Purpose • Update on progress and wider context • Feedback on formal consultation • Chapter 4 of consultation document
Agenda and Contents • Update on progress – Andy Stewardson • The wider context of company taxation – Jeremy Tyler/Lisa Cristie • LATP and Accounting Issues – Peter Drummond • Tax Adjustments to Accounting Profits – Andy Stewardson • Consequences and Opportunities for computation of I-E Profits – Carol Johnson • General Insurance Issues – Dave Moran/Stephen Brown • Potential Wider Reform of the I-E Regime – Robert Baird/Lisa Cristie • Contact Details • Open Forum
Updated timetable (indicative only) • Was Now • Announcements PBR 2010 Budget 2011 • Main legislation FB 2011 FB 2012 • Solvency II effective from 1/11/2012 1/1/2013 • 5 extra months to develop options? • 7 extra months to develop legislation?
Industry concerns • Possible reduction in HMRC/HMT resource and loss of momentum. • Need for clarity when modelling for: • Internal model applications • QIS 5 • Commercialplanning • 3. Sought firm direction of travel for early 2011 in key areas.
Industry “key areas” • Life 1. Shape of the LATP calculation. • 2. Unrelieved expenses and losses on transition will be carried forward for offset against appropriate future income. • 3. Income and gains previously taxed under the old regime not to be taxed again under the new regime. • 4. Any deferral of taxation of “unavailable” amounts 5. Future of the I-E regime. • GI 1.Future of CERs. • 2. Extent of any spreading of reserving changes.
Government response • We want to help, but at the same time… • We must not pre-empt ministerial choices • We must not give false assurances (to protect all sides) • We must not facilitate tax avoidance • Emerging clarity
Emergency budget 22 June • Rate cut to 24% funded by CA changes and bank levy • Programme of corporate tax reform (5 year road map) to be set out in Autumn, for consultation
Objectives of CT reform • a broad tax base, • a low tax rate, • a more territorial approach so as to improve competitiveness of UK corporate tax regime
Potential scope of reform? • CFC reform (long term and interim) • Foreign branches • Taxation of IP, R&D tax credits • Other reforms that might help fund further CT rate cuts or provide material simplification
Approach to reform? • Tax policy making: a new approach • consultation on design and scrutiny of draft legislation • Intention is to have a period of reform followed by stability: e.g. legislation for new CFC regime in spring 2012
A new basis for life assurance trade profits (“LATP”) • Key proposal in Consultation Document:- LATP should be based on profit reported in the accounts • Responses indicated general acceptance of this principle • Main advantages - this basis would be audited and consistent with companies in general • But this was just the starting point: • - how would the profit figure be used? • - what adjustments would be made to that figure?
Alternatives to the accounts • No specific suggestions emerged for an alternative to the accounts on an ongoing basis • However, suggestion that existing FSA Return basis could be maintained for tax purposes only as a transitional measure (e.g. until IFRS 4 Phase II fully implemented) • This will need detailed consideration as part of discussions on measures needed to deal with transition
The starting point • Required starting point is a figure for Profit Before Tax attributable to shareholders • Potential difficulties around split of policyholder and shareholder tax • Emerging consensus: • best to start with Profit Before All Tax and then make adjustments as appropriate (including for policyholder tax) • a rule setting out the principle that the starting profit figure should be gross of all tax would be better than detailed mechanical rules to achieve this
Other aspects of the LATP starting point • No reason not to apply the general rule as for other companies that profits be computed in accordance with generally accepted accounting principles (“GAAP”) • Profit would need also to include other relevant items included outside the profit and loss account (e.g. in reserves) • Detailed consideration will need to be given to the separation of profits from life / non-life business reported in a single P&L/income statement • Special cases such as OLICs and Mutuals will need separate consideration
Accounting developments • Consensus: life companies will be deemed ‘publicly accountable’ so required to adopt IFRS in full under the Accounting Standards Board’s proposals • However: for insurance contracts UK GAAP forms basis of IFRS 4 Phase I – significant uncertainty over future of ABI SORP and FRS 27 • So if IFRS 4 Phase II not applicable until 2014 or later, could still be an uncertain transitional period and a variety of bases for technical provisions: e.g.
