Wednesday's Budget included significant announcements for insurance companies on the post-Solvency II tax regime.
Consultation on the impact of Solvency II has been ongoing for some time. Underlying this is a recognition that significant changes will need to be made to the current life tax regime, since FSA returns will no longer exist in a form which supports that regime.
The Government has published a Technical Note which sets out the decisions it has taken on how the taxation of insurance companies will operate from 2013. The Note is a welcome development, in that it gives industry more certainty about the shape of the future tax regime so that they may plan accordingly. It also moves the consultation on to a next stage where the detail of how these decisions will be implemented can be hammered out.
The Government recognises that there remains a substantial amount of work to be done to complete the job of constructing an effective new tax regime. Another consultation document is to be issued in April 2011 for this purpose and legislation will be included in Finance Bill 2012.
This e-bulletin summarises the main proposals. There will be more opportunity to comment once the April consultation document comes out.
The key points to note are:
- The starting point for the calculation of a life company's taxable trading profits will be its statutory accounts.
- The I-E system is essentially to be preserved for basic life and general annuity business only Gross roll up business and protection business will be excluded and taxed on a trading profit basis.
- The rules for apportioning income and gains between categories of business will be simplified.
- Complex rules governing the tax treatment of transfers of business are to be simplified.
- Transitional rules will cater for the move to an accounts-based regime, which will be the subject of public consultation.
- Transitional provisions will also allow life companies with significant tax assets to carry those assets forward into the new regime.
- The Government intends to preserve the relief available to general insurers for claims equalisation reserves.
These are dealt with in more detail below.
Calculation of trade profits for life companies
Under Solvency II, the starting point for the calculation of a life company's taxable trading profits will be its statutory accounts (a fundamental departure from the current system of using the surplus in the FSA regulatory return). This will be subject to a number of adjustments, many of which replicate current tax treatment. Amounts allocated to policyholders will, for example, be tax deductible. A tax deduction will also in principle be available for tax borne on behalf of policyholders (the Government will consult further on the measure of the deduction including whether deferred tax should be included).
The Technical Note also states that there will be no special tax rule to govern the treatment of a Fund for Future Appropriations (FFA) (under UK GAAP) or an Unallocated Divisible Surplus (UDS) (under IFRS). The Government acknowledges that amounts treated as liabilities within the scope of the UDS may be impacted by IFRS 4 phase II (and that potential increased profit volatility will also feed into trade profits) but it will consider these issues once the content and timing of phase II are clear.
Other technical issues
Scope of I-E
The I-E system is essentially to be preserved for basic life and general annuity business (BLAGAB), though gross roll up business (GRB) will be excluded.
Protection business (for policies written after 1 January 2013) will also be excluded.
There will be a comparison between trading profits and the I-E result to ensure that the amount taxed under I-E is not less than the trading profit.
The Government will also consult to explore further the extent and impact of unpredictable volatility of I-E results and its effect on the interaction of I-E trade profit.
PHI and GRB will no longer form separate categories of long term business, but will, together with protection business, form a combined category taxed on a trading profits basis.
Current categories of Friendly Society tax exempt business will be unaffected.
The rules for apportioning income and gains between categories of business will be simplified to eliminate anomalies and in principle make apportionments on a factual commercial basis rather than using a detailed, prescribed methodology. The Government will consult further on this and on a simple statutory rule where a factual approach is not feasible or appropriate.
Shareholder fund assets
In the expectation that under Solvency II the LTIF/shareholder fund divide will not continue, the current proposal is that the tax treatment of a company's assets (and specifically whether income or gains form part of the trading profit computation) will be determined by their status as fixed or circulating capital.
Dividends attributable to GRB
These will continue to be taxed in full.
Unlike under the current regime there will be no special provision in relation to untaxed surplus originating in mutual companies and now held in proprietary companies following a demutualisation.
There is to be no change to the principles underlying the tax treatment of mutual business as a result of Solvency II.
Transfer of business
Complex rules governing transfers of business are to be simplified. The general principles behind the simplification will be that accounting profits and losses will be followed for arm's length transfers; and that, for connected party transfers, accounting profits or losses on the transfer will be disregarded and instead profits or losses will be taxed as they emerge in the transferee.
There will be special provision for a transfer to a non-UK entity and, as at present, a targeted anti-avoidance rule.
There will be transitional rules to cater for the move to an accounts-based regime (with the overall intention that taxable and relievable amounts should be taxed or relieved only once). These will be consulted upon.
The Government proposes that:
- transitional timing adjustments will be made for deferred acquisition costs and deferred income reserves;
- untaxed surplus within court schemes (i.e. accounts profits not recognised in the regulatory return whose distribution to shareholders is subject to restrictions imposed by courts, for example on a business transfer, demutualisation or inherited estate attribution) should be brought into tax over a 10 year period (plus a 2 year deferral where a court scheme imposes an absolute bar on release of surplus); and
- other adjustments arising from differences in timing of recognition of profits or valuation differences should also be brought into tax over a 10 year period.
The Government has also recognised the need to allow life companies with significant tax assets to carry those assets forward into the new regime. In particular, unused GRB losses will be available for carry forward after transition against profits in the new combined trading profits category, possibly subject to streaming; as will a proportion of unused BLAGAB trading losses against BLAGAB trade profits; and excess BLAGAB expenses into the new I-E computation.
General insurance companies and Lloyd's corporate members: claims equalisation reserves (CERs)
The Government acknowledges that, with the requirement to maintain CERs withdrawn under Solvency II, legislation is needed either to provide for continued tax relief or to ensure that reserves are released over a 6 year transitional period.
The Government's stated intention is to legislate in the Finance Bill 2012 to retain the relief, subject to industry (with whom it will engage further over the summer) giving a "robust justification" for its retention.
A link to the HM Revenue & Customs Technical Note can be found here.
A link to our general Budget client bulletin can be found here.
A link to the HMRC 2011 Budget pages can be found here.