Clause 26 - Abolition of relief for equalisation reserves: general insurers

Finance Bill – in a Public Bill Committee at 5:30 pm on 12th June 2012.

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Question proposed, That the clause stand part of the Bill.

Photo of Cathy Jamieson Cathy Jamieson Shadow Minister (Treasury)

Clauses 26 to 30 relate to the claims equalisation reserves. With your permission, Mr Bone, and in order to make it easier for the Committee, I intend to speak to clauses 26 to 30 collectively, rather than individually, although I understand that we would have to vote on them individually.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

Order. If it is convenient for the Committee, we will take clauses 26 to 30 together.

Hon. Members:

Yes.

Photo of Cathy Jamieson Cathy Jamieson Shadow Minister (Treasury)

Thank you, Mr Bone. I do not think that hon. Members would have been as excited if I had spoken to each individual clause for the same length of time. It would be helpful to take the clauses together, given that they all relate to the claims equalisation reserves.

The measures will repeal the current legislation for the tax treatment of claims equalisation reserves. For general insurance companies, the tax treatment of equalisation reserves is governed, as I am sure that all Government members of the Committee know, by sections 444BA to 444BD of the Income and Corporation Taxes Act 1988. Section 47 of the Finance Act 2009 and the Lloyd’s Underwriters (Equalisation Reserves) (Tax) Regulations 2009 provide for same tax treatment for Lloyd’s corporate and partnership members that maintain an equivalent reserve to that maintained by general insurance companies.

Because of European Union regulatory changes, the Government are abolishing the ability of corporate members of Lloyd’s and insurance companies to obtain a tax reduction for transfers to equalisation reserves. Funds in existing equalisation reserves will be taxed, spreading the release evenly over the six years from the date that the solvency II capital requirement came into force. Clauses 26 to 29 make the changes in relation to general insurance companies, while clause 30 makes them in relation to secondary legislation with regard to Lloyd’s.

The measure deals with the taxation impacts arising from the removal of the regulatory requirement for general insurers to maintain claims equalisation reserves as a result of the implementation of the solvency II directive. The measure repeals the current tax rules and the parallel rules for Lloyd’s, and provides for a transitional period over which the built-up reserve will be charged to tax.

The measure was originally announced in the 2011 Budget and, again, an informal consultation with an industry working group took place between April and August 2011. Both the Association of British Insurers and Lloyd’s—representing general insurance companies and corporate and partnership members at Lloyd’s—were included in the consultation. It would be fair to say that some concerns were raised during the initial stages. Colin Graham, the UK insurance tax leader at PricewaterhouseCoopers, said:

“This could put UK-based insurers at a competitive disadvantage to insurers based in some other countries at a time when the Government is seeking to attract industry back to the UK. Relief already claimed will reverse, costing the industry £500m over six years from 2014 onwards.”

Will the Minister address the importance of a competitive UK tax regime to attract investment, particularly at this point in time? Does he have any concerns about the competitiveness of the UK tax regime? What assessment has been made of the measure’s impact?

To return to the point of the clauses, an equalisation reserve—also described as a claims equalisation reserve—is a reserve built up, generally from profitable years, as a cushion against periods with worse than average claims experience. Insurance companies in the UK—but not Lloyd’s members—are required by the Insurance Companies (Reserves) Regulations 1996 to establish  equalisation provisions. Those provisions, which are in addition to the provisions required to meet the expected ultimate cost of settling claims outstanding at the balance sheet date, are required by the Companies Act to be included in technical reserves, even though they do not represent known liabilities at the balance sheet date.

From 1996, general insurers were allowed to treat amounts transferred into CERs as tax deductible, and amounts transferred out were treated as taxable receipts. In 2009, rules were introduced to allow equivalent deductions for Lloyd’s corporate and partnership members. Not every territory in Europe has a regulatory requirement to maintain equalisation reserves. Again, I wonder whether we can impress that on the Minister in the context of these clauses, because it could be argued, and indeed some people have taken the view, that CERs are not required because any business risks would be provided for in the company accounts.

I mentioned earlier that during the consultation process, industry groups were very unhappy about the proposals. They were calling for CERs to continue for tax purposes only, as I understand is the case in Luxembourg. However, I also understand that at that time Her Majesty’s Revenue and Customs and the Treasury were not convinced by the arguments advanced by the industry groups. I think that it would be fair to say that they have now accepted the changes, but perhaps it is the case that they knew that the changes were coming and therefore have reluctantly accepted them, rather than rocking the boat.

I have a couple of points in relation to aspects of clause 30 that relate specifically to Lloyd’s and Lloyd’s corporate members. I have mentioned the regulatory requirement for general insurance companies—but not members of Lloyd’s—to maintain CERs in respect of certain lines of business. It is important to recognise at this point that the clauses deal with both the situation in relation to Lloyd’s and the wider insurance sector.

