Tax Transparent Funds

HMRC have issued draft guidance on the taxation of Tax Transparent Funds (TTF).  Page 10 of the guidance deals with loan relationships and confirms that capital movements on loan relationships will be taxed on a look through basis.

What the guidance does not address is the interaction of the loan relationship look through basis and TCGA 103D that treats a holding in collective ownership TTFs (CTTF)  as an asset for CGT purposes, supplanting the look through basis for CGT.  

It is not immediately apparent what prevents capital movements on loan relationships being taxed twice, once under the loan relationship regime on a look through basis and again under the CGT rules where the holding in the CTTF is treated as the asset.   In my opinion CTA 2009 464 prevents the possibility of double taxation by giving priority to the loan relationship amount but it's a bit surprising HMRC have not addressed.  I intend to raise with HMRC and I'll post again on this if I hear back.

ABI Guide to Good Practice for Unit Linked Funds

Further to the consultation Process, the ABI has now issued a revised guide to good practice in unit linked funds.  From a quick run through the tax sections nothing substantive has changed since the draft guide that was issued prior to consultation.  So the overall position remains that there is little in the way of clear guidance.  (For instance the guide does get in to the nitty - gritty of two year carry backs for deemed gains or what to do where the shareholder benefits from CGT losses in a unit linked fund that are not reflected in the price of that fund.)

There is however, quite a bit about documentation required and I would suggest that firms should be looking at what formal documentation they have on allowing for tax in the unit price and considering whether this meets the good practice guidance. 

Solvency 2 and Deferred TAX

The PRA have issued have issued a Supervisory statement on solvency 2 and deferred tax.

Key points:-

The supervisory statement applies to recognizing  deferred tax in the solvency 2 balance sheet and the tax effects of a 1:200 shock.

The statement makes an explicit link between recognizing deferred tax assets for solvency 2 and the rules for recognizing deferred tax assets under International accounting standards (IAS 12).  IAS 12 applies a probable test for recognizing deferred tax assets, i.e. a deferred tax asset should be recognized if it is more likely than not that a timing difference or tax loss can be utilized against future profits .  There is no concept of a valuation allowance in IAS 12 and if it's more likely than not that a loss can be utilzed then a deferred tax asset can be recognized in full.  Accordingly under solvency ii there will be much more scope to recognize deferred tax assets than in PRA returns as prepared currently, where there is an assumption that deferred tax assets will not be recognized.

As in IAS 12, firm's are able to consider the use of management actions (i.e. tax planning) in determining whether it is possible that deferred tax assets can be recognized.

The PRA provide quite a lot of guidance on how the probable test for recognizing a deferred tax asset should be applied.  There is a specific reference that models should have a "sufficient level of granularity to address the relevant detail of all applicable tax regimes."  I think this will require tax departments to assist / sign off on in the preparation of actuarial models that calculate deferred tax.

The PRA does not expect a tax losses to be recognized in a firm's SCR calculation, if the notes to its statutory accounts disclose that: it has unrecognized tax losses; and those tax losses were not recognized because it was considered not probable that future profits would arise against which they might be utilized. Although the supervisory statement does say that this expectation of non recognition can be refuted.

There is a specific reference to companies and supervisors applying judgement to the recognition of deferred tax assets.  This seem to me to be the challenge that companies face. When financial markets crash tax departments generally put quite a lot of effort into determining what deferred tax assets they have available for recognition in GAAP accounts and there will generally be quite a lot of discussions, to and froing with the auditors etc.  But my impression of the solvency 2 process is that it doesn't lend itself to judgement because the sheer volume of data bring churned out is too large.   

This Blog

Just a quick housekeeping post on the future of this blog.  When I started the life assurance tax blog I said I would do a couple of posts a week for a year and reconsider whether to continue with the blog at that point.  There are now 112 posts on the blog and its just over a year since I started so I decided to take stock.

