The draft legislation, released after the pre-Budget report, did not distinguish between policies effected on or after March 14, 1989 and those effected before that date and this would have brought gains on pre-March 14, 1989 policies into the loan relationship charge.
The revised legislation confirms that the favourable position for pre-March 14, 1989 policies has been reinstated in the Finance Bill, pro-vided such policies have not subsequently been enhanced.
From now on, in practice, how policies will be taxed under the loan relationship rules depends on what basis of accounting the company adopts. In this respect, a company will generally adopt a fair value approach but in cases where the financial reporting standard for smaller entities (FRSSE) applies, a historic cost basis can be adopted. This is important in the context of the loan relationship rules as it is generally thought that the majority of companies which own or would be interested in investing in a life policy would satisfy the definition of a small company, to which the FRSSE can apply, and most of these would adopt a historic cost basis. A company is a small company for this purpose if it satisfies two of these three requirements:1: Turnover is £6.5m or less.2: Balance sheet total is £3.26m or less.3: The average number of employees is 50 or less.
For companies which adopt a fair value basis of accounting, the increase in the value of the policy that arises over an accounting period will be taxed as an NTC under the loan relationship rules. This increase will be in effect the difference between the surrender value of the policy at the start of the year and the surrender value at the end. Where the company has a policy that was owned at the start of the first accounting period starting on or after April 1, 2008, the value of the policy will be determined at that date to determine the chargeable event gain that has arisen up until the policy enters the loan relationship rules.
That gain will not, however, be taxed until the policy is finally encashed, when it will, in effect, “inflate” the NTC at that point. Where a company invests in a UK life policy (or an EEA life policy suffering a UK equivalent rate of tax) credit will be given for the tax deducted within the fund.
The situation is, however, different where a company adopts an historic cost basis of accounting. For companies which owned policies before the start of their first accounting period on or after April 1, 2008 and are assessed on the historic cost basis, there would be no deemed chargeable event gain at the commencement of the first accounting period starting on or after April 1, 2008. This is because the measure of the deemed gain is the carrying value for accoun-ting purposes – which will be the historic cost.
Furthermore, there would be no future NTCs on an annual basis under the loan relationship rules. A tax liability could only arise when an encashment or part-encashment takes place, in which case, the gain (NTC) will be measured by deducting the original investment (historic cost) from the amount realised from the full encashment.
When the proposals were originally published, many people felt that this was the end of the use of investment bonds as a tax-deferral vehicle. This is clearly not necessarily the case but all advisers active in this area need to discover the accounting basis used by the company in question to determine whether tax defer-ral will or will not be available.
Brian Murphy is financial planning manager at Axa Life