LAM03210 - Calculation of ‘I’ Income and chargeable gains: Box transfers: FA12/S116
Background
The rules for determining the extent to which a chargeable gain or allowable loss is referable to BLAGAB are detailed at LAM05100. In summary where assets are matched with BLAGAB liabilities the gains on disposal (or deemed disposal) of those assets will be referable to BLAGAB. If the assets are not matched then chargeable gains or allowable losses will be allocated on the basis of a commercial method.
As the chargeable gain element of “I” is transaction based (in that the accrued gain/loss only comes into charge on a disposal) there is a potential distortion and vulnerability in the life company apportionment rules as they relate to gains. This is because a gain can accrue, perhaps over many years, while an asset is matched to one type of business. However, the gain may crystallise when the asset is matched with a different type of business, since matching is simply an internal allocation of assets by the business. Absent specific rules a change in that allocation will not generate a disposal for gains purposes. For example, absent special provisions, it would be possible to change the matching of a BLAGAB asset so that it becomes a pension (non-BLAGAB) matched asset prior to disposal and therefore not generating a chargeable gain in the I-E profit calculation.
In order to address this risk, the legislation contains what has become known as the box transfer rules. These provisions ensure that a company cannot avoid tax by shifting assets internally between specified categories or ‘boxes’ which have different tax treatment.
The provisions deem a disposal to take place to crystallise any chargeable gain or loss accruing up to the point at which assets are transferred between categories of business or ‘boxes’. The deemed disposal is at fair value as defined in FA12/S139(1) – effectively market value. This is an essential part of ensuring that the commercial allocation rules work properly.
The boxes were also a feature of the pre-2013 legislation. Although the pre-2013 categories were different the broad intention was the same with the differences mirroring the apportionment rules in LAM05000. The transitional rules to deal with the shift from the old boxes to the new are referenced in LAM14070.
FA12/S116 deems a disposal when there is a transfer of an asset from one category, e.g. a specific pool of assets, to another. A life company may be managing certain collections of assets separately. These could be held to match specific policyholder liabilities such as in the case of unit-linked policies. Companies may have one or more with-profits funds where policies within the fund are entitled to a share of the profits of the business and in such cases the assets are held in a separately managed pool. There may also be separately managed pools held to comply with requirements arising from transfers of business or as part of capital requirements for regulatory purposes. For example as below:
| Type of fund | Description |
|---|---|
| Internal Unit-linked funds | Assets backing liabilities to policyholders where the benefits under the policy are linked to the value of those assets |
| With-profits (WP) funds | Assets backing liabilities under WP policies where benefits are in whole or part dependent on the profits of WP fund: typically, but not always, profits are split 90:10 or in some cases 100:0 |
| Sub funds within WP funds | These are separate pools of assets within the WP fund with their own rules for sharing of profits. There may be sub funds within funds – often set up as part of a transfer of business. These may be 90:10 or 100:0 (i.e. wholly policyholder) and/or have special restrictions on use of the funds. |
The FA12/S116 categories or ‘boxes’ may reflect these commercial arrangements, particularly in the case of separate with-profits funds. However this will not always be the case and for chargeable gains purposes the specific statutory basis applies. This will differ for example for unit-linked life (BLAGAB) funds where for chargeable gains purposes there is only one box for all the BLAGAB unit linked funds whereas commercially each unit-linked fund is separately managed.
The Boxes FA12/S116 Assets held for purposes of long-term business
The rules deeming a disposal when an asset transfers ‘boxes’ are in FA12/S116 which also defines the boxes. The following four categories in the long-term business below are regarded as separate boxes:
Diagram showing box categories of assets
There are potentially four types of boxes to consider:
- assets matched to BLAGAB liabilities
- assets matched to other long-term liabilities
- assets in a with-profits fund not matched to long-term liabilities
- assets not in a with-profits fund and not matched to long-term liabilities
Chargeable gains and allowable losses on non-matched assets will be subject to apportionment if long-term business liabilities include a mix of BLAGAB and non-BLAGAB.
If there is more than one with-profits fund in the insurance company, each with-profits fund is treated as a separate box-FA12/S116(3).