My experience with the blog is that its been fine to do and I personally find it a useful aide memoire.  That said the blog doesn't get that many readers and it hasn't been successful as a way of generating feed back and / or client work.  So I'm going to keep the blog going and available to all but I'm afraid that the volume of posts and the average length of posts will decline, so the focus will be more on quick updates.

It did occur to me that an alternative would be to split the blog between a pay and a non pay area.  Then I would have the quick updates as free to air, but to access longer pieces there would be a subscription (perhaps £1,000 a year). Obviously I could tailor the subscription section to the subscribers and maybe take requests to cover certain topics.  The introduction to life tax series is something that I would expand if there was some subscription income to be had. If you would be interested in the subscription option or if you have any other thoughts on the future of the blog then please email me richard.bentley@bentleyforbesconsulting.co.uk.

Emerging Markets Series of DFA Investment Trust Company v Dyrektor Izby Skarbowej w Bydgoszczy (Case C-190/12)

This is an ECJ Case that caught my eye.  Like a number of cases it involves an EU government (Poland in this case) turning up at the ECJ to argue that treating non  - domestic tax payers on a different basis to equivalent domestic tax payers is not a restriction on the free movement of capital.  And the ECJ rejects their arguments.  

What distinguishes this case is that the investor suffering Polish withholding tax was resident in the USA.  But the ECJ still found that the withholding tax was a restriction on the free movement of capital. The ECJ noted that there was a procedure for the exchange of information between Poland and the USA and therefore the effectiveness of fiscal supervision was not grounds for supporting the Polish government's claims.

Spanish Double Taxation Treaty

The double taxation agreement between the UK and Spain comes into force from 12th June 2014.  My previous post covered the implications of the treaty for life insurance companies with pension business.

Bond Funds and section 490 (1) (b) CTA 2009

After HMRC's technical note on loan relationships I was thinking what would be a good way to make the qualifying investments test (i.e. a fund with > 60% of its investments as loan relationships is taxed as a loan relationship) less onerous?

It seems to me that the wording of CTA 2009 490 (1) "there is a time in the period (i.e the accounting period of the company with the holding in the fund) when that company, scheme or fund fails to meet the qualifying investments test." is disproportionate as a fund that exceeds the 60% limit for one day of an accounting period is to be treated as a loan relationship for the whole of that accounting period.

It might be easier for companies to apply this legislation if there was a grace period during which a fund could fail the qualifying investments test without having to be treated as a loan relationship.  So perhaps you to treat a fund as a loan relationship if it fails the qualifying investments test for 30 days in an accounting period. (I think the idea that once a fund has failed its a loan relationship for the whole period else you might have funds that regularly skip between bond and equity.)

This still leaves the problem that the fund still has to be monitored on a day by day basis which can be particularly tricky for some offshore funds where information on the underlying investments may be hard to obtain.  Perhaps there could be second rule that says that if a fund passes the qualifying investments test when purchased and on the last day of a company's accounting period then it is to be treated as an "equity" fund for the period.  HMRC might worry about funds cheating i.e. ensuring that bond funds pass the qualifying investments test on the last day of an accounting period but I would not see this as a big worry.  Firstly it is the company's accounting period and not the funds that you would test on. Secondly is it really going to be worth the hassle and cost of annually selling 41% of a fund's bond assets and reinvesting in equities to obtain equity treatment for a bond fund?

In my world you would run the two tests side by side, that is even if an equity fund did fail the qualifying investments test on the last day of an accounting period then there would still be the <30 day safe harbour.

A final thought of another approach.  For UK AIFs we have a counterpart to the qualifying investments legislation in the ability to pay an interest distribution (although here the fund paying the distribution has to have > 60% of its investments in loan relationships for the whole of the dividend period).  Perhaps we could piggy back off this and say that a company has to treat any investment that pays an interest distribution as a loan relationship but that any UK fund that doesn't pay interest distributions is an equity fund?

Update to Loan Relationship Consultation

HMRC have now issued a technical note on the corporate debt and derivatives consultation.  The note can be found here.

