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First-tier Tribunal (Tax)
You are here: BAILII >> Databases >> First-tier Tribunal (Tax) >> Legal & General Assurance Society Ltd v Revenue & Customs [2009] UKFTT 225 (TC) (06 August 2009)
URL: http://www.bailii.org/uk/cases/UKFTT/TC/2009/TC00175.html
Cite as: [2009] SFTD 701, [2009] UKFTT 225 (TC), [2009] STI 2748
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INCOME TAX/CORPORATION TAX
Insurance companies
- This is a joint referral under para 31A of Sch 18 to the Finance Act 1998 by Legal & General Assurance Society Limited ("the Society") and the Commissioners for Her Majesty's Revenue and Customs ("HMRC") in the following terms:
- A revenue account in respect of the whole of the long term business.
- A revenue account in respect of the Life and Annuity business.
- A revenue account in respect of the Permanent Health Insurance business.
- A revenue account in respect of the Capital Redemption Business.
- A revenue account in Appendix 9.4 of the regulatory returns for 2001 to 2004 (for 1999 and 2000 in Schedule 4) in respect of the with profits part of the Life and Annuity business.
- There was an agreed statement of facts as follows:
- I had 9 ring binders of documents and heard evidence from Mr Ian Gibson, former Appointed Actuary for the Society, and Mr John Jenkins FIA, partner in KPMG, expert witness called by the Society. I find the following further facts:
- The issues arise because of the Society's way of distributing surplus to with-profit policyholders described in paragraphs 2(26), 2(56) and 3(7) above. The issues in this referral arise because the legislation does not appear to cater for the Society's situation.
- The Society's LTIFs are listed in paragraph 2(12) above. The L&A Fund comprises (a) the with-profits part, and (b) the non-profit part which includes the 1996 Subfund. The L&A Fund contains two categories of business: basic life assurance and general annuity business ("BLAGAB") and pension business. These are taxed differently; BLAGAB is taxed on the I minus E basis, and pension business is taxed under Schedule D Case VI computed on Case I principles in accordance with section 436 of the Taxes Act 1988:
- Section 83 of the Finance Act 1989 deals with the computation of pension business in accordance with Case I principles.
- From 2001, s 83A(2) provided as follows:
- In summary (and on the basis that the LTIF is divided into separate parts each requiring preparation of separate revenue accounts), receipts of investment income and gains are Case I receipts only to the extent that they are "brought into account" in such separate revenue accounts required to be prepared under the ICA 1982 (or from 2001, Chapter 9 of IPRU (INS)) in respect of the part concerned, rather than the revenue account for the whole of the LTIF. However, by s 83A(4) if the total of the items brought into account in the separate accounts is not equal to the total amount brought into account in the account prepared for the whole business, a further separate revenue account covering the balance is treated as having been required and prepared. Accordingly the next step is to identify the revenue accounts that are required to be prepared.
- Section 17 of ICA 1982 provides:
- The 1996 Regulations were in force in relation to the years 1999 and 2000. The relevant regulations are as follows:
- Section 18 of ICA 1982 (which was also in force in relation to the years 1999 and 2000) may also be relevant:
- The 1996 Regulations also provide:
- For years from 2001, the relevant provisions are to be found in paragraph 13(1) (a) of Appendix 9.4 to IPRU (INS). This provided as follows:
- In issue in this referral is the status of the memorandum Form 40 for the with-profits part of the L&A Fund prepared in accordance with Schedule 4 to the 1996 Regulations or Appendix 9.4 to IPRU (INS). Is it a separate revenue account required to be prepared under ICA 1982 or, from 2001, Chapter 9 of IPRU (INS)? Mr Gammie, for the Society, says no, essentially because "required to be prepared" refers to the requirement under s 17 of ICA 1982 to prepare what might be described as a real Form 40, and not the information to be given in "a revenue account in the format of Form 40," the different wording indicating that it is not a real Form 40. Mr Ewart, for HMRC, says yes, essentially because the regulations do require preparation of the memorandum Form 40. The significance of the issue is that if Mr Gammie is right the Society is required to prepare a Form 40 for the L&A Fund (and the other funds within the LTIF) and a summary of the total of the LTIF. If Mr Ewart is right the Society is required to prepare (in addition to the Forms 40 for the other funds within the LTIF and the summary of them) Form 40 for the whole of the L&A Fund plus a Form 40 (ie the memorandum Form 40) for the with-profits part of the L&A Fund, the totals of the amounts brought into account will be greater than those for the LTIF as a whole. While the possibility of the total of the amounts brought into account in the separate Forms 40 being less than the total amount brought into account in the Form 40 in respect of the whole of the LTIF is dealt with in s 83A(4), the possibility of the total being greater is not dealt with (which is issue 2 of the referral).
