For many insurers, the move to an accounts-based commercial allocation will require significant management. Proposed methodologies will need to be explained to, and agreed with, HMRC.
Replacement of the previous formulaic allocation of non-linked amounts to BLAGAB is welcome but there are new challenges relating to both non-linked assets backing policy liabilities and surplus assets. For example, methodologies may need to be developed to deal with negative liabilities, the treatment of reattribution plans and cross subsidies between products. However, overall we expect the treatment of income items to be less problematical than for gains. While gains allocation has improved, with revised rules now aligning the capital gains boxes with share pools, the requirement to allocate gains to BLAGAB ‘to fairly represent the contribution that the asset has made to BLAGAB during the period’ introduces historical complexity.
The commercial allocation of accounting profit to the BLAGAB and OLTB trade profit calculations will involve separate challenges, for example identifying and excluding profits on shareholder grandfathered and structural assets; and the allocation will need to be consistent with the income and gains allocation.
As the I-E profit will be BLAGAB only, the amount charged at policyholders’ rate and the minimum profits test will be driven by BLAGAB trade profit (BTP). That profit should be derived from accounting profit using commercial allocation consistent with that used for the I-E calculation. It is adjusted as under the current regime plus any relevant transitional adjustments. However, the amount of policyholders’ tax deduction is now more carefully specified and includes current and deferred tax. Current tax being the tax charged at policyholder rate for the period - so iteration is still necessary. Deferred tax must relate to specified BLAGAB items and be calculated by reference to the policyholders’ rate. Companies may need to refine how they calculate deferred tax.
The shareholders’ share of BLAGAB non-taxable distributions deducted in the minimum profits test uses a new fraction (essentially profit divided by income plus gains, with I+G on a tax rather than accounts basis). This should give more consistent results, avoiding the previous defaults to 0 or 1. However, the fraction is likely to be lower than at present as expenses are excluded from the denominator. Consequently, shareholder effective tax rates are likely to increase.
Should there be a BLAGAB trade loss this can be carried back, set off against other profits of the company or group relieved. However, the available loss is restricted by any BLAGAB non-trading deficit of the company. This is a significantly harsher restriction than with the current regime.
There are two imperatives; model the likely impacts of the new regime and talk to HMRC about commercial allocation. Both need to be started now as time is short and we expect both insurance groups and HMRC will face resource constraints. The lead time for making any necessary systems changes looks tight.