Technical note

The technical note marks a slimming down of the original proposals of the consultation document.  I think this is a good thing, there is no necessity that a consultation should result in a lot of detailed legislation.  The loan relationship legislation has been around from 1996 and it probably warranted a general review.  The conclusion that nothing very much needs changing is in line with my own experience of the legislation, it's certainly better than what went before.

There are a few insurance specific points in the technical note.  

• One area where there will be changes is that loan relationship credits and debits will only be recognized for tax when they are included in the profit and loss, amounts included in "equity" (OCI etc) won't be recognized for tax (until they are "recycled to profit and loss).  These proposals are included at paragraph 2.6 of the technical note.  There is an acknowledgement that not taxing loan relationship movements taken to equity might cause mismatches and volatility in taxable profits for insurers, but there is no detailed discussion of what might be done here.  For a bit more on accounting developments see my post of 10th April 

• Corporate streaming is covered in paragraph 2.13 of the technical note.  This notes that streaming does fulfill an important function for insurance companies with pension business and thankfully doesn't trot out the line that streaming was an anti avoidance measure.  HMRC conclude: "It may be preferable to retain the rules, but in a revised form, possibly with additional anti-avoidance protection to address the manipulation seen by HMRC in the past"  Which is very welcome.  

• What there is no mention of is that if corporate streaming is being retained then we should tighten up the revised section CTA 2009 490 to ensure the FII element of streamed dividends is treated as such in a life insurance company.  This point was covered in my post of 28th March.

• At paragraph 2.14 of the technical note there is an announcement that HMRC will continue to work on improvements to the bond fund rules in CTA 2009 section 490 and 493.  Presumably this will look at the current section 490 (1) (b) that requires that a company treats a collective as a loan relationship if it fails the qualifying investments test at any point in a company's accounting period.  Some relaxation here to prevent funds that have more than 60% of their investments in loan relationships for a short period of time being treated as loan relationships, would be welcome.

IFRS 4 Update

An update on the progress on a new international accounting standard for insurance.  This is largely culled from the notes that the big 4 have produced on this subject which in turn come from the ILAG financial practitioner briefing.  I'm including a link to the KPMG material on this, but all of the big 4 have similar content.

http://www.kpmg.com

The key points for me are that:

• IFRS 4 now has a planned effective date of 1 January 2018.  This is also the planned date for implementation of IFRS 9.  This is a welcome development as the two standards cover the assets investments an liabilities of an insurer and to implement one before the other would have led to some odd results and two transitions.  

• Given that, even if everything goes to plan, we are four years away from implementation I will put this on the pending pile, at least until a revised IFRS 4 is issued next year 

• There seems to be some discussion over how the requirement to take changes in the discount rate on reserves to the OCI will be implemented.  It seems as if companies will have a degree of choice here and will be follow different rules for different portfolios.  I'm sure there is a good reason for this, although rather harder to think what it might be.  It would seem to suggest that you could get two companies with identical business and identical results, both accounting under IFRS 4 but showing different amounts as profit.

• The links below are to my previous posts on IFRS 4 and related topics.

21 August

2nd August

25 July

On a more speculative theme I wonder if the ability to have different treatments within IFRS 4 and the whole UK GAAP / IFRS issue might make HMRC and HMT consider how appropriate a profit based tax is for insurance companies?  This might be because it is notoriously difficult to measure the profit on long term business in any one set of accounts.  Also for "one period" companies that operate in conditions of near perfect competition I can see that maximizing profit equals maximizing welfare and that if governments are determined to levy a corporation tax then profit is the least bad base for the tax.  

But I'm don't see that any of those arguments apply for insurance.  You won't get perfect competition in regulated markets and what we want from insurance companies is stable companies who make long term profits from providing products that people need, rather than making short term profits driven by a sales culture.  To pick a topical example you might want insurers to provide good value products for people with small pension pots at retirement, even if that meant accepting a low return on capital employed.  Perhaps insurance companies who embrace these social "goods" should be taxed as pseudo mutual companies and exempt from tax on profits.  

