Life Tax Measures - Update Following Publication of the Finance Bill

The Finance Bill 2003 was published on 16 April. It contains the changes foreshadowed by the Inland Revenue announcement on 23 December 2002. However a number of significant alterations to the proposals have been made.

The amending provisions are in clause 169 (Volume I of the Bill page 108) and the detail is contained in Schedule 33 (Volume II pages 373 to 396). As usual, the Bill was accompanied by Explanatory Notes issued by HM Treasury, the parts relevant to clause 169 and Schedule 33 being in Volume II of the notes, 72 pages under the heading "Board of Inland Revenue, Finance Bill 2003 Clause 169, Schedule 33".

The full text of the Bill is available on the United Kingdom Parliament website (www.publications.parliament.uk) and the Explanatory Notes are available on the HM Treasury website (www.hm-treasury.gov.uk).

This briefing provides an update on the life tax measures contained in the Bill, and changes made between the publication of draft legislation in January 2003 and the publication of the Bill.

The legislation is intended to reform:

Scope of Case I receipts

Treatment of insurance business transfers for tax purposes (including the carry over of losses and the Case I tax position of the transferor and the transferee)

Treatment of capital losses (the legislation is particularly targeted at the prevention of "bed and breakfasting" both externally and internally to the life company, and it is proposed to be amended to throw a ring-fence around policyholder chargeable gains and allowable losses)

The capital gains proposals apply to gains accruing and deemed disposals on or after 23 December 2002, although there is an exclusion for losses below 10m arising in the period between 23 December and 31 December 2003 (see below for further details). The majority of the other proposals will apply to periods of account beginning on or after 1 January 2003. Certain provisions which were not signalled in the 23 December press release or draft legislation published on 21 January 2003 are effective from Budget Day, or, if relieving rather than charging provisions, for periods of account beginning on or after 1 January 2003.

The rest of this article considers the provisions in more detail, and in particular the extent to which the provisions reflect (or do not reflect) concerns represented to the Inland Revenue, and any new provisions contained in the Finance Bill which were not contained in the original press release of 23 December or the subsequent draft legislation.

Case I profits of life assurance

The main thrust of the 23 December proposals has been incorporated into the Bill. The main Case I proposals as currently drafted are summarised below:

For periods of account beginning on or after 1 January 2003, where a life insurer transfers assets directly out of the investment reserve the amount of the transfer will be treated as a taxable receipt and included in the computation of profit (proposed new section 83(2B) FA 1989). The reference to "payments made" included in the draft legislation published in January has been removed. Despite this, the wording of the Explanatory Note (and the nature of the items which the proposed legislation is intended to treat as a taxable receipt) make it clear that it is not the intention to exclude cash transfers from section 83(2), or, indeed, section 83(3) (see below). Furthermore, the scope of the proposed provisions makes it clear that section 83(2B) is applicable to an insurance business transfer.

An exception is proposed to section 83(2B) FA 1989 for transfers of assets made for at least their fair value (proposed new section 83(2D) FA 1989). Furthermore, transfers of assets to discharge loan or other liabilities are excluded unless they constitute the discharge of a liability in respect of which the principal was brought into account on Form 40 but not taken into account as a receipt (proposed new section 83(2C) FA 1989). The latter is intended to "catch" repayments of contingent loans where the initial receipt was entered into Form 40 but not treated as a taxable receipt (see further detail below with regard to contingent loans).

Proposed new section 444AD of the Taxes Act provides a further exception to section 83(2B) for the value of assets transferred under an insurance business transfer scheme, where the transferor and transferee have jointly elected under proposed new section 444AD that the value should be transferred from the investment reserve of the transferor into the investment reserve of the transferee.

The draft legislation published earlier this year contained a further exclusion where payments made by the transferee directly or indirectly derive from amounts on which the transferor was charged to tax under section 83(2B) FA 1989. This would, for example, have applied where assets are transferred from the long term fund of the transferor into the shareholder fund of the transferee, and a contingent loan is made into the transferee to make up the shortfall. The section would have applied to prevent a double charge under section 83(2B) in both the transferor and transferee. The Inland Revenue have stated in their explanatory note that this is to be withdrawn.

Section 83(2) FA 1989 is proposed to be rewritten so that "other income" is "taken into account" as a Case I receipt, subject to certain limited exceptions.

Proposed new section 83ZA FA 1989 has been introduced to deal particularly with contingent loans, where, as highlighted in our January briefing, the initial proposals would have given rise to significant mismatches or even double taxation in respect of historic transactions, and would have jeopardised the efficiency of such funding in the future. The way in which section 83ZA operates is considered further below.

FA 1996 Schedule 11 (loan relationships) is proposed to be amended to provide that where an insurance company stands in the position of a debtor as respects a contingent loan made to a company within the meaning of section 83ZA, it is not regarded as arising from a transaction for the lending of money. Therefore the loan relationship rules apply only to interest in respect of it.

Changes are proposed to be made to the anti-avoidance provision contained in section 83(3) FA 1989, which operates to treat as a taxable receipt an addition to the long term fund which would not otherwise have been taxable, to the extent that the addition was made as part of or in connection with a transfer of business or demutualisation, and to the extent that the life company makes losses in the current period or future periods. A transfer of business is defined in current law as including a "total reinsurance", the definition of which is restricted to the reinsurance of business written prior to the reinsurance. Furthermore, a transfer of business does not include a transfer of business where the reinsurer is a "pure reinsurer". Both of these exclusions from the definition of "transfer of business" are removed. The impact of this is discussed further below.

Proposed new section 444AE of the Taxes Act deals with transfers of contingent loans under an insurance business transfer, and provides that a loan will be treated as having been repaid in the transferor immediately before the transfer and made to the transferee immediately after the transfer. This is presumably drafted to preclude arguments from taxpayer companies that the accounting treatment for the loan in the past was in a different company, and therefore the rules applicable to the repayment of that loan do not apply to the transferee.

Section 83AA(3) FA 1989, which required the matching of a "tainted addition" with a loss in the transferor in certain circumstances, is proposed to be repealed.

The deduction for policyholder tax is proposed to be redrafted (new section 82A FA 1989) so that it is not necessary that the tax be "expended in respect of the period of account". The effect is that a deduction for deferred tax provisions is no longer precluded. However the full extent of the policyholder tax deduction is subject to the publication of regulations, and the Inland Revenue have stated that stop-gap regulations may be required if definitive regulations cannot be agreed upon in time for Royal Assent.

Section 432E of the Taxes Act ("the Needs Basis") is proposed to be redrafted so that unallocated surplus arising in a mutual will no longer be diverted into BLAGAB (and therefore not taxed on the profits basis)...