Life Assurance Companies - New Taxation Regime

Introduction

This article outlines the new taxation regime for life assurance companies and their policyholders as provided for in section 53 Finance Act 2000. There were two regimes operating prior to this change - one in the IFSC and the other for our domestic assurance companies. There will be just one regime for all policies and contracts commenced from 1 January 2001.

Overview of current regime

The current regime for assurance companies in the IFSC, which have only non-resident policyholders, is that they are taxed in a similar fashion to any other trade. The profits accruing to the shareholders are liable to corporation tax. The policyholders may be liable to tax in their own country of residence but they are not liable in this State.

The current domestic regime is that the income and gains accruing to policyholders’ funds are taxed within the fund on an annual basis at the standard rate of income tax, while shareholders’ profits are taxed at the corporation tax rate. The policyholder is not liable to any further tax on maturity or encashment of a policy.

Overview of new regime

From 1 January 2001 the IFSC regime will be extended to all assurance companies so that there is no annual tax imposed on policyholders’ funds. However, when an assurance company makes a payment to a policyholder, the company will have to deduct tax on the investment return to the policyholder at the standard rate of income tax plus three percentage points. That tax will be a final liability tax. However, tax will not be deducted from a payment to a person who is neither resident nor ordinarily resident in the State and who has complied with the declaration requirements.

This system, where a policyholder’s investment is allowed to grow tax free throughout the term of the policy, is common in other EU countries and is referred to as the “gross-roll-up system”.

The new regime will come into effect for existing domestic companies from 1 January 2001, but only in respect of new policies issued from that time. The existing life assurance business of these companies at that time will continue to be taxed on the old basis viz. an annual tax on the investment return of policyholders’ funds. For existing IFSC companies there will effectively be no change in their tax regime except that from 1 January 2001 they will be entitled to sell their products on the domestic market, and they must comply with the new declaration procedure.

Details of the legislative changes

Section 53 Finance Act 2000 introduces Chapters 4 and 5 into Part 26 TCA 1997. Chapter 4 provides a new regime for taxing life assurance companies themselves, both those operating from the IFSC and domestic assurance companies. Chapter 5 provides a taxation regime for the investment return of a life assurance policy where the policyholder is resident or ordinarily resident in the State. In general, that investment return is only taxed when realised.

Chapter 4 TCA 1997: Taxation of Assurance Companies - New Basis

Profits of life business - new basis

Chapter 4, which comprises section 730A, provides that the profits of a life assurance company will be computed and charged to tax under the provisions applicable to Case 1 of Schedule D where the profits arise from “new basis business” as defined. Such business is:

• the policies of domestic life companies commenced on or after 1 January 2001 together with such companies’ existing pension business, general annuity business and permanent health business (so far as already taxed under Case 1 of Schedule D),
• all policies of IFSC life companies, commenced on or after 1 January 2001, and
• all policies of new life companies set up on or after 1 April 2000, unless such company elects undersection 730A(2) to have its policies commenced prior to 1 January 2001 taxed on the old basis.

Sections 730A(3) and 730A(4) provide that new basis business is to be treated as a separate business whose profits are to be computed in accordance with and charged to tax, under Case 1 of Schedule D.

Section 730A(5) provides that in making the Case 1 computation a deduction is allowed for amounts allocated to policyholders but not in respect of amounts reserved for policyholders.

Chapter 5 TCA 1997: Policyholders - New Basis

Chapter 5 introduces six new sections which deal with the taxation of the investment return on a life assurance policy

Taxation of policyholders

Section 730B sets out that the intention of the Chapter is to impose a tax charge in respect of life assurance policies which come within the definition of “new basis business” other than such a policy which relates to pension business, general annuity business or permanent health insurance business.

Chargeable event

Section 730C(1) gives a definition of “chargeable event” in relation to a life policy. These are the occasions on which a tax charge can arise. Such occasions are:

• the maturity, the surrender or assignment (in whole or in part) of the life policy, and
• the 31st of December 2000 in respect of a life policy previously issued by a life company which commenced business between 1 April 2000 and 31 December 2000 where the company is charged to tax on profits of that period under Case 1 of Schedule D - in other words, the company did not elect under section 730A(2) to be taxed on the old basis.

However, if the maturity or surrender in whole or in part of a life policy is occasioned by a death or disability which gives rise to benefits under the policy, a chargeable event does not arise.

Section 730C(2) states that a chargeable event does not occur on the assignment of a policy as a security for a debt or on the discharge of such a debt so secured. For example, if on taking out a loan from a bank, a policyholder assigns his or her life assurance policy to the bank as security for the loan, a chargeable event does not arise.

Gain arising on a chargeable Event

Sections 730D(1) and 730D(3) provide that where there is a chargeable event in relation to a life policy a gain arises in the amount of:

• the policy proceeds less premiums paid^*, where the event is the maturity or total surrender of the policy,
• the value of the policy at the time of assignment less premiums paid* where the vent is the total assignment of the policy,
• the amount payable less a proportionate part of premiums paid*, where the event is the partial surrender of the policy, and
• the value of the part assigned less a proportionate part of premiums paid*; where the event is the partial assignment of the policy, and
• the value of the policy on 31 December 2000 less premiums paid* where a chargeable event is deemed to occur on that date.

