealt with as capital assets. These issues are addressed
separately below.
Categorisation of assets
3.3.1.4 For the majority of life companies, the categorisation of assets of a life
company is currently based upon the regulatory classification. SHF assets will be
treated as capital assets; assets of the LTF will in the main be dealt with as
circulating assets:
The SHF is generally dealt with as if it were a separate investment business
within section 1219 CTA2009.
Section 83XA FA 1989 provides that “structural assets” (broadly, shares in,
debts from and loans to insurance dependants) of a non-profit fund are
treated in the same way as SHF assets.
3.3.1.5 Typically in other businesses, assets which would be regarded as capital
rather than circulating assets would include investments in group companies
including joint ventures, joint operations and associates; own-occupied property; and
goodwill and intangible assets. The identification of such assets held by life
companies is not likely to be problematic.
3.3.1.6 HMRC‟s recognition at the Open Meeting on 20 June 2011 that the capital
asset category will not be limited to such assets is to be welcomed, and that a life
company may carry on a separate investment business within section 1219 CTA
2009 which will continue to be recognised as such in the post 2012 regime. For
example, many life companies currently maintain investment portfolios which are
separately identified and managed as representing “shareholder capital”.
3.3.1.7 Life insurers will need to determine to what extent assets in what is currently
the SHF represent such a separate “investment business” portfolio and to what
extent they are an intrinsic part of the life business and so should be treated as
circulating assets. This is an issue to be determined having regards to the facts of
each case, including the extent to which there is a differentiated and separately
managed portfolio. This may not always be straightforward.
Transitional matters – SHF and s83XA assets
3.3.1.8 The Consultation Document envisages that existing SHF and section 83XA
assets will be grandfathered and will continue to be treated as now. This
grandfathering is intended to apply on an “asset” rather than a “portfolio” basis; thus
on the disposal and reinvestment of current SHF assets, the classification of the
replacement assets will fall to be determined on a factual basis as above.
3.3.1.9 Whilst grandfathering is clearly appropriate in many cases, some companies
have suggested that it would be administratively simpler for them to transition all
29
assets to their new classifications on 1 January 2013. Companies should also
therefore be able to opt out of the proposed grandfathering treatment.
Transitional matters – LTF assets which fall to be classified as capital assets
3.3.1.10 There will be situations in which LTF assets which do not currently fall
within section 83XA would fall to be treated from first principles as capital assets. An
example would be investments held by the LTF in group companies other than
insurance dependents. (Assets held by an internal linked fund should be dealt with
as circulating assets since they are held to back the linked liabilities.) It will be
necessary to determine how such assets shall be dealt with on transition.
3.3.1.11 There are a number of possible options to deal with this transition. Value
differences up to 31 December 2012 in respect of such assets will have been
reflected in trading profits computations either as they arose and/or as part of the
wider transitional measures (refer Chapter 4 below). Accordingly, the simplest
approach is likely to be a transition based upon 31 December 2012 value:
No further adjustments would be required in respect of trading profit
calculations
For BLAGAB I minus E purposes, there would be a deemed disposal and
reacquisition for chargeable gain or loss purposes at that date. The BLAGAB
share of any resulting gain or loss would be held over, as a BLAGAB
chargeable gain, until an actual disposal of the underlying asset.
Capital contributions
3.3.1.12 New capital may be introduced into a life company, as for any trading
company, by means of a capital contribution from the shareholder. A capital
contribution into a life company will currently be injected into the SHF; a transfer
then may or may not be made from the SHF into the LTF.
3.3.1.13 Capital contributions are dealt with as capital items and not as trading
receipts in the case of other traders. To prevent any uncertainty on the point, HMRC
should confirm that the same treatment will continue to apply to life companies.
3.3.2 What processes might be put in place to give companies certainty over
the nature and tax treatment of particular assets?
3.3.2.1 As at 3.1.11.3 above dealing with allocation, the agreement of the
categorisation of assets should be part of the self assessment process, dealt with
through discussion between a company and its CRM and reflecting the facts and
circumstances of each company‟s specific circumstances.
3.3.2.2 In particular, it would not be appropriate to seek to prescribe a list of assets
which will automatically be treated as capital or circulating assets. A prescribed list
may actually create problems in unusual situations (which is where difficulties are
more likely to arise in any case).
30
3.3.3 How should the shareholders’ and policyholders’ shares of BLAGAB
gains be identified?
3.3.3.1 The Consultation Document accepts that there should be a continuation of a
(limited) offset of BLAGAB and capital asset gains and losses. It is appropriate as a
matter of policy that there is such an offset.
3.3.3.2 The transition to Solvency II need not give rise to significant complications
with regard to the operation of section 210A of the Taxation of Chargeable Gains
Act (“TCGA”) 1992. In particular:
Chargeable gains and allowable losses on SHF assets (which are currently
referred to in the legislation as “non-BLAGAB” chargeable gains and
allowable losses) would need to be redefined to reflect the new segregation
and to refer to capital assets (or similar); and
The policyholders‟ and shareholders‟ shares of BLAGAB gains and losses
could be calculated on a basis consistent with the rules as currently drafted
(with clarification that these amounts relate to the BLAGAB apportionment of
gains and losses on circulating assets).
3.3.4 What implications are there for other existing tax rules (for example
sections 171, 171A, 212 TCGA 1992, substantial shareholdings exemption)?
Capital allowances
3.3.4.1 It will be necessary to ensure that the post 2012 regime interacts
appropriately with the capital allowances legislation in order to ensure that capital
allowances are duly reflected in trading profits computations for BLAGAB and GRB-
PHI, and in the BLAGAB I minus E computations.
3.3.4.2 Capital allowances on management assets should be allowed in the
BLAGAB and GRB-PHI trading profits calculations and in the BLAGAB I minus E
computation. Capital allowances which have not previously been given in life trading
profit calculations, because accounting depreciation was effectively tax deductible
as a result of section 83(2), should be given under the new regime.
CGT boxes
3.3.4.3 Currently, the legislation provides for SHF assets to form a separate box
(sections440 A&B ICTA 1988), with transfers between that box and other boxes of
the company being dealt with as market value transactions.
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3.3.4.4 A separate box treatment should continue for capital assets of the company.