Stamp duty land tax

A belated budget update, something that I missed at the time and maybe not everybody is aware of.

HMRC has announced that as part of the Investment Management Strategy, the Government will consult on the SDLT treatment of the seeding of property authorised investment funds and the wider SDLT treatment of co-ownership authorised contractual schemes.

In my experience life insurance companies, generally, want to move away from direct property holdings and instead invest in property collectives.  However, the prospect of a charge to SDLT simply as a result of collectivization can prevent non - tax driven reorganizations from being contemplated.  So it would be a definite step forward if some form of "seeding relief" as used to exist for unit trusts could be developed.  It's my understanding that the old seeding relief was removed as people were using it to make property transactions (as distinct from reorganizations) SDLT free.  So perhaps tricky to come up with something that is simple enough to be usable in "innocent" transactions but catches avoidance.

Tax relief on management charges in pricing of BLAGAB funds

I wanted to set out a numerical example of the implications of management charges to BLAGAB unit linked funds and tax in pricing.  It's actually Phillip Govan's example but I'm going to borrow it.

Assume that there is a BLAGAB fund of £100,000 with a taxable investment reserve return of £10,000 and that there is an internal management charge to the fund of £1,000.  I'm assuming no expenses, that the BLAGAB unit linked fund is the entire business of an insurance company and that policyholder and shareholder tax rates are 0.

The question is what tax should the policyholder be charged.  It's tempting to say £2,000, that is the taxable return at 20%.

But then this gives an odd result when compared to the corporate tax charge.  The charge for the company is £2,000 (i.e £1,000 at 20% shareholder tax and £9,000 @ 20% policyholder tax). As the charge to the policyholder is also £2,000 the shareholder hasn't borne any of the tax charge.

An alternative way to do this would be to deduct tax from the BLAGAB unit linked fund net of the management charge.  Now the tax charge to the fund is £10,000 - 1,000 @ 20% = £1,800.  The charge on the corporate is £2,000 as before and the shareholder is now bearing tax of £200, which is  the management charge (which in my example is pure profit as I've set expenses to 0) @ 20%.

I think this option is superior to the take tax out of the fund at a flat 20% approach, in particular it recognises the approach of treating the BLAGAB unit linked fund as a stand alone company, meaning that the management charge is, effectively, an external expense.  I think most life companies effectively provide for tax relief on management charges but often it is disclosed as a reduction in management charge (i.e. the charge for a BLAGAB fund is 80% of the charge for a pension fund).

About me and Bentley Forbes Consulting

I am Richard Bentley the author of Life Assurance Tax Blog, I provide tax consultancy services, mainly to life insurance companies but I also cover general insurance.  These services are provided via my company Bentley Forbes Consulting Limited.

Bentley - Forbes Consulting has been in business since 1999 and has worked with 20 different organizations over that time, including mutual insurers, friendly societies, unit linked offices and with profits companies.  Generally the work done either involves being an in house tax manager to companies who don't have the resources to justify a full time tax professional or working on project roles and  / or providing cover for larger companies.

Work done includes 

Preparing year end tax provisions on a UK GAAP and IFRS basis including advising on recognition of deferred tax assets and IAS 12 and working with fastclose.

Preparing corporation tax computations for a wide variety of insurers, with good experience of the Thomson Reuters One Source life tax product

Review of tax in unit pricing.

Assisting and advising on project to transfer back office functions to a new provider of outsource services.

Advise on investments by life assurance companies including accessing the 0% rate for USA pension schemes.

Advice on part vii transfers and re - organizations. 

Together with Philip Govan I have a license for the Thomson Reuters One Source life tax product.

And much, much more.  Full CV available on request please email

richard.bentley@bentleyforbesconsulting.co.uk 

or call 07531 415 976

Charge out rate £125 per hour - happy to discuss daily equivalents.

