AFM Response to the HMRC Consultation Document
“Life Insurance Companies: A New Corporation Tax Regime”
AFM Response to the HMRC Consultation Document“Life Insurance Companies: A New Corporation Tax Regime”
Introduction
This is the response of the Association of Financial Mutuals (“AFM”) to the HMRC Consultation Document “Life Insurance Companies: A New Corporation Tax Regime” dated 5 April 2011 (the “ConDoc”).
The Association of Financial Mutuals
The AFM was established on 1 January 2010, as a result of a merger between the Association of Mutual Insurers and the Association of Friendly Societies. Financial Mutuals are member-owned organisations, and the nature of their ownership, and the consequently lower prices, higher returns or better service that typically result, make mutuals accessible and attractive to consumers.
AFM currently has 57 members and represents mutual insurers and friendly societies in the UK. Between them, these organisations manage the savings, protection and healthcare needs of 20 million people, and have total funds under management of over £80 billion. Approximately half the members have balance sheet totals of £50m or less, and thus the AFM represents a significant number of smaller independent life assurers.
As mutual organisations:
- our capital is limited and we have no shareholders to whom to make recourse and tax can only be borne by our customers;
- we pride ourselves in the way we treat our customers fairly – our customers are our members;
- we have extensive promises outstanding that we are committed to in full;
- the nature of most of our contracts is inflexible, particularly the life business where we are constrained by more rigid qualifying policy rules.
Summary
For mutual insurers the mutuality principle should apply so that, in particular:
- there should be no BLAGAB life assurance trade profits computation (so that the I-E basis applies without adjustment under section 85A or its successor); and
- there should be no extended GRB life assurance trade profits computation and no alternative basis for charging income and gains referable to the extended GRB (including PHI and new protection) category.
Additionally, existing exempt businesses in friendly societies (and transferred from friendly societies) should not be affected. (We note this is confirmed in the Technical Note, paragraph 2.7.)
General comments
We welcome the opportunity to comment on the ConDoc on behalf of mutual insurers.
We welcome the assurances from Ministers that the treatment of exempt business in friendly societies will not be affected by the proposed new tax regime. We also welcome the comments that the mutuality principle will be applied (see paragraphs 3.28 to 3.30 of the ConDoc and 2.17 of the Budget Day technical note “Solvency II and the Taxation of Insurance Companies” (the “Technical Note”)). In particular therefore there should be no taxable life assurance trade profits for BLAGAB or the expanded GRB category (“New GRB”) carried on on a mutual basis.
In this document the term “mutual insurer” should be read as including a friendly society except where the context otherwise requires, and “friendly society”, where used, should therefore be read as referring exclusively to a friendly society.
Chapter 2: Trade Profits
Starting point
Are any practical difficulties anticipated in identifying the trade profits starting point? If so, how could they be addressed?
As discussed below in the section “Mutual insurers” this should not be relevant to mutual insurers.
Could the approach set out in paragraphs 2.1 to 2.4 give rise to material inconsistencies between companies?
See comment above.
What is the nature and extent of income, gains, expenses and losses included in statements in the accounts other than the income statement or profit and loss account?
See comment above.
What is the nature and extent of any tax elements not included in the tax lines in the accounts?
See comment above.
Are there any special considerations in relation to UK branches of overseas companies if, for example, these do not use UK GAAP or IFRS?
See comment above.
Loan relationships and derivative contracts
Given that investment returns are integral to a life company’s trading profit, and given that loan relationship rules are founded on accounting treatment, might it be feasible to continue to disapply those rules in computing life company trade profits, and rely purely on the accounting results to capture the relevant income and gains?
Could such an approach also apply to derivative contracts?
This section does not deal with the taxation of loan relationships and derivative contracts in the I-E (i.e. amounts referable to taxable BLAGAB). The trading profits calculation of such amounts should not be relevant for mutual insurers.
Intangible fixed assets
Under the new accounts based regime, do you think that the exclusion from the provisions of Part 8 of CTA 2009 of intangible fixed assets held by an insurance company for the purposes of its life assurance business should be removed, and, if so, why?
The treatment of intangibles in a trade profits calculation should not be relevant to a mutual insurer.
What implications, including fiscal impacts, would you expect to arise if the exclusion were removed? What types of assets would be affected?
See comments above.
What transitional issues would arise?
See comments above.
Policyholder tax
Is it possible to identify an accounts-based method of computing policyholder tax deductions, which is simple, consistent, transparent and linked to tax actually paid?
This should not be relevant for a mutual insurer.
