LAM14050 - Finance Act 2012 Transitional provisions: Disregard of amounts previously taken into account: deferred acquisition costs (DAC) and deferred income reserve (DIR): FA12/SCH17/PART2/PARA22
If an amount has been taken into account for tax purposes before 1 January 2013, it is not to be included in any future trade profit calculations. Similarly, if an amount has been brought into account as an I-E expense before 1 January 2013 it is not to be included in any BLAGAB I-E calculation after 1 January 2013.
In practice, DAC and DIR are the most obvious accounting items which potentially either fall out of account or are taxed twice but there are likely to be others. Paragraph 22 applies whenever there is a mismatch between the pre and post-2013 rules so that amounts fall out of taxation or are recognised more than once.
Life insurance companies incur costs to acquire business but do not necessarily write these off immediately in the accounts. Acquisition costs are generally spread over an appropriate period of years, depending on the nature of the policies to which they relate. As a result, there will be an amount of deferred acquisition costs (DAC) held on the balance sheet as an asset which have not yet been deducted in the profit and loss account. Similarly, there will be an amount of deferred income reserve (DIR) representing premium or other income relating to a future accounting period which has not yet been recognised in the profit and loss account. More information on accounting for acquisition costs is in LAM07040.
However, in the regulatory return, acquisition costs and premium or other income were written off or recognised in full. In comparing the balance sheets, the regulatory balance sheet will have zero DAC and DIR but the financial statements balance sheet will have what is often a sizeable DAC asset and also some DIR.
In comparing the balance sheets as at 31 December 2012, the provision at FA12/SCH17/PARA7(2)(a) treats DAC as an excluded item. DIR was treated as an excluded item under FA2012/SCH17/PARA7(2)(e) and Regulation 4 (Category 7) of the supplementary regulations at SI2012/3009.
This means that the DAC and DIR on the balance sheet at 31 December 2012 are ignored for the purposes of calculating deemed receipts or expenses under those provisions.
Therefore, as no opening adjustment has been made to take into account the earlier tax treatment of DAC and DIR, the transitional provisions require adjustments in the tax computation for the DAC and DIR held at 31 December 2012 as they are released to the profit and loss account in the financial statements.
In practice, methods will have been agreed for identifying the amount of DAC and DIR in the profit and loss account that relate to periods prior to 1 January 2013. These will have to take account of the company’s accounting policies as well as the method for allocating income and expenses between categories of business.
For computations from 2014 onwards, it will be necessary to understand what has been agreed, and on what basis, and obtain any necessary comfort that the agreed approach has been followed.