There has been quite a change to the taxation of gains made under these policies. As announced in the 2007 pre-Budget report, the application of the loan relationship rules to all investment life insurance contracts – largely investment bonds – from April 1, 2008 means that gains made under UK and offshore contracts will be taxed as non-trading credits under the loan relationship rules. The original position, as set out in draft legislation, changed in a number of important areas following the publication of the Finance Bill 2008.
No mention was made in the Budget of the application of the loan relationship rules to an investment life insurance contract but, as mentioned above, some significant changes to the draft legislation have been introduced as follows:
i: Before April 1, 2008, all life policies effected by a company before March 14, 1989, which have not been subsequently enhanced as to benefit or term, were outside the chargeable events legislation and would in effect produce a tax-free return for the company.
The draft legislation released after the preBudget statement did not distinguish between policies effected on or after March 14, 1989 and those effected before March 14 ,1989. This this would have brought gains on pre-March 14, 1989 policies into the loan relationship charge. The publication of the revised legislation confirms that the favourable position for pre-March 14, 1989 policies has been reinstated in the Finance Bill, provided they have not subsequently been enhanced.
ii: Subject to the satisfaction of certain conditions, under the previous legislation, an endowment policy effected by a company as part of a commercial mortgage arrangement would not have given rise to a chargeable event gain on maturity or the payment of death benefits.
The original draft legislation made no reference to this rule, nor does the Finance Bill . This means that, as things stand, gains on such policies will be brought into charge to tax under the loan relationship rules unless they are pre-March 14, 1989 policies which have not been subsequently enhanced. However, the mortality element of such gains will be ignored (see iv below) and it is only the investment element that is taxable.
iii: Capital redemption policies were for the most part brought within the loan relationship legislation in February 2005. The draft legislation in the Finance Bill defines an investment life insurance contract as including capital redemption policies so that corporately-owned capital redemption policies effected before March 14, 1989 and not subsequently enhanced will also fall outside the loan relationship rules.
iv: Under the chargeable events legislation there is a general rule that in determining the amount of any chargeable event gain on death, the surrender value immediately before death is used and not the sum assured actually paid. The reason for this is to exempt from tax the mortality profit, that is, the excess over the surrender value.
The Finance Bill maintains this rule for the purposes of calculating the non-trading credit, that is, annual gains, for loan relationship purposes and extends it to critical-illness benefits.
v: It seems tolerably clear that, in practice, how policies will actually 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 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 small company, to which the FRSSE can apply, and most would adopt an historic cost basis. A company is a small company for this purpose if it satisfies two of the following requirements:
i: Turnover is £5.6m or less.
ii: Balance sheet total is £2.8m or lessiii: The average number of employees is 50 or less.
Fair value and historic cost must be considered in more detail before going further and I will do that next week.