The Inland Revenue issued a press release on 23 December 2002 entitled “Making Taxation of Life Insurance Companies Fairer” about new rules for the taxation of life offices (including Friendly Societies carrying on life assurance business). Some of the new rules took effect from 23 December 2002. While the broad structure of life office taxation is unaltered, the full complexity of the proposals become apparent in January 2003 with the publication of draft clauses for inclusion in Finance Bill 2003 and a 35-page explanatory note which seeks assistance with some gaps in the proposed legislation. In a somewhat unusual style, the Revenue, having decided which nails are to be pulled, are seeking the assistance of any reader who can help design the instrument of torture to do the job! However, not all the proposals are unwelcome. Some remove significant barriers to portfolio transfers of business between insurers.
The proposals fall into broad categories.
8.2 CAPITAL GAINS TAX LOSSES
As the law stood before 23 December 2002, life insurance companies could crystallise losses on investments for tax purposes without disposing of them, by transferring them between different parts of their business. The rules that prevent other types of company obtaining relief for losses realised by bed and breakfasting on the open market did not apply to life insurance companies. The extent to which life insurance companies were prevented from setting losses realised on assets held outside the long-term insurance fund against gains realised on assets held inside the fund, and vice versa, was unclear.
Under the new rules, relief for losses crystallised by both internal and external bed and breakfasting will be restricted. Other measures prevent losses realised on the disposal of assets held outside the long-term insurance fund from being offset against the policy holders' share of gains on assets held within the fund, and vice versa.
8.3 CASE I TRADING PROFITS
There are special rules for calculating trading profits that apply only to life assurance business. Some of these special rules deal with the treatment of increases in the value of investment assets and determine when such increases are treated as trading receipts in computations for tax purposes. The old rules worked reasonably well where business remained in the company that wrote it and there were no unusual financing arrangements, ensuring that all increases in value were eventually included in computations of profits. But there was increasing uncertainty about the consequences of transfers of business and certain types of financing arrangement such as borrowing money on terms that the principal is repayable only on the emergence of future profits (“contingent loans”). There was also uncertainty about the consequences of expenses being met other than through the company's revenue account, with the consequence that a corresponding appreciation in the value of investments escaped the revenue account and so, it was argued by some, the computation of trading profits for tax purposes.
The new measures seek to remove uncertainty by ensuring that increases in the value of investments are included in Case I computations no later than the time that they are taken from the long-term business fund, whether on a transfer of business, through the substitution of contingent loans or otherwise. It is made clearer that amounts brought into a life company's revenue account in its regulatory return are Case I receipts whatever label they are given and whichever line of the account the company chooses to record them at. And where expenses are charged other than to the revenue account (so excluding a corresponding increase in investment values from the account) a corresponding amount will be included as a receipt in computing trading profits. There will be special rules for excluding from charge those contingent loans which are used to bolster a company's solvency, but to include those which fund abnormal distributions of profit.
8.4 BUDGET 2003 MEASURES
Other measures, not mentioned in the 23 December 2002 Press Release, will ensure that:
- only the actual amount of distributions from UK companies is taken into account in all Case I computations and the so called notional Case I comparison
- the anti-avoidance rules relating to reinsurance as a substitute for a business transfer are strengthened to complement the changes on such transfers
- mutual companies will not be able to avoid tax when they demutualise by creating abnormal amounts of pre-demutualisation surplus
- the rules which require an addition of funds to a life company in connection with a transfer of business to first match the addition with a loss incurred by the transferor are repealed.
The first three measures will apply from Budget Day. The last will apply for periods beginning on or after 1 January 2003.
8.5 TRANSFERS OF BUSINESS
The old rules for dealing with the computational aspects of transfers of business and the continuity of entitlement to reliefs such as capital losses following such transfers did not work satisfactorily in all cases, especially if the transfer was part way through the transferee's period of account.
The new rules for transfers will improve the rule for apportioning the income and gains of companies involved in transfers of business and ensure the appropriate degree of continuity for entitlement to reliefs relating to transferred business. A number of changes to the draft legislation published in January will be reflected in the Finance Bill, in particular:
- the carry over of allowable losses will be substantially simplified – eliminating the streaming rules. But they will be aligned with the loss set off rules described above
- the proposal to tax as a receipt an excess of liabilities over assets assumed on a transfer will be dropped
- the rules requiring a deemed regulatory return will be modified to cater for a case where an actual return does not end with a transfer.
8.6 RATES OF CORPORATION TAX
The Government is also making changes to the rate of corporation tax on the policy holders' share of a life company's profits. The rate of tax on all policy holders' income and gains will be equal to the lower rate of income tax, and no profits will be charged at a rate equal to the basic rate (the rate applying in particular to chargeable gains). This will apply for the financial year 2003 and later. As a consequence, in determining the amount of any additional tax payable on a gain on a UK life policy or annuity contract, policy holders will be treated as having paid tax at the lower rather the basic rate of tax. This change will take effect on 6 April 2004.
A life insurance company will also be permitted to set losses not used in other ways against Case I profits of later periods when computing the amount of Case I profit that is used to determine the shareholders' share of profits and income. This will apply for the calculation of profits for periods beginning on or after 1 January 2003. Losses from the immediately preceding period can be carried forward to 2003.