More generally, it is suggested that the section 440 “boxes” are amended so as to
become:
Circulating assets linked (or directly attributable) to GRB-PHI;
Circulating assets linked (or directly attributable) to BLAGAB;
Other circulating assets; and
Capital assets, including SHF and section 83XA assets as at 31 December
2012 which are treated as capital assets.
Legislative references to assets of the LTF
3.3.4.5 There are various places in which the life tax legislation refers explicitly to
assets of the “long-term insurance fund”. Many of these provisions will be re-written
as part of the broader reforms to the regime for taxing life insurance companies.
However, those which remain will need to be amended so as to replace references
to assets of the long-term insurance fund with reference to circulating assets (or
similar).
3.3.4.6 There are also a number of places where other legislative provisions
differentiate as between assets of the LTF and other assets of a life insurer. These
provisions will need to be recast to refer to the expected new segregation as
between circulating and capital assets. Examples would include:
Sections 171 to 171C
Section 211(2A) TCGA 1992.
3.3.4.7 The implications of section 151(3) CTA 2010 may also need to be
reconsidered so that shares in companies treated as capital assets would not fall to
be ignored in establishing 75% and 90% group structures for group relief purposes.
Substantial shareholdings exemption
3.3.4.8 In the case of a disposal of shares held in the LTF, the definition of
“substantial” is currently modified, so as to be an interest of 30% or more.
3.3.4.9 Within a life tax regime which differentiates between capital and circulating
assets, the SSE should apply to all capital assets which meet the required tests,
including the normal shareholding threshold.
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Other matters
3.3.4.10 Following the introduction of Solvency II, section 83XA FA 1989 should be
repealed, otherwise than as regards the grandfathering of section 83XA assets on
transition.
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3.4 Other Considerations
3.4.1 Mutual insurance
Key points:
In general terms in respect of mutual matters the ABI defers to the representations
made by the friendly societies' and mutual insurers' trade body, The Association of
Financial Mutuals (AFM).
There is a clear statement in the consultative document at 3.28 that the Government
has no intention that the changes brought about by the implementation of Solvency II
should alter either the policy approach or implementation of the mutual principle as
currently understood. However, there are concerns that the separation of an insurers
business for tax purposes in calculating trade profits separately for BLAGAB and
GRB may mean for a mutual that those businesses may not be viewed as mutual on
a standalone basis.
For a mutual insurer the only relevant allocation of income and gains should be the
allocation of amounts to (taxable) BLAGAB for the I minus E computation. Where,
unusually, a mutual insurer has a taxable trading profit, a factual commercial
allocation should tend to produce a nil profit where the company‟s overall profit is nil.
There is concern that this may however give a potentially taxable result purely from
fiscal adjustments (for example, a policy holder tax deduction which does not match
the accounts tax charge).
Provided that HMRC are willing to accept that, in certain circumstances, a simple
methodology (for example, based on section 432A or section 432B) is an
appropriate commercially based allocation, particularly for smaller entities (and in
particular smaller friendly societies), then a statutory alternative method may not be
necessary.
3.4.1.1 In general terms in respect of mutual matters the ABI defers to the
representations made by the friendly societies' and mutual insurers' trade body, The
Association of Financial Mutuals (AFM). There is a clear statement in the
consultative document at 3.28 that the Government has no intention that the
changes brought about by the implementation of Solvency II should alter either the
policy approach or implementation of the mutual principle as currently understood.
However, there are concerns that the separation of an insurers business for tax
purposes in calculating trade profits separately for BLAGAB and GRB business may
mean for a mutual that those businesses may not be viewed as mutual on a
standalone basis. This result would be absurd if the insurance business as a whole
is mutual and it would be helpful if the new legislation made it clear that this will not
be the case. .
34
Does the adoption of an accounts basis for trade profits have particular
consequences for mutual insurance companies?
3.4.1.2 The adoption of an accounts basis for trades profits purposes should not be
relevant to mutual insurers.
Does the adoption of a factual commercial apportionment have particular
consequences for mutual insurance companies?
3.4.1.3 For a mutual insurer the only relevant allocation of income and gains should
be the allocation of amounts to (taxable) BLAGAB for the I-E computation.
3.4.1.4 Where, unusually, a mutual insurer has a taxable trading profit, a factual
commercial allocation should tend to produce a nil profit where the company‟s
overall profit is nil. There is concern that this may however give a potentially taxable
result purely from fiscal adjustments (for example, a policy holder tax deduction
which does not match the accounts tax charge).
3.4.1.5 Provided that HMRC are willing to accept that, in certain circumstances, a
simple methodology (based on section 432A or section 432B) is an appropriate
commercially based allocation, particularly for smaller entities (and in particular
smaller friendly societies), a statutory alternative method may not be necessary. It
would, however, be a concern if HMRC required lengthy justification for such an
approach by smaller and simpler entities, since a significant benefit of the Statutory
Alternative Method should have been a lower compliance burden.
A method based on section 432A or section 432B is likely to be commercially based
for companies or societies with fairly straightforward business such as a single fund
where the assets are managed together and held to back all of the business rather
than particular types.
3.4.2 Are there other aspects of the Technical Note of 23 March 2011 which
may have particular consequences for mutual insurance companies, or for
reinsurance companies?
3.4.2.1 Where particularly relevant to mutual insurers these points have been
covered elsewhere in this paper, otherwise, as stated above, the ABI defers to the
submission of the AFM.
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3.5 Transfers of Long Term Business
Key points:
There is broad support for the new approach under which trade profits and losses
arising from whole and part transfers between unconnected parties will be calculated
according to the normal accounting rules and where whole or part transfers occur
between connected parties, no profits or losses arising from the transaction will be
recognised. The aim will be to recognise profits or losses on these insurance
contracts when they emerge in the hands of the transferee.
In the circumstances of a connected party transfer, the favoured option is that the
profit / loss as recognised by the transferor, but not taxed or relieved under the
general rule as set out above, is also the amount not taxed or relieved in the
transferee. Any additional adjustment by the transferee at the time of the transfer
should be tax effected immediately.
Relief should be given for “VIF” on the basis that symmetry should be achieved for
tax purposes between the transferee and transferor.
