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Three days that shook the life offices

Industry relief that Chancellor Gordon Brown is extending consultation from the initial shock of just three working days on his planned raid on life fund policyholders’ savings will be short-lived, as the measures are set to come into force this January.

The ABI and life offices have made written representations to the Treasury, Inland Revenue and FSA following the Chancellor’s proposed tax hikes on life funds.

Proposals in the pre-Budget statement would apply shareholder tax rates to policyholders’ funds and increase the tax take on non-profit and unit-linked investment returns from January 1.

Norwich Union estimates this will result in a one-off 150m hit on its life fund.

Brown invoked industry ire after allowing only three working days’ consultation on what are very complicated tax changes. The proposals will still come into force next January but following a lengthened consultation period, the measures will be incorporated into the Finance Act, expected in late March/early April next year.

Legal & General pensions strategy director Adrian Boulding says: “With three days’ consultation, it is not so much a stealth tax as a smash and grab raid.”

Treasury spokeswoman Rachel Gibbons says as the proposals were officially deemed anti-avoidance measures, the Government was not obliged to consult at all. Given the Government’s determination to force the tax hikes through, the consultation extension does appear to be just paying lip-service to the industry.

Gibbons says: “The measures will still come into effect from January 2005 but this gives us more time to consider detail with the industry. The Government is committed to this policy and this is more time than they previously had and we are not obliged to consult on anti-avoidance measures.”

In effect, two tax changes from Brown’s suite of proposals will affect life offices and their policyholders, one a tax on life fund surpluses, the other a tax hike on non-profit and unit-linked investment returns.

If MVRs and bonus cuts were not enough to put most with-profits policyholders off financial services for life, the Government’s latest proposals to hit life funds with these additional taxes will do little to encourage people to save long-term.

Norwich Union says the measures will triple the taxation of its 4.3bn with-profits surpluses and cost the fund 150 in total. As life funds have a variety of policies invested in them that attract different levels of tax, life offices were allowed to blend these to form an average tax rate. In NU’s case this equated to 10 per cent but Brown wants to tax surpluses at the highest applicable rate, 30 per cent.

NU Life chief executive Gary Withers says: “The Chancellor is not closing a loophole as he is making out, this is a stealth tax on policyholders. It is likely to limit the freedom of the fund to invest in equities so will reduce the long term investment returns and it is very difficult to see how this is consistent with the principle of treating customers fairly.”

NU’s policyholders will bear the brunt of this because of the fund’s 90/10 structure, which means policyrather than shareholders will be the worst hit. Providers with different structures are less affected. Certainly, those funds that do not have significant reserves will not be affected. Prudential, Friends Provident and Britannic are among the least affected because of their fund structures.

Gibbons is adamant that the measure will not affect policyholders, which in part seems to reflect the nebulosity surrounding the ownership of orphan assets. She says: “There is no reason why life insurance policyholders would be worse off as a result of this measure. The same low tax rates still apply to the funds that are properly used to pay pensions and policies.”

The second tax hike will also diminish the embedded value of the non-profit part of life funds from 2005 onwards. Legal & General, which is unclear on how the first tax change will affect it, believe this will cost the group up to 300m in loss of embedded value.

This change affects the way in which taxable profit from writing pension business is determined. Where all business is written in one fund, tax was levied in relation to the proportion of pension bonuses to total bonuses. This is 20 per cent in L&G’s case meaning only 20 per cent of the investment return was taken into the tax calculation and after expenses were deducted this meant unit linked and non-profit business faced little tax.

Under the proposed rules, the with-profits sub-fund will be separated out and tax on non-profit and unit-linked business will be computed on the proportion of pension to total reserves in these funds. In L&G’s case this is 90 per cent increasing the taxable profit several-fold.

L&G says: “At this early stage it is not possible to give a precise estimate of the likely financial impact of the proposed legislative change on L&G. However, it is our belief the impact of the proposed change on the embedded value will not exceed 300m.”

NU is not materially affected by this latter change and Friends Provident says it does not face a big one-off hit.

Besides groups making representations individually, the ABI is to lobby the Government over the tax increases which it says, like NU, fly in the face of treating with-profits policyholders fairly.

ABI director of financial regulation and taxation Peter Vipond says: “This tax hike will hit pension funds and many endowment policies, hardly the kinds of policyholder that deserves an extra tax burden. The Revenue should not, as a matter of principle, try to sneak through a significant tax increase by order rather than through primary legislation.”

Ned Cazalet says the Government’s proposals, which, under the aegis of closing tax loopholes, are a result of life funds paying negative taxation over the past three years. He believes that the Government feels short-changed after life funds actually received an aggregate tax rebate of 12m 2001-2003 because of the losses incurred in the bear market.

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