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EXPLANATORY NOTE CLAUSE 72:ACQUISITIONS DISREGARDED UNDER INSURANCE COMPANIES CONCESSIONS SUMMARY 1. This clause gives statutory effect to an undertaking given by certain insurance companies when they entered into non-statutory arrangements with the Board of Inland Revenue. It ensures, for accounting periods after the proposed ending of those arrangements, that trading profits arising from intra-group transfers of investments which escaped tax under the terms of the arrangements are brought into charge on the disposal of the investments. 2. Under the arrangements the profits and losses from General (non - Life) business of insurance companies within each group were computed and assessed to tax as if the group were a single company. The arrangements permitted trading profits on intra-group transfers of investments to be excluded from the group assessment. The undertaking in question ensured those profits were brought into tax on a disposal of the investments outside the group by requiring the profits or losses on that disposal to be computed by reference to the cost of the investments to the group company which first acquired them. The Board has notified insurance companies of its intention to withdraw the arrangements for accounting periods beginning on or after 1st January 1999. Without the benefit of the undertaking insurance companies gave on entering the non-statutory arrangement, profits and losses on disposals of such investments in accounting periods after the withdrawal of the arrangements might, under existing law, have to be based on the cost of the investment to the group company making the disposal or, for investments subject to the "loan relationship" rules for corporate and government debt, on the latest value in the company’s accounts. The clause prevents this outcome, which would allow profits deferred under the terms of the arrangements on earlier intra-group transfers to escape tax altogether, by giving statutory effect to the undertaking. 4. The clause allows for the possibility of transitional arrangements being entered into with the groups concerned, having effect for a limited period, to permit an orderly withdrawal from the full arrangements. The clause has effect for disposals made in accounting periods beginning on or after 1st January 1999. ___________________________ DETAILS OF THE CLAUSE THE CONDITIONS 6. Subsection (1) sets out the tests to be met before the section can apply to the disposal of any asset by a company, called the relevant company in the clause. They are that
"insurance company" has the meaning given in the part of the Taxes Act dealing with such companies - subsection (8) "group" takes its meaning from the rules in the Taxation of Chargeable Gains Act 1992 - subsection (7)) "asset" includes any asset which was exchanged for or converted into the asset being disposed of, where the rules in section 473 ICTA 1988 allowed a tax free exchange - subsection (9). This also applies to assets exchanged under sections 471 and 472 (certain gilts) which contain their own provisions equating the assets for tax purposes. "relevant event " is defined in subsection (6), in relation to any asset, as either a disposal outside the group or another event which the terms of the arrangements required to be treated as an occasion on which a profit or loss was calculated for tax purposes. THE OPERATIVE RULES 7. Subsections (2) to (4) set out the main operative rules, depending on the nature of the asset and its previous tax treatment. The object of each of the subsections is to bring into account on a disposal by the relevant company any profit which was ignored by the non-statutory arrangements. 8. Subsection (2) deals with the disposal of assets where any liability to tax arises only on disposal or realisation. These assets are known as "realisation basis" assets, and include all assets which an insurance company holds as portfolio investments backing its insurance business except for "loan relationships", that is company and Government debt, which have their own rules. Realisation basis assets are mainly shares but can include other assets such as real property. Where "realisation basis assets are sold, the excess of the sale proceeds over the cost to the company is brought into account as a profit in the period of realisation. The subsection, taken in conjunction with subsection (5), provides that where the cost of these assets is to be brought into account the cost figure to be used is, in effect, an amount equal to the original cost of the assets to the group. The subsection preserves reliefs available in 1999 for intra-group transfers under any transitional provisions for withdrawing the non-statutory arrangements. This result follows because the subsection applies only where the cost of acquisition of an asset has to be taken into account for tax purposes. 