Transitional measures • No clear view that special transitional measures required for transition from UK GAAP to IFRS (if applicable) • Covered by existing tax provisions • In general should not be major differences due to degree of convergence • However, important there are specific transitional measures for move from: • FSA Return to accounts • IFRS 4 Phase I to IFRS 4 Phase II • Common view: some form of spreading needed for transitional adjustments
Transitional issues • A number of specific items will need detailed consideration – in particular in move from FSA Return to accounts • Key elements include: • Important to consider impact of more than one change in quick succession • Defer transitional differences from 1st change? • Ignore transitional differences where clear will reverse on subsequent change?
Fund for Future Appropriations (“FFA”) • Consultation asked specific questions about the FFA (UDS in IFRS terms) • Responses clarified that: • FFA relates only to With Profit funds – although it can encompass non-profit business written in a WP fund • Use of FFA governed by ABI SORP • Transfers to FFA determined by allocation of bonuses, so…. • .…in practice limitations on FFA imposed by various formal factors • However, FFA has uncertain future under IFRS 4 Phase II
Next steps • Further detailed discussion with Working Group on tax adjustments to accounts profits – as covered in next session
Consultation Document Paragraphs 2.20 to 2.42 • Scope: • Application of general tax rules to life companies • Profit volatility • Treatment of profits “unavailable” to shareholders
Application of general tax rules to life companies • Consensus that general tax rules should apply unless there is a clear case to the contrary. • Suggested areas for review: • Intangible fixed assets • Capital allowances on management assets • Research & Development • Land remediation • Substantial Shareholdings Exemption
FFA/UDS and mitigation of volatility for with-profits business • General agreement that FFA/UDS provides an effective spreading facility. • FFA defined in Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410): • “This item is to comprise all funds the allocation of which either to policyholders or to shareholders has not been determined by the end of the financial year.” • “FFA is a bi-product of actuarial valuation of surplus, but mechanically, the transfer to/from the FFA ensures that the balance on the technical account reflects the profit derived from the declaration of surplus.”
FFA/UDS and mitigation of volatility for with-profits business • Not clear how IFRS 4 Phase II will treat value not allocated between shareholders and policyholders. • Differing expectations about basis for split between liabilities and equity. • Concerns for mutuals as to how a nil starting profit is achieved without FFA/UDS.
Mitigation of volatility in fee income for linked business • Unanimous that no special measures needed. • Potential transitional issues around treatment of reserves for investment contracts included in FSA reserves but not statutory accounts.
Volatility in fixed liability (NLNP) business - 1 • “The inherent profit volatility of non-linked non profit business should be no different whether that business is written in a non profit company, a non profit fund in a with-profits company or in a with-profits fund.” • “Profits on NP business in a WPF are largely paid out to policyholders and can be smoothed.” • “A smoothing mechanism for NLNP business is justified.” • “No need for a special regime for NLNP business.”
Volatility in fixed liability (NLNP) business - 2 • If changing asset values can be reflected in expected yields, the volatility in a NP fund is mitigated - so depends if liquidity premiums can be reflected in liabilities. • “For annuities, if there is no liquidity premium allowed in valuing liabilities under Solvency II, insurers would be exposed to potentially catastrophic movements in profits.” • “The profit volatility would be expected to be modest, as investment risk will be smaller than in WP business.” • “As a mutual we object to tax on profits on NP business in addition to I-E policyholder tax paid.”
Volatility in an accounts-based regime - 1 • Sources of volatility • Accounting volatility caused by measuring economically matched assets and liabilities on different bases. • Economic volatility from use of FV for unmatched assets. • Insurance risk • No recognitions basis. • Movements in intangibles will be brought into account. • May be no FFA/UDS to mitigate volatility. • Volatility on annuities may increase depending on liquidity premium issue.
Volatility in an accounts-based regime - 2 • Key impacts • “Tax revenues to HMT will be volatile and unpredictable.” • “There will be high likelihood of tax losses becoming trapped.” • “Volatility of taxable profits will impact on the ability of companies to recognise deferred tax assets - negative impact on balance sheets and share prices.” • “Business model will have to adapt to tax volatility.”
Volatility in an accounts-based regime - 3 • Unique features of life assurance • “In long term business the final profit is not known until the policy ends.” • “It is unreasonable to handicap the operation of the longer term nature of the contracts by short-termism when it comes to taxation.” • “Volatility not bad in itself, but problems where cash availability and taxable profits do not match.” • Interaction of I-E with LATP. • Policyholder interests - Insurance companies do not speculate on own account. • Insurance risk (mortality, morbidity, lapse etc ) on liabilities.
