LAM07040 - Trade profits: Financial statements and tax rules: deferred acquisition costs, deferred income reserves and the value of in force business: FA12/SCH17/PARA22

The costs of acquiring new business, which may be significant, are deferred for accounting purposes. The costs are carried forward as an asset on the balance sheet and released to (that is, charged to) profit or loss over the period in which margins from the related policies are recognised. The Companies Act 2006 defines acquisition costs as the costs of acquiring insurance policies which are incurred during a financial year but relate to a subsequent financial year. The deferral of acquisition costs acts to offset ‘new business strain’, that is, the requirement to establish policyholder liabilities at inception of a policy in excess of premiums received for those policies.

Similarly, certain up-front fees received are often deferred and held on the balance sheet as deferred income, often known as a deferred income reserve. The annual movement on both Deferred Acquisition Costs (DAC) and Deferred Income Reserves (DIR) are recognised for both accounting and taxation purposes but there is a significant exception.

Prior to the introduction of the new life tax regime on 1 January 2013 both income and acquisition costs were fully recognised in the regulatory returns and therefore in the trade profit calculations (other than PHI) without deferral. This meant a transitional difference arose between the regulatory returns and accounts on the move from the regulatory return based tax regime to the FA12 accounts based tax regime. However DAC and DIR balances were excluded from the transitional calculation LAM14050. The result is that for tax purposes any movements on DAC or DIR balances which were in existence at 31 December 2012 will need to be excluded from the accounting profit in order to avoid double taxation or double relief being given. This does not apply to DAC and DIR referable to PHI.

Under FA12/SCH17/PARA22 any amounts which have been taken into account in calculating trade profits for an accounting period ending on or before 31 December 2012 are disregarded in the CTA09/S35 calculation. Insurers should have arrangements in place to track the pre-2013 DAC and DIR balances as they unwind in the post transitional accounts to enable tax adjustments to be made.

Another example where an adjustment under FA12/SCH17/PARA22 will be required is where the insurer acquired an asset described as the value of in force business (VIF) before 1 January 2013. VIF is an asset which relates to the future profits expected to arise from a portfolio of insurance contracts and arises when an insurer acquires a block of business from a third party. The carrying value of the VIF is tested for impairment and amortised through the income statement.

Although VIF was an asset which was not recognised for solvency purposes the cost of acquiring the VIF had the effect of reducing surplus, and therefore trade profits, in the regulatory returns before 1 January 2013. As an amount was taken into account in calculating profits any amortisation in the accounts is not deductible for tax if it relates to VIF acquired before 2013. Where the transfer of business took place under the FA2012 provisions VIF assets are specifically excluded from Part 8 by CTA09/S806(3)(a) and there are specific rules in FA12/S130 which govern whether VIF is relievable LAM13070.

The FA12/SCH17/PARA22 disregard applies widely to any amounts which were previously tax effective in the regulatory returns, and not brought into account on transition, and is not restricted to DAC, DIR and VIF.