LAM01080 - Introduction and long-term insurance business overview: taxation of products

The pay-out to policyholders on savings products (other than on death) is generally related to the premium paid and investment returns. How this is calculated depends on the policy terms. If this investment return was earned by an individual outside of a life policy, by holding investments directly, then tax may be due on investment income and capital gains (subject to allowances and exemptions).

The investment return accrues to the life company and, subject to some exceptions, is taxed within the life company. This is broadly a proxy for tax that would be payable by a basic rate taxpayer if the underlying investments were held directly. This is the justification for the so called ‘I-E’ tax basis which is explained in LAM02000. Policies that fall within the definition of Basic Life Assurance and General Annuity Business, more commonly referred to as ‘BLAGAB’ will be taxed on their I-E profits.

Not all savings policies are taxed as BLAGAB. FA12/S57 lists the exclusions of life assurance business from the definition of BLAGAB. LAM01140

Policies such as pension savings policies, ISA account business and overseas life assurance business are excluded from the definition of BLAGAB business. These types of policies benefit from falling outside the I-E basis. This is because individuals holding such investments through other vehicles would not be subject to income tax or capital gains tax on accrual of investment return, for example, in an ISA account. For pensions the policyholder (subject to limits) receives a tax deduction up front for contributions and is not taxed on the income and gains rolled up over the life of the savings policy. Instead the policyholder is taxed when funds are withdrawn from the policy or on receipt of income from a pension annuity purchased from the proceeds.

Overseas life assurance business is excluded on the basis that the policyholder is non UK resident and would not have a tax liability on income and gains.

Protection business is excluded on the basis that it does not include an investment return element for the policyholders and is therefore a ‘risk’ product. These policies, from 1 January 2013, are taxed on a trading basis in the same way as general insurance policies. Policies written prior to 1 January continue to be taxed as BLAGAB unless the election described in LAM14040 has been made.

The investment return on non-BLAGAB policies remains taxable income in the life company as part of the trade profit calculation. The trade profit is taxed after allowing a deduction for claims paid and provisions for future liabilities to policyholders, which will include the investment return passed on to policyholders. Effectively then, to the extent that the investment return is reserved for policyholders, there is no net corporation tax liability on the company on this income.