Unauthorized Unit Trusts Loan Relationships

A statutory instrument has now been issued that includes amendments to take non - exempt unauthorized unit trusts (NEUUTs) out of the deemed loan relationship rules in section 490 of CTA 2009. This is a logical development; if a NEUUT holds loan relationship assets then these will be taxed in the NEUUT so there would be the potential for double taxation if a company's holding of the NEUUT was also in the loan relationship legislation.  

The new legislation comes into effect from 6th April 2014 (i.e. it co-insides with the new regime for unauthorized unit trusts) and the SI can be found here.

Statutory instrument

The change to the legislation also means that if a NEUUT holds both bonds and equities then the tax treatment of income will be correct for a corporate, that is the loan relationships will be taxed in the NEUUT, the dividend income will be exempt and the dividends from the NEUUT will be received as dividends with no further tax to pay for a company.  This avoids the problem that, I think, exists for AIFs under the new section 490.

As I've said before the HMRC people dealing with unauthorized unit trusts seem to have a rather better understanding of the issues involved than their colleagues involved in the reform of the loan relationship provisions.  Sadly, although NEUUTs have lots of good features, there is still the problem that they are not CGT exempt so can give rise to a double charge to tax on capital gains.

Finance Bill 2014

Finance Bill 2014 has now been published and can be found following this link:

Finance Bill

The new legislation amending CTA 2009 465 and 490 re collective investments treated as loan relationships (see previous posts of 22 January, 4th Feb and 20th February on this topic) is at section 27 of the Finance Bill.

As far as I can see the defect identified in my post of 22 January has not been corrected in the published legislation.

That is where a distribution is made by a collective that is  treated as a loan relationship all of the distribution is within the loan relationship legislation. This is the case regardless of whether the collective is an AIF or an offshore fund.  This approach gives the wrong result where a collective that is treated as a loan relationship also has an element of equity investment because all of the dividend (or interest distribution) from the AIF will be taxed as loan relationship whereas some of the income giving rise to the dividend is exempt dividends. 

The problem becomes exacerbated when a UK AIF that is treated as a loan relationship cannot (or chooses not to) pay a interest distribution, as now the interest income arising to the fund might be subject to double taxation, once in the AIF and again in the hands of the corporate investor. Streaming the dividend into FII and UFII rather than taxing it as a  loan relationship will, pretty much, sort out this problem and also ensures exemption for the dividend element of the return. Streaming will also also ensure the correct result for pension business of insurance companies as the streaming will allow the tax in the collective to be recovered in the insurance company.

So it seems to me that revising the Finance Bill to ensure that streaming still apply to AIF non  - interest dividends where the AIF is treated as a loan relationship would be a definite improvement on what we have at present.  Of course this is dependent on streaming being retained for life companies but I understand that there are some encouraging signs here.

Budget 2014 Pensions

I wanted to make a couple of observations on the budget proposals for changes to the pensions legislation.  The government issued a budget day document "Freedom and choice in pensions".  Link to the document is below:

Pension Changes

My observations are as follows:

This Reads Like a Treasury and not a HMRC Document:  That is the overall tone is positive: this is a shiny new policy that will improve consumer choice in the pensions market, boost savings and make president Putin realize the error of his ways and retreat from the Crimea.  An issue at the top of HMRC's agenda is pensions liberation - I wonder when they were informed their boss was planning a mass jail break?

This is coming really soon: The new system is to come into force from April 2015.

This might, really, be coming very soon: Normally the above points would be reconciled by the implementation date for the new system being pushed back to allow HMRC and providers to sense check the new system.  However, there will be an election in the UK on 7th May 2015.  Although the policy has been a political triumph its impact will be dissipated if the government is forced to announce they can't get the detail to work, so I think we will have something new in place by April 2015.

Specific Points from the document

The thrust of the proposals is summed up in the sentence :"The tax rules will be drastically simplified to give people unfettered flexible access to their pension savings"

That may be true although the government has a particular view of what is free and unfettered, the minimum age limit for drawing defined contribution benefits remains at 55 and will increase to 57.  So the government is prepared to treat the public as responsible adults  - as long as they are 57 or over.