Volatility in an accounts-based regime - 4 • Suggested remedies • Extended carry back of losses over ten years. • Spreading of the payment of tax liabilities over 6 years. • 3 year profit averaging. • Equalisation regime. • Carry back / group relief for XSE
Profits “unavailable” to shareholders - 1 • “Inequitable for shareholders to pay tax on profits that are not yet available to them.” • “SCR is as an additional liability to policyholders because it provides support to policyholders and as such should be tax deductible.” • “Companies Act requires distributable profit to be declared as surplus.” • “Recognitions basis implies that life companies are a special case.” • “General tax law does not provide a principle linking taxation of profits to availability to shareholders. But life tax law does.”
Profits “unavailable” to shareholders - 2 • What are “unavailable” profits? • Profits “encumbered” by Court or FSA requirements to retain as capital. • Amounts released from reserves to meet capital requirements. • Excess of S2 liabilities over accounts • WP profits not allocated (eg FFA/UDS) • “We reluctantly conclude – in part by analogy with for example banks – that profits meeting solvency requirements may be more similar to business commitments.”
Consequences and Opportunities for Computation of I-E ProfitsCarol Johnson
Chapter 2 concerned with • Computation of Life Assurance Trade Profits • Consequential changes to I-E computations • Opportunities to simplify and address current problems • Apportionment rules • Questions 2.45,2.47,2.52,2.53,2.57,2.60 -2.63 relevant to last 3 bullets and Working Group 2
Consequential changes –loss of shareholder fund/ long term-insurance fund distinction • Condoc responses • Companies likely to continue to maintain LTIF and SHF distinction in internal records • Investment company treatment justified by role SHF assets play in supporting long-term risks of the life assurance business • Any change would need to recognise that certain assets represent fixed capital - extension of structural assets definition suggested • Transitional issues are important. • Working group discussion • How is SHF to be defined in absence of regulatory requirement
Consequential changes - determining policyholders share of profits • Condoc responses • Almost universal agreement that the current basis of allocation should be suitably adapted to refer to the accounts instead of the regulatory return. • Acceptance that there was a discussion to be had about the taxation of GRB profits particularly when those profits emerge in a mutual .
Opportunity for change - PHI into GRB • Condoc responses • General agreement that it should be considered. Concerns over transitional arrangements. • Suggestions included taxing GRB and PHI together on an actual Case I basis and moving to a BLAGAB only I-E.
Opportunity for change – build up of excess E • Condoc responses • Acknowledgment that operation of section 85A exacerbates build up of excess E and general concern that moving to accounts based LATP will make the problem worse • Proposed solutions include • - Restrict I-E and LATP to BLAGAB and tax GRB and PHI together on actual Case 1 basis • - Allow carry back/surrender of excess E • - Reengineer section 85A • - Reclassify protection business as GRB
Apportionments • Condoc responses • No clear consensus with some suggesting minimal change and others advancing alternatives to current rules. • Split on desirability of single rule • Strong consensus that direct allocation should not be extended . Suggestion that companies should have the option to follow hypothecation and direct matching of assets with liabilities. • Split on the need to ensure 100% allocation of income and desire to continue with needs basis • Concern that rules could generate Case I profits in mutuals
General Insurance Issues • Impact on direct taxation of General Insurers: • Removal of regulatory requirement for Claims Equalisation Reserves • (CERs) resulting in related tax adjustments no longer being available • If new Solvency II methodology for calculating insurance technical • reserves is followed for financial statements there will be a one-off • transitional impact and a new method of calculation going forward with • potentially lower levels of reserves
Consultation Document Questions: CERs • How effective are current CER rules? • Impact of no replacement mechanism? • What should a replacement mechanism look like? • Administrative and compliance costs? • How should built up reserves be released?
Consultation Document Responses: Effectiveness of current CER rules • No significant effect on smoothing of profits generally • Significant part of volatile business not included within current rules. • Trigger points for releasing reserves set too high
Consultation Document Responses: Impact of no replacement mechanism • UK competitiveness reduced as many EU member states will be keeping a • tax effective CER notably France, Germany, Ireland, Italy, Netherlands & • Spain • Increased profit volatility
Consultation Document Responses: Shape of replacement mechanism • Based on current system but with some modifications • Suggested modifications • - include greater proportion of volatile business • - increase number of CER classes • - review calibration of CER calculation