I may want to impress further points on the Minister, but it would be helpful if he could respond to those points. It is worth noting that clause 26 repeals existing tax legislation providing for tax relief for CERs maintained by general insurers and introduces transitional rules to tax built-up CERs over six years. Essentially, one sixth of a company’s existing CERs will be brought into tax each year for a six-year period.

Clause 27 sets out a provision that an insurance company may make an irrevocable election to treat the built-up reserves as taxable in one calendar year as opposed to being spread. That will enable companies to plan the taxation of the reversal of CERs and potentially to optimise tax loss planning.

Clause 28 relates to double tax relief. The clause is relevant where a company has built up CERs that will be taxable and carries on business through a permanent establishment outside the UK for which DTR is due in respect of any income or gain. A proportion of DTR may be offset against the premium income.

Clause 29 specifies that where there is a transfer of whole or part of the business to another insurance company—within the charge to UK corporation tax—the transferrer and transferee may jointly make an irrevocable  election within 28 days of the transfer for the deemed receipts to be allocated between them. For the year of transfer, an apportionment would be made between the transferrer and transferee based on the date of transfer. The remaining deemed receipts would then arise in the transferee. It seems that if such an election were not made, the deemed receipts would arise in the transferrer on the cessation of trade.

As I have mentioned a couple of times, not every part of Europe has that regulatory requirement. I wish to press the Financial Secretary on that point and ask him what further comments the industry has made, if any. Is he confident that there is consensus on this issue, as there was on the earlier ones? As I have said, I might have other questions on the clauses that I want to return to.

Photo of Peter Bone Peter Bone Conservative, Wellingborough 5:45 pm, 12th June 2012

I thank the shadow Minister for outlining clauses 26 to 30. I remind the Committee that we are debating clauses 26 to 30 together, so if anyone wants to speak on any of them, now is the time to do so. Does the Financial Secretary wish to speak?

Photo of Mark Hoban Mark Hoban The Financial Secretary to the Treasury

I will say very little, Mr Bone, because the hon. Lady has done my job for me in setting out briefly but succinctly the point of each clause. I shall, however, make one or two comments.

For most insurers—not for Lloyd’s—claims equalisation reserves flow from existing insurance regulations. What we are seeing is their replacement by the EU directive, solvency II, which is due to come into place in, I think, 2014. An extensive part of the Bill, to which we will come quite soon, I hope, deals with the broader reforms of life assurance taxation to reflect solvency II.

One thing that flows from solvency II is the removal of the need to have claims equalisation reserves, so there will be no regulatory requirement to hold them, but that prompts the question of what should happen to the taxation of such reserves in future. A number of industry participants have asked the question that has been asked here, about whether the measure would remove or erode UK insurers’ competitive advantage. When we signalled our intention to remove the claims equalisation reserves, or change the tax treatment of them, we made the point that if insurers could provide strong reasons to maintain the tax treatment on competitiveness grounds we would listen to the arguments. The evidence that we received from insurers was not, however, strong enough to justify retaining the current treatment, so we opted to change it, but recognised that significant claims equalisation reserves had built up and that it was therefore appropriate to soften the impact on insurers by enabling the unwinding of the reserves to be spread over six years, so we did listen to the industry in that respect.

Photo of Cathy Jamieson Cathy Jamieson Shadow Minister (Treasury)

Perhaps the Financial Secretary has answered my question, by saying that the evidence was assessed as not being strong enough, but will he say a bit more about the arguments that the industry made at that point? Was it content that the six-year unwinding process was the solution?

Photo of Mark Hoban Mark Hoban The Financial Secretary to the Treasury

The reality is that the industry accepted that its arguments were not that robust, and the industry’s consent to introduce the changes has been gained.  Reserving systems vary from country to country, and a number of countries have yet to decide exactly how they will approach the issue under solvency II. One of the benefits of solvency II is to produce a single regime for solvency purposes across Europe, so one would hope that the tax treatment in individual countries would flow from that.

We have put in place changes to the taxation of foreign profits—particularly as a consequence of the reforms that my hon. Friend the Exchequer Secretary has driven through—that are particularly valuable to the insurance industry and to those who wish to take advantage of solvency II to use London as the headquarters of their European operations. The insurance industry supports our tax changes, and we are starting to see the benefits emerge, as companies decide to move their domicile to the UK. I am content that we have the right position.

My final point is on clause 30, which applies the rules to Lloyd’s. As I pointed out earlier, it was the case that Lloyd’s was not required to set up equalisation reserves, but the 2009 statutory instrument to which the hon. Lady referred provided the opportunity to do so. Clause 30 ensures that there is consistent treatment of those reserves across all insurers, including Lloyd’s.

Question put and agreed to.

Clause 26 accordingly ordered to stand part of the Bill.

Clauses 27 to 30 ordered to stand part of the Bill.