There is a statement at paragraph 3.13 of the document that "The tax free lump sum(usually 25% of an individuals pot) will continue to be available.

Paragraph 3.17 of the document includes a discussion of the inheritance tax treatment of pensions.  This includes an intriguing statement:"The government believes the tax rules that apply to pensions on death need to be reviewed to ensure they are appropriate under the new system.  In particular the government believes that a flat rate 55% will be too high in many cases."

There are a number of changes to the existing rules that will apply from 6 April 2014 to 5 April 2015. These include: reducing the other income necessary to qualify for flexible draw down from £20k to 12k, allowing pension wealth of less than £30k to be taken as a lump sum (previously maximum £18k) and the capped draw down limit has been increased to 150%.

Those in public sector defined benefit schemes and individuals who have already taken an annuity will not be able to benefit from the new rules.  Indeed it will no longer be possible to transfer from a public defined benefit scheme to a private scheme.  The status of individuals in private defined benefit schemes is uncertain.

At 4.11 the document includes a statement: "The government want to ensure that consumers receive good quality guidance that meets their needs and choices.  It is important that consumers know the advice they receive is focused on their best interests and not those of the provider."

In my opinion, successful implementation of this policy statement is crucial to the practical success of the reforms.  Although there is widespread dissatisfaction with annuities I suspect annuities bought from the best buy table are a decent deal.  Individuals may be unhappy with the level of income they get, but  that might be due more to a combination of human nature, low interest rates and increased longevity than any market failure.  But many consumers buy an annuity from their existing provider and pay over the odds as a result, if this could be prevented it would do far more to move pension provision to an optimal outcome than any amount of changing the draw down rules.

What should companies do now?  It is difficult to say anything very definite on this point.  Future products is obviously an interesting area but life insurance companies will employ people who know more about this that I do.  However, I do think that there might be a general point for companies with employees aged (say) 50+.  If these individuals were paid less but compensated with higher employer pension contributions then there would an employers and employees national insurance saving.  To date the objection to this would be that individuals need a salary in the here and now, rather than a pension accrual.  But if we are moving in to an era where the tax rules will be drastically simplified to give people unfettered flexible access to their pension savings perhaps this won't be such a big issue?  Long term, I suspect this is too good to be true, indeed the IFS recently recommended imposing national insurance on employers pension contributions* http://www.ifs.org.uk/bns/bn130.pdf

So now might be a good time to look to maximize national insurance savings by way of employers contributions and might be attractive to employees as well.

* Thanks to Daron Gunson for pointing out

Deemed gains two Year Carry Backs

Further to my earlier posts on the ABI Guide to Good Practice I was giving a bit more thought to the implications of not allowing for the two year carry back of deemed disposal losses in pricing a BLAGAB fund.

The "risk" here is the the unutilized losses in the fund can be overstated by 2/7s of the loss arising that is eligible for carry back and as a result tax deducted from the fund is overstated.  To illustrate, assume gain year 1, £700.  Gain year 2, 0.  Loss year 3, £700.  Then with a two year carry back there are no CGT losses, but if the carry back rules are not applied in the unit pricing there are losses of £200 (i.e. 2/7s of the year 3 loss).  The 2/7 is a maximum figure, if there were gains in year 2 then the unutilized loss would reduce.

Returning to the above example if we assume that the unutilized loss in year 3 is 20% of the fund value and that no value is placed on unutilized losses then the impact of not including carry backs of deemed gains in the pricing of the fund is 2/7 * 20%* tax rate.  If we assume that the tax rate is 20% then the impact in terms of fund value is just over 1%, well in to the territory where an error in the unit price has to be corrected.

This of course leads us to another debate about whether the failure to reflect the two year carry back of deemed losses is an error. I would tentatively suggest, that if all a company's unit pricing documentation says, is that policyholders will be taxed as if their fund was a stand alone company, then it probably is an error.  After all the ABI guide requires that "The firm should ensure that the value of the fund takes account of any appropriate tax relief attributable to asset classes held in the fund."

