Pensions Corporate Streaming and PAIFs

This is a follow up on the posts of 11th July and 20th June on HMRC's proposals to abolish corporate streaming.

The issue here is that pension investments should not be subject to UK tax but if a pension fund or pension scheme uses an authorized investment fund (AIF) as an investment vehicle then there can be tax leakage as the AIF is liable to corporation tax and there is no mechanism for say a trust based SIPP or a pension scheme to obtain a refund of the tax deducted.  A similar analysis applies for ISAs.

It's important to note that although this tax leakage is inappropriate its not particularly widespread.  This is because if the AIF is a bond fund it will probably pay a tax deductible interest distribution.  If the AIF invests in equities (either UK or foreign) then the dividends will be exempt from tax.  Where tax leakage can be an issue is in certain balanced funds and property AIFs that are not Property Authorized Investment Funds (PAIFs) .

Currently pension investments of life assurance companies do not suffer tax leakage when they invest in a property AIF that is not a PAIF due to the corporate streaming rules.  A quick numerical example (ignoring expenses).

Property income in AIF = 100.  Therefore tax in AIF = 20 and amount available for distribution is 80.  When the distribution is received by a life insurance company it will come with a notional amount of income tax that can be offset against the insurance company's corporation tax liabilities or repaid.  So the effective income in the life company is 80  +  20 =  100.  As this is referable to pension business it is not subject to a tax charge in the life company and the tax leakage suffered by a  SIPP etc is avoided.  

But if HMRC's proposals to abolish corporate streaming are adopted then  tax leakage will  apply to pension business investments of life insurance companies as well as other pension arrangements.

The answer to all these tax leakage issues would seem to be invest in a PAIF.  I don't intend to go into a full description of the taxation of PAIFs (not my specialist area so treat my comments with a degree of caution) but the key points would seem to be

The property income of the PAIF is not subject to tax (see here si 2006/964 regulation 69 (Y1)).

Although there is a general requirement to deduct tax from PAIF dividends this does not apply where the dividend is paid to inter alia a UK company, a pension scheme or an ISA. (see here si 2006/2867 regulation 7  - this is the REIT statutory instrument but looks as if also applies to PAIFs).

The problem to date has been that there are few PAIFs available for investors.  Royal London has had a PAIF since 2010 but the only other PAIF I am aware of is an M&G fund.  However, it seems as if other investment managers are catching up, searching the internet there are references to Standard Life, L&G, Ignis and Aviva all intending to convert to PAIF status.  What I haven't been able to find is a central list of funds with PAIF status.  If anyone is aware of such a list perhaps they could let me know.

 

Friday Round Up

Links to HMRC's website this week

HMRC has published three consultation documents in connection with the UK's Investment Management strategy

http://www.hmrc.gov.uk/news/investment-management-strategy.htm

There's the UK response to the OECD document on tax avoidance

https://www.gov.uk/government/news/g20-next-stage-in-securing-new-global-standard-for-tackling-avoidance-and-evasion-reached 

And an update on the GAAR; which as the Finance Bill has received royal assent is now law.

http://www.hmrc.gov.uk/gaar/advisory-panel.htm

Also from CCH tax news FATCA implementation has been delayed for 6 months.  See link below to IRS hopefully it works.

http://tinyurl.com/qapr6zw

(Looks like it does work but you will need to right click and then select open link rather than left clicking.)

Have a good weekend.

Update on accounting developmets

A post on developments in UK GAAP for insurers and progress on IFRS 4 phase ii.
The background to this is I went to an ILAG presentation on Financial Reporting.  It was billed as being for people with a good knowledge of the area.  I decided to go anyway on the basis of how complicated could it be?  Turned out it could be plenty complicated - I think I got 60% of what was going on but please don't take anything I say on the topic as gospel.

• UK GAAP

Ray Tidbury of Mazars spoke on this topic at the ILAG presentation.  UK GAAP will cater to the life insurance industries sense of exceptionalism by being boiled down to four standards FRS 100 - FRS 103 with FRS 103 being for just life insurance.  There is supposed to be an exposure draft coming out in July (FRED 49) but I don't think this has been published yet  - I'll link to it in the Friday update when the FRC publishes.

FRS 103 is really a consolidation of existing UK GAAP so will bundle together features of IFRS 4 phase 1, FRS 27 and the ABI SORP.

However, FRS 103 will apply to insurance contracts rather than all of the business of an insurance company and the IFRS 4 definition of insurance business will apply.

Unlike IFRS 4 phase ii FRS 103 will allow shareholder surplus to be included in the FFA i.e. not recognised in profit.

IFRS 103 will apply from 1 January 2015 although this will mean reworking 2014 figures for comparatives.

