Claims for Section 213 Carry backs

Question: what to do if making a claim to carry deemed disposal losses back to the two previous accounting periods if it is not possible to amend the corporation return for the earlier period?

That is at 31.03.2017 a tax computation is prepared for the period to 31.12.2016 showing deemed disposal losses for the period.  The loss can be carried back to accounting periods 31.12.2015 and 31.12.2014 but if  HMRC has not opened an enquiry on 31.12.2014 we are out of time to amend the return.

There is some good guidance on this at CTM 90630

The rules are that in the example above  the deemed loss being carried back to 2015 would be included in an amended return.

However as it is no longer possible to amend the 2014 return the loss carry back instead falls within the rules in TMA 1970 schedule 1A and the carry back is given effect by way of a repayment.

Rather neat as it means there is no requirement to go through the administrative gymnastics of somehow reopening a closed accounting period.

Authorised Contractual Schemes: Consultation

HMRC has issued a Consultation on authorised contractual schemes (ACS).

Consultation states pension schemes and insurance companies are the main investors in ACS, most investors currently exempt but this consultation is to future proof for taxable investors.

Proposal to allow ACS operators to claim and manage capital allowances for participants.

Proposal to require ACS operators to  provide investors with sufficient information to meet their tax obligations.

Previous posts of tax transparent funds are Here.

Corporation Tax Rates

Corporation tax rates for 31 December year ends

Year to 31 December		Rate
2017		19.25%
2018		19.00%
2019		19.00%
2020		17.50%	*

*  Assumes 17% rate not yet substantively enacted

NB Rates are calculated in months and not days so will be slightly out from official rates.

Finance Bill 2016

Finance Bill 2016 has been held over for the summer holidays.  The Report Stage is now scheduled for 3rd September with third reading to follow in the House of Commons.  As HOC third reading is when the Bill becomes substantively enacted for IFRS and UK GAAP purposes Finance Bill is likely to be substantively enacted for Q3 reporting.  Most important implication is that the 17% rate to apply from 2020 will be substantively enacted from September  / October.

The Taxation of BLAGAB Products

Changes to the rate of capital gains tax and dividends applying from 6th April 2016 have an impact on the decision of whether to invest in equities via an insurance policy taxed as a BLAGAB business or via direct investment.

The changes are: The introduction of an effective 7.5% surcharge on dividends received by individuals. Dividends received by an insurance company in respect of BLAGAB business are not taxable and there is no adjustment to the tax rates applying when a policy is surrendered  / matures which remains at 20% for higher rate tax payers and 25% for additional rate tax payers.  Accordingly the new dividend rules give a BLAGAB policy an advantage over direct investment.

However, the rate of tax for additional and higher rate tax payers on capital gains is reduced to 20% from 6th April 2016.  Capital gains in a BLAGAB insurance product are taxed at 20% but with an allowance for inflation (indexation allowance) not available to individuals.  There will be an additional tax charge for additional  / higher rate tax payers on surrender / maturity of 20% for higher rate payers and 25% for additional rate payers.  Accordingly, for higher and additional rate tax payers even before considering capital gains tax allowance, capital gains on direct investment are taxed more lightly than capital gains on an asset held in a BLAGAB insurance policy.

I ran a few numbers to see under what circumstances it could still be beneficial to invest in a BLAGAB insurance policy.  Obviously one set of circumstances where a BLAGAB product can be useful is deferring the incidence of taxation from a period when an individual is a higher or additional rate tax payer to a period when they pay tax at a lower rate (that is the higher rate and additional rate charge is levied on the tax payer only when the product is surrendered or matures).

Ignoring the possibility of deferring taxation until a lower rate of tax applies then whether it is better to invest in equities via a BLAGAB product or via direct investment depends on the availability of the capital gains tax allowance and the split of investment return between dividends (where the BLAGAB policy does better) and capital gains (where direct investment does better).

In the short term direct investment might well be better as you would hope that capital gains would be a significant element of total returns and the availability of capital gains tax allowance would be significant.  Over longer periods however a BLAGAB policy becomes a better bet as capital gains tax allowance is not so relevant and the percentage of total returns made up from dividends increases.  In fact there is some evidence that if you look at a long enough period most of the return from equities comes from (reinvested) dividends and capital appreciation is matched by inflation. In these circumstances a BLAGAB policy stacks up very well against direct investment.

So perhaps still a role for BLAGAB insurance products investing in equities albeit a niche product as hard to see as useful for individuals who are in a position to pay into ISAs or pensions.

