LAM05110 - Apportionment rules: Allocation of BLAGAB and non-BLAGAB trade profits: FA12/S114-115

This section explains the requirements for the allocation of trade profits to BLAGAB and non-BLAGAB.

An acceptable commercial method for allocating trade profit is likely, in practice, to follow closely the allocation methods for income and gains. As explained below, the allocation of profits arising from with-profits business is likely to be an exception to this general practice. However, the requirement is for consistency rather than exact alignment given that in this case it is general accepted accounting profits ‘GAAP’ profits that are being allocated as opposed to income and chargeable gains. The general principle is that the commercial allocation methodology for trade profits results in an allocation that fairly represents the contribution made be each category of business

The results of this allocation will feed in to the calculation of:

• the non-BLAGAB trade profits or losses LAM07010.
• the BLAGAB trade profits for the purposes of the minimum profits test LAM07230.
• BLAGAB losses for purposes of any loss relief LAM15000.
• the split of I-E profits between shareholder and policyholder LAM06000.

As for allocation of income and gains, there are some particular considerations for trade profit allocations depending on the structure of the life company business.

As most of the trading income is usually reserved to fund tax deductible payments to policyholders, the investment return on non-BLAGAB income does not generally produce a substantive net tax liability.

With-profits funds – allocation of trade profits

As stated in LAM05070, a with-profits fund is a pool of assets backing a defined block of long-term business. The shareholder is entitled to a defined revenue flow from the with-profits fund.

The shareholder revenue is typically defined in one of two ways. For older policy designs (often referred to as conventional business) the shareholder is entitled to a proportion of policy bonuses (often 1/9th of the bonuses). This business is often referred to as 90/10 business. For policies where policy benefits are determined by reference to with-profits units (referred to as unitised with-profits (UWP) business) the shareholder is typically entitled to a percentage of the value of the with-profits units. Both types of business may be written in a single with-profits fund. The rules for determining the profit due to the shareholder and the manner of allocation of all other value between policies are set out in the relevant PPFM. The PPFM will prescribe how policyholders’ bonus entitlements are calculated and the amounts that are to be transferred to shareholders from time to time (share of bonus or percentage of the value of UWP units etc.). Both are calculations that will often be determined by ‘asset share’.

The contribution of with-profits funds to trade profits is the amount of transfers to shareholders less any expenses of with-profits fund policies that are not otherwise charged to the with-profits fund. The transfers to shareholders are subject to scrutiny by with-profits actuaries and with-profits committees.

The trade profit calculation aims to determine the shareholders’ share of BLAGAB (and therefore non-BLAGAB) profits. There is a direct correlation between the percentage of bonuses transferred plus the percentage of UWP fund values transferred and shareholders’ profit realisation from a with-profits fund. Therefore, the split of bonuses and percentage of UWP fund values between BLAGAB and non-BLAGAB policies can provide a reasonable basis for a commercial allocation of with-profits fund trade profits. For example, if the percentage of bonuses and percentage of UWP fund values from a with-profits fund in a particular period were split between BLAGAB policyholders and other policyholders in the proportion 25:75 it would be reasonable for the allocation of the shareholders’ profits to be allocated between the two categories of business in the same proportion. Other methods may be appropriate depending on the particular circumstances.

The tax adjustments, are allocated to the two separate businesses in a way that fairly represents the contribution made by those businesses to the accounting profit or loss as adjusted to take into account the tax adjustments.

Assets not in a with-profits fund – allocation of trade profits

The allocation of profits generated outside a with-profits fund between BLAGAB and other long-term business should reflect the contributions of the various categories of business.

In practice, the allocation methods for income, chargeable gains and expenses will already provide information on how income and gains are allocated within the company. The trade profit calculations will in practice reflect the same type of allocations – reflecting what is in the books and records of the company for income, gains and expenses.

Where the company commercially manages particular streams of business and separately calculates profits for those streams the same allocation may be followed for tax purposes.

To the extent that amounts not allocated to a with-profits fund are not directly attributable to particular business streams, for example income from a pool of non-linked assets, an indirect commercial allocation method as used for income and gains, will be needed LAM05060. Any approach adopted for allocating trade profits should be consistent with that used when identifying the BLAGAB element of income and expenses for the “I-E” computation (FA12/S115).