New Clause 29 - Life insurance: rate of tax on insurance company chargeable gains and treated as paid on policy gains (No. 2)

Finance Bill – in a Public Bill Committee at 6:00 pm on 25th June 2002.

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'.—(1) In subsection (3) of section 88A of the Finance Act 1989 (lower corporation tax rate on certain insurance company profits), after ''as consists of income'', insert ''or gains''.

(2) After subsection (3)(d) of that section, insert—

''(e) chargeable gains.''

(3) This section has effect from 1st April 2002.'.—[Mr. Flight.]

Brought up, and read the First time.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

I beg to move, That the clause be read a Second time.

The new clause must be probing because under the Ways and Means resolution requirements, it cannot address the second half of what is required. However, it would address what the Minister would agree has been an anomaly since the Finance Act 1999 by reducing the amount of tax paid by life insurance companies on policyholder capital gains from 22 to 20 per cent. I would like it to make a matching reduction in tax credits for higher-rate taxpayers who receive taxable proceeds from life policies.

The new clause would restore equality of tax treatment between those who save through life insurance policies, and those who save directly or through unit trusts. The Finance Act 1999 reduced the rate of capital gains tax paid by basic rate taxpayers from 22 to 20 per cent. without making a matching reduction in the rate of corporation tax paid by insurance companies on investment-backing life insurance saving policies. Few basic rate taxpayers—about one in 250—pay any capital gains tax because of the annual exemption. In contrast, all the 25 million individuals who save through life insurance policies indirectly pay some capital gains tax each year, as life companies have to pay corporation tax on policyholder capital gains with no equivalent to the exemption limit.

The amounts in 1999 and 2000 were substantial, which may be one reason why the Government have dragged their feet on dealing with the problem. However, one unforeseen result of the fall in share prices over the past two years, which sadly continues, is that the Exchequer cost of removing the anomaly and the rate differential is now relatively small—some £10 million—compared with the total corporation tax paid by the life insurance companies, which was some £2.7 billion in the last year for which figures are available.

I hope that the Paymaster General agrees that this anomaly is unfair and needs correcting. As I pointed out at the beginning, it is necessary to reduce the rate paid by life insurance companies and to reduce the credit from 22 to 20 per cent. for higher-rate taxpayers.

Photo of Michael Jack Michael Jack Conservative, Fylde

I support my hon. Friend the Member for Arundel and South Downs, who elegantly summarised the technicalities of the new clause. The Paymaster General may recall that I raised this matter with the Minister for E-Commerce and Competitiveness when he was Financial Secretary in 2000. He did me the courtesy of writing a letter, in which he said that the case for change was not wholly without merit. In the same letter, he confirmed that the cost of the measure, to which my hon. Friend referred, would be some £30 million. I am pleased, or perhaps saddened, that if the Government were minded to introduce the measure, the estimated fall in stock market prices would now be significantly less. It would be interesting to hear their figure.

With regard to equity and the operation of the i minus e formula in life assurance taxation, the

Government have, in fairness, adjusted the personal rates of tax in the composite rate used in qualifying policies to reflect changes in personal taxation. However, the anomaly has remained in capital gains taxation for some time, as my hon. Friend the Member for Arundel and South Downs said. I was equally heartened by a comment made by the then Economic Secretary during the Report stage of the previous Finance Bill that the issue should be kept in mind. The hon. Lady indicated that what she described as a package approach would probably be the best way to address it. I assumed from that that the Government were minded to examine the wider issues relating to life assurance taxation so that the matter could be addressed. To the best of my knowledge, however, such a package has not been forthcoming. As my hon. Friend said, the regular savings of some 25 million people in the UK include some form of life assurance. As we know, there is considerable disquiet among the holders of some policies about whether the companies will deliver the financial result that the policyholders expected.

Although saving through life assurance has taken a battering, it should not get such a bad reputation that people do not see it as a tax-effective and personally effective way of saving in the long term. This change would have a modest but beneficial effect on the returns from life assurance policies. I hope that the Government will agree at least to consider it, with a view to making the necessary changes.

