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Taxation of long-term business 2

Allocation of profits between categories
Items other than investment return
Items other than investment return and, until 31
December 1999, loan interest payable, are allocated
between the various categories of long-term business on
an ‘actual’ basis. Premiums, claims, and the movement
in the liability to policyholders are split between categories
in the regulatory returns, and these splits should
be used as far as possible. Other items must be split, if
possible, by reference to the company’s accounting
records but, in some cases, such as allocating the cost of
support departments, an apportionment may be necessary
by reference to some suitable alternative measure.
For example, the cost of maintaining the computer system
may be apportioned by reference to the numbers of
policies in each category. For PHI and class VII the allocation
must be of items in the modified statutory
accounts. For life assurance business the allocation must
be of items in the regulatory returns.
Investment return and loan interest payable
The allocation of investment return is more complex
and reflects the different bases of taxation for the various
categories of long-term business. There are two
basic approaches: one is used for BLAGAB and CRB I
minus E and for the trading profits of PHI and class
VII, the other for the case VI businesses. The first
method is used for loan interest payable.
Mean fund apportionment
Mean fund apportionment is the term used to
describe the apportionment for I minus E, PHI, and
class VII. It seeks to apportion investment income,
chargeable gains, realised gains, and interest payable
by reference to an allocation of the long-term business
assets. Chargeable gains will be included in BLAGAB
and CRB I minus E. Realised gains will be included in
the PHI and class VII trading profits. Loan interest
payable will be included in BLAGAB and CRB I minus
E, in PHI and class VII trading profits, and in the computations
for the case VI businesses.
The allocation here is made by reference not to the
assets themselves but to the liabilities of the long-term
business. The allocation to each category is then
expressed as a percentage of the total and the percentage
used to apportion the income and gains.
The allocation has three steps:
calculate, for each category, the mean liabilities to
policyholders (‘mathematical reserves’), including
declared bonuses from the regulatory returns;
deduct the mean amount of property-linked assets;
and
add amounts for the mean tax investment reserve
(TIR) which is that part of the long-term liabilities
disclosed in the regulatory returns over and above
the mathematical reserves and declared bonuses;
this would include both liabilities which have
fallen due and the value of additional amounts not
yet appropriated to policyholders.
The first and third of these steps produce an allocation
of mean total assets. The second ensures that the
percentages only reflect the split of assets not linked
to particular categories.
There are three supporting allocations to consider:
net assets which are property-linked to more than
one category are split by reference to the mean
property-linked mathematical reserves of those
categories;
the TIR is split by reference to mean with-profits
mathematical reserves plus reversionary bonuses,
unless these are less than 5% of the total, in which
case it is split by reference to mean total mathematical
reserves; and
once the amount of the mean total assets,
including linked assets and the share of the TIR,
allocated to OLAB is known, specific assets are
attributed to this category up to this amount and
are then treated as if they were directly linked to
this category.
Once the apportionment fractions have been determined:
income and gains from property-linked assets
linked to one category or those attributed to OLAB
are allocated to those categories;
income and gains from property-linked assets
linked to more than one category are apportioned
to those categories by reference to property-linked
mathematical reserves;
the remaining income and gains are apportioned
by reference to the mean fund apportionment
fractions;
loan interest payable on loans attributed to property-
linked funds is allocated to the categories to
which those funds are linked;
other loan interest payable is apportioned by reference
to the mean fund apportionment fractions.
Apportionment for case VI businesses
Apportionment is also needed for the profits of the
case VI businesses. The subject of the apportionment
is the investment return from the regulatory returns,
whether investment income or the movement in
investment values brought into account. There are
two methods used: one for with-profits business and
one for non-profits business. Where parts of the longterm
fund are dealt with as separate funds, including
separate forms 40 and 58, in the regulatory returns,
the methods are applied to each part separately.
The method for a fund or part of a fund containing
with-profits business is principally designed to ensure
that the profit before technical tax adjustments for
each category is that proportion of the surplus for the
period after deducting bonuses which the bonuses
allocated to the category bear to the total bonuses.
The investment return is that needed to achieve this
result and the method is known as the ‘Needs’ basis.
If the Needs basis investment return proves to be consistently
lower, it will be replaced by an alternative
measure based on the rate of investment return actually
recorded in the regulatory return or, if lower, a
particular gilt yield. This alternative, which is very
rarely required, is known as the ‘Floor’.
The method for a fund or part of a fund containing
no with-profits business is similar to mean fund
apportionment, except that the TIR is excluded from
the calculations. One effect of this is that the mean
fund apportionment used to apportion investment
income and gains for I minus E may differ significantly
from that used for investment return for the
case VI businesses. In some cases more than 100% of
the income may fall into the various computations
and in other cases less. A further difference is that the
direct attribution of assets to OLAB is taken from the
mean fund apportionment but is only used to apportion
investment income from the regulatory return. A
percentage must be calculated for OLAB in the same
way as for other categories, and it is then used to
apportion the movement in investment values
brought into account.
Consequences
The taxation of a particular investment made by a
long-term fund will depend on:
whether it is directly property-linked to a category
of business;
if not, the categories between which the investment
return from it will be apportioned;
the treatment of investment income and gains
from it for BLAGAB and CRB I minus E and PHI and
class VII profits; and
the treatment of investment return from it in the
regulatory returns for the case VI businesses.
Technical adjustments
General
Where adjustments would be required in the tax computations
of companies generally, those adjustments
are made to the computations of companies writing
long-term business. The adjustments must, however,
be allocated among the categories of long-term business
for inclusion in the computation in the same
way as the accounting items to which they are adjustments
for tax.
Income
Income for I minus E is generally that arising from the
assets of the long-term business, but there are three
areas worthy of specific note:
The taxation of income from, and capital movements
in, loan relationships is generally determined
by the accounting treatment, in the case of
long-term business in the modified statutory
accounts. However, for life assurance business (but
not other long-term business), an election system
has been available for periods up to 31 March 2000
whereby a company could elect asset by asset and
period by period for assets accounted for on a
market-to-market basis to be taxed using the accruals
basis. This election was originally due to expire
on 31 March 1998. It has been extended twice but
has now been ended.
Certain specific areas of investment activity such as
foreign exchange, financial instruments (principally
interest rate derivatives), and loan relationships
are subject to tax on an accounts basis. The
tax regimes normally applied here are modified for
life assurance business and apply only to amounts
apportioned to BLAGAB. They are disapplied for
the case VI businesses which are taxed only by reference
to what is brought into account in the regulatory
returns.
Certain profits from investments are generally taxable
as trading profits but not as investment
income or chargeable gains. Examples include stock
underwriting and unit trust management fee
rebates. These are treated as miscellaneous income
for I minus E and the amount apportioned to
BLAGAB is taxed there.
Gains
Special provisions apply to investment in collective
investment schemes. Where gains from such investments
would be apportioned to BLAGAB, the investments
are deemed to be sold and reacquired at the
end of each accounting period. The resulting gain is
then spread over seven years for inclusion in the I
minus E computation.
Expenses
Special provisions apply to expenses of acquiring business
and to commissions in particular. Where such
expenses are allocated to BLAGAB, relief for the
expenses must be deferred and spread over seven
years for inclusion in the I minus E computation. •
Jargon buster
BLAGAB
basic life assurance and
general annuity business
class VII
pension fund management
CRB
capital redemption business
I-E (I minus E)
investment income and
chargeable gains less
expenses
ISAB
individual savings account
business
LRB
life reinsurance business
OLAB
overseas life assurance
business
PB
pension business
PHI
permanent health insurance
TIR
tax investment reserve

01_06_06.pdf