- Why the question whether the memorandum Form 40 is a separate revenue account so required matters, is in relation to the apportionment of the amounts that are brought into account in respect of the L&A Fund between BLAGAB and pension business for computation of the profits of pension business in accordance with Case I principles in accordance with s 432 of the Taxes Act 1988 (referred to below as "s 432"). My understanding is that while most income and expenditure relating to pension business, consisting of items such as premiums (Form 41), claims (Form 42) and bonuses are identified as relating to pension business separately, the items brought into account for investment income and gains cannot be directly identified as relating to pension business as they are identified only at the level of the relevant Form 40 which for the L&A Fund will comprise both BLAGAB and pension business; this is so whether the relevant Form 40 is the one for the L&A Fund as a whole or the memorandum Form 40 (which as explained in the reply to para 13(b) of Sch 4 to the 1996 Regulations, see paragraph 12 above, is itself an apportionment of the figures for the L&A Fund) in addition. Part of these amounts brought into account therefore needs to be apportioned to pension business. There are separate rules for the apportionment of non-participating funds (ie non-profit funds) in s 432C and s 432D (based on the liabilities of each part), and participating funds (ie with-profit funds) in s 432E (which is based on the bonuses attributed to each part, and is known as the needs basis). If Mr Gammie is right, in relation to the L&A Fund there is only one Form 40 and the apportionment will be in accordance with s 432E; if Mr Ewart is right there are two Forms 40 (real and memorandum) each of which are to be apportioned separately under s 432E, which involves apportioning more than the total of the amounts brought into account in respect of the L&A Fund. It seems to be common ground that (on the assumption that Mr Ewart is right that both a real and a memorandum Form 40 are required for the L&A Fund) one cannot achieve an apportionment of the with-profits part and then the balance as a non-profit part in accordance with the rules for apportioning participating and non-participating funds respectively (which seems to fit the scheme of the legislation). This is because there is no requirement to prepare a Form 40 for the balance of the L&A Fund; such an additional deemed Form 40 is treated as required only if the total of the amounts brought into account in the separate Forms 40 for parts of the LTIF is less than the total (s 83A(4)), and here we are dealing only with a memorandum Form 40 for the with-profits part of the L&A Fund when there is already a Form 40 for the whole of the L&A Fund. As found as a fact, it would not be possible to have two Forms 40 relating to the with-profits and non-profits parts respectively of the L&A Fund. HMRC have offered an apportionment on this basis as a solution (see paragraph 21(6) below) but as it was thought by Mr Ewart to increase the tax to even more than HMRC's preferred method (although the premise was not explored or proven), because the apportionment of the non-profit part, which is based on the proportion of liabilities, apparently results in almost the whole of the amounts brought into account being apportioned to pension business, this is not acceptable to the Society.
- Having stated the issue in outline I turn to set out in more detail the contentions of the parties on the issue 1 in the reference of whether the memorandum Form 40 is a separate revenue account that is required to be prepared under the ICA 1982.
- Mr Gammie and Mr Jaffey contend in relation to issue 1 that "required to be prepared" under the ICA 1982 (or, from 2001, Chapter 9 of IPRU (INS)) is a term of art referring to s 17 of that Act as can be seen from considering the history of the relevant provisions. The following is taken from their written closing submissions into which I have inserted the statutory provisions:
- In contrast to Mr Gammie's detailed historical approach, Mr Ewart's and Mr Yates' approach to issue 1 is more broad brush. To quote their skeleton argument:
- Before attempting to reach any conclusion on issue 1, I set out the arguments on issue 2 which may inform the answer to issue 1 since if there is no satisfactory answer to the effect of the memorandum Form 40 being required to be prepared this may help to indicate that it is not so required to be prepared.
- Mr Gammie and Mr Jaffey contend in relation to issue 2 (again quoting from their closing submissions):
- Mr Ewart and Mr Yates contend in relation to issue 2 (again quoting from their skeleton):
- I have considered the purpose of the apportionment provisions in s 432 in paragraph 15 above. Because different methods of apportionment are used for participating (with-profits) and non-participating (non-profit) policies the purpose of s 432 would be served if the separate figures for amounts brought into account for with-profits policies which are contained in the memorandum Form 40 were used. The apportionment is made in order to compute a profit on Case I lines for pension business. In spite of Mr Gammie's concentration, one might say over-concentration, on the traditional accounting (s 17 ICA 1982) requirements, the actuarial investigation (s 18) part of the regulatory framework is particularly important for a computation on Case I lines, since Form 58 is part of the process. Starting from the end of Form 40 (which adds income less expenditure to the fund carried forward), Form 58 deals in addition with changes in the value of the mathematical reserves, resulting in the surplus. A tax computation on Case I lines must start with that surplus (see Northern Assurance Co v Russell 2 TC 571). Why should another requirement derived from s 18, the memorandum Form 40, not be relevant if one is considering the purpose of the tax legislation?
