21 March 2000
LIFE & GENERAL INSURANCE COMPANIES AND LLOYD’S MEMBERS
Summary of measures
Changes are to be made to the tax rules applying to insurance companies and Lloyd’s members to make them fairer.
The Government considers that the current treatment of both general insurance companies and Lloyd’s members needs reform. General insurance companies and Lloyd’s members will face a claw back of the tax benefit they get by not discounting their provisions for unpaid claims. This rule will also apply where they significantly overestimate the provisions they make for claims settled in future years. There will be an exemption for Lloyd’s members writing only small amounts of business.
The measures to claw back the benefit of tax deferral will apply for company accounting periods beginning on or after 1 January 2001 and, in relation to individual members of Lloyd’s, for the tax year 2001-02. But such individuals will fall outside the rules where a member participates in only a very small proportion of a syndicate’s business.
The detail of the legislation will be in regulations made under powers to be included in the Finance Bill. This will allow the Inland Revenue to consult with the industry closely over the detail to ensure that the scheme is effective but also keeps compliance burdens to a minimum.
Clear rules will also be laid down for the attribution of interest payable by life assurance companies to different types of business.
A. General insurance companies and Lloyd’s members
1. The new rules bring general insurance companies and Lloyd’s members broadly into line with other companies. Other businesses with long term provisions must follow accounting standards which require a best estimate, discounted where material. They also bring the UK more into line with other major insurance markets.
2. The new rules will apply to provisions for unpaid claims, claims handling expenses and unexpired risk reserves, including in the case of Lloyd’s, reinsurance to close contracts. Insurers will remain free to decide the right level for these provisions. But if it turns out they have had tax relief for significantly more than the value of the claims actually made, discounted by reference to the time the provision was established, they will have to pay what amounts to an interest charge on the tax deferred. The rate of interest will be designed to do no more than cancel the advantage a company got by obtaining too large a tax deduction. Companies and Lloyd’s members will, though, be given a new freedom to have only part of their provisions taken into account for tax purposes. This will help those who wish to establish their tax liability with certainty now rather than risk the uncertainty of a higher tax bill in a future year. There will also be two rules to avoid the need for tax adjustments. The first will apply in all cases where provisions have only slightly exceeded the discounted best estimates of the claims to which they relate. The second, as mentioned above, will eliminate the need for adjustments for Lloyd’s members, where a member participates in only a very small proportion of a syndicate’s business.
3. These measures will apply for company periods of account beginning on or after 1 January 2001 and, in relation to individual members of Lloyd’s, for the tax year 2001‑02. The calculations which test whether there has been a benefit from tax deferral will operate on the basis that provisions for periods of account commencing before 1 January 2000 all related to liabilities incurred in the year 2000. And the new rule allowing insurance companies and Lloyd’s members to limit the amount they deduct in respect of their claims provisions to a figure lower than that disclosed in their accounts will come into force for periods of account beginning on or after 1 January 2000 (and correspondingly for Lloyd’s individual members in the tax year 2000‑01).
4. The detail of the legislation will be in regulations made under powers to be included in the Finance Bill. This will allow the Inland Revenue to consult with the industry closely over the detail to ensure that the scheme is effective but also keeps compliance burdens to a minimum. In relation to members of Lloyd’s, the Government has considered the level at which the exemption should be set where a member participates in only a small proportion of a syndicate’s business. The Government is minded, subject to consultation, to adopt a figure of 4%. The Government believes that this limit strikes the right balance between ensuring that the new rules remain effective and avoiding unnecessary complexity. It anticipates that the effect of the proposed limit will be that most individual members of Lloyd’s, and most member companies controlled by individuals, will fall outside the scheme.
5. Anti avoidance legislation aimed at controlled foreign companies (“CFCs” - primarily companies in tax havens) will be strengthened by these changes. Groups sometimes use CFCs which are captive insurance companies in tax havens to reduce their tax bills. The proposed legislation will help to ensure that any advantage they get is reversed. Other measures applying to CFCs are described in Budget Note REVBN2K.
6. The new rules will not apply to long term business such as life assurance, nor will they apply to companies carrying on business on a mutual basis.
B Apportionment of interest payable
7. Life assurance companies are taxed in different ways according to the nature of the business they write. Income and gains arising in relation to pension business and some other types of business are exempt from tax, while income and gains relating to ordinary life assurance business are taxable in the hands of the company.
8. A life assurance company does not generally separate out in its books the income and assets relating to different kinds of business, so rules have been developed to ensure that the right amounts are attributed to each of the different sorts of income. But these rules do not apply to interest and other finance costs payable by the company.
9. Until recently life assurance companies have not usually paid out much by way of interest on loans because they have tended not to borrow. But some companies have begun to borrow significant amounts, often in relation to reinsurance arrangements or transactions in derivatives and other financial instruments. The amounts involved make it desirable that there should be clear rules to show a company how to attribute the interest to the different types of business.
10.The rules will follow closely the rules that apply to interest income, but there will be variations to deal with special types of interest such as interest on the late payment of claims. There will be other minor changes to the rules for apportionment of life insurers' income and gains to ensure that the legislation currently in force produces broadly the results originally intended. These changes mainly affect insurers much or all of whose business involves policies where benefits are linked to the performance of specified assets.
11.The new rules will apply for accounting periods beginning on or after 1 January 2000 and which end on or after today.
A. General insurance companies and Lloyd’s members
1. A discounted reserve is one which recognises the return from investing funds set aside now to meet a future liability. For example, at an expected rate of return of 6%, £750,000 set aside now would be enough to meet a liability to pay £1 million in 5 years’ time.
2. Under existing law insurance companies get tax relief not only for the claims they pay out but also for reserves to cover the cost of settling claims which are not yet finalised. Insurance companies are obliged by Schedule 9A to the Companies Act 1985 to calculate their reserves on a prudent basis. They may, under certain conditions, discount their reserves, but in practice rarely do so.
3. This requirement to create reserves on a prudent and usually undiscounted basis differs from the accounting rules for other companies. A company other than an insurance company may not create reserves for claims unless there is a very good chance that they will materialise, and in general must discount its reserves.
4. The position with Lloyd’s syndicates is somewhat different. Here the syndicate is entitled to deduct the premium for “reinsurance to close (RITC)”. This performs a similar function to an insurance company’s provision for unpaid claims. The Inland Revenue had thought that for tax purposes a syndicate should calculate its profits on the footing that only a best estimate of its liabilities – which might reflect an element of discounting and which might be less than the RITC premium paid to reinsure those liabilities – would be allowed. But, in a tax appeal heard last year, the General Commissioners for the City of London decided that the Revenue’s understanding of the law was erroneous. Having taken legal advice, the Inland Revenue has now decided not to challenge this ruling.
5. Lloyd’s members are taxed on an underwriting year basis, with a three year deferral of profits. The measures to claw back the benefit of an excessive deduction for liabilities will be introduced for the 1998 syndicate year of account. This is taxed in 2001 for corporate members and in 2001/02 for individuals. Syndicates will be able to reduce tax deductions for the 1997 year of account in anticipation of the new rules. And the new rules will for Lloyd’s members treat all liabilities that arose before 1997 as if they arose in 1997.
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