The relief for VIF should be given in line with the treatment in the transferee's
accounts. This would result in any initial credit on recognition of the VIF in the
transferee being taxable. However amortisation of the VIF in subsequent years
would then be treated as deductible. This approach is in line with the principle that
the accounts treatment should be followed for tax purposes as far as possible.
3.5.1 In the context of a connected party transfer is it possible for each party
to account for the transferred assets and liabilities at different values?
3.5.1.1 This is possible – for example where the reserving basis differs between
transferor and transferee such that the reserves / liabilities recognised in the
transferee differ from those in the transferor even though the assets transferred are
ascribed an identical value. Both parties do have a certain level of discretion in
respect of the accounting treatment of business transfers.
3.5.2 If so, will it be necessary to introduce a rule to ensure that profits and
losses are recognised once and once only over the life of each policy?
3.5.2.1 Given the potential for discrepancies in the values recognised in the
transferor and transferee, such a rule will be required. The key question then relates
to the timing of any fiscal adjustments made in respect of asymmetries between the
transferor and transferee.
36
3.5.2.2 By way of example, take a scenario in which the transferor had assets of
£100m and reserves of £80m, but the transferee only set up reserves of £75m in
respect of the transferred business due to a less prudent reserving basis. Here, if
the transfer is between connected parties, the £20m loss in the transferor would be
disallowed. However there are then several possibilities regarding the tax treatment
in the transferee:
For £20m of the profit arising in the transferee to not be taxed (i.e. the
amount equivalent to the loss in the transferor), but the £5m arising from the
reserve release to be taxed immediately. The transferee would then be taxed
on the basis of its unadjusted accounting profits in subsequent years
For the transferee to not be taxed up-front on any of the £25m profit from the
transfer – but for the £5m profit arising on the one-off reserve release to be
brought into tax over the remaining lifetime of the transferred business. This
could be achieved, for example, by requiring the transferee to make fiscal
adjustments each year equivalent to the difference between the reserves it
holds in its accounts and the reserves it would have held had it used the
same reserving basis as the transferor.
3.5.2.3 While it is not entirely clear that the first approach necessarily produces a
“stand-in-the-shoes” result, it would clearly be easier to apply than the second option
(which would potentially involve significant additional complexity in "tracking" the
amount in respect of the reserve release). Adoption of the first option its thus
preferred on the grounds of simplicity.
3.5.3 It is possible that, on a transfer between connected parties, the
transferee may not be within the charge to corporation tax. Under what
circumstances is this likely to occur and when should unconnected party
treatment be applied?
3.5.3.1 HMRC‟s concern appears to be that that a life company could use provisions
in any new legislation designed to achieve equality of treatment between the
transferor and transferee in order to transfer life business with a significant VIF
outside the scope of UK tax. However:
If the business transferred is genuine overseas business written by a UK life
company then it is highly likely that this business would cease to be subject
to UK tax irrespective of any Part VII, as a result of the forthcoming branch
exemption (which will be effective in 2012 onwards).
There is at least a theoretical possibility that a transferee may not be within
the charge to corporation tax following a connected party transfer (for
example on an intra-EU transfer subject to the Freedom of Services
Directive). However such instances are likely to be very rare. In most cases,
if the business transferred is administered in the UK then it would still be
37
taxable there, regardless of the fact that it might be transferred to a non-UK
company
3.5.4 In the context of third party transfers where the transferee recognises an
asset for the Value of In Force Business (VIF) is there a case for relief to be
given?
3.5.4.1 There is a case for this relief on the basis that symmetry should be achieved
for tax purposes between the transferee and the transferor.
3.5.4.2 The VIF transferred will constitute the net present value of future surplus
arising. This surplus will be taxable when it emerges, and the transferee should be
entitled to relief for the cost of acquiring the right to receive the future income
stream. In a third party transfer, the transferor will be taxed on any profit made on
the disposal of the VIF, regardless of whether this profit relates to an additional
payment from the transferee or to the fact that transferee agrees to accept liabilities
that exceed the assets transferred. Allowing some form of relief in the transferee for
consideration paid for VIF therefore appears equitable.
3.5.4.3 In this context, there are two possible ways in which acquired VIF can be
accounted for under IFRS, as set out in IFRS 4 (Insurance Contracts). These are
firstly recognising an asset in respect of the VIF, which is then amortised over time,
or secondly netting the VIF off on initial recognition against the liabilities acquired.
There is a risk that an approach which denied relief for VIF recognised on the
transfer (e.g. by seeking to disallow relief for its amortisation) might put those
companies that choose to recognise an explicit asset in respect of VIF at an unfair
disadvantage when compared to those that decide to net the VIF against the
liabilities acquired.
3.5.5 If so how should that relief be calculated and when should it arise?
3.5.5.1There appear to be three potential approaches, which are set out below.
Immediate relief is given for the full amount of the VIF - i.e. treating any
credit in respect of the VIF recognition as non-taxable. Where VIF is
acquired for cash consideration (and consequently no credit arises) a
deduction will be given for the cash-purchased VIF. Provision then needs to
be made for debits in subsequent periods relating to the amortisation of the
VIF to be non-deductible
Relief is given in line with the treatment in the transferee's accounts. This will
result in any initial credit on recognition of the VIF in the transferee being
taxable (and no up-front deduction being available for cash-purchased VIF).
However amortisation of the VIF in subsequent years would then be treated
as deductible.
Relief is given over a fixed period / at a fixed rate regardless of the
accounting amortisation (e.g. similar to the capital allowances rules)
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3.5.5.2 In all three cases, the intention is that relief should be obtained for the
consideration paid for the VIF. This differs from the current position, where no relief
is obtainable for acquired VIF.
3.5.5.3 In all cases, consideration would also have to be given as to whether any
credit related partly to the release of a non-deductible reserve (for example a
reserve in respect of pension contributions). Following the principle of symmetrical
treatment, any profit arising on such a relief should be non-taxable (on the basis that
no relief would have been given for the creation of the reserve).
3.5.5.4 The second of the three approaches outlined above is preferable as it is in
line with the principle that the accounts treatment should be followed for tax
purposes as far as possible.