- However, the purpose of s 432 would not be served if the amounts brought into account shown in the memorandum Form 40 were added to those in the Form 40 for the L&A Fund because more than the totals for that Fund, would be apportioned partly to pension business. The duplication is considerable; for 1999 the amounts brought into account for the whole of the L&A Fund are £2,625,450,000 and the amounts relating to the with-profits part of that Fund contained in the memorandum Form 40, which are themselves obtained by making an apportionment of the items in the L&A Fund as set out in paragraph 12 above, are £2,113,818,000. Accordingly, the purpose of s 432 would be served if the amounts brought into account in the memorandum Form 40 were used, but not if they were used in addition to the figures in the Form 40 for the L&A Fund.
- I start with issue 2 as this might inform the answer to issue 1. I must say that I find both parties' contentions unsatisfactory. I find Mr Ewart's contention (which is part of his main contention) particularly unsatisfactory because it involves apportioning more than the total amounts brought into account for the L&A Fund as a whole. He suggests that this is no different in principle from the BLAGAB part taxed under I minus E, and the pensions part taxed on Case I principles, not adding up to the total. I disagree. In my view, the idea that one should apportion more than the total is not only wrong in principle but contrary to the purpose of apportionment which is to deal with amounts brought into account that cannot be separately identified as relating to pension business in the way that items such as premiums and claims can be identified. In addition, Parliament has specifically dealt with apportioning less than the total in s 83A(4) by stating that "there shall be treated as having been required and prepared a further separate revenue account covering the balance." I do not read into this that there is nothing to prevent the total of the separate accounts being greater than the total, as Mr Ewart contended. A much more natural reading is that in all cases the whole of the amounts brought into account are to be apportioned. If one apportions more than the whole I assume that the result will be that part of the excess will be apportioned to pension business and treated as additional income in the computation. Mr Ewart has to avoid this result by "concession" (see paragraph 21(6) above) but the effect on the figures was thought by Mr Ewart to result in the tax being even higher, although this premise was not explored or proven than under his contention involving double counting.
- I find Mr Gammie's contention on issue 2 (which to be fair arises only if he is wrong on his main contention) equally unsatisfactory. Starting from the assumption (contrary to his main submission) that the memorandum Form 40 is a separate account required to be prepared under the ICA 1982 (or Chapter 9 of IPRU (INS)), he applies s 83A(4) so that there is treated as having been required and prepared a further separate revenue account covering the balance. He says, which I can accept, that a balance can be negative as well as positive, so that a negative deemed Form 40 is required for the balance. This is the same as the memorandum Form 40 except that the amounts brought into account are negative. The total of the amounts brought into account in the three Forms 40 (actual, memorandum and deemed) is therefore equal to the amounts brought into account in the Form 40 for the whole of the L&A Fund. The apportionment of this amount is then made with the effect that the amounts apportioned by reference to the memorandum Form 40 and the negative deemed Form 40 effectively cancel out (although Mr Ewart suggests that since there are no actual policyholders in the deemed account it is impossible to know whether the apportionment should be by reference to with-profits or non-profit policies, a point that was not pursued). Assuming, however, that it can be done, one is in the same position as if the memorandum Form 40 was not required to be prepared. Therefore if under issue 1 the memorandum form 40 is a separate account required to be prepared, the effect of issue 2 is that the result is the same as if it had not been required to be prepared, which makes it difficult to see why it should be required. It would, as Mr Ewart says, make better sense (as a matter of policy rather than interpretation) for the memorandum Form 40 to cancel the with-profits part of the Form 40 for the whole of the L&A Fund, presumably before making the apportionment, effectively leaving the balance reflecting the non-profit part, but this may have been a misunderstanding of Mr Gammie's contention which I understood to be that one did not cancel out the memorandum Form 40 against the negative deemed Form 40 before making the apportionment, but apportioned each of them separately. In summary, the effect of the memorandum Form 40 being a separate account required to be prepared is so unsatisfactory that it might suggest that the situation does not arise. In other words is the answer to issue 1 that the memorandum Form 40 is not required to be prepared?
