Life insurance - Solvency II - Mazars - United Kingdom

The Government has made announcements on the future of life company taxation in the context of the implementation of Solvency II in 2013.

A major consultation program is taking place between HMRC and the life insurance industry following its consultation which formally closed in summer 2010.

The main changes proposed, which will be introduced in the 2012 Finance Bill once all the detail of the legislation has been drafted, are as follows:-

Statutory accounts basis as starting point

1. As announced in last year’s spring Budget, life insurance companies will be taxed on the basis of their statutory company accounts prepared under UK GAAP or IFRS instead of using the FSA returns as a starting point.
2. The Fund for Future Appropriations (under UK GAAP) or Unallocated Divisible Surplus (under IFRS) will be effective for tax purposes, in recognition of the fact that in the statutory accounts these reserves are more controlled than in the regulatory returns. Proprietary with-profits businesses normally only transfer amounts to those reserves where the profits have not been allocated between policyholders and shareholders. This will therefore permit tax-effective smoothing and prevent distortions. There may be further change due to IFRS 4 Phase II as it remains uncertain whether the UDS will survive in its current form. Transitional adjustments will take appropriate account of amounts forming part of an FFA or UDS at the transitional date, in so far as the opening values of those reserves may be different from the reserve shown at Line 51 of Form 14 of the FSA returns.
3. Policyholder bonuses and policyholder tax will continue to be deductible, and with reference to the latter, HMRC may be prepared to consider representations regarding the deduction of deferred, rather than just current policyholder tax.

“Real trading profits business” separate from the I-E basis of taxation

Currently, all life insurance business is taxed on its income less expenses(I-E), and an insurance company will only be taxed on a “real trading profits business” under the usual rules for trading profits on its general insurance business (if it is a composite insurer) and its non-life long term insurance business (notably Permanent Health Insurance, or “PHI”).

Since apart from life insurance business, insurance is normally considered as a single trade, these non-I-E profits are the subject of one computation separate from the I-E computation.

On the basis that the I-E basis of taxation is designed to allocate tax in a life insurance company between the policyholders and the shareholders of the life insurance company, HMRC consider that the following life insurance categories should be moved to the “real trading profits” category, as there are no policyholders’ tax considerations involved:-

1. Gross rollup Business, (Pension Business, Overseas Life Assurance Business, ISA Business, Child Trust Fund Business, Life Reinsurance Business) on the basis that the policy benefits roll up free of policyholder tax
2. Protection business, which includes, for instance PPI insurance for loans and credit cards in the event of mortality or morbidity. These are unlinked policies with no investment component, which means that under the I-E basis, management expenses, especially acquisition expenditure including commission, is fully offset against, for example, the investment returns from investment-type policies, allowing the company to price those products gross if it wishes. HMRC consider that this gives an excessive tax advantage where both categories of business are carried out in the same life company. The removal of protection business from the scope of I-E will therefore remove this advantage. We have made representations to the effect that existing business should be grandfathered and HMRC is giving due consideration to transitional rules.

Apportionments between taxable/tax-exempt BLAGAB and “real trading profits” business

The current rules to apportion profits and gains between the businesses for tax purposes are mechanical and tend to produce unusual results in both directions. Government intends to simplify the existing rules, to eliminate existing anomalies and to bring tax apportionments more in line with the commercial reality. Apportionments will therefore in principle be made on a factual commercial basis, insofar as possible.

For obvious reasons, this means that there will no longer be a detailed methodology prescribed, as commercial arrangements will differ between companies. instead each company will discuss and agree an appropriate approach with HMRC before the relevant tax returns are filed. There will be a simple fallback statutory rule where agreement cannot be reached on a commercial basis of apportionment.

This will be a welcome change where profits and gains form assets are specifically hypothecated internally to support unlinked business, for instance pension annuities, but currently have to be allocated across all the business categories according to the statutory formulas, with distortive results, as they do not support linked business.

Shareholder’s fund – alignment with treatment of non-technical account in general insurance companies

Currently, assets held in the shareholders’ fund of a proprietary life insurance company are treated as investments while those held in the long term insurance fund are treated as trading assets unless specific legislation excludes them as structural assets of non-profits funds (at the moment insurance dependents). HMRC proposes to draw the line instead between fixed and circulating capital, in line with the tax treatment of general insurance companies, unless the regulatory requirement for life insurance companies to maintain a separate long term fund is retained.

HMRC were consulting with the industry about extending the categories of structural assets, but now expect this to be merged into the new distinction instead.

Mutual Insurers

The Government has indicated that it does not intend that there should be any change to the principles underlying the tax treatment of mutual business as a result of Solvency II. Mutuality will be determined, as now, by reference to the facts of individual cases in the light of the principles of mutuality and the taxation of mutual business established by the courts in decided cases in the past.

Following through the logic of this approach, mutuals should under the proposed new regime, treat their GRB mutual profits as outside the scope of corporation tax.

Transfers of Long Term Business

The Government intends to simplify the complex rules which currently govern transfers of long term business.

Apportionments

Legislation will be introduced to correct a defect in the apportionment formula determining the allocation of non-profit fund items to gross roll-up business. This will apply for periods of account beginning on or after 1 January 2011, pending the more extensive reforms to the apportionment rules under the I-E changes.

For more information please contact:

Carine Beidas

Senior Manager, Financial Services Tax