3.5.5.5 This approach would produce the same result regardless whether the
transferee choose to set up an explicit VIF asset or chose to offset it against the
liabilities acquired. The recognition of VIF / de-recognition of liabilities would reduce
the initial loss in the transferee arising from the excess of liabilities over assets.
However the profit in subsequent periods would then also be reduced, either via the
amortisation of the separate VIF asset or because, under the second method, there
would be no (or, at the very least, a lower) margin within the reserves acquired to
unwind over the lifetime of the policies. In both cases the overall position regarding
the recognition and unwind of VIF should be neutral.
3.5.5.6 An alternative from a tax perspective would be to allow an initial tax loss in
the transferee (i.e. disregard the VIF), but then also disallow amortisation of the VIF
(or an element of the liability unwind in respect of VIF), increasing taxable profits.
However it is not clear how practical such an approach would be for two principal
reasons. Firstly, where no separate VIF asset had been recognised (i.e. because
the VIF had been netted off against liabilities acquired), identifying an amount to
disallow in subsequent periods could be problematic. Secondly, because of the
difficulties involved in identifying the correct disallowance, such an approach might
create asymmetries between the tax treatment of those companies that recognise
an explicit VIF asset and those that decide to net the VIF off against acquired
liabilities - i.e. the former companies might get tax relief sooner or later than the
latter companies. In view of these two factors, the viability of the third approach
outlined above (i.e. giving relief for the VIF over a fixed period) is uncertain.
39
3.6 Treatment of Protection Business
Key points:
Use the FSA's definition for protection per the retail distribution review (“RDR”) regulations in order to align the tax and commercial definitions.
There is no need to introduce an anti-avoidance test for in-force policies as alterations are rare and tend to reduce premiums.
The new basis should apply to protection policies going on-risk on or after 1 January
2013.
3.6.1 Definition
3.6.1.1 The Government has announced that “protection business” written on or
after 1 January 2013 will be removed from the scope of the I minus E tax regime
and will fall to be treated similarly to existing GRB policies. The consultation
document states that the intention is to identify business which is no longer
appropriate for I minus E treatment and the preferred approach is to identify such
business that has zero savings content; i.e. where a policyholder cannot obtain
more than a return of premiums, other than in respect of the insured event. HMRC‟s
suggested definition is:
“A long-term insurance contract where the benefits payable under the contract
cannot exceed the return of premiums paid, unless they are payable only on death
or in respect of incapacity due to injury, sickness or infirmity”.
3.6.2 Are there any difficulties in adopting the definition of protection
business outlined above? Will it provide a sufficiently clear dividing line?
3.6.2.1 The proposed definition is probably sufficient and should provide reasonable
certainty for those operating in the market. It should also achieve fairness between
competitors and go some way to limit scope for artificial tax structuring
arrangements.
3.6.2.2 However, the above definition still leaves opportunities for potential
manipulation of the rules so that companies are able to continue writing protection
products in an I minus E environment by simply making minor changes to new
protection contracts written on or after 1 January 2013 at little extra cost.
3.6.2.3 Accordingly, it would be preferable to align the definition of protection
business with the definition used for RDR purposes (per the FSA glossary) so that
what falls to be classified as a pure protection product for regulatory purposes is
followed for tax purposes:
40
“(1) a long term insurance contract in respect of which the following conditions are
met:
(a) the benefits under the contract are payable only on death or in respect of
incapacity due to injury, sickness or infirmity;
(b) [deleted]
(c) the contract has no surrender value, or the consideration consists of a
single premium and the surrender value does not exceed that premium;
and
(d) the contract makes no provision for its conversion or extension in a
manner which would result in it ceasing to comply with (a) or (c);
(2) a reinsurance contract covering all or part of a risk to which a person is
exposed under a long-term insurance contract.”
3.6.2.4 It is recognised that the regulatory definition may need to be adjusted in
respect of certain whole life policies for tax purposes to limit the scope to which the
regulatory definition applies.
3.6.2.5 Section 473 Income Tax (Trading and Other Income) Act (policies and
contracts subject to the chargeable events rules) should contain a specific exclusion
for policies which fall into the definition of protection business written on or after 1
January 2013.
3.6.3 What is the most practicable method of dealing with pre-existing policies
which are changed after 31 December 2012?
3.6.3.1 The simplest approach would be to treat all variations to policies written
before the commencement date as protection business under the existing rules and
continue to treat them as BLAGAB. This approach appears to have limited future tax
risk to the Exchequer on the premise that variations to policies are made
infrequently. For example, one leading provider which writes in excess of 300,000
new contracts of insurance per annum; experienced only 1,230 variations in the
period May 2010 through to June 2011, of which only 195 related to events which
resulted in a increase in premiums and therefore attracted additional commission
payable. This simplified approach would be strongly welcomed by the Industry as it
would provide the certainty needed over the tax treatment of such policies for pricing
purposes and give rise to the least disruption to existing operations.
3.6.3.2 If the Government considers it necessary to introduce legislation to deal with
significant variations of pre-existing contracts, the definition should be aligned to the
definition in the fundamental reconstructions section of the HMRC Insurance
Policyholder Tax Manual as to what constitutes a significant variation (IPTM8100
onwards). The legislation should only apply to those variations which result in both
a non-trivial increase in premiums and further commission payable.
41
3.6.3.3 There are complexities in adopting either of the proposed HMRC options.
From a systems perspective, option 1 appears to be the “simpler” approach to take
as it does not require the life company to track the split of the policy to determine the
tax treatment. It is certainly the case that for some life companies, depending on the
type of variation made, the option of splitting a policy between the pre-2013 policy
and what constitutes the post 2013 policy is not viable as their systems simply will
not allow it. Option 1 does however pose a wider pricing and potential Treating
Customers Fairly issue in that where tax relief is factored into the original price and
there is a significant variation to a term assurance policy such as an increase in the
sum assured (the nature of the policy does not change), this would result in a re-
pricing of the whole policy not only to reflect the increase in cover but to also cater
for the loss of tax relief and therefore changing the basis on which the policyholder
purchased the original policy, which may seem unfair to the customer.
3.6.3.4 The Government may have concerns over new policies that are written in the
run up to the commencement date and the potential manipulation of the tax rules in
that period. This could be dealt with by the introduction of an anti-forestalling
provision for any subsequent variations of these policies.