• IFRS 4 Phase ii

A second exposure draft has now been issued.  See link below
http://www.ifrs.org/Current-Projects/IASB-Projects/Insurance-Contracts/Exposure-Draft-June-2013/Pages/Exposure-Draft-and-comment-letters.aspx

If you scroll down through the note explaining how they made a mistake in the first version of the second exposure draft you will come to the ED.

I'll confess I've not gone through the ED but found this a good summary with a few tax comments.
http://www.kpmg.com/au/en/issuesandinsights/articlespublications/pages/ifrs-4-phase-ii-revised-exposure-draft.aspx

The speakers on this topic at the ILAG presentation were Joanna Yeoh from the IFRS and Tamsin Abbey of Deloitte.

Key points as far as I can see are

The proposal that all profit (past, present and future) should be recognized in reserves on the transition to IFRS 4 phase ii has been abandoned.  Instead transition will be dealt with by assuming that IFRS 4 phase ii has always been in place with profit "earned" to the date of transition being included in reserves.  This removes the possibility that taxable profits based on IFRS 4 phase ii would include amounts that hadn't been earned and that might never materialize.

There seems to be the prospect that more items will be included in the OCI than is currently the case, this might include unrealized gains as well as differences between discount rates at policy inception and market interest rates.  My (bitter) experience with US GAAP is that at some point someone decides that the I-E tax charge needs to be divided between the income statement and the OCI.  This is a shocking task.

Given the use of the OCI its not clear to me that profit before tax per the income statement will be the best starting point for a computation of taxable profits.

If the OCI is used for unrealised gains on bonds and HMRC's proposal to disregard amounts in OCI for loan relationship purposes is adopted it might reduce the volatility of the I-E result which would be welcome.

As per the above the result of the "mirroring" approach for participating contracts might result in amounts on with profit contracts that are currently included in the UDS  emerging as profit.

Current date for implementation is 2018 although I did note from the IFRS notes that it is described as "approximately three years from the standard being issued".

Part 7 Transfers HMRC Guidance

I was looking at HMRC's guidance on transfers of long term business.  What struck me was how short the guidance is, just seven pages which is roughly a quarter of section 16A of the LAM.  To some extent the brevity is welcome I think it illustrates the point that now that FSA returns aren't the basis for tax computations the need for complicated anti avoidance is reduced.

Another reason for the brevity is that there's very little by way of proper guidance, it's really just a restatement of the general intention of the legislation.  In particular although we have new anti avoidance provisions in FA 2012 132 these are covered in three brief paragraphs.  I suppose it is difficult for HMRC to comment on how it will apply anti avoidance provisions in practice until it sees some part vii transfers under the new rules but hopefully something more useful will be issued in due course.

Looking at this guidance it seems very clear to me that the only proper solution is for HMRC to issue a proper new LAM.

The guidance can be found at

http://www.hmrc.gov.uk/life-assurance/long-term-business-rules.pdf

And my previous muttering on the need for a proper LAM are in the post of 24th June.

Friday Round Up

• The Finance Bill 2013 is now the Finance Act 2013

http://services.parliament.uk/bills/2013-14/finance.html

• HMRC have issued a draft statutory instrument on the Taxation of Regulatory Capital Securities.  This I think is for banks not insurers but presumably in time there will be something similar for insurers.

http://www.hmrc.gov.uk/drafts/130715-basel3-regs2013.pdf

• The OECD have published their contribution to the holiday reading market - An action plan on "Base erosion and profit shifting"

http://www.oecd.org/tax/beps.htm

Pension Business Investment in French Equities

In 2012 and in response to the decision of the European Court of Justice in the case of FIM Santander c-338/11 the French government abolished withholding tax on dividends paid to certain foreign collective investment vehicles including UCITs.  For more on the change in French law this seems a good link.
http://www.clearstream.com/ci/dispatch/en/cic/CIC/Annnouncements/ICSD/Tax/France/A12155.htm

There are some complications around this.  Firstly the French authorities have not released any details on how UCITs and similar funds can obtain the 0% rate.  Secondly France currently withholds tax at 15% on dividends paid to pension schemes.  There is an argument that this withholding contravenes EU law.

Putting these complications to one side it would seem that a UK life assurance company investing pension business funds in French equities would be better off in an OEIC and obtaining 0% withholding than it would investing directly and suffering withholding tax at 15%.  However, UK investors see Europe as a single market.  For other European countries such as Holland, Netherlands, Switzerland and Germany pension business assets that are invested directly obtain a better rate of withholding under the relevant double taxation agreement than is available to an OEIC.

So a withholding tax optimised European portfolio would have its French investments in an OEIC and would invest directly in the relevant double taxation agreement European countries listed above.

HMRC Proposal for Corporate Streaming

Just a quick update on this topic.  I understand that John Buckeridge of HMRC was speaking at a conference and said that HMRC were very aware of the detrimental effect on insurance companies of abolishing corporate streaming  and will be looking at this in detail as part of the consultation.  So perhaps I was being too pessimistic in my post of 20th June.