However, we note that in the unusual circumstances where part of a mutual insurer’s business (for example, its New GRB) is not able to benefit from the mutuality principle, we do not think that a profit should arise purely from differences between the accounts tax charge and the calculation of policyholder tax – for example, because the latter denies a deduction for deferred tax amounts, or because a cash tax basis applies to current tax. Where the organisation has no shareholders, all tax is policyholder tax (and therefore deductible).
What are the implications of restricting relief to amounts payable in respect of a particular year?
See above.
Chapter 3: Other Technical Issues
Allocation of profits, income and gains
For what lines of business can the accounts profit arising on that business be directly determined and allocated?
To what extent will current internal accounting and actuarial procedures enable companies to allocate directly a substantial part of the income and gains arising on assets held for the purposes of its life insurance business? What will be the cost of introducing new systems and/or adapting existing systems?
What bases might be acceptable and/or possible for the allocation of assets which are not directly allocated to products or lines of business?
Will companies always be able to compute the accounts profit of a with-profit fund?
Is allocation by bonuses always representative of the actual allocation of assets to the different categories of business?
What special considerations are there where non-profit business is written within a with-profit fund?
This document focuses on the allocation of investment income and gains. Are there other types of income or expenditure which could not be attributed to categories of business by reference to internal accounting systems?
How should chargeable gains be allocated?
Would retaining a liabilities based approach for chargeable gains be appropriate?
If I-E allocation does not follow that used for trade profit purposes are there any mechanisms that could protect against significant under or over allocation?
What would be an appropriate process for reaching agreement with HMRC and ensuring fairness between companies?
In what circumstances should any election for factual allocation be revoked/revocable?
What would be an appropriate basis for the single apportionment rule?
We have deliberately not tried to answer the individual questions but to give a commentary about how the approach might in general terms be applied for a mutual insurer.
Paragraph 3.2 of the ConDoc refers to the factual allocation of trade profits and the factual allocation of income and chargeable gains to BLAGAB. We agree that these are the matters which should be considered. We also note that in almost all cases it is unlikely to be possible to give an allocation of the whole of those profits, or the whole of those income and gains, without consideration of a residue of amounts not immediately identifiable with one business or the other – for example, there may be assets which are clearly circulating assets of the long-term insurance business but are equally clearly not particularly associated with a specific part of the business, for which some “proportionate” allocation may be derived. We discuss this further under the separate topics below.
For a mutual insurer we consider (as discussed in the section on mutual insurers below, from page 9 onwards) that the apportionment approach should only address the allocation of investment income (including loan relationship value movements) and chargeable gains to taxable BLAGAB. There should be no need to allocate trade profits, and no requirement to identify amounts of investment income and gains attributable to New GRB, tax-exempt BLAGAB and tax-exempt other business.
We accept that mutual insurers will have to allocate all elements of investment income and chargeable gains but should not be required to identify the amounts allocated otherwise than to BLAGAB.
Trade profits
This should not be relevant for a mutual insurer as discussed below and we do not address the apportionment of trade profits in this document.
Income and chargeable gains
For investment income companies may be able to identify the business to which it relates to a greater or lesser extent. We consider that companies should be free to follow the principles used for their own internal records, so far as possible, and then seek to allocate any residual income on a reasonable basis.
We assume, in the first instance, that fixed capital assets can be separately identified and that if general insurance business is not “merged” with long-term insurance business for tax there is a factual separation which can be followed.
We envisage that companies’ methods may include the following approaches:
- certain assets, and the associated income, may relate to only one of the categories of long-term business – this might include solely linked assets, foreign branch assets, other assets identified as backing foreign business (branch or otherwise) and in many cases loan relationships backing an annuity book[1];
- a second heading of assets may be identifiably connected with more than one category of business, but typically with part only of one or the other category (treating categories other than taxable BLAGAB as a single category), and the income should be allocated between the business reflecting the mix for that group of assets – the analogy with the current position would be hybrid (or mixed) linked assets, or assets might represent certain asset share pools which are identifiably (at any point) mixed between BLAGAB and GRB policies and the income should be allocated in accordance with the appropriate shares; and
- a residual collection of assets not readily identifiable with a specific part or parts of the business, which would need to be allocated on a residual basis.
The residual basis may reflect a mean liability calculation adjusted to take account of amountsallocated at a previous stage – for example, deducting linked (including hybrid linked) liabilities, annuity liabilities and so on. This will depend on whether companies have their own methods for these amounts.
For loan relationship fair value movements (and similar items) the same approach should be followed.