9. Subsection (3) deals with the disposal of assets now represented by "creditor relationships". This phrase takes its meaning from the loan relationships legislation in Finance Act 1996 (subsection 8) and covers debt assets held by a company. The subsection, taken in conjunction with subsection (5), ensures that where the original cost to the group of the asset is less than the notional closing value (NCV) of the loan relationship at 31 March 1996 that cost is to be substituted for the original NCV in calculating the figure to be brought into account under Paragraph 6(2) or 6(3) Schedule 15 FA 1996 as a loan relationship trading credit or debit on the disposal. The NCV is used in the transitional rules for loan relationships where an asset previously taxed on the realisations basis moves to the new basis applying to all loan relationships. It ensures that any profit accruing on the asset up to the start of the loan relationships rules is brought into account when the asset is finally disposed of outside a group. By substituting the original cost to the group for the original NCV any profit ignored on a transfer to which the arrangements applied is effectively brought in when the loan relationship is sold outside the group. 10. Subsection (4) gives a special rule for the disposal by the relevant company of loan relationship assets which were the subject of a "spreading" election under Paragraph 6 (4) of Schedule 15 FA1996. This election meant that a company did not wait until it disposed of an asset outside its group before bringing in the accruing profit at 31 March 1996 when the loan relationships rules started. Instead it allowed a company to elect to bring in the combined accruing profits and losses on all its assets in equal amounts over 6 years. The subsection provides that the amount to be brought into account under the election is not disturbed. It also provides that where there is a profit that was ignored in a transfer under the arrangements on an occasion before 1 April 1996, it is to be brought into account on a disposal of the asset outside the group as a trading receipt under the loan relationships rules. 11. Subsection (5) applies generally to subsections (1) to (4). It ensures that the cost to be used in any calculations of profit or loss in subsection (2) and in comparing cost with NCV in subsections (3) and (4) is the original cost to the group of the asset being disposed of - being the cost to group company which either held it when the arrangement was entered into, or which acquired it subsequently from outside the group -regardless of whether there has been one or more than one intra-group transfer of the asset to which the arrangements applied. The subsection works by looking back through the previous intra-group transfers of the asset to which the arrangements or the loan relationship group rules applied until there is a transfer to which they did not apply. The cost of the asset to the acquiring company on that transfer is the cost to be used for the purposes of the clause. 12. Subsection (9) ensures that the transfer of a creditor relationship within a group after 31 March 1996 is not treated as a disposal for the purposes of this clause. OTHER PROVISIONS 13. Subsection (10) gives a definition of non statutory arrangements for the purposes of the section. The first definition will be of relevance to accounting periods ending before the proposed withdrawal of the full arrangements for accounting periods beginning on or after 1st January 1999. The second definition caters for the possibility of transitional arrangements in 1999 14. Subsection (11)(a) ensures that amounts to be brought into account for tax purposes under this clause do not include gains which have been or will be taken into account under the Foreign Exchange Gains and Losses transitional provisions in FA 1993. 15. Subsection (11)(b) makes explicit the Board’s power to enforce whatever rights it may have under the terms of the arrangements. 16. Subsection (12) gives the starting date for the application of the section to disposals made by the relevant company. ____________________________ BACKGROUND 17. Since 1968 the Board of Inland Revenue has allowed insurance companies to enter into a non-statutory arrangement for computing and making returns of trading profits. The arrangement is confined to UK companies and groups. It allows profits on a group’s general (non-life) insurance business to be taxed as if the group were a single company. The 1968 arrangement formalised practices which, for a few insurance groups, had previously been agreed on an individual basis. The detailed terms of the arrangement have varied from time to time, but have always included undertakings that ensure tax on profits realised when assets are moved within the group is brought into charge when the assets leave the group’s ownership. The arrangement is described in Chapter 11 of the Board’s General Insurance Manual which is available under Open Government. The standard terms of the arrangement in force since October 1994 are set out in an annex to this note. The arrangements paralleled similar dispensations that were sometimes given by the Department of Trade and Industry to permit groups to submit a consolidated supervisory return. The intention behind the arrangements was that they would save work for both the groups and the Inland Revenue. Whilst it was always recognised that the arrangements contain significant concessionary elements, both the Inland Revenue and the insurance industry saw administrative rather than tax savings as the main driver. 