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Reports of death of deferral exaggerated

The Government announced on February 10 that “a number of avoidance schemes have been disclosed to the Inland Revenue which aim to generate capital losses using corporate capital redemption bonds. From today, where one of these bonds is disposed of by a company, no capital loss can arise.”

The Finance Bill published on March 24 contains legislation to put the question beyond doubt. While some commentators have suggested this spells the end of tax deferral for companies using capital redemption bonds, this could not be further from the truth.

Nevertheless, it is unfair that all corporate investors which have chosen to invest through a CRB should lose their ability to take small surrenders with no immediate tax liability, especially when so few were taking part in the type of scheme giving concern to the Revenue.

This measure should be more effectively targeted and the ABI has communicated this to the Revenue.

What does this announcement, in fact, mean? From February 10, 2005, the tax treatment of CRBs held by companies will follow the accounting policy followed by the corporate investor. As a result, both new and existing corporate investors in CRBs will need to decide whether a CRB is still a suitable investment. For some it will be more suitable but for others it will be less suitable and for some there will be no change. However, this new regime does not affect either new or existing corporate investors in life bonds.

Where a company is trading in financial assets, it seems that it will use a fair value (or mark to market) accounting basis. This means that at the end of each accounting period (usually the year to December 31), the market value will appear in the balance sheet. Any change in value since the end of the previous accounting period will flow through to the profit and loss account. This change in value will be subject to corporation tax (or given relief, if negative) in that accounting period.

Where the company intends to hold a CRB to maturity (which will be the case for most investors), it seems the company will use an amortised cost accounting basis. This means that at the end of each accounting period before a CRB is sold or matures, it will normally be recorded in the balance sheet at an amount equal to the premium. Thus, nothing will appear in the profit and loss account. Gains will arise when the company disposes of the CRB in whole or part, according to the true economic increase in value reflected in the disposal.

In an explanatory note issued on March 3, the Revenue stated “there are no transitional rules”. This is disappointing as it is a taxation change with retrospective effect although ministers would no doubt only accept that it was retroactive.

On February 10, the Government published a draft Finance Bill clause to remove the provision in paragraph 1A(b) Schedule 9 Finance Act 1996 which exempts CRBs from the loan relationship rules. Since then it has also become clear that it will be necessary to ensure a clean acquisition cost for the loan relationship rules. This will be achieved by deeming an assignment to occur on February 10 for consideration equal to the then surrender value. Any chargeable event gain arising, because of the deemed assignment, will not cause an immediate tax liability but will be carried forward and reduced by any later loan relationship gains.

However, if a company has previously taken a part surrender from its CRB over the amassed 5 per cent allowances, a deficiency may now arise. These deficiencies will not be of any benefit to the corporate investor. However, had the assignment not been deemed to take place, with the passage of time, performance would be likely to prevent any such deficiency from occurring on a later termination event. It is therefore important that the Revenue further considers relieving deficiencies which arise because of the deemed assignment.

While this measure does not seem to be properly targeted, it is not the end of tax deferral for companies using CRBs. Often, corporate investors will be no worse off and could be better off.

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