- Turning to issue 1, I have identified in paragraph 23 above that the purpose of the tax legislation would be served if the amounts brought into account in the memorandum Form 40 were used but only if they are not used in addition to the figures in the Form 40 for the L&A Fund. I consider next the nature of the memorandum Form 40. Schedule 4 to the 1996 Regulations, which contains the reference to the memorandum Form 40, starts by listing the forms included in the part of the return to which this Schedule relates (forms 46 to 49, 51 to 58, 60 and 61) and providing that they are to be laid out as shown in the Schedule. The memorandum Form 40 is not one of these. The reference to it in Schedule 4 of the 1996 Regulations starts "The following information shall be given…" and there follows 23 items of which I set out No 13 again:
- The primary reason for my decision is that a memorandum Form 40 is not a "separate revenue account required to be prepared under the [Insurance Companies] Act in respect of a part of that business" or a "separate revenue account required to be prepared under that Chapter [Chapter 9 of IPRU (INS)] in respect of a part of that business." While a memorandum Form 40 is certainly something required to be prepared, it is not so required as a separate revenue account (meaning an account in Form 40) but is merely information to be provided in similar format in so far as it has not been provided elsewhere in answer to a list of information required to be provided by the appointed actuary and as support for the starting point for the separate with-profits Form 58 (which could have been prepared without a memorandum Form 40), so that the apportionment of part of the surplus to with-profits policies can be verified. Since the contents of the memorandum Form 40 are themselves an apportionment of the totals for the L&A fund, there seems no reason in principle why they should be brought into an apportionment of items brought into account for the whole L&A Fund to pension business. The separate revenue accounts that are required to be prepared under the Act (or Chapter 9 of IPRU (INS)) are accordingly solely the real Form 40s.
- Mr Gammie's historical approach lends some support to this conclusion. Although he deals with the connection between accounting and tax at the end of his submissions I think the connection is central to them. His arguments are really that: (1) one of the accounting requirements is the revenue account, (2) By s 17 ICA 1982 an insurance company "shall prepare" a revenue account, and s 17(2) uses the expression "required by subsection (1) to be prepared", (3) the same expression ("the revenue account required to be prepared by every company under section 17(1) of the [ICA 1982]"), was used in reg 8 of the 1983 Regulations in relation to both the summary revenue account and the separate revenue accounts, although unaccountably the 1996 Regulations drop the word "required" (and there is nothing in IPRU (INS) that is materially different), (4) tax legislation in general follows accounting and in s 83A(2) refers to the Summary Form 40 as "a revenue account prepared for the purposes of the Insurance Companies Act 1982" (the same words as were used in the original s 83(2) (for the Summary account) and also s 432B(2) (for both the Summary and separate accounts)), and to the separate accounts as "any separate revenue account required to be prepared under the Act" (the s 17(2) ICA 1982 and 1983 Regulations wording), (5) therefore, he concludes, tax legislation adopted language from s 17 ICA 1982, which refers to the summary and separate revenue accounts but not to the memorandum Form 40 (which is required pursuant to regulations under s 18 ICA 1982, both the 1983 and the 1996 Regulations being in identical form in referring to "a revenue account in the format of Form 40")). I agree with the linguistic argument that when s 83A(2) refers to "any separate revenue account required to be prepared under the [ICA 1982]" it had in mind the separate accounts prepared under s 17 and not the memorandum Form 40 prepared pursuant to s 18. The only problem I have with the argument is that it is strongly related to traditional accounting requirements under s 17 whereas the connection between tax and accounting is much weaker for insurance companies than for other companies. As I have said, the s 18 part seems more relevant to a Case I computation which starts with the surplus shown in Form 58, being the result of the actuarial investigation under s 18. But against this, I consider that the historical approach and the wording itself points strongly to the connection of the separate accounts with s 17, and does not allow me to adopt Mr Ewart's literal approach that the memorandum Form 40 is a "separate revenue account required to be prepared under the [ICA 1982]," namely under s 18, even though that approach would be supported by the purpose of the provisions, at least so long as that form were used on its own.
- Finally, I rely on issue 2 to decide issue 1. If Parliament says nothing about how to deal with both the Form 40 for the L&A Fund and the memorandum Form 40 for the with-profits part of it, which clearly creates double counting if they are both "separate revenue accounts required to be prepared under the [ICA 1982]," this is a strong argument why Parliament did not intend the s 432 apportionment to use the memorandum Form 40. If Parliament had intended the memorandum Form 40 to be used in the s 432 apportionment it would surely have dealt with the excess total as well (I discount the possibility that Parliament would have intended double counting).
- For all these reasons I prefer Mr Gammie's contentions on issue 1. Standing back from the detail, the result is the same as if the Society had the same type of articles as other insurance companies and so it cannot be said to be an impossible interpretation. Indeed to a small extent the Society's with-profits policyholders can benefit from the profits on non-profit policies through the 1996 Subfund and so their position is not that different from the normal case of such policyholders having a discretionary right to share in the whole of the profits of the non-profit business.