18. The proposed withdrawal of the arrangements was prompted by a variety of reasons. First, the commercial world and the tax system have moved on since the arrangements came into being. With the introduction of corporation tax self assessment, the arrangements no longer had administrative value for the Inland Revenue. Furthermore new legislation did not and could not reflect the existence of non statutory arrangements of this type and its interaction with existing legislation was problematic. Since 31st March 1996 Paragraph 12 Schedule 9 FA1996 has allowed no gain /no loss intra-group transfers of loan relationship assets. This has made a significant part of the terms of the arrangements redundant. And the arrangements, which in some respects treat companies within a group as one for administrative purposes, are incompatible with the obligations imposed under corporation tax self assessment. It can thus be said that the arrangements have reached the end of their useful life. There was also concern about the behaviour of certain groups in response to the arrangements. Whilst these groups had remained within the terms of the arrangements, their use of the concessionary element, allowing profits to be deferred for tax, went far beyond its intentions. The arrangements provided planning opportunities not permitted by statute or tax case law and not available to other large commercial groups. And non-statutory arrangements of this kind are open to justifiable criticism as undermining Parliament’s authority over the taxing system. Thus it was no longer thought appropriate to maintain in existence a basis of taxation for which there was no statutory cover. The Clause makes a distinction between investments which now represent loan relationships and those which do not. Where the investment is now represented by a loan relationship, any profits deferred on intra-group transfers up to 31st March 1996 (the date from which the relevant part of the loan relationship legislation took effect) are effectively brought into charge on disposal of the investment as loan relationship trading credits. For other investments the clause works by substituting the original cost to the group company which first acquired the investment for the cost to the company making the disposal in calculating the profit or loss on that disposal. 21. Gains which have been or will be taken into account under the Foreign Exchange Gains and Losses transitional provisions in FA 1993 are excluded from the amounts brought into charge by the clause, as are deferred profits on intra-group transfers of investments already taken into account for tax under other undertakings in the arrangements. For example, the arrangements provided that when a company to which the arrangements applied was sold out of its group, profits deferred on assets previously transferred to it would at that point, to the extent they were not otherwise brought into account, be charged in the group’s tax assessment. 22. Deferred profits arising on intra-group transfers of assets (on transfers before 31st March 1996 where the assets transferred are now represented by loan relationships) to a company leaving the group in an accounting period beginning on or after 1st January 1999, are left by the clause to be charged to tax on the outgoing company as and when it eventually disposes of the asset. 23 Negotiations are taking place with the Groups and their trade body (the Association of British Insurers) about the proposed ending of the arrangements. The clause allows for transitional measures following withdrawal of the full arrangements to have effect. Individual companies within each group will for accounting periods within corporation tax self assessment be required to submit returns and self assess. But the clause will permit the exclusion of trading profits on intra -group transfers of assets from the self assessment for the transitional period (to the extent that this is not already allowed by the ‘loan relationship’ rules). This will enable the Board to agree with insurance companies any special rules necessary for an orderly ending of the arrangements. 24. Example of the operation of the clause Companies A, B and C are members of the ABC group, an insurance group that entered into a non-statutory arrangement with the Board of Inland Revenue on standard terms in 1991. 1990 sale of a block of shares from an unconnected third party to Company A for £100. 1994 Company A sells the shares intra-group to Company B for £130 (their then market value). 1998 Company B sells the shares intra-group to company C for £135. (their then market value). 2000 Company C sells the shares to an unconnected third party for £150.
Scenario A Without the Clause and assuming the undertaking given by the group when entering into the arrangement was not honoured
Scenario B With the Clause
In scenario B all the conditions of subsection(1) of the clause are satisfied in relation to the intra - group transfers of the shares in 1994 and 1998. Subsection (2) of the clause, taken in conjunction with subsection (5), requires the cost to be brought into account in calculating the profits or losses on the disposal by Company C in 2000 to be an amount equal to the original cost of the shares to the ABC group.. This original cost is the cost of the shares to Company A in 1990 when it bought them from the unconnected third party for £100. ________________________________ ANNEX EXTRA-STATUTORY GROUP ASSESSMENT The Board has agreed to an extra-statutory arrangement under which the principal company of a group of insurance companies may elect to have a single assessment made on it on the combined Corporation Tax profits less losses of the constituents of the group. The arrangement applies only to non-life business and there will be separate assessments on each company in respect of profits from long-term insurance business. Particulars of the arrangement are as follows:-
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