Clause 55 - Overview

Part of Finance Bill – in a Public Bill Committee am 10:30 am ar 19 Mehefin 2012.

Danfonwch hysbysiad imi am ddadleuon fel hyn

Photo of Mark Hoban Mark Hoban The Financial Secretary to the Treasury 10:30, 19 Mehefin 2012

Mr Bone, it is a pleasure to serve under your chairmanship on this sunny Tuesday morning. We can make huge progress in this morning’s sitting by debating over 120 clauses. I am sure that you will be relieved to know that I shall not be discussing each clause and schedule in detail individually, but if members of the Committee so wanted, I am sure that I could arrange for that to happen. However, I thought that I would try to set out why we are seeking to replace the existing tax regime for life insurance and what the benefits of the new regime are. Importantly, I also want the Committee to have confidence in that approach, and I want to discuss the consultation that happened between the Treasury and the insurance sector to get to this point.

Clauses 55 to 179 establish a new tax regime for life insurance companies and friendly societies—friendly societies are covered in part 3 of the Bill. The clauses represent a wide-ranging and fundamental revision of both the basis on which life companies’ taxable profits are computed and the detailed rules by which those profits are taxed. The changes will enhance the effectiveness of the tax system and bring the taxation of life companies more in line with that of other companies, as well as with the commercial realities of the life insurance business. In addition, the changes support the Government’s policy of reducing complexity in the tax system.

The UK insurance industry makes an important contribution to our economy. It is the largest in Europe and the third largest in the world. Life insurance companies play a vital role in providing pensions, life and health protection, and investment products. The Association of British Insurers estimates that, in 2010, there were some 21 million pension policies in force, along with 13 million life protection policies and 10 million savings policies. The insurance industry is also an important source of Government revenue, with life insurance companies paying £1.2 billion in corporation tax in 2009, including £720 million paid on the behalf of policyholders.

As I have said, this is a wide-ranging revision of the tax rules for life companies. The package of changes amounts to some 127 pages of legislation in total, with the new core regime contained in fewer than 80 pages. To put that in context, we are repealing some 147 pages of existing primary legislation spread over 22 Acts. There will also be significant reductions in the 80 pages of secondary legislation that support the existing regime. For instance, the regulations concerning friendly societies will be reduced from 38 pages to just seven.

Let me give the Committee some background. The changes are made necessary in part by the solvency II directive—an EU directive looking at the solvency of  insurance companies—which triggers a need to change the basis of life insurance taxation in the UK. Currently, one of the unique features of the taxation of life companies is that taxable profits are not, as is the case for companies generally, based on their accounting profits. Instead, taxable profits are derived from regulatory returns made to the Financial Services Authority. Under solvency II, the regulatory returns made by insurance companies to the FSA will no longer provide the information necessary to make the current basis of taxation work. Change is therefore essential.

I will now set out the main areas where we are making changes and explain how we have worked with industry groups to ensure that the rules are workable. The first area is trading profits, which will be calculated on the basis of life companies’ accounting profits. This is a significant change and is welcomed by the industry. It will simplify life company taxation and bring it into line with general tax rules.

Secondly, life companies are uniquely subject to the income minus expenses, or I minus E, basis of taxation. This ensures that tax is collected both on the profits and on the investment income accruing for the benefit of policyholders. This will continue but, unlike now, the scope of I minus E will be restricted to the type of business where it is appropriate to tax shareholder profit and policyholder income together. Life protection business such as term assurance, which does not attract significant investment return, would therefore be excluded from I minus E. This is acknowledged by the industry as a sensible rationalisation. It would simplify the system and eliminate distortions which can lead to competitive disadvantage for some companies.

The third main change is that the system will be simplified further by amalgamating two of the three existing categories of insurance business recognised for tax purposes. The new combined category will comprise what is currently “gross roll-up business”, such as pensions and annuities, and home and health insurance, including critical illness policies. It will also contain life protection business written under the new regime. Again, the industry firmly supports this change.

The fourth change concerns the allocation of income gains and profits. The allocation of income gains and profits between the categories will in future be determined by reference to the commercial activities and processes of individualcompanies. Currently they are determined by statutory formulae which are often arbitrary in their impact and do not reflect commercial reality. Again, the industry very much welcomes this alignment of tax with the commercial nature of the transactions. The fifth and final point is that in a number of areas life companies will be brought within the rules applying to companies generally, simplifying the tax system greatly by reducing the need for special provisions for the sector.

On the question of the tax impact of the changes, those cannot be assessed with certainty. In particular, the tax yield, including transitional arrangements, is sensitive to future movements in equity and bond markets. The Office for Budget Responsibility has forecast the market developments, and that has been used to help project the tax impact of these changes. On the basis of these projections we expect that over the first four years of the new regime, which is the forecasting horizon that we use, the changes will result in an increase in tax receipts as set out in the Red Book.