For chargeable gains, this approach may be possible, if necessary with modifications. For example:
- linked and hybrid linked assets should be treated as above (and box transfers may be necessary if there are transfers from (say) BLAGAB solely linked to another “category”, although the number of “boxes” should be kept to a minimum as discussed below);
- where assets are clearly and consistently not referable to BLAGAB (for example loan relationships backing pension annuities, or assets backing foreign business) no part of the chargeable gains should be referable to BLAGAB (and this could be the same “box” as solely linked New GRB assets);
- other hybrid areas, such as for example with-profits asset pools are likely to be more dependent on the company’s own behaviour and its records; for example, if the company keeps certain equities in defined asset share “pools” year-in year-out, a hybrid treatment may be acceptable but where the assets may move into or out of such pools, or between pools with different mixes of business, it is likely to be preferable to treat the assets as in the “residual” category – in particular, otherwise there may be a proliferation of “boxes” and box transfers.
For other assets, such as land, similar treatments should apply – in particular treating the rent as income and chargeable gains on disposals as for other chargeable gains.
We do not consider there is any requirement to separate out amounts referable otherwise than to taxable BLAGAB – whether an amount is referable to tax-exempt BLAGAB, New GRB or tax-exempt other business is not of particular relevance once it has been identified as not referable to taxable BLAGAB. (This approach has an obvious corollary when considering the necessary “boxes” for chargeable gains purposes.)
Statutory Alternative method
We consider that the statutory alternative method should be simple to use. We expect that all but smaller companies should be able to use a factual allocation based on their internal systems and methods and that the alternative method should therefore be a “safety net” for entities whose internal resources – particularly tax resources – may not be able to operate such a factual allocation. Accordingly, for familiarity, we consider the alternative method should resemble aspects of the current system.
We note that the ConDoc refers to a single [statutory alternative] rule and that the Technical Note similarly referred to “a… rule”. We consider that simplicity suggests that there should be a single clear rule. We also consider that companies should be able to make a choice between this simple (and not unreasonable) rule and a factual approach and assess whether they wish to apply their resources in applying the factual approach.
We note that a single rule should (assuming it is suitably defined) allocate 100% of items arising in the year; for items such as chargeable gains the rule should take into account that gains may arise over several years and therefore should not, intrinsically, be volatile year on year. (As a counterexample consider the use of a “needs basis” to the company as a whole. One way of regarding the needs basis is as allocating, firstly, sufficient investment return to each category of business to establish a nil profit– therefore filling the requirements of expenses, claims and contractual increases in liabilities (call this the “core allocation”); only then is the effect of bonuses considered and the excess income allocated in proportion to bonuses. That can mean, in particular if there are changes in the actuarial assumptions, that the core allocation may fluctuate considerably year on year, even if bonus proportions (BLAGAB to GRB) are reasonably consistent. Following this basis to allocate chargeable gains may give rise to unreasonable results.)
Accordingly, we consider that a formulaic approach similar to that in sections 432A and 432C of ICTA 1988 should be adopted. More specifically, we consider that the approach should:
- apply at a company level not a (sub)fund level;
- only apply to income and gains from long-term insurance assets (i.e. excluding “structural” or “fixed capital” assets – and for a composite, general insurance business assets);
- directly allocate linked assets (solely linked and hybrid linked) similarly to the current sections 432A and 432C;
- include an optionality in respect of foreign business assets (similar to the current treatment in sections 432A and 432C); and
- allocate the balance in accordance with fractions based on the current sections 432A and 432C.
In effect this would be a section 432A approach.
In calculating the allocation under that approach the fraction should be
where “A” would represent taxable BLAGAB amounts (liabilities, linked assets, etc.) and “B” would represent all other business.
Certain non-Directive friendly societies have triennial valuations and the current apportionment rules operate with appropriate formulaic adjustment for the intervening years. We understand that the FSA have yet to decide the appropriate treatment post-Solvency II, and it is possible such a position may need to be included in the statutory alternative method.
Combining GRB and PHI
What levels of unused GRB and PHI losses might exist at 31 December 2012?
Some mutual insurers may have GRB losses (which may have arisen from fiscal adjustments, for example) but we are not in a position to quantify this. Mutual insurers may also have PHI losses, particularly where the business has not been taxed on a mutual basis.
However, the losses should become irrelevant if the mutuality principle applies to New GRB.
Would it be difficult in practice to stream transitional losses between GRB and PHI?
Not relevant for mutual insurers (see above).
Other than unrestricted use against new GRB/PHI profits and streaming, what approaches to transitional loss use might be feasible.
Not relevant for mutual insurers (see above).
What levels of PB losses subject to streaming exist now, and what might remain at 31 December 2012?
Not relevant for mutual insurers (see above).
Is there likely to be any difficulty in practice in identifying PB profits within a new GRB/PHI category?
Not relevant for mutual insurers (see above).
To what extent will PHI business be backed by equities with dividends being allocated to PHI on a factual basis?