3.6.3.5 Another issue which requires clarity is the treatment of policies which have a
start date in 2012 but are only put on risk in 2013; so-called “pipeline” business. It is
general industry practice to allow customers to backdate the start of their policy to
the date of their quote as long as they are willing to pay the back premiums
(backdating can go as far back as six months). It should be the date at which a
policy is put on risk that determines the applicable tax treatment. That is, where the
quote is given in 2012, and the customer chooses to take up the policy in 2013 but
backdates the premiums to the quote date, the Industry suggests that the policy
should be subject to the new tax rules and fall outside the I minus E regime.
3.6.4 Other
3.6.4.1 Companies that write solely protection business and are therefore currently
taxed each year by reference to life assurance trade profit would be interested in the
option to switch over completely to the normal trading basis from 1 January 2013 i.e.
that existing basis as well as new business is taxed on a normal trading basis. This
would be a simplifying measure for the companies involved and should result in no
loss of revenue to the Exchequer.
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3.7 I minus E Volatility
Key points:
The life insurance business is subject to volatility caused by a number of different
factors but investment returns and movements in asset values are the principal
reasons for volatility in the measure of I minus E profits.
The problem with I minus E volatility centres around short term mismatches between
the I minus E profit and the life assurance trade profit and in particular the lack of
fungibility of I minus E losses to allow a smoothed approach to be taken in the
comparison.
The changes already announced to the scope of the I minus E regime and its
consequent interaction with the measure of BLAGAB only trade profits may address
to some extent the issue of I minus E volatility to the satisfaction of the industry.
Nevertheless, some further measures are proposed here that may address
shortcomings in the current tax rules that can lead to difficulty, particularly with
regard to the interaction of I minus E profits and the minimum profits test.
3.7.1 Is action necessary to take account of I-E volatility? If so, why? Can real life examples be provided to demonstrate the need for action?
3.7.1.1 The life insurance business is subject to volatility caused by a number of
different factors but investment returns and movements in asset values are the
principal reasons for volatility in the measure of I minus E profits.
3.7.1.2 It should be noted that the primary source of volatility is asset value
movements whereas income tends to be relatively constant on any given portfolio. I
minus E volatility also needs to be considered in the context of trade profits volatility
insofar as the latter impacts on the minimum profits test and the consequent
imposition of a charge under section 85A FA 1989 on any excess adjusted life
assurance trade profits. This difference is exacerbated by the realisations basis
used for capital gains in the measure of the I minus E profit compared with the
inclusion of market value movements in the life assurance trade profits computation.
The changes introduced to the taxation of protection business and the proposal to
restrict I minus E to BLAGAB only are acknowledged in the consultation document
as two measures which will go some way to addressing this issue.
3.7.1.3 In all consideration of volatility and possible mitigating factors, it should be
borne in mind that volatility itself is not bad; however the issue for insurers is that
they may have unrealised profits that are not realised for a number of years and so
could face significant liquidity issues if forced to pay tax on amounts that cannot be
realised for the benefit of their shareholders (i.e. profits arising in the with-profits
fund that are yet to be distributed to the shareholders).
43
3.7.1.4 The problem with I minus E volatility therefore becomes short term
mismatches between the I minus E profit and the life assurance trade profit and in
particular the lack of fungibility of I minus E losses to allow a smoothed approach to
be taken in the comparison.
3.7.2 If action is necessary, what should it be, and what effect would it have?
3.7.2.1 The best and simplest approach to address I – E volatility, is to permit life
insurance companies to carry back excess management expenses to offset I minus
E profits in the same company in the preceding year This would significantly help
to address the liquidity issues and short term timing issues mentioned above.
3.7.3 Will I-E volatility be increased by a move to an accounts basis? If so, why?
3.7.3.1 A move to an accounts basis does not necessarily increase volatility; the I
minus E basis for BLAGAB remains fundamentally unchanged by the move to an
accounts basis and some of the current exacerbating factors will be addressed by
changes already proposed.
3.7.4 What impact is IFRS 9 expected to have on I-E volatility?
3..7.4.1 The possible impact of IFRS 9 on members‟ results is still under
investigation so at this stage it is not possible to comment on whether it may affect
volatility in the I minus E computation.
3.7.5 What are the implications for the interaction between I-E and trade
profits of the decided changes, particularly those listed at paragraph 3.42?
Will those changes ameliorate or exacerbate any perceived difficulties with
the current regime?
3.7.5.1 The changes already announced to the scope of the I minus E regime and
its consequent interaction with the measure of BLAGAB only trade profits may well
address the issue of I minus E volatility to the satisfaction of the industry.
Nevertheless some further measures are set out above that may address
shortcomings in the current tax rules that can lead to difficulty, particularly with
regard to the interaction of I minus E profits and the minimum profits test.
3.7.6 What implications does the treatment of transitional adjustments (see Chapter 4) have for the trade profit/I-E interaction?
3.7.6.1 It is understood that the transitional adjustments outlined in Chapter 4 of the Consultation Document will be included in the LATP and add to its volatility with subsequent impacts on the interaction of LATP and I minus E. This emphasises the importance of addressing I minus E volatility along the lines outlined above.
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Chapter 4 Transitional Issues
4.1 Transitional Adjustments
Key points:
End 2012 differences between the FSA (tax) and accounting balance sheets will
require analysis
Items specific to individual companies may require agreement with the CRM and
flexibility in the law is required to address such items
2012 apportionment fractions should be used to allocate investment return items
deemed to be brought into account on transition.
Tax in relation to with-profit funds should not be crystallised on transition but should
be deferred until the relevant allocation (in most cases the bonus declaration) has
been made.
Anticipated changes in accounting standards: if such changes do take effect in 2013
and/or in early subsequent periods the resulting transitional adjustments should be
spread over the remainder of the period to 2022 (when the 10 year spread on the tax
transition will cease). Should the accounting changes take effect only in later
accounting periods, the industry would wish to discuss more targeted transitional
measures.
4.1.1 General proposals
4.1.1.1 The Consultation Document identifies a number of transitional adjustments
that will arise from the timing and valuation differences between the current
regulatory regime treatment and the accounting rules that will apply under the new
regime. The potential differences on transition are significant and therefore the 10
year spreading facility is very much welcomed by Industry.