- On the basis of my decision on issue 1, issue 2 does not arise and I do not propose to answer it beyond the remarks I have made above. If I am wrong on issue ,1 I would want to hear further argument on issue 2 about the effect of the double counting arising from Mr Ewart's contention, and whether it is possible to apportion negative amounts brought in a memorandum Form 40 arising from Mr Gammie's contention, and I hope that if the Upper Tribunal or a court reverses my decision on issue 1 the parties would be allowed to provide this.
- My answers to the two issues referred are therefore:
- HMRC have a right to apply for permission to appeal against this decision pursuant to Rule 39 of the Rules. The parties are referred to "Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)" which accompanies and forms part of this decision notice.
[2009] UKFTT 225 (TC)
TC00175
Appeal number: SC 3026/09
CORPORATION TAX – insurance company – with-profits policyholders sharing in profits of with-profits policies only – which revenue accounts are "required to be prepared" for the purposes of FA 1989 s 83A(2)(b)? – not the memorandum Form 40 in respect of the with-profits part of the Life and Annuity fund
FIRST-TIER TRIBUNAL
TAX
LEGAL & GENERAL ASSURANCE SOCIETY LIMITED First referrer
- and -
THE COMMISSIONERS FOR HER MAJESTY'S
REVENUE AND CUSTOMS [corporation tax] Second referrer
TRIBUNAL: JOHN F AVERY JONES CBE (TRIBUNAL JUDGE)
Sitting in public in London on 16 and 17 June 2009
Malcolm Gammie QC and Ben Jaffey, counsel, instructed by McGrigors LLP, for the First referrer
David Ewart QC and David Yates, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs for the Second referrer
© CROWN COPYRIGHT 2009
DECISION
"In accordance with paragraph 31A of Schedule 18 to the Finance Act 1998, [the Society] and HMRC jointly request that the issues set out below should be referred to the Special Commissioners for their determination. The years involved are 1999-2004 inclusive. [The Society's] corporation tax returns are under enquiry in relation to the issue for the relevant periods.
Background
It is agreed by [the Society] and HMRC that in determining the receipts to be brought into account under section 83(1) of the Finance Act 1989 when the profits of an insurance company in respect of its life assurance business are computed in accordance with the provisions of that act applicable to Case I of Schedule D, regard is to be had to section 83A Finance Act 1989.
The question that arises is how section 83A should be interpreted, and, in particular, subsections 2(b) and (4) (as they stood before amendment and substitution respectively by Schedule 9 Finance (No. 2) Act 2005).
For the relevant years, [the Society] has included the following revenue accounts in its returns to the regulatory authorities:
Issue 1
Which of the revenue accounts prepared by [the Society] in relevant years are 'recognised' for the purposes of section 83A(2) Finance Act 1989, and in particular which, if any, such accounts are 'required to be prepared' for the purposes of section 83A(2)(b) of that Act?
Issue 2
If the revenue account in respect of the with-profits part of the Life and Annuity business is 'required to be prepared' and is therefore 'recognised' for the purposes of section 83A, how are subsections (3) and (4) of section 83A to be construed and applied in the circumstances of [the Society's] case?"
The Society was represented by Mr Malcolm Gammie QC and Mr Ben Jaffey, and HMRC by Mr David Ewart QC and Mr David Yates.
"The following statements have been agreed between the Appellant and Respondents as fact in these proceedings. Save where specifically provided, to the extent the facts referred to could be subject to variation over time they are facts applying in the period 1 January 1999 to 31 December 2004 (the 'Period of Dispute').
General Background of the Society
(1) The Society is a company incorporated in England and Wales with its registered office at One Coleman Street, London EC2R 5AA.
(2) The Society was initially constituted by Deed of Settlement dated 14 April 1838, the Legal & General Life Assurance Society's Act 1878, and the Legal & General Assurance Society's Act 1919. It was incorporated on 1 April 1920, and registered in England and Wales with company number 166055.
(3) The Society is a wholly owned subsidiary of Legal & General Insurance Holdings Limited which, in turn is a wholly owned subsidiary of Legal & General Insurance Holdings No.2 Limited, which, is in turn a wholly owned subsidiary of Legal & General Group Plc ("L&G Group Plc"). L&G Group Plc is the ultimate holding company of all companies in the Legal & General Group ("the Group") and is a company whose shares are listed on the main list of the London Stock Exchange. The Group's activities include life assurance, general insurance, investment management and other financial services.
(4) The Society is and was during the Period of Dispute engaged principally in life assurance and pensions business and has a small portfolio of general insurance business which is essentially in run-off. The volume of general insurance business is decreasing as new business is now written by another subsidiary company, Legal & General Insurance Limited.