Gain not treated as arising on a chargeable event

Under Section 730D(2) a gain does not arise on the happening of a chargeable event in relation to a life policy if at that time the life company is:

• in possession of a declaration in relation to the life policy referred to in section 730E(2) (viz. a declaration of non-Irish residence made at the time of taking out of a policy by a policyholder) or a declaration referred to in section 730(E)(3) (viz. a declaration by policyholder that he/she is neither resident nor ordinarily resident in the State), and
• is not in possession of any information suggesting that:
  1. the contents of the declaration are not, or are no longer, materially correct;
  2. the policyholder failed to advise the life company that he/she had become resident in the State; or
  3. the policy holder is resident or ordinarily resident in the State.

Declarations

Section 730E sets out the terms of the non-resident declarations to be made by a policyholder seeking a gross payment to be made to him/her in respect of a life policy.

Subsection (1) specifies who exactly the policyholder is. Subsection (2) relates to a the declaration required from a policyholder who was never resident in the State. Subsection (3) relates to the declaration required from a policyholder who was resident in the State at the time of taking out the policy but subsequently becomes neither resident nor ordinarily resident in the State.

Subsection (4) provides that where two or more people are policyholders they are to be treated as if each of them were a policyholders for declaration purposes and the imposition of tax.

Deduction of tax on the happening of a chargeable event

Section 730F(1) provides that the tax rate to be applied to a gain arising on the happening of a chargeable event is the standard rate of income tax plus 3 percentage points where the gain arises on maturity or surrender or assignment, in whole or in part, and a rate of 40 per cent where the gain arises on the chargeable event treated as happening on 31 December 2000. Under subsection (2) and (3) the life company is liable for the tax and is entitled to meet that liability from the policyholders proceeds/funds.

Returns and collection of appropriate tax

Section 730G sets out how the tax collected by a life company is to be accounted for and paid to Revenue. Under subsection (2) and (3) a return of tax payable is to be made and the tax to be paid to the Collector- General twice yearly i.e. 30 days after 30 June and 30 days after 31 December in respect of chargeable events happening in the first and second half, respectively, of each year. Under subsection (4), an assessment can be raised where an Inspector is dissatisfied with a return and under subsection (5) any necessary adjustments or set-offs to secure correct liability of the life company (and if necessary a policyholder) can be made where a return contains any amount of tax deducted in error.

Life Assurance Companies and Group Relief

Overview

Section 54 Finance Act 2000 amends section 420 Taxes Consolidation Act 1997 to allow life assurance companies to avail of group relief in respect of “new basis business” under the new “gross-roll-up” regime for taxing life assurance companies which is effective from 1 January 2001. The preceding article on Life Assurance Companies explains the term “new basis business” and outlines the new taxation regime in place.

Access to group relief

Section 420 TCA 1997 provides for theallowability of group relief i.e. one member of a group which incurs a trading loss can surrender that loss for set off against profits of another member of the group. Because the profits and losses arising to a life assurance company were, in general, not computed on a normal trading Case 1 basis, but rather on an historic Income less Expenses basis, access to the group relief provisions were denied to such companies.

Under section 53 Finance Act 2000, the new tax regime for life companies effective from 1 January 2001 provides that profits and losses of “new basis business” of such companies will be computed under Case 1. Under section 54 Finance Act 2000, access to group relief is, therefore, allowed in respect of this new basis business.

Life assurance policy or deferred annuity contract entered into or acquired by a company

Overview

Section 55 Finance Act 2000, which amendssection 595 TCA 1997, alters the basis on which companies are taxed on the disposal of a life assurance policy or deferred annuity contract. In general, in respect of such policies or contracts entered into on or after 1 January 2001, the profit on disposal will suffer an exit tax equal to the standard rate of income tax plus three percentage points.

New regime - Basis of taxation

Under the old domestic life assurance regime there is an annual tax at the standard rate of income tax on the income and gains of the policyholders’ fund. For a policyholder who is an individual there is no further tax to pay on redemption of the policy. However, for a company, the proceeds on disposal of a life assurance policy is grossed up at the standard rate of income tax, brought into account as a chargeable gain accruing to the company and included in profits, with a tax credit being given at the standard rate of income tax.

Under the new regime there will be an exit tax on redemption of a policy. The treatment as applied heretofore for companies will no longer apply. The relevant policies affected are life assurance policies and deferred annuity contracts (other than foreign life assurance and deferred annuities) which are “new basis business” [the term “new basis business” is explained in the article on Life Assurance Companies on page 19]. Companies will suffer a similar exit tax as individuals on redemption of such policies.

Profits of life business

Life assurance companies trading from the IFSC exclusively with non-resident customers are taxed in accordance with the rules applicable to Case 1 of Schedule D - section 710(2) TCA 1997. In effect, this means that the shareholders’ profits are taxed at the 10 per cent corporation tax rate and no tax is levied on policyholders’ funds. This is referred to as a “gross-roll-up” regime.

From 1 January 2001, IFSC life assurance companies will be entitled to sell their products on the domestic market. Under existing legislation, if they did so they would lose their entitlement to the 10 per cent tax rate. Section 56 Finance Act 2000 ensures that the eligibility to the 10 per cent rate will continue to apply but only to the that element of profit which derives from doing business with non-residents.