IFRS 4 Phase ii

There was an update on IFRS 4 phase ii at the recent ILAG financial reporting seminar.  It seems as if IASB is close to having a draft standard prepared and the speakers from Deloittes thought 2020 or 2021 were likely implementation dates.

The definition of insurance remains (substantively) unchanged from IFRS 4 phase 1 so contracts accounted for as investment business will not be affected by the change to IFRS 4 phase ii.

No indication yet of what will happen to UK GAAP, i.e. will it align to IFRS 4 phase ii?

An interesting comment was that annuity business would be accounted for differently under IFRS 4 phase ii.  That is under current GAAP profits are recognised up front on the sale of an annuity. However, under IFRS 4 phase ii a contractual service margin is set up when a policy is sold, effectively spreading profits over the life of the contract.  Also there doesn't seem to be a place in IFRS 4 phase ii for VIF / AVIF or DAC.

No discussion of tax consequences in the ILAG forum.  I imagine there will need to be a decision over whether there is a bespoke transitional regime for the change from IFRS 4 phase i to phase ii or if the general rules in CTA 2009 section 180 will be used CCH Link.

Issues around modelling of future tax cash flows in light of the change and impact on SII and LACDT.

New Rules for Loss Carry Forward Implications for SII

HMRC has published a consultation on proposed reforms to corporation tax loss relief.

Summary

This turned out to be a long note so I thought I'd sum up.  To date the focus for life insurers on the new rules for loss relief has been the damaging impact they will have on the SII balance sheet. Working through the proposals in the condoc I think the impact of the rules on SII capital is complicated but may not be disadvantageous for all life assurance companies.

Basics

The reform applies to carried forward trading losses, excess management expenses, non  - trading loan relationship deficits, UK property losses and non-trading losses on intangible fixed assets. Capital gains tax loss rules remain unchanged

It would appear that the rules for loss carry backs and group relief will remain unchanged, although no draft legislation has been issued.

The reform is a mixture of good and bad news.

The good news is that where losses arise after 1 April 2017 companies will have the ability to carry the losses forward and set against the taxable profits of different activities and other group members. Current loss relief rules allow brought forward losses to be set only against profits from the same company and sometimes only against profits of the same source source (i.e. a trading loss can only be set against trading profits of the same company.) 

But the bad news is that from 1 April 2017 the amount of profit that can be relieved by carried forward losses is restricted to 50% of the total profit.  The 50% restriction will only apply where more than £5 million of carried-forward losses are being used across a group of companies in a given year.  Accordingly a group of companies can set brought forward losses against £5m of profits without restriction with the 50% restriction applying above that amount.

There is a difference in the timing of the good news and the bad news.  The restriction on using losses applies to all losses including those arising before 1 April 2017 but,

The ability to use losses against taxable profits of other activities and the profits of other group members only applies to losses arising after 1 April 2017.

Accordingly companies with  losses as at 1 April 2017 will only be able to set those losses against 50% of  profits from the same company post 1 April 2017 (and trading losses can only be set against trading profits), but a  loss arising after 1 April 2017 can be set against 50% of profits (regardless of source) of the same company plus 50% of other profits in the group.

Life Insurance Company Specific

The reform applies to excess management expenses but excess Basic Life Assurance and General Annuity Business (BLAGAB) expenses are excluded.  What is not clear is what will happen to BLAGAB Trading Losses, will BLAGAB trading losses arising post 1 April 2017 be  eligible to set against profits from other trades and other group members?

The condoc recognises that the new rules may have an impact on the Solvency II capital of Life Insurance Companies via the impact on both own funds and the capital requirement [A bit more on this below].  The Treasury would " like to understand ways in which the impact on insurers’ regulatory capital could be mitigated through the detailed design of the reforms, while noting the significant policy and legal challenges in making these detailed changes specific to the insurance sector."

Recognition of Deferred Tax Losses

Losses arising Before 1 April 2017

Under IAS 12 where a company has accumulated tax losses it recognises a deferred tax asset in respect of the losses "to the extent that it is probable that future taxable profit will be available against which the unused tax losses can be utilised."

IAS 12 identifies two sources of future taxable profits:

• Taxable temporary differences relating to the same taxation authority and the same taxable entity, which will result in taxable amounts against which the unused tax losses or unused tax credits can be utilised before they expire.

• Other taxable profits arising before the unused tax losses or unused tax credits expire.