Transfers into or out of these boxes from elsewhere in the company (including long term business fixed capital LAM11030) or from other group companies are subject to special rules.
‘Assets matched to liabilities’ is defined in FA12/S138. An asset is matched to a liability if, in accordance with the ‘applicable method’ (broadly commercial allocation), some or all of the income or other return arising from that particular asset is specifically referable to that category of business.
To be ‘specifically referable’ the allocation of the income or other return is a consequence of a contractual requirement imposed on the company relating to the category of business FA12/S138(8).This enables chargeable gains relating to assets held to back all unit-linked life policy liabilities to be identified and calculated as if there was a single separate pool of assets. Under the terms of the relevant policies, an appropriate rate of tax on those profits will be charged to each of the individual unit-linked funds and deducted in determining the liability to policyholders.
Where there are assets in a life company that are not regarded for tax purposes as held for the purposes of the long-term business, there is a fifth ‘other than long-term assets’ box FA12/S116(6)(b). Assets falling within the definition of long-term business fixed capital FA12/S122 LAM11030 will be in this category Transfers from and to the long-term business boxes to and from the ‘other assets’ box are subject to special rules FA12/S116(5). LAM03210
The box rules are designed largely to protect the chargeable gains tax liability in respect of BLAGAB business. Therefore it follows that the separation of the long-term business assets into the multiple boxes shown in the diagram above does not apply where all the income of the company’s long-term business is chargeable to corporation tax under the trading rules - FA12/S116(4). In that case there will be at most two separate boxes: one for assets held for the purposes of the long-term business and, exceptionally, a second for other assets FA12/S116(6).
FA12/S117 applies the box rules to the assets attributed to the UK permanent establishment through which an overseas life insurance company effects or carries on life insurance business.
Interaction with TCGA: the appropriations to, and from, stock rules
The appropriations to, and from, trading stock rules at TCGA92/S161 could conceivably apply in principle to a transfer to and from, the other assets box inFA12/S116(6)(b) to another box. However, FA12/S116(5) has precedence being the more specific section.
Effect of a transfer between boxes
On the transfer of an asset (or part of an asset) between long-term business boxes, there is a deemed disposal and reacquisition at fair value for the purposes of corporation tax on chargeable gains FA12/S116(1). Where an asset moves from the matched non-BLAGAB box to matched BLAGAB box there will be no chargeable gain (because of the effect of TCGA92/S37 and S39 LAM07100). The base cost for any future disposal of the asset from the BLAGAB box will be calculated by reference to fair value at the time of the transfer.
Example: Deemed disposal
Lifeco has a UK equity unit-linked life fund (A), holding shares which are matched to its BLAGAB business. It also has a UK equity unit-linked pension fund (B).
Shares are reallocated internally from A to B at market value of £500k. Although the shares are still owned by Lifeco, the transfer between boxes triggers a deemed disposal
The chargeable gain is based on the fair value (equivalent to market value) of £500k less A’s CGT base cost of, say, £300k (including indexation to 31 December 2017). There is a chargeable gain of £200K to include in Step 1 of FA12/S75.
As the asset was matched to BLAGAB business before the reallocation, all of the chargeable gain will be BLAGAB. The base cost of the shares is now £500k.
Explaining the example
Without the S116 boxes, Lifeco could transfer the shares from the unit-linked life fund to the unit-linked pension fund with no chargeable gain arising as the shares remain owned by Lifeco throughout. After transfer, the shares would be within the pension unit-linked fund where any increases in value may be treated for tax purposes as accruing for the benefit of policyholders and will be reserved in the accounts. Accordingly any increases in value will not directly create additional tax liabilities for the company.
If the transfer was between two with-profits funds where there was a mix of BLAGAB and non-BLAGAB under rules, there would again be a deemed disposal of the whole of the asset from one with-profits fund share pool to the other, with only the proportion referable to BLAGAB being added at Step 1 of S75 (or step 2 if there was a loss). Modifications to the share pooling rules FA12/S119 facilitate the separate treatment of assets in different with-profits funds where there are disposals of shares which would normally be held in a single pool for chargeable gains purposes. LAM03230