4.1.1.2 It should be possible for companies to determine the transitional adjustments
in practice and the expectation is that most companies will be able to prepare a
reasonably detailed reconciliation between the closing regulatory balance sheet at
31 December 2012 and the accounts balance sheet at the same date. Such a
reconciliation process will be expected to be sufficiently detailed and complete in
order to assess how the various components should be treated for tax under the
transition and agreed between company and HMRC (on the filing of the 2013 tax
return).
45
4.1.1.3 The three identified transitional adjustment categories in the Consultation
Document are DAC / DIR, untaxed surplus within court schemes and a „catch-all‟
residual adjustment category.
4.1.1.4 In the majority of cases, the transitional proposals to deal with DAC and DIR
should not pose any problems in practice i.e. it should be possible to track the DAC /
DIR balances as they unwind in the post-transition accounts and tax adjustments
can be made accordingly. The same logic applies to purchased VIF which should
be subject to similar transitional measures.
4.1.1.5 Equally, for the small number of companies subject to a court scheme, it will
be necessary to discuss the detail of these on an individual basis with the CRM as
part of the wider assessment of the overall transitional adjustment. It is anticipated
that where a case can clearly be made that an untaxed amount (held in Form 14.51,
say) is constrained under the terms of a scheme, then eligibility for the additional 2
year deferral will be made available.
4.1.1.6 For the residual category, a significant number of items are expected for
most companies, to include surplus brought forward in Form 14.13, adjustment to
investment values including structural assets, adjustment for technical provisions
etc. A list of items identified to date is highlighted in the attached appendix along
with the issues to be further addressed.
4.1.1.7 The appendix also highlights those areas which will require specific
transitional arrangements, for example, to deal with the transitional implications for
those tax rules which will not survive into the new regime (e.g. FAFTS, formulaic
apportionments) to cover the transitional implications of the likely loss of the LTF –
SHF split, and to deal with any new rule for policyholder deferred tax deductions.
Such rules would include whether any transition could be tracked on a factual basis
or otherwise. The appendix puts forward skeleton proposals for these which, of
course, will need further development and work over the course of the consultation
including whether any transition can be tracked on a factual basis or otherwise.
4.1.1.8 The apportionment approach to apply to the transitional adjustments (to
allocate across the different business categories) is likely to depend on the nature of
the particular component involved. For example, it is likely that DAC or DIR, can be
allocated on a factual basis, whilst for the removal of the book value election (Form
14.51) a more appropriate basis is likely to be the 2012 apportionment basis
including section 432CA. The appendix makes reference to the most likely allocation
basis to apply to the various adjustments. Overall, the allocation rules for
transitional adjustments deemed to be brought into account as investment return
should be based on apportionment fractions.
4.1.1.9 Turning to accounting standards, the question of what is possible in the year
of transition (2013) is certainly not clear-cut. In this year, the accounts
measurement of trading profits may need to change as a result of the introduction of
Solvency II unless the current Solvency I models are maintained. If there is change,
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there are a number of options and companies have not yet determined which
approach to adopt and may not for some months yet. It may be possible, for
example, for companies to choose to change from a Phase I accounting policy to
something more relevant and no less reliable or more reliable and not less relevant
in respect of their valuation of long term insurance liabilities (e.g. Solvency II or
some hybrid). There are a number of technical IFRS issues to overcome in this
assessment, as well as practical and financial implications to consider, before any
decision can be made. The timing for making such decisions for any company is
certainly not imminent and more likely to be over the next 12 months.
4.1.1.10 Any adoption of IFRS Phase II (or Solvency II) will result in a further profit
transition, attributable both to a different measure of policyholder liabilities being
used and no explicit DAC. It is also the case that the treatment of the UDS under
Phase II is not yet clear. It is a possibility that expected shareholder interests would
be re-classed as equity, again resulting in a transitional spike.
4.1.1.11 In summary, there will be one or more accounting transitions in relation to
the implementation of IFRS Phase II and possibly after interim use of Solvency II
liability valuations (especially if certain aspects of Solvency II are on a delayed
timetable). However, the timing of these further transitions is as yet unclear. On the
assumption that the anticipated accounting changes do take effect in 2013 and/or
early subsequent periods, the resulting transitional adjustments, particularly those
arising in respect of balance sheet items treated as giving "residual" and thus
spread adjustments on the tax transition, should be spread over the remaining
period to 2022 (when the 10 year spread on the tax transition will cease). Such an
approach would provide simplicity and a degree of coherence given that most
groups are viewing Solvency II and IFRS Phase II in tandem and will no doubt adopt
the new accounting bases at different times. This approach would also have the
merit of dealing with the transitions of „like‟ items on a consistent basis so as to
avoid one spike being spread and another spike on the same item (which may be in
part a contra item) being taxed / allowed in a single year. Should the accounting
changes take effect only in later accounting periods, the industry would doubtless
wish to discuss more targeted transitional measures.
4.1.2 How should transitional adjustment be apportioned between categories
of business?
4.1.2.1 See above and the attached appendix.
4.1.3 Is the correct reference for determining the adjustments a comparison of
the closing regulatory balance sheet at 31 December 2012 with the accounts
balance sheet at the same date ? Would other parts of the regulatory return or
accounts need to be considered ?
4.1.3.1 The comparison between FSA balance sheet and the accounts balance
sheet at 31 December 2012 will determine the entire transitional adjustment amount
at that stage. A template has already been produced to capture this amount.
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However, as referred in 4.1.1.11, there are further transitional amounts to consider
as a result of accounting changes that will be made.
4.1.4 What existing rules will require transitional arrangements in addition to
the main transitional adjustments? What arrangements are appropriate?
4.1.4.1 See above and the attached appendix.
4.1.5 Are there any practical difficulties in identifying DAC or DIR for
disallowance or elimination?