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury 6:15 pm, 25th June 2002

The new clause would reduce the rate of tax that life insurance companies and friendly societies paid on the part of their capital gains that would contribute to benefits payable to policyholders. The logic behind the clause is to bring the rate of corporation tax on those gains in line with the rate of tax applied to the capital gains of individuals. There are, however, fundamental differences between the regimes for taxing gains made by companies—especially life companies—and those for taxing the capital gains of individuals. Therefore an attempt to align the corporation tax rate on gains with the rate applying to an individual's gains is too simplistic.

For example, individuals enjoy taper relief, whereas companies have indexation. Individuals have an annual exempt amount below which gains are not taxed. Life companies can deduct management expenses in computing their liability on chargeable gains, whereas individuals cannot. Life companies can also fund payments to policyholders from incoming premiums without realising assets and therefore making capital gains. That enables companies to defer making taxable gains almost indefinitely and so reduces the effective tax rate that they pay on policyholder gains.

The hon. Member for Arundel and South Downs and the right hon. Member for Fylde (Mr. Jack) suggested that there were small savers who had not exhausted their annual exempt amount of capital gains tax liabilities who might lose out as a result of the current regime. Most policyholders benefiting from life assurance policies do not pay any further tax when the policy has been cashed. Instead, the amounts paid by

the insurance company in corporation tax are effectively treated as satisfying the tax other than the higher rate tax that would have been paid by the individual if they had held and disposed of the assets personally. For the reasons that I have given, the effective rate of tax paid by life companies on the policyholder profits cannot readily be equated with individual tax rates. That is especially true of chargeable gains, where the life company's significant advantages make a direct comparison difficult.

The right hon. and hon. Members also referred to the recent fall in the stock market and suggested that it might not be that expensive for the Exchequer to consider making this particular move at this time. However, the Inland Revenue's cost estimate of the new clause is £55 million. It is not easy to make such an estimate, but that is its best estimate of the total cost. Clearly, in years when the stock market has fallen quite sharply, the cost is reduced, but we cannot base estimates of the cost on past performance of the stock market. We have to consider its future performance when making such estimates. The gains and losses realised by a life company in a particular year need not be those that have accrued in the year, so any estimate could be quite wide of the mark.

Another matter is relevant to consideration of this issue. We said in the Budget that a consultative document on reforms of the corporation tax system would be issued in the summer. One issue that it covers will be future treatment of capital gains made by companies. The question of what rate of tax should be charged on gains made by life insurance companies will naturally arise during those consultations, so it would be premature to consider that in isolation now.

Photo of Michael Jack Michael Jack Conservative, Fylde

I am grateful for the Minister's response. Would she now, or in correspondence, refresh my memory as to when the current rate of capital gains tax in i minus e was set, when it was last changed and what was the logic of that change?

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury

I shall certainly deal with the right hon. Gentleman's points through correspondence. I did not say that there was no case for looking at this issue. I said that it should be considered during the wider consultation on the corporation tax regime. That paper will be issued this summer. For those reasons, I suggest that the hon. Member for Arundel and South Downs consider withdrawing the motion and new clause, otherwise I shall have to advise my hon. Friends to reject it.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

We raised this matter during the debate on the Finance Bill in the year 2000 and the Government treated it reasonably sympathetically. They said that it had some merit and that they would look at it. We are now two years on. I was glad to hear what I took the Minister to be saying, which was that the issue would be looked at during the consultation on the reform of the corporation tax system and insurance company taxation system. I cannot entirely agree that it is that complex an issue to resolve.

As to cost, the figure that the Minister quoted, which is very different from that worked out by the Association of British Insurers, may not have taken

account of the other part of the proposal that could not be in the new clause. Those paying higher rate tax should have another 20 per cent. and not another 18 per cent. to pay. Both adjustments are needed. It seems genuinely wrong that saving via insurance should be tax disadvantaged for the great majority of people by having a 22 per cent. rather than a 20 per cent. rate. I hope that what the Minister had to say to a fair extent tacitly accepts that. It will therefore be addressed as part of the overall package. I beg to ask leave to withdraw the motion.

Motion and clause, by leave, withdrawn.