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.