This is work that the Treasury has conducted in collaboration with the industry and other stakeholders, and their contribution has been vital to ensuring that we get the regime right. The clauses have been subjected to extensive consultation and the process has attracted some positive comments across the board. The Association of British Insurers said that it would like to express its

“appreciation of the consultation process with HMRC which has been open, thorough and very professionally conducted.”

Informal consultation started in 2009 and since then we have maintained close co-operation with the insurance industry and other stakeholders through a series of joint working groups. These working groups have considered the complex and difficult technical issues in detail, and—this relates back to Opposition amendments—we have set up a forum to identify and consider particular concerns of friendly societies and mutual life assurance companies. The work of these groups is continuing and will help to ensure a smooth transition to the new regime.

We have issued two consultation documents and held a series of 13 well-attended open meetings to consider aspects of the new regime. There has been ongoing dialogue with individual insurers, representative and professional bodies and industry advisers. Throughout, consultees have contributed fully and constructively. This has greatly added to our understanding of the issues, and many of the changes we are making owe a great deal to suggestions we have received.

Concerns have been raised in a number of areas, and significant adjustments have been made to the legislation in the light of representations. These include the relief for policyholder deferred tax provisions, the transitional arrangements, the targeted anti-avoidance rules and the carrying forward of trade losses into the new regime. We have sought to accommodate industry concerns, where possible, without putting the Exchequer at risk or introducing unnecessary complication. Overall, the industry has welcomed the collaborative approach we have taken to the consultation process and supports the regime we are introducing.

Since the Bill was introduced, we have continued that consultation, which has highlighted the need for Government amendments to address points of detail in four areas. None of those amendments represents a change of policy; they are technical adjustments to ensure that the rules will operate effectively and as intended. In all but one case, the need for amendments was identified by consultees. The amendments have been discussed with industry representatives and have benefited from the comments received.

The amendments may be placed into four groups. Amendments 135 and 136 amend clause 126, which provides appropriate relief where losses on loan relationships are reflected in both the trading result and the I minus E result. The need for a restriction of losses is acknowledged by the industry, but we received representations that the rule, as currently framed, could restrict relief in certain circumstances where that would be unjustified. The amendments eliminate that possibility.

Amendments 137 to 143 amend clauses 129 and 130. The amendments address transfers of business between connected companies, based on two issues identified by the industry.

Amendment 144 amends paragraph 154 of schedule 16, which addresses the way in which certain reliefs may be carried back to an earlier period so that the full benefit is obtained. Further consultation made it clear that the amendment is needed to ensure that the measure works in all circumstances.

Finally, amendment 145 amends paragraph 27 of schedule 17, which addresses the transition of life companies’ holdings of securities into the new regime. We have become aware that the rules would have permitted indexation allowance to create or enhance a capital loss when disposing of securities, which is not generally permitted under capital gains rules. The amendment ensures that excessive allowable losses do not arise.

Opposition amendments 195 and 196 would prevent the making of regulations under clauses 151 and 152 without prior consultation with interested parties. Unsurprisingly, given the nature of previous amendments tabled by the Opposition, the amendments also require the Chancellor to lay before the House a report on the impact of any such regulations—a recurring theme in this debate.

Clause 151 applies the rules on mutual life assurance companies to friendly societies and permits regulations to modify those rules, as necessary. Regulations have been made under a similar existing power. Clause 152 applies the rules on the transfer of long-term business between companies to friendly societies and also permits regulations to modify those rules, as necessary.

The Government stand firmly behind the idea of mutual co-operation and support on which friendly societies, and the mutual model generally, is founded. The Government are also committed to fostering diversity within the financial services industry, in which friendly societies play an important role. Moreover, the Government fully support the type of consultation and transparency for which amendments 195 and 196 call—I have already talked about the extent of the consultation we have undertaken to deliver the new regime—but the amendments are unnecessary. Regulations under clause 151 have been drafted, and we are already discussing those with the industry. That consultation and liaison will continue, allowing us to monitor the impact and operation of the regulations. Copies of the draft regulations have been provided to the Committee with the letter that my hon. Friend the Exchequer Secretary sent on 11 June.

The regulation-making power under clause 152 rewrites an existing power that has not been used. We have no current plans to make such regulations, and, of course, we would consult if any regulations were necessary.

Those simplifications should be seen alongside other tax changes we have made, or are making, that will benefit the life insurance industry. We are making major changes to the taxation of foreign profits, which will reduce compliance burdens, provide flexibility to UK headquartered groups and make solvency II-related, cross-border restructuring easier. Additionally, the industry will benefit from the branch exemption introduced last year and the reduction we are making to the corporation tax rate.

This package of tax reforms enjoys the broad support of the life insurance industry, providing the UK with a more effective, commercially orientated regime for the  taxation of life companies, simplifying the tax code and making Britain an even more attractive place to do business. I commend the clauses, schedules and Government amendments to the Committee.