(5) The Society, at the date of this statement, has authorised share capital of £1,000,000,000 divided into 1,000,000,000 ordinary shares of £1 each of which 201,430,403 have been issued and are fully paid.
(6) The Society prepares its statutory and regulatory accounts to 31 December each year.
(7) The Society has been allocated the taxpayer reference 268/11700/15005. The Society's Tax District is Large Business Service, Insurance Sector.
Business of the Society
(8) The Society is and was during the Period of Dispute engaged in the business of providing and administering contracts of life assurance and other contracts giving rise to long-term liabilities (together referred to as the "Long Term Business"). General insurance business does not fall within the description of Long Term Business.
Fund Structure
(9) Section 28 of the Insurance Companies Act 1982 ("ICA 1982") stated that life insurers carrying out long-term insurance business "shall maintain an account in respect of that business".
(10) A life insurer's fund in relation to long-term business is generally known as the long-term insurance fund ("LTIF"). The LTIF can be composed of separate funds (which can be broken down into parts) representing subsets of the overall business. Each such fund is itself identified as a separate long-term business fund under Regulation 8(b)(i) of the Insurance Companies (Accounts and Statements) Regulations 1996 ("1996 Regulations") or long-term insurance fund under Rule 9.14(b)(i) of the Interim Prudential Sourcebook ("IPRU (INS)"). The fund structure is almost invariably set out in the insurer's articles of association.
(11) An insurer's assets which are outside of the LTIF are known as the "Shareholder Fund." The Shareholder Fund consists of assets which effectively belong 100% to shareholders. These assets can (if necessary) be used to cover regulatory capital requirements. Where an insurance company writes general insurance business, this is written within the Shareholder Fund. Any shareholder entitlement to surplus from the LTIF must first be transferred from the LTIF into the Shareholder Fund before it can be paid out by way of dividend or otherwise used.
(12) During the Period of Dispute, the Society maintained the following funds for the purposes of the preparation of revenue accounts under Regulation 8(b)(i) of the 1996 Regulations and Rule 9.14(b)(i) of the IPRU (INS) in respect of its categories of Long Term Business:
(a) Life and Annuity fund ("L&A Fund");
(b) Permanent Health Insurance fund ("PHI Fund");
(c) Capital Redemption fund ("CR Fund"); and
(d) Pensions Fund Management fund ("PFM Fund").
(13) These funds correlated directly to the categories of business which the Society was authorised to write (as set out in paragraph 28 below). Life and Annuity Business and Linked Long Term Business were written in the L&A Fund. Permanent Health Business was written in the PHI Fund. Capital Redemption Business was written in the CR Fund. Pension Fund Management Business was written in the PFM Fund, although from 1 January 1993, the Society reinsured all of the liabilities arising in relation to its Pension Fund Management business with another company in the Group. Each fund contained only assets and liabilities in relation to contracts with policyholders relating to the relevant category or categories of business.
(14) The funds referred to at paragraph 12 above combined to constitute the Society's long-term insurance fund in relation to its Long Term Business ( "the Society's LTIF").
(15) The assets held in the Society's LTIF are sufficient to cover The Society's liabilities and to generally provide the additional working capital that enables it to bear the risks associated with policies already written and to write new policies.
With-profits policies, non-profit policies and surplus
(16) Life insurance policies can be characterised as either with-profits or non-profit policies. It is common practice in the industry for life insurers to sell both with-profits policies and non-profit policies. Policies where benefits are linked to particular assets or types of assets (known as "linked" policies) are a particular type of non-profit policy.
(17) One of the features of life insurance policies is that regular premiums are often fixed at outset even where they are payable for many years. Hence the premiums are calculated based on an estimate of the risks to which the life insurer is covering over the term of the policy. Since events will not necessarily turn out to be consistent with this estimate, the premiums paid may be too large or too small for any particular individual policy. Periodically the insurer will need to estimate the extent of this excess or deficit. The estimate of the aggregate excess or deficit is known as the surplus (or if negative, the strain) for the insurer.
(18) Under with-profits policies, the policyholder is eligible to participate in the relevant surplus. This surplus is distributed to policyholders in the form of bonuses which attach to policies and increase the total minimum guaranteed payment on death or on a certain date. Bonuses may be added by the life insurer each year to increase the guaranteed payment and a final bonus may be added when a claim is made. The final bonus is also discretionary and can be varied to reflect prevailing financial conditions. Non-profit policies provide for a fixed monetary benefit or for benefits directly linked to the performance of a particular set of assets.
