An Inland Revenue press release published on the 10 February changed the way that capital redemption...
An Inland Revenue press release published on the 10 February changed the way that capital redemption bonds are taxed in the hands of UK resident companies.
Capital redemption bonds (CRBs) differ from normal investment bonds in that they are not contracts of life assurance.
Insurers usually issue the contracts for a fixed term, say 80 years, promising to pay a fixed sum on maturity equal to the higher of the value of the underlying assets, or 2.5 times the premium.
Traditionally, the tax position of a CRB in the hands of a UK resident is the same as that applying to life assurance bonds; in other words, gross roll-up (if offshore) and ability to take tax deferred withdrawals within the 5% withdrawal allowance.
They have been popular with corporations as a means of investing stored reserves for the medium to long term as they can defer any tax charge until a later date. The CRB had an added attraction in that there is no requirement for a life assured - a minor complication for corporations as they would need to use employees (usually directors) as the lives assured, who could leave the company at some stage in the future.
The change came after a scheme came to light whereby CRBs were being used to generate artificial CGT losses for capital gains tax purposes. This worked as shown in the following example:
This loophole used to apply to life assurance policies, but this was closed in the Finance Act 2003, so that in future only the real economic loss (in the example, £25,000) could be offset against capital gains.
Oddly, the changes at that time did not apply to CRBs, which seems to be explained by the Revenue view that CRBs are not within the CGT regime. To move against CRBs now seems to suggest that the Revenue were unsure of their own analysis and this now puts the position for companies beyond doubt.
Instead of mirroring the changes in 2003, however, the Revenue has taken an approach that brings CRBs held by companies within the 'loan arrangements' provisions. These rules apply to companies investing in debt-based investments (for example, bonds, bank deposits etc), and seek to tax them on the profit and loss made as they accrue rather than as they are paid.
CRBs were excluded from these rules, and the change now revokes this exclusion. Generally, this would mean that a company -owned CRB would be taxed based on annual increases in value, but according to Revenue guidance it will still be possible to defer tax until the surrender of the bond if the company does not reflect the value of the bond in its accounts on a fair value basis. However, the ability to use the 5% withdrawal allowance will be lost.
These proposals are retrospective, and affect all company-owned CRBs, not just those used as part of the avoidance scheme the Revenue are wanting to close down. It is proposed that a chargeable event calculation is made on existing bonds as at 9 Feb 2005, to be carried forward until the bond is surrendered.
Obviously, there will be discussions between the industry and the Revenue over the coming months, primarily aimed at removing the retrospective nature of this tax, or at protecting the vast majority of legitimate bondholders whose motivation was not the aggressive tax avoidance envisaged by the Revenue.
The above information is based on analysis of the Inland Revenue Press Release issued on 10 February 2005. The proposals are not guaranteed to become law.
XYZ Ltd proposes to sell some investments, resulting in a chargeable gain of £500,000, on which there is a tax liability of, say £150,000. It enters into an arrangement whereby it purchases a CRB for £500,000 from a third party worth, say £475,000, with an original premium of £480,000. It then surrenders the policy, and the chargeable event loss is 475,000 - 480,000 = (-£5,000), as no account is taken of the purchase price.
A calculation also needs to be done for CGT purposes, and any amounts already accounted for under income tax are excluded, so the calculation is 0 - £500,000 =(-£500,000). This loss can be used to reduce the other gain to nil, resulting in a tax saving of £125,000.
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