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.