(19) A life insurer has discretion in any year as to how much of its accrued investment return in respect of capital appreciation to recognise as surplus. In practice, many with-profits insurers simply recognise the amount of surplus needed to allow for the payment of appropriate bonuses to with-profits policyholders.
Distribution of Surplus
(20) The entitlements of with-profits policies to participate in certain parts of the surplus arising within an insurer are also commonly set out in an insurer's articles of association, and such entitlements invariably correspond to the fund structure.
(21) Within a proprietary life insurer (i.e. a life insurer with shareholders, as opposed to a "mutual"), policyholders are not normally entitled to receive 100% of any surplus declared. The practice of life insurers in relation to the distribution of surplus and its allocation between shareholders and policyholders varies. The specific rights of with-profits policyholders to participate in surplus are almost invariably set out in the articles of association of the insurer and almost invariably there will be a minimum level of participation set out for with-profits policyholders.
(22) One common approach of insurers is to specify that the with-profits policyholders will participate in the overall surplus from the fund in which the policy was written. Often a minimum participation rate is set such as 90%.
(23) A different, albeit less common approach is for the with-profits policyholders to participate in that part of the surplus that is attributable to the with-profits part of the fund only. Where this approach is adopted, it is possible that in addition the policyholders may at the discretion of the insurer also participate in part of the surpluses from all or part of the non-profit business.
The Society's Distribution of Surplus
(24) The Society commenced writing its modern range of with-profits policies in May 1954. The Society's 1954 Articles of Association set out in Article 2 that with-profits policies (defined by the Society as "new participating polices") should be written in the life assurance fund of the Society. "Life assurance fund" referred to the L&A Fund. The L&A Fund subsequently changed its name to the "life and annuity fund" in 1996.
(25) The L&A Fund contained both with-profits and non-profit policies during the Period of Dispute.
(26) In accordance with the Society's Articles of Association, the Appointed Actuary was required to certify what portion of the surplus distributed from the L&A Fund may properly be regarded as having been derived from the with-profits policies. Of the surplus so certified, the Board was required by Article 100(4) of the Society's Articles of Association to distribute at least 90% for the benefit of with-profits policies and the balance was to be transferred to the profit and loss account. During the Period of Dispute, the Board determined that the percentage to be distributed to the with-profits policyholders was precisely 90%.
Regulation
(27) During the Period of Dispute the regulator for the Society's Long Term Business was the Financial Services Authority ("FSA"). Until 30th November 2001 the relevant regulatory provisions applying to the operation of the Society's Long Term Business were contained in ICA 1982 and the 1996 Regulations. The relevant regulatory provisions with effect from 1 December 2001 have been contained in the Financial Services and Markets Act 2000 ("FSMA 2000"), and IPRU (INS).
(28) During the Period of Dispute, the Society was authorised by the FSA to carry on the following categories of business.
(a) Life and annuity business – contracts of insurance on human life or contracts to pay annuities on human life, but excluding (in each case) contracts within paragraph III of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 ("FSMA RAO 2001") (the "Life and Annuity Business"). The Life and Annuity Business is written in the L&A Fund;
(b) Linked long term business – contracts of insurance on human life or contracts to pay annuities on human life where the benefits are wholly or partly to be determined by reference to the value of, or the income from, property of any description (whether or not specified in the contracts) or by reference to fluctuations in, or in an index of, the value of property of any description (whether or not so specified). Linked long term business is written in the L&A Fund.
(c) Permanent health business – contracts of insurance providing specified benefits against risks of persons becoming incapacitated in consequence of sustaining injury as a result of an accident or of an accident of a specified class or of sickness or infirmity, being contracts that (a) are expressed to be in effect for a period of not less than five years, or until the normal retirement age for the persons concerned, or without limit of time; and (b) either are not expressed to be terminable by the insurer, or are expressed to be so terminable only in special circumstances mentioned in the contract (the "Permanent Health Business"). The Permanent Health Business is written in the PHI Fund.
(d) Capital redemption business – capital redemption contracts, where effected or carried out by a person who does not carry on a banking business, and otherwise carries on a regulated activity of the kind specified by article 10(1) or (2) of FSMA RAO 2001 (the "Capital Redemption Business"). The Capital Redemption Business is written in the CR Fund.
(e) Pension fund management business – (a) pension fund management contracts and (b) pension fund management contracts which are combined with contracts of insurance covering either conservation of capital or payment of a minimum interest, where effected or carried out by a person who does not carry on a banking business, and otherwise carries on a regulated activity of the kind specified by article 10(1) or (2) of FSMA RAO 2001 (the "Pension Fund Management Business"). The Pension Fund Management Business was written in the PFM Fund. Since 1 January 1993, the Society has reinsured all of the liabilities arising in relation to its Pension Fund Management business with another company in the Group.
