Budget Notes


Who is likely to be affected?

1. Companies and friendly societies carrying on life insurance business and societies carrying on non-life business.

General description of the measure

2. Legislation will be introduced in Finance Bill 2008 to:

•    simplify the tax law relating to financing arrangements (contingent loans and financial reinsurance) used by life insurance companies;

•    align the tax treatment of transfers of tax exempt "other" business, between friendly societies with transfers of such business between a friendly society and a life insurance company;

•    change the definition of foreign currency assets introduced by Finance Act (FA) 2007, remove a requirement to certify the amount of these assets and allow companies to use the revised version for 2007;

•    remove the power to modify the computation of chargeable gains in respect of structural assets held by life insurance companies; and

•    repeal spent provisions and clarify the effect of provisions.

3. These changes are further products of the consultation on how to simplify certain aspects of the tax law relating to life insurance companies launched by HM Revenue & Customs (HMRC) in May 2006.

Operative date

4. The new financing rules will have effect for periods of account beginning on or after 1 January 2008.

5. The rules for transfers of tax exempt other business between different types of friendly society will have effect for transfers taking place on or after the date that Finance Bill 2008 receives Royal Assent.

6. The changes to the foreign asset rules will have effect for periods of account beginning on or after 1 January 2008 and ending on or after 12 March 2008, subject to the ability to elect for these rules to have effect for 2007.

7. The power to modify the computation of chargeable gains in respect of structural assets will be repealed from the date that Finance Bill 2008 receives Royal Assent.

Current law and proposed revisions

8. Life insurance companies have requirements for capital which cannot normally be met by straightforward borrowing. Instead they have used a variety of more complex financing arrangements including contingent loans and financial reinsurance contracts to meet these requirements. In many cases the arrangements do not give rise to any tax issues. However, HMRC has seen examples of financing arrangements which have been used to generate profits without tax being paid on them, instead of contributing to working capital. Legislation introduced in FA 2003 sought to give an appropriate tax treatment for contingent loans, but the legislation, in section 83ZA of FA 1989, is complex and mechanical in seeking to distinguish cases where there is tax avoidance from those where there is not, and until amendments made by FA 2007, was also seriously flawed.

9. Revised legislation will be introduced in Finance Bill 2008 to deal with financing arrangements. The revised legislation will impose a tax charge only when the financing arrangements are used to generate surplus which is transferred to shareholders and which would not have existed without the arrangements. It will not affect financing designed simply to provide working capital or improve solvency. The legislation will also give relief for repayments of loans or recapture of reinsured liabilities to the extent that surplus has been taxed.

10. Friendly societies are entitled to a tax exemption in respect of long-term health and other sickness business, commonly known as "other" business, which is not available to other companies writing insurance business. A more generous exemption is available to "old" societies, ones registered before 1 June 1973, compared to the exemption available to "new" societies. As the tax exemption depends on the nature of the society, a transfer of previously tax exempt other business from an old society to a new society would result in the loss of tax exemption. However, as a result of changes made in FA 2007, an old society can transfer its tax exempt other business to a life insurance company which remains entitled to the tax exemption for business in force at the time of the transfer. Therefore the law will be changed to allow the transfer of tax exempt other business between old and new friendly societies on the same basis as those between a friendly society and an insurance company. Accordingly the tax exemption will only be retained by the society in relation to business in force at the time of transfer. Any attempt by the transferee to write new tax exempt business or to increase the scale of existing tax exempt business will result in the loss of the exemption.

11. The term "foreign currency assets" (FCAs) was introduced by FA 2007 to describe assets backing overseas business, the income and gains from which are directly referable to gross roll-up business. To qualify as FCAs, there is a requirement that relevant assets must be certified as FCAs within 3 months of the company's year end. Operational experience in dealing with FCAs has brought to light some difficulties arising from applying the rules in practice. Legislation will be introduced in Finance Bill 2008 to amend the definition of FCAs (which will become "foreign business assets") and to improve the operation of the rules by removing the certification requirement. In addition the 3 month time limit having effect for 2007 will be changed to 12 months, and all companies will be allowed, but not required, to use the new rules for their 2007 tax return.

11. FA 2007 introduced a definition of "structural assets", which are assets that are treated as part of the capital structure of a life insurance company's business, rather than assets on a disposal of which a trading profit should arise. Accordingly gains on disposal of structural assets are only treated as chargeable gains. FA 2007 also included a power to modify the computation of chargeable gains from the disposal of structural assets, particularly where the assets were held in 1989 when there were major changes in the law. It has now been agreed that this power is unnecessary and will be repealed. Discussions continue about a possible extension (using another power) of the list of assets that will count as "structural assets".

Further advice

12. If you have any questions about these changes, please contact Richard Thomas on 020 7147 2558 (email: richard.thomas@hmrc.gsi.gov.uk) or Colin McHardy on 020 7147 2614 (email colin.mchardy@hmrc.gsi.gov.uk). Information about Budget measures is available on the HM Revenue & Customs website at www.hmrc.gov.uk