LAM01160 - Introduction and long-term insurance business overview: key concepts: simplified example of the I-E calculation
For BLAGAB the tax system is aiming to tax the company on both the shareholder profit and the policyholder investment return. The table below shows the components of the each of these elements.
| Company/ shareholder profit | Policyholder return | Total | |
|---|---|---|---|
| Premium | P | (P) | nil |
| Investment return | I | I | |
| Claims | (C) | C | nil |
| Expenses | (E) | (E) | |
| Opening liabilities | OL | (OL) | nil |
| Closing liabilities | (CL) | CL | nil |
| Bonuses | (B) | B | nil |
| Total | Trade Profit | Policyholder net return | I-E |
The I-E is subject to corporation tax. That part of the I-E representing the trade profits is taxed at the normal CT rate. The remainder of the I-E profit is taxed at the ‘policyholder rate’ linked to the basic rate of income tax (FA12/S102(3)). On maturity/surrender the policyholder will receive the net return with credit for basic rate tax. Depending on their personal tax position and any top slicing relief they will be liable for any higher rate or additional rate tax. There is no additional tax for qualifying policies.
In a simple case, for a (non-mutual) life company writing non-linked pension business (non-BLAGAB) and non-linked BLAGAB life business, the main components charged to tax can be summarised as:
- Non-BLAGAB trade profits based on commercial apportionment of the accounting profit taxed at the normal CT rate.
- I-E profits based on apportioned BLAGAB investment income plus BLAGAB chargeable gains less BLAGAB expenses.
- The I-E profit is then taxed at the normal CT rate (19% in 2018) up to the amount of the adjusted BLAGAB trade profits (apportioned using an acceptable commercial method).
- The balance of the I-E profit is taxed at the policyholder tax rate which is the basic rate of income tax (20% in 2018).
- This is subject to a ‘minimum profits test’. If the sum of the I-E profit is less than the BLAGAB trade profit, then the I-E charge is increased up to the amount of the BLAGAB trade profit and is all charged at the normal CT rate. This adjustment is matched by an increase in expenses carried forward in the I-E computation.
This is a highly simplified explanation to illustrate the principles. It does not set out all the adjustments required – in particular in relation to BLAGAB trade profit calculations. These are explained in the relevant chapters.
A numeric example to demonstrate the principles is as follows:
- total profits in 2018 were £1,000m.
- of these £600m were allocated to pension business (using commercial allocation).
- investment income and gains less expenses allocated to BLAGAB were £1,250m. (bear in mind that there is no direct link between the BLAGAB I-E result and the trade profit).
The highly simplified tax calculation would be as follows:
| I-E profit | £1250m | £’m |
|---|---|---|
| Taxable at normal CT rate | 400 @ 19% | 76 |
| Taxable at policyholder rate | 850 @ 20% | 170 |
| Tax on I-E profit | 246 | |
| Non-BLAGAB profits | 600 @ 19% | 114 |
| Total tax charge | £360m |
The I-E charge combines tax on the company trade profits with tax on the investment return accruing to fund policyholder benefits. The £1,250m may include loan relationships gains, income from property and interest bearing securities and chargeable gains less related interest and management expenses and loan relationship deficits. In this case the first £400m of the I-E profit is taxed at the normal CT rate of 19%. The balance of £850m is taxed at the policyholder rate of 20%.
The minimum profits test (not shown in the example) aims to ensure that tax is always paid on company trade profits (in this case it would be based on the £400m), even if there is a loss attributable to policyholders. In the past the CT rate was higher than the policyholder rate and attributing more profit to trade profit would result in a higher tax charge. With CT rates below the basic rate of income tax this is no longer the case.
The non-BLAGAB charge taxes the company on the profits it makes from pension and any other non-BLAGAB long-term business. The investment return on non-BLAGAB is included in the non-BLAGAB trade profit calculations. In practice, this return is offset by liabilities to policyholders. Non-BLAGAB is excluded from falling within the definition of BLAGAB (FA12/S57(2)(a)) and is therefore not subject to the I-E tax charge. The non-BLAGAB profit is taxed under CTA2009/S35 – FA12/S71.
This is a highly simplified example for illustration only. There is no minimum profits test adjustment required, nor any other complicating factors such as BLAGAB losses or excess BLAGAB expenses or other computational items such as double tax relief. A more detailed and realistic (although still simple) tax computation is set out in LAM08000 and cross references are made there to the relevant sections in the manual which explain the underlying basis.
The principal chapters covering the I-E charge are in LAM02000 (overview), LAM03000 (Calculation of Income ‘I’) and LAM04000 (Calculation of expenses ‘E’).