If, however, there is specific disclosure that the two year carry back is not adopted then the error point is, perhaps, more debatable.

ABI Guide to Good Practice

A few thoughts on the ABI Guide to Good Practice.  Plus I went to the ILAG forum on tax provisioning in unit linked funds presented by Financial Risk Solutions and I'll try and summarize some of the comments from there. 

Where are we? The ABI last issued its Guide to Good Practice in Unit Linked Funds in 2012.  This guidance can be accessed by following the link in the post of 5th November.  The ABI has now issued a draft guide, updated, following the FCA's thematic review on the governance of unit linked funds.  This draft guidance is part of a consultation process that ends on the 28th March and a link to the draft is below. There is an expectation that by 31 December 2014, firms should have reviewed their operations against the updated guidelines set out in this Guide and begun making progress towards following them.

ABI Good Practice

The revised guidance is of particular relevance for those working in life assurance tax as the fair allocation of tax between customers and shareholders was one area that the FCA identified as requiring improvement.

Is This is a Good Idea? In my opinion, no its not.  If the FCA believed that certain approaches to tax in unit pricing were incorrect then it should have set out what it objected to, and the changes required.  Its effectively trying to outsource its work to the ABI, but the ABI is guided by its members, not vice versa.

What has stayed the same in the draft guidance? Much of the text of the guidance is the same as per the December 2012 guidance.  More importantly the overall emphasis remains on documenting policies, particularly in areas such as tax where judgement is required; disclosing those policies to customers, and, if required, regulators; and applying policies consistently.  The Guide,  generally, does not lay down hard and fast rules.

What are the Tax Changes The specific commentary on tax is at paragraphs 5.58 - 5.64 of the document.  I've set this out below and have attempted to highlight in red the bits that have changed or are added to the December 2012 guidance.

5.58

Under the tax regime applicable to UK life assurance firms, basic rate tax on the policyholders’ investment return from investing in a life product is assessed on the life assurance firm itself. For unit linked business, the firm therefore levies charges in respect of taxation on the unit linked funds.

5.59

The firm's approach to tax will often be outlined in the policy documentation. Making charges in respect of taxation and the tax commentary in its marketing literature and policy documentation should be consistent. The firm should amend such documentation when material changes to tax regimes arise which impact on charges to policyholders’ funds. For funds where tax charging basis varies from the firm’s standard approach, e.g. where the standalone basis is not applied, such variations should be disclosed, if material to the policyholder outcome.

5.60

The calculation of tax - related charges is complex, and there is not necessarily a single right answer to the treatment of tax in unit-pricing. However, the pricing methodology adopted should seek to preserve fairness between different generations of policyholders and between policyholders and shareholders.

5.61

Where the assets in the linked fund back taxable business (e.g. Life Bond business) the following principles should apply to the calculation and deduction of tax charges:

• ·Customers should be treated fairly.

• ·The firm should document how its chosen basis of charging funds in respect of taxation meets its aims, including achieving broad equity between generations of customers and fairness between the firm and the fund.

5.62

The following factors should be considered when choosing the basis of levying

charges in respect of taxation:

• ·The impact of tax balances in the fund as these can distort the risk profile ofthe fund (e.g. through gearing).

• ·Consistency with current tax rates and tax regime (with changes beingimplemented from the effective date of the change, unless equity demands otherwise).

• ·Appropriate value on deferred tax assets and liabilities.

• ·The firm should ensure that the value of the fund takes account of anyappropriate tax relief attributable to asset classes held in the fund.

• ·Appropriate procedures are put into place that are operationally robust,bearing in mind that taxation in pricing deals with future events whose outcome is uncertain.

• ·Appropriate relief for external expenses charged to the fund.

• ·The discounting of tax rates where there is likely to be a prolonged period from the pricing date until the expected date of payment of the tax, for example on deemed and unrealised gains or losses. The approach to discounting should also be consistent with the settlement of tax provisions, or the holding of cash within a fund against the provision, required to avoid accidental or inappropriate gearing of the fund.