Under current (i.e. pre 1 April 2017) loss relief rules, establishing a deferred tax asset for losses against taxable temporary differences (i.e. deferred tax liabilities) is generally quite straightforward.  The taxable temporary differences have to relate to taxable amounts against which the losses can be set but as, under existing rules,  losses brought forward can be set against all profits arising in the same company (sometimes limited to the same source) in future periods the test is easy to meet. But from 1 April 2017 only 50% of the profits from taxable temporary differences can be relieved by brought forward trading losses and accordingly deferred tax recognition by virtue of taxable temporary differences may be reduced.

Recognition of a deferred tax asset in respect for losses on the basis of future profits arising from sources other than taxable temporary differences is  quite difficult under current loss relief rules as senior management and auditors have to be happy that it is probable that such profits will arise.  Although in theory it is possible to recognise all expected future profits even those arising many years from now the requirement that these profits will probably be available often means that only profits from a particular period of time are considered (5 years or 10 years perhaps).  Again it is possible that the new loss relief rules will see a reduction in deferred tax assets recognised as now it will only be possible to use 50% of the expected future profits arising in a specified time period to support deferred tax asset recognition.

What is important to note is that for losses arising before 1 April 2017 the proposed new rules will either leave a deferred tax asset for losses as it was before the change, or result in a reduction in the amount of deferred tax asset recognised.  

Losses arising after 1 April 2017

For post 1 April 2017 losses the impact of the proposed  new rules on deferred tax asset recognition is more nuanced.  The post April 2017 loss can only be set against 50% of taxable profits, clearly worse than the current rules, but the types of profit that losses can be set against is widened to include profits in other group companies and from other activities. Accordingly, the impact of the new rules on loss recognition for post 1 April 2017 losses will vary depending on each group's tax profile.

Life Insurance Companies Deferred Tax Asset Recognition for Losses in the SII Balance Sheet

Life insurance companies can recognise deferred tax assets for tax losses in two places in the  SII return.

• Deferred tax assets can be recognised in own funds (i.e the asset and liabilities included in the SII balance sheet).

• An allowance for the deferred tax impact of the stress event can be included in the companies Solvency Capital Requirement, this is generally known as the loss absorbing capacity of deferred tax (LACDT).

For own funds the above analysis on deferred tax assets should be, broadly, applicable to life insurance companies.  However, I think the implications for LACDT are more complex. There are two points that occur to me.

A simplified view of SII is as follows:-

That is the SII balance sheet can be seen as an opening IFRS balance sheet plus SII adjustments (that is SII own funds generally higher than IFRS net assets) less the deferred tax calculated on those adjustments.  Sticking to my simplified approach the stresses that make up the pre tax SCR could "hit" either the IFRS base balance sheet or the SII adjustments.  

If a stress impacts the SII adjustments then the question is what impact does that have on the deferred tax liability for SII adjustments?  Generally the position is that the stress loss represents a tax loss and accordingly the impact of a stress that impacts on the SII adjustment is to reduce the deferred tax liability in the stressed balance sheet by amount equal to the stress loss multiplied by the appropriate tax rate.

In these circumstances the loss absorbing capacity of deferred tax has been demonstrated and the new loss relief rules are not an issue.  [Obviously things could be more complicated, particularly if the stresses make SII adjustments negative].

However, the stresses that make up the SCR could hit the IFRS oval in the above diagram. In this case the analysis is more complicated.  As the IFRS result is the starting point for the calculation of taxable profits the impact of the stresses may be to create tax losses, the issue to be determined in calculating LACDT is whether those losses can be recognised in the post stress balance sheet.  In recognising a deferred tax asset for tax losses arising from the stress event a life insurance company can consider the potential for loss relief from carry backs and group relief.

If group relief and loss carry back is insufficient to use up the tax loss on stress then loss carry forward can be considered.  An insurance company can demonstrate the brought forward losses can be utilised either against deferred tax liabilities in the pre - stress balance sheet (but these would be reduced by any amounts already allowed for in establishing LACDT for stresses that hit the SII adjustments "oval")  Or expected future profits arising in the insurance company.  In both calculations it would seem that, the new rules introducing a  50% restriction on taxable profits that can be relived by brought forward losses need to be considered.  This would imply a reduction in LACDT compared to the  calculation using the current rules.