4.1.5.1 There should not be any problems in practice.
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4.2 Carry Forward of Tax Attributes
Key Points:
It is important that companies are able to carry-forward existing life assurance trade
losses as BLAGAB trade losses where those current life assurance trade losses
commercially relate to losses on BLAGAB. This should ensure tax relief to match
with the underlying economic losses
This should be done on a “Factual Basis”, matching many of both HMRC and the
ABI‟s other proposals. Such a basis should ensure that for companies who have
acquired life assurance trade losses by way of intra-group Part VII transfers, external
Part VII transfers (including associated reinsurance transactions) or major fund
restructuring transactions, an equitable amount of life assurance trade losses will
convert into BLAGAB trade losses. In such cases, a simple “netting” or other basis
is unlikely to generate an appropriate result.
Such a calculation only need be performed once, and could be agreed in advance
with the CRM
For companies with a more straightforward history, the BLAGAB trade losses could
potentially be determined by the Insurer electing to deduct GRB losses from life
assurance trade losses to determine post Solvency II BLAGAB trade losses.
4.2.1 How should the BLAGAB proportion of transitional life assurance trade
losses be determined?
4.2.1.1 At the date of the introduction of Solvency II, it will be necessary to consider
what proportion of life assurance trade losses existing at transition will convert into
BLAGAB trade losses. This is important for those life assurers who will have life
assurance trade losses as at transition, especially as the transitional adjustments
are likely to accelerate taxable profits.
Recommendation
4.2.1.2 A “Factual Basis” should be used to ensure that genuine BLAGAB trade
losses are not unduly forfeited. Companies should be able alternatively to elect to
use the “Net Basis”, where they have a relatively simple tax history, that makes the
“Net Basis” appropriate. These should be the most effective ways of ensuring that
the amount of life assurance trade loss as at transition that converts into a BLAGAB
trade loss is just and reasonable.
4.2.1.3 HMRC desire simplicity, consistency and fairness on this matter. The bases
outlined above, are the simplest that could be applied to give a consistent and fair
result, and would also correlate with the wider use of producing tax computations on
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a factual basis as far as possible. Any calculations necessary to determine the
BLAGAB trade loss would:
only need to be made once by the life assurer
could be agreed with HMRC prior to the submission of the 2013 tax
computations
Analysis supporting the recommendation
4.2.1.4 Three bases of determining the BLAGAB proportion of LATP losses have
been considered:
The “Factual Basis”
The “Net Basis”; and
The “Apportionment Basis”
These bases are examined below.
Factual Basis
4.2.1.5 Under this basis life assurers would be required to determine what part of
the life assurance trade losses arose historically in respect of their non-GRB
business, and the subsequent utilisation or otherwise of those losses.
4.2.1.6 This would be consistent with the future apportionment basis and reality.
This would be an effective way for life assurers, who have acquired life assurance
trade losses via acquisitions, Part VII transfers or other major transactions such as
fund restructures to recognise genuine value for losses acquired in respect of the
underlying businesses. Many acquisitions arise after the acquired business has
underperformed and has therefore accrued economic losses. It overcomes the
problems that would arise if the BLAGAB trade loss is determined as being simply
the life assurance trade loss less the GRB loss, which are illustrated under the “Net
Basis” below.
Net Basis
4.2.1.7 This basis determines the BLAGAB trade loss by simply netting the life
assurance trade loss carry forward against the GRB loss which is carried forward
into the GRB-PHI trade profit regime. This should work in companies with simple
histories.
4.2.1.8 However, in certain circumstances, a “Net Basis” could result in the
diversion of life assurance losses properly attributable to BLAGAB. An example
would be where there is a Part VII transfer of a business with £100m of life
assurance trade losses, but no GRB losses, into a company with £100m of GRB
losses but no life assurance trade losses. A “Net Basis” applied to the combined
entity could result in £nil BLAGAB trade losses being brought forward after transition
despite economic losses of £100m having arisen in the transferor. The “Factual
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Basis” would permit the insurer to look through the Part VII Transfer so that the
BLAGAB proportion of the life assurance trade losses could be accurately tracked,
and any remaining at transition would be carried forward into the new regime as
BLAGAB trade losses.
4.2.1.9 This basis is unlikely to be suitable for general use, but may provide a simple
basis for straightforward entities to compute their BLAGAB trade losses without
having to resort to detailed factual computations, that would approximate to the
same result.
4.2.1.10 Companies should have the ability to elect to use this basis.
Apportionment Basis
4.2.1.11 This method has the advantage of simplicity, in that a BLAGAB
apportionment fraction could be applied to the life assurance trade losses to
determine the quantum to carry forward as BLGAB trade losses at transition.
4.2.1.12 However, this basis has a number of key weaknesses that mean that it is
unlikely to produce a fair and realistic result:
There is no necessary correlation between liabilities (or any other method
such as net premiums earned) and losses arising
Using one of the existing apportionment fractions may prove inadequate,
especially if life assurance trade losses arose in respect of Linked Business
4.2.1.13 Therefore, an apportionment basis is not recommended.
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Chapter 5 Taxes Impact Assessment
5.1 Fiscal Impact
Key points:
The transitional adjustments arising on the change from a regulatory return to an
accounting basis are expected to generate substantial additional amounts of tax in
aggregate for some companies even after the transitional proposals set out in the
Consultation Document.
The future level of DAC in the period 2010 to 2012 will depend on the relative
strength of three trends: sales of new policies through the period (sales and DAC
would seem to be leveling off if not declining), the action of intermediaries and
insurers in advance of the introduction of RDR (likely to generate more sales and
more DAC) and the change in the nature of commission to intermediaries (which
would tend to decrease the amount of acquisition costs).
5.1.1 General observation
5.1.1.1 Based on information supplied previously in the Consultation process the
transitional adjustments arising on the change from a regulatory return to an
accounting basis are expected to generate substantial additional amounts of tax in
aggregate for some companies even after the transitional proposals set out in the
Consultation Document and discussed in section 4.1. The tax impact of specific
proposals needs to be seen against this general background.
5.1.2 Is it reasonable to assume that the increasing trend in DAC from 2005 to
2009 will continue to 2012?
5.1.2.1 Movements in DAC are expected to be determined by the interaction of three
factors:
The level of historic sales of new policies.
Future sales of policies in the period 2010 to 2012.
Changes in the type and basis of commission payments.
5.1.2.2 The assumption is that the greater part of acquisition costs is accounted for
by commissions.
