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Life Insurance: Apportionment of income and gains

Draft legislation has been published aiming to prevent with-profits life insurance companies with non-profit business from manipulating their mix of business to permanently shelter profits from tax.

This can be achieved by way of a combination of the following characteristics of life insurance company taxation:-

  • The “book value” election, which permits a life office with more than an insignificant proportion of with-profits business not to bring into account in Form 40 of its FSA return all increases in the value of its assets. This “smoothing process” reduces the profit brought into charge to tax until those amounts are released back to Form 40 in future years. This works even where the with-profits office has some non-profit business. Amounts thus deferred are customarily referred to as the “investment reserve.”
  • The statutory apportionment rules, which regulate the split of the profits attributable to Basic Life and General Annuity Business or Gross Roll-Up business of a life company and impact on the effective rate of corporation tax that it pays. HMRC noticed that by manipulating their mix of business in future years, certain life offices could ensure that the amounts eventually released back to Form 40 as an increase in the value of non-linked assets could fall out of the charge to tax altogether, resulting in a loss of hundreds of millions to the Exchequer.

The original Ministerial announcement stated the intention to tax all future profits of non-profit funds as they arise, without a deduction for book value elections, even where the company was a with-profits company.

As a transitional rule any “investment reserve” already accumulated will continue to be deferred, but when released, the amount released would reflect the mix of business in 2009 as and when they are brought into account, and not the mix of business in the year of release.

Following consultation with the industry, HMRC have now agreed that going forward, book value elections could continue to reduce taxable profits, but that amounts released would be apportioned, not by reference to the mix of business in the year of release., but by reference to the mix of business in the year of the book value election.

The legislation will be introduced in the Finance Bill 2010 and has effect in relation to accounting periods beginning on or after 9 December 2009. Under the transitional rules, investment reserves already accumulated will be brought into tax on the basis of the mix of business in the period beginning before 9 December 2009.

This means that for most calendar year companies, the formula by reference to which their current accumulated investment reserves will be taxed in the future when released to revenue account will be the formula for apportioning profits for the year ending 31 December 2009.

The legislation identifies amounts released on a LIFO basis so that they are treated as released from most recent years first, and any unallocated amount is treated as released from the reserve accumulated for the period beginning before 9 December 2009.

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