Friday Round Up

A trifle delayed.

• The Finance Bill received its third reading on 2 July and so is substantively enacted from that date

http://services.parliament.uk/bills/2013-14/finance.html

• HMRC  held an open meeting on the consultation on corporate and government debt; slides from the meeting are

https://www.gov.uk/government/consultations/modernising-the-taxation-of-corporate-debt-and-derivative-contracts

For more on the connsultation see posts of 6,12 and 20th June.

• Interesting comment from George Osborne

" When it comes to Her Majesty’s Revenue & Customs, despite the fact that this department will see a 5% reduction in its resource budget, we are committed to extra resources to tackle tax evasion.

The result is that we expect to raise over £1bn more in tax revenues from those who try and avoid paying their fair share.’"

There's a comment on the government's plans to raise revenues from unspecified anti - avoidance measures in the post of 22 March on the 2013 budget.

• HMRC have issue a briefing note on the Deutsche VAT case on whether VAT should be charged on portfolio investment management charges.

http://www.hmrc.gov.uk/briefs/vat/brief1113.htm

• There is a HMRC consultation on Withdrawing relief for interest on loans to to purchase life annuities.

https://www.gov.uk/government/consultations/withdrawing-relief-for-interest-on-loans-to-purchase-life-annuities

 

Tax Recruitment

High Finance Group have a multi- national reinsurance client that is recruiting for a tax accountant.  If you are interested in the role please click on the link below.

http://www.highfinancegroup.co.uk/job/tax-accountant-jobid-aa54898

Loan relationship deficit carry back

With bond values haven fallen in June 2013 I suspect some companies will have loan relationship deficits when they prepare tax provisions at the half year and thought in would be timely to take a look at the rules for the carry back of loan relationship deficits.

The pre Finance Act 2012 rules for the carry back of loan relationship deficits were not very satisfactory, in particular relief by way of carry back might be inappropriately restricted in situations where there was both a loan relationship deficit and a life assurance trading loss.  Its important that the new rules do not give a similar result  - there has been an unprecedented increase in bond values over the last 10 years, that has to unwind at some point and as it does many life insurers are likely to have loan relationship deficits.

Originally I was hoping to do an all singing and dancing analysis on the carry back rules but looking at the legislation this remains a very complicated area especially the interaction with life assurance trading profits so as this is a free blog I'll restrict the coverage to some "observations".  Very happy to discuss in more detail if people have particular issues.

The legislation covering loan relationships and life insurance companies is in sections 386  - 391 of CTA 2009.  As per section 388 the "basic rule" is that loan relationship deficits have to be set against BLAGAB income of the period before there is any carry back or forward.  Section 388 of CTA 2009 refers to step 4 of section 73 FA 2012 so the current period offset of loan relationship deficits includes receipts as per the minimum profits test FA 2012 93 (5) (a) but is before taking in to account management expenses.  By requiring that loan relationships  are offset against current period BLAGAB income before taking in to account  management expenses the scope for effective loan relationship deficit carry backs is reduced.

However, there is some good news in that section 92 (1) of FA 2012 reads 

"This section applies if an insurance company has a BLAGAB trade profit for an accounting period."

Accordingly I believe that there is no minimum profits calculation in a period where there is a BLAGAB trade loss.  Previously it seemed that an excess adjusted trading profit did have to be calculated in circumstances where there was a trading loss (but that loss was smaller than the excess E amount) although the only practical result was to restrict loan relationship deficit carry backs.

Even if a current period loan relationship deficit can be carried back it can only be set against available profits of the previous 12 months.  Available profits is defined in CTA 2009 section 390 and is (ignoring charitable deductions)

The net loan relationship credits of the period that the deficit is being carried back to (so its not possible to set loan relationship deficits carried back against other non - loan relationship income and gains) less (the management expenses of the period - less the amount of those management expenses that can be offset excluding loan relationship credits.)

So say that there was a loan relationship deficit available for carry back of 25, a loan relationship credit in the previous period of 30, other BLAGAB I of 10 and management expenses of 20.

The available profits would be (I think) Loan relationship credits = 30

Less Management expenses = 20

Less non loan relationship income that management expenses can be set against 10.

So available profits are 30 -(20-10) = 20.

And only 20 of the 25 loan relationship deficit can be carried back.

I think the available profits provision is to prevent a loan relationship deficit carry back displacing management expenses which tidies up the FA 2012 section 93 adjustment.

Finally as per CTA 2009 389 (2A) when a loan relationship deficit is carried back the amount is "left out of account for the purpose of applying section 93 of FA 2012 in the case of that period."

So its not included in the minimum profits test of the carry back period.  Again this is a welcome and pragmatic development.