The level of historic sales of new policies
5.1.2.3 DAC can be thought of as a “water tank” with an inflow of deferred
acquisition costs on new sales, an outflow of deferred amounts arising on historic
sales being released to income statements. The level of DAC – the tank – will be
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driven by the relative size of these inflows and outflows. The chart below shows the
sum of new premiums and the sum of net DAC (both from FSA returns).
5.1.2.4 It can be seen that levels of new premiums started rising in 2002, peaked in
2007 before trailing down to 2008 with a slight rise in 2009. Assuming a seven year
deferral period for DAC, the acquisition costs for the rising 2002 to 2007 sales will
expire over the period 2008 to 2013, to be replaced by an inflow of lower levels of
sales from 2008 onwards. This would imply a decline and then a levelling off of
DAC in the period 2010 to 2012. The beginings of this can be seen in the net DAC
line and numbers whose rate of increase is tailing off in recent years.
Future sales in the period 2010 to 2012
5.1.2.5 Examining the chart above a flat trend of sales is expected oscillating around
a £130bn level. However this trend is likely to be perturbed by a short term increase
in sales leading up to the introduction of RDR in 2013. This is short term increase
will be driven by intermediaries seeking to boost commission income on savings
products before such commission is replaced by a fee based system post 2013.
The size of this expected “spike” in sales is not known but is likely to be noticeable.
This short term sales “spike” will generate a “spike” in acquisition costs and will
increase in DAC up to 2012.
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Changes in the type and basis of commission payments
5.1.2.6 The amount of acquisition costs (and hence deferred acquisition costs)
arising on new business 2010 to 2012 may be reduced by a movement away from
an initial commission model to an initial and trail commission model.
5.1.2.7 Around five years ago insurers began changing the way they paid
commission to advisers. Historically many had paid an upfront commission payment
to investment to advisers, along with a small amount of renewal commission every
year if the policy remained in force. This has been slowly replaced by the initial and
trail model that has long been used by the fund industry. Under this model, the
adviser receives an upfront commission payment (which is smaller than the previous
model, say 4%) plus annual trail commission payments based on the funds held in
the scheme (typically 0.5% which is noticeably larger renewal commission). These
trail commission payments are paid ongoing as long as the policy remains in force.
5.1.2.8 Thus the amount of upfront commission will be reduced going forward
compared to historical trends with a greater degree of commission being in the form
of trail commission. The significance of this is that trail or renewal commission will
usually be accounted for as administration expenses rather than acquisition costs. It
is also worth noting that as the “new model” trail commission is driven by the market
value of investments rather than new premiums, new premium sales cannot be used
as an indicator of future trail commissions.
Summary
5.1.2.9 The future level of DAC in the period 2010 to 2012 will depend on the
relative strength of three trends: sales of new policies through the period (sales and
DAC would seem to be levelling off if not declining), the action of intermediaries and
insurers in advance of the introduction of RDR (likely to generate more sales and
more DAC) and the change in the nature of commission to intermediaries (which
would tend to decrease the amount of acquisition costs).
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APPENDIX
Life Insurance Companies: A New Corporate Tax Regime – Transitional Issues
Basic adjustments and principles
Issues to be addressed
Surplus brought forward (F14.13) should not be taxed
Assumption is that surplus brought forward has already been through the Form 40 tax gate and will not be subject to any further tax on transition. However, companies will need to examine the composition of any reported deficits (i.e. negative entries) as relief may not have been obtained when they arose.
Adjustments to investment values (F13.92 - F13.98) are prima facie taxable
Method of apportionment between categories – proposal is to use 2012 apportionment including section 432CA
Write-down of value of structural assets within section 83XA FA 1989 requires:
general deferral until disposal to avoid transitional adjustment including cases where the write-down was offset against investment reserve (F14.51).
Value of DAC (F13.99) agreed not to be taxable but subsequent amortisation would be disallowed
This rule to be extended to analogous assets such as purchased VIF appearing in F13.92 - F13.98
Apportionment likely to be factual
Other asset adjustments (F13.101) are prima facie taxable
Companies will need to examine the composition of these entries. Some parts may not be taxable if the increase in value would not fall into trade profit on general principles e.g. deferred tax assets. Apportionment needs to be fair and reasonable.
Provision for terminal bonuses should be deductible
Legislation may need to clarify this given Last‟s case
Other adjustments to technical provisions should be deductible
This will include differences between current IFRS / UK GAAP and mathematical reserves including FRS 27 realistic liability adjustments.
Apportionment likely to be factual
There will be a subsequent transition for adjustments from adoption of Solvency II or of the Phase II approach in respect of liability measurement – to be relieved over the balance of the period to 2022.
Removal of the book value election (F14.51) is prima
Method of apportionment between categories – proposal to use 2012 apportionment including section 432CA
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facie taxable Suitable method for deferral where onward distribution to shareholders is restricted under a Court Scheme.
Other adjustments to liabilities will need analysis. Where a liability arises from something which would be a trading deduction it should be deductible but otherwise not
Value of DIR (factually apportioned) not to be deductible but subsequent release would not be taxed
Treatment of contingent loan, financial reinsurance balances and inter fund transfers and appropriate rule for deduction reversing previous FAFTS
Deduction for policyholder deferred tax – on the basis that if a deduction is available in the new regime.
Establishment of UDS – FFA should be deductible
A subsequent transition will result if the shareholder proportion of UDS is released to retained earnings under a Phase II liability approach - this should not be subject to tax.
Section 440(4) box reallocations can arise on change of apportionment basis
If only three boxes should be restricted to assets becoming box (d) (direct attribution) from (e) (hybrid attribution) if the relevant pool is matched exclusively to BLAGAB
Deduction for policyholder tax on new basis should be available but may differ from existing practice
Need to agree acceptable basis for the future
Companies need to examine the relief already obtained to understand effects of transition.
Companies with historic grossing-up methodology may be in a different position from others where prior year adjustments to historic periods arise subsequent to transition
Section 440(4) box reallocations and appropriations to or from capital account could arise on removal of SHF – LTF split
Grandfathering needed for assets in SHF and structural assets within section 83XA FA 1989 to capital account
Grandfathering needed for LTF assets to circulating capital