However, the assumption in SII is that the stress event happens immediately after the balance sheet date.  Accordingly for periods ended on or after 31 March 2017 a tax loss arising from the stress will be eligible to set against 50% of profits arising in other group companies in future periods.  This would represent a source of LACDT that is not available under the current loss relief rules.  There may be some difficulties in forecasting future profits with sufficient accuracy to demonstrate that it is probable that loss relief will be available.  The PRA are sceptical about using group relief as a basis for LACDT recognition and requires that the stress event is modelled for the company receiving the loss as well as the insurance company.  Similar points will probably be raised about setting brought forward losses against profits of other group members but are perhaps easier to satisfy given that the brought forward loss can be surrendered in any accounting period whereas group relief can only be surrendered  in the year of loss.

On the basis of the above and assuming that the proposals included in the condoc apply to insurance companies then I think the process for calculating LACDT would like something like this.

1. Allocate stresses between SII adjustments and IFRS base. 
2. To the extent stresses impact SII adjustments calculate LACDT via reduction in deferred tax liability for SII adjustments included in base balance sheet. 
3. Calculate impact of stresses on IFRS profits and calculate tax loss in year of stress.
4. Establish LACDT for loss carry backs and group relief.
5. Establish LACDT for loss carry forwards arisng from the IFRS stress, from 31 March 2017 this will be on the basis of the new loss relief so possible to look at group as a whole.

This is (probably) more complicated than the LACDT calculation under the present rules where the distinction between stresses that impact SII adjustments and stresses that impact IFRS / tax computations is not significant.  However, on the positive side I think that the new rules are not all bad news for LACDT recognition and there may even be companies who are able to recognise more LACDT using the new loss relief rules than they were under the existing rules.

However, the above assumes that the new loss relief rules do apply to insurance companies.  As set out in the condoc HMT are prepared to consider changes that will reduce the impact of the new rules on SII capital so we may end up with different rules for insurers. 

Life Assurance Manual and OLAB Guidance

The life assurance manual is no longer included in the HMRC manuals section of the gov.uk web site. It is currently in the archived section of gov.uk LAM.

Also HMRC's guidance on OLAB also archived.  Very out of date but still a useful summary of the highly complicated rules.

OLAB_2000

I've also saved down a copy and can send links if required.

The Prudential Assurance Company Limited v HMRC (Court of Appeal Decision)

The Court of Appeal decision in the Prudential portfolio dividends and ACT case has been published. The judgement is here and a summary here.

A summary of the summary:

The Court of Appeal dismissed the appeal on issues 1 - 20 but upheld the appeal on issues 21 - 23. As issues 21 - 23 are points of detail (on foreign dividends and the interaction of ACT and mainstream corporation tax), the position is largely as per the High Court judgement, and in particular:

Foreign source portfolio dividends for the periods covered by the GLO are not exempt from UK tax, but

Companies are entitled to credit relief for tax on foreign dividends equal to the higher of the foreign tax actually suffered on the dividend and the nominal rate of tax payable on profits in the dividend paying company's country of residence, capped at the UK rate of corporation tax.

For the purposes of calculating ACT, foreign dividends are to be treated as being FII, including a tax credit equal to the higher of actual foreign tax paid on the profits of the dividend paying company or the nominal rate of tax on profits in the dividend paying company's country of residence.

Basis for the "nominal rate" part of the calculation is that if a UK company ("A") receives a dividend from another UK company "B" and B has paid no corporation tax on the profit from which the dividend is paid then, as there is an exemption for UK dividends,  no tax is paid.  Assume there is a third company "C" resident in a country with a nominal rate of tax equal to the UK rate,  C ,however, pays no tax in its country of residence and pays a dividend to A.  If credit is only  allowed for the actual tax withheld on C's dividend then the dividend will be taxed at the UK rate with no credit relief.  C's dividend has been taxed at a higher rate than B's dividend, to make the taxation of dividends from B and C equivalent credit needs to be given for the nominal rate of tax.

HMRC have indicated they will appeal, this FT article refers.  I have been told (by people who understand these things) that it will be July before we know whether HMRC will be allowed to appeal.

But clear Court of Appeal not happy with the length of time taken in this case or the conduct of the case in general as is shown in paragraph 22 of the judgement:

"As Mr Ewart QC for HMRC opened the appeal to us it soon became clear that the lack of pleadings meant that the parties disagreed about what was the scope of the trial; what were the issues that the judge had to decide; whether points had or had not been raised; whether or not they could be raised on appeal; and even what the judge had decided. This is no way to conduct litigation involving millions of pounds. We were told that this unacceptably cavalier approach to pleadings was a common feature of this kind of litigation. It must stop."