The changes only apply to UK companies, so non-UK companies, individuals and trustees are not affected.

The legislation applies to what it defines as ‘investment life assurance contracts’. This includes investment bonds, capital redemption bonds and life assurance contracts which acquire a surrender value. For clarity, life assurance contracts which cannot accrue a surrender value are outside the scope of these rules. In addition:

• Policies of life insurance (but not annuities or redemption contracts) which were held at 13 March 1989 and which have not been enhanced since are entirely excluded from the legislation.
• Where the difference between a lump sum pay-out on death or the onset of critical illness and the surrender value at the time of the claim results in the lump sum pay-out being greater than the surrender value, only the surrender value at the time of payment for death or critical illness will be included for calculating tax under the loan relationship rules.

Under the loan relationship rules corporation tax will, in principle, be charged each year on profits, gains and losses arising on a year-on-year basis.

The tax charge on any profit will depend on how the policy is accounted for by the company. The two methods of accounting we are going to consider within this document are fair value and historic cost. Please note that it is unlikely that a company can change its accounting basis easily and this would need to be discussed by the directors of the company and the company accountant.

Under this method, any increase in the value of an investment life assurance contract over an accounting period will be taxed as a non-trading credit (NTC).

For example, where a company has an accounting period of 1 August to 31 July, it will be the surrender value of the policy on 31 July 2009 (say, £110,000) minus the surrender value on 1 August 2008 (say, £100,000) which provides the NTC (in this example £10,000).

Under this method, there is no increase year-on-year within the accounts. Instead, only when partial or full withdrawal is taken which causes a possible gain will any gain be taken into account. So, where in the example above the increase value of the policy is shown at the end of the accounting period, under the historic cost basis the value stated in the accounts would be the same as that shown at the start of the accounting period (ie £100,000 at both 1 August 2008 and 31 July 2009).

Where a company falls within the Financial Reporting Standards for Smaller Entities (FRSSE), its accounts may be able to be prepared on the historic cost basis. The FRSSE is a standard that may be applied by companies that qualify as ‘small’ under the Companies Act and other entities that would have qualified as ‘small’ had they been incorporated. There are a number of criteria which need to be considered to establish if a company can apply the FRSSE standard.

An example is that two out of the following need to be met:

1. Turnover is £6.5 million or less.
2. Balance sheet total is £3.26 million or less.
3. The average number of employees is 50 or less.

Examples of both these accounting bases follow.

For a UK company that held an existing investment life assurance contract in force as at 1 April 2008, the legislation sets out a formula to determine how future withdrawals will be taxed from the start of the next accounting period on or after 1 April 2008. This includes a ‘deemed’ surrender occurring at the start of the first accounting period beginning on or after 1 April 2008.

For example, company ABC Limited has an accounting period starting 1 June. The new legislation is applied from 1 June 2008. On this date any investment life assurance contracts held will be ‘deemed’ to be fully surrendered and a full surrender calculation will need to take place, although no tax liability will arise at this time.

Any chargeable event gain arising to the company on this ‘deemed’ surrender will be brought into account as a non-trading credit in the accounting period in which the company actually disposes of its interest (or part interest) in the policy. Any gain made after this date will be taxed under the loan relationship rules, not the chargeable event rules. In particular, the 5% tax deferred allowance will no longer apply.

If the policy is fully surrendered before the next accounting period begins, the existing chargeable event legislation will apply ie prior to 31 May 2008 for ABC Limited.

The formula for these calculations is described as: P/SAR = B

P = Paid and is the amount paid by reason of the related transaction,
SAR = Surrender All Rights and is the amount that would have been payable on a surrender of all of the rights under the contract immediately before the related transaction.
B = The amount of ‘Chapter 2 gain’ subject to corporation tax at this time.

The legislation defines any gain from the ‘deemed’ surrender as a ‘Chapter 2 gain’. The Chapter 2 gain will then be brought into account when a future part surrender or a full surrender is made.

For a company which adopts a historic cost basis then the deemed surrender gain would be avoided.

Fair value basis example

The assumptions are as follows:

• Company A has an accounting year 1 May to 30 April.
• Directors of Company A invested £98,000 in an offshore investment bond on 1 March 2008 and the bond is now worth £100,000 at the end of the accounting year.
• No withdrawals have been taken.
• Company A is subject to corporation tax at 26% in 2011/2012 tax year, 28% in 2010/2011 tax year.
• Deemed full surrender takes place in accordance with the new legislation and a £2,000 Chapter 2 gain is realised (although no tax is payable at this point).

Accounting year – 1 May 2009 to 30 April 2010
Fair value basis 1 May 2009 = £100,000
Fair value basis 30 April 2010 = £110,000
So the NTC is £10,000 which is subject to corporation tax at 28% (£2,800).

Accounting year – 1 May 2010 to 30 April 2011
Fair value basis 1 May 2010 = £110,000
Fair value basis 30 April 2011 = £115,000
So the NTC is £5,000 which is subject to corporation tax at 26% (£1,300).

Accounting year – 1 May 2011 to 30 April 2012
A full encashment of the investment bond is made on 12 December 2011.
Fair value basis 1 May 2011 = £115,000
Fair value basis at Surrender Date (12 December 2011) = £118,000
So the NTC is £3,000. However, we also need to bring into account the Chapter 2 gain which is £2,000.

As already stated, a company holding a UK life assurance investment policy previously received no relief for any life corporation tax suffered within the policy.

The Finance Act 2008 introduced the ability for a credit to be given for the life company corporation tax paid within the life policy from the accounting period after 1 April 2008. Corporation tax will still be based on the company’s accounting basis (year on year), with a credit for the life policy taxation available only on full surrender of the policy.

For more information please contact your Business Consultant.