Because the rules permit a deduction for amounts calculated under regulatory principles, insurers drawing up accounts under international accounting standards, where there is no requirement to treat equalisations reserves as liabilities in the balance sheet, are still entitled to a deduction.
Lloyd's members have been able claim similar treatment following rules introduced in the Finance Act 2009, which had retrospective benefit for corporate members' 2008 tax returns, relating to business written from 2005.
With the introduction of Solvency II the need to maintain a separate regulatory equalisation reserve will disappear, and consequently so too will the benefit of the built up tax deduction for the reserve.
Following a lengthy period of consultation between HMRC and the insurance industry, draft legislation detailing how this will happen has been released as part of Finance Bill 2012. Various options were discussed as part of the consultation process, including a new tax-only equalisation reserve and recalibration of the formulae to create a more accurate or responsive reserve that more accurately reflects the fluctuations caused by the insurance cycle of market volatility. Neither of these was pursued as HMRC and HM Treasury felt there wasn’t a strong justification to continue the tax relief. This is a disappointing result, particularly in the context of general market-wide results for 2011, a year containing a significant number of natural disasters that create a genuine need for smoothing. It remains to be seen whether there will be a level playing field across the EU and whether other countries that currently permit CER tax deductions will also remove these when Solvency II arrives, and therefore how the new legislation fits with the current government’s claims to wanting to make the UK tax regime competitive.
The new rules require built up reserves to be released and spread over a period of six years. An encouraging change, following the first draft of the legislation, has been the introduction of the ability to accelerate the release by either bringing the whole reserve into tax up front, or electing to bring the remaining reserve into tax at any point during the six year period. Groups may make this decision for several reasons, including utilisation of losses, foreign tax credits or even to simplify tax accounting implications.
Lloyd's corporate members who may not have claimed the deduction under the rules introduced in 2009 and insurers that have elected (under ICTA88/S444BA (4)) not to claim a deduction for all or part of a reserve should consider claiming deductions for CER in any open tax returns, and other general insurers should consider recognising full reserves in their accounts for 2011 through to 2013 (while tax rates are still on their way down) before the staggered release which, on the current timetable, will begin in 2014 accounting periods, when the corporate tax rate will fall to 22%.