5.63

The scope and nature of the taxation of UK life assurance firms, and therefore of unit-linked life funds, may be subject to change over time. Wherever possible, and where appropriate announcements of future changes should be taken into account in fund tax charge calculations.

In addition, firms should:

• ·Ensure that the offsetting of losses against gains before calculating tax liabilities is done fairly and consistently.

• ·Document their processes and procedures for offsetting gains and losses and have in place systems and controls to ensure those processes and procedures are correctly applied.

• ·Aim for consistency of approach in offsetting gains and losses and the rationale for any inconsistency should be documented with a view to ensuring that all policyholders are being treated fairly.

5.64

The investment return on Pension Business is not subject to corporation tax. However, taxes may be suffered on assets held to back Pension Business and the life company may be able to recover an element of such tax.  Allowance for tax recoveries on pension funds should be done on an appropriate and consistent basis.

My comments on the substantive points are as follows:

There is, for the first time, a specific requirement to provide appropriate relief for external expenses charged to the fund.  At the ILAG seminar there was an interesting discussion over the true economic effect of shareholder charges to the fund.  However, I think it is clear that this guidance only covers external fees.  It was suggested that if the shareholder charge to the fund was net then it would not be necessary to provide for tax relief on specific external costs.  I would have thought this might be OK if both the implicit gross management fee and its net equivalent was disclosed to customers.

For the first time there is an explicit requirement to discount the tax on unrealized and deemed gains.  But I have never come across a company that didn't provide a discounted rate for such amounts.

At paragraph 5.63 the guidance makes some additional comments on offsetting gains against losses before calculating tax liabilities. However, the wording here is very vague and I think expanding the guidance possibly provides for more diversity of approach than under the December 2012 guidance.  For instance in the ILAG seminar reference was made by George McCutcheon of FRS to the two year carry back of deemed losses under TCGA 1992 section 213 (3). The 2012 ABI guide included a comment that "The firm should ensure that the value of the fund takes account of any appropriate tax relief attributable to asset classes held in the fund." And I would say that this means that company's do have to apply the two year carry back in providing funds with a value for losses.  The draft guide also includes this wording but now there is this additional guidance refers to the need to apply loss offsets fairly and consistently, which, to me, seems to muddy the waters.  

There was an interesting bit in the FRS presentation at the ILAG forum, on valuing CGT losses.  This looked at the fund value method and the transaction value method depending on whether the fund concerned was expanding and contracting.  Those interested in the mechanics of such an approach can follow the link to the full analysis at:

FRS Paper  

There is, however, a bit of a gulf between these actuarial approaches and how most life insurers value losses in practice.  I suspect an approach along the FRS lines will become the best of the best practice for the more engaged life insurers.

Where the FRS approach was in line with industry practice was that it looked at losses and prospective gains on a stand alone fund basis. There was also a discussion over what should happen when CGT losses in one fund are used against other gains of the company and whether there should be a price for the "sale" of losses from a unit linked fund to the "shareholder".  To my mind there should be such an assumed sale as it is intrinsic to the "stand alone" assumption.  That is if each unit linked fund is to be treated as a stand alone insurance company, then that stand alone company is only going to transfer its losses to another entity for market value.  However, I think my opinion is a minority view and there is certainly nothing in the Guidance as it stands that suggests that such an approach might be required.

For the first time the Guide comments on tax in pension business linked funds referring to tax that is suffered on assets held to back pension business.  This I assume is a reference to foreign withholding tax and, potentially, the deemed income tax deducted from the UFII element of AIF dividends (which effectively recovers tax leakage in an AIF).  The issues here are complicated as the offset of withholding tax is the result of the tax suffered by the pension customer and the insurance company's own corporate tax position. Again the wording in the draft guidance is loose enough to support a variety of treatments. However, I would have thought that, where an insurance company is able to obtain a beneficial rate of withholding tax on pension business under a double taxation treaty, the benefit of that reduced rate should be reflected in the unit price.