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U-turn for the worse

Last week, I started my look at the proposed changes to the taxation of UK-resident companies which invest in investment-based life insurance policies with an overview of a couple of key issues that have had to be taken into account when advising companies on the investment of funds.

The first issue is ensuring that the funds can be tied up for the proposed investment term. This will remain critically important. The second issue was the impact of investment on business assets taper relief for the owners. If the proposed changes to capital gains tax made in the pre-Budget report are enacted, that risk will disappear because business assets taper relief will disappear.

Just before going to press, we had the Chancellor’s statement that a new entrepreneurs’ relief will be introduced from April 6, 2008 that will broadly speaking offer a 10 per cent rate on cumulative qualifying gains of up to £1m made on the disposal of a sole proprietor’s trading business, an interest in a trading partnership or shares in a trading company by an officer or employee of the company who holds at least 5 per cent of the company’s shares. The draft legislation for this relief is not yet available and it will be important to check if there could be any detrimental consequences in relation to this new relief for corporate investment. I will look at the new relief in more detail in a later article.

That possible risk to the new entrepreneurs’ relief aside, the choice of investment tax wrapper for companies remains the same as that for individuals, namely, UK and offshore bonds and UK and offshore mutual funds. Companies can also invest directly into equities, bonds and so on, as well as hold funds on deposit.

As I mentioned last week, the loan relationship rules have applied to capital redemption plans since February 2005. This has meant that there will be a deemed disposal of the bond every year, with deemed gains, as well as any real gains, being subject to tax. So tax deferment through capital redemption plans went out of the window, so to speak.

Losses and deemed losses under the loan relationship rules can, however, be used. More on this later. Now it looks as if we will have to consider the loan relationship rules in connection with all investment-based life policies. Broadly speaking, the new rules will:

  • Apply to all investment-based life insurance policies or annuity contracts owned by a company but not pure protection policies, that is, policies without a surrender value.

  • Apply from April 1, 2008. On the first day of the first accounting period of the company to begin on or after April 1, 2008, an existing policy or annuity will be brought within the loan relationship rules.

  • As at that date, the company will be treated as surrendering the policy or contract. Any chargeable event gains arising on this deemed surrender will be brought into account as a non-trading credit in the accounting period when the company actually disposes of its interest in the policy. Any gains or losses, realised or deemed, arising from that date will be subject to the loan relationship rules.

  • Where a company effects an investment-based life insurance policy or annuity in an accounting period which begins on or after April 1, 2008, that policy will be subject to the loan relationship rules from inception.

  • Where the policy or annuity forms part of the basic life insurance and general annuity business of an insurer taxed in the UK under the I minus E system, there will now be a mechanism to give credit to the company for tax suffered by the insurer.

    The new rules do not distinguish between policies effected by a company before or after March 13, 1989, nor do they make exceptions for endowment policies assigned as collateral security for a commercial mortgage to the company. Therefore, pre-March 14, 1989 policies that have an investment content that are currently free of the chargeable event rules will be brought within the charge to tax in the first accounting period starting on or after April 1, 2008 and so will those exempt endowment policies.

    This means there has been a massive U-turn in Government policy which will probably hit smaller businesses hardest. There is, however, one crumb of comfort, which is that the company will in future get a basic-rate tax credit for gains arising on policies with UK and certain EEA insurers. More next week.

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