(29) A company effecting or carrying on contracts of long-term insurance must submit an annual regulatory return to the regulator in a prescribed form as set out in the 1996 Regulations and IPRU (INS) (the "Regulatory Return").
(30) The Regulatory Return is in the public domain and is available on request from the regulated insurer.
Components of a Regulatory Return
(31) The provisions of the 1996 Regulations and subsequently IPRU (INS) set down the contents of the Regulatory Return which under the 1996 Regulations was divided into six Schedules containing a series of forms which presented the key financial information. Each Schedule contained forms in sequential order of numbering. The Society's Regulatory Returns prepared for the years ending 31 December 1999 and 2000 included all six schedules. Schedule 2 (General business) and Schedule 5 (Additional information on business ceded) are not relevant to this Statement of Agreed Facts.
(32) The information that was included in a Regulatory Return under IPRU (INS) was substantially the same as the information included in a Regulatory Return under the 1996 Regulations except for some minor amendments.
(33) The forms previously included in Schedules 1, 3 and 4 pursuant to the 1996 Regulations continued to be submitted as part of a Regulatory Return under IPRU (INS) for the period 2001 to 2004 with the exception of certain forms originally included in Schedule 1.
Schedule 1: "Balance sheet and profit and loss account"
(34) Schedule 1 met the requirements for a balance sheet and profit and loss account as specified in Section 17 of ICA 1982. Revenue account is addressed below at paragraph 41. Schedule 1 included the following forms:
Form 9: "Statement of solvency"
(35) The level of solvency of an insurer was demonstrated by Form 9 which showed the extent to which the assets of the company exceeded the amount of its liabilities and an additional capital margin required by the regulator. Because the regulator's aim was to try and ensure continuing solvency the valuation of assets and liabilities for the purpose of Form 9 was carried out on a prudent basis. The information included in Form 9 was derived from the information included in Form 13 and Form 14.
(36) A life insurer was always required to complete only a single Form 9.
Form 13: "Analysis of admissible assets"
(37) The two sides of the balance sheet for the LTIF were presented in two forms: Form 13 in relation to assets; and Form 14 in relation to liabilities.
(38) Form 13 contained details of assets held by the LTIF.
Form 14: "Long term business liabilities and margins"
(39) Form 14 contained a summary of the liabilities of the LTIF which were set out in Form 9 and made up of current liabilities such as outstanding claims, tax payable, creditors, and liabilities in respect of future payments to policyholders under their contracts of insurance which were referred to in the Regulatory Returns as "mathematical reserves". The amount of the mathematical reserves depended upon actuarial assumptions regarding the amount and timing of future claims. The actuarial assumptions that were used were required to be stated within the information provided by Schedule 4.
Schedule 3: "Long Term Business"
(40) This Schedule provided accounting information for an insurer's Long Term Business. Schedule 3 met the requirements for a revenue account, as specified in Section 17 of ICA 1982 and subsequently Appendix 9.3 of IPRU (INS). Schedule 3 included the following forms:
Form 40: "Revenue account"
(41) Form 40 contained the revenue account for each fund. It set out the income and expenditure in relation to the Long Term Business. The items included in a Form 40 were based in part on information provided in two further forms in Schedule 3: Form 41 "Analysis of premiums and expenses" and Form 42 "Analysis of claims."
(42) The Form 40 revenue account was one of the key building blocks of the Regulatory Return. The Form 40 recorded the premiums received, plus the investment income and gains receivable (this being on a book value basis for non-linked business), plus other miscellaneous income, less claims paid, less expenses paid, less tax paid (or provided for), less the transfer of the shareholder's share of surplus to Form 16, less other miscellaneous outgo. This gave the total increase to the fund over the year, which was added to the "fund brought forward" in order to derive the "fund carried forward" amount. This "fund carried forward" amount (which is shown in line 59 of Form 40) was a key output of Form 40, and was the total amount of the LTIF (or the relevant fund as applicable) recognised at the end of the accounting period.
(43) The "fund carried forward" amount shown at line 59 of Form 40 was transferred to appear at line 14 of Form 14. Form 14 fed into Form 9, the overall solvency assessment. It would been impossible to prepare Form 9 without Form 14, and it would have been impossible to prepare Form 14 without Form 40.
Forms 41 and 42
(44) Forms 41 and 42 (which provide an analysis of premiums, claims and expenses) provided further details in relation to the following entries in Form 40: Line 11 ("Earned premiums"); Line 21 ("Claims incurred") and Line 22 ("Expenses payable").
Schedule 4: "Abstract of valuation report prepared by the appointed actuary"
(45) This Schedule set out the information to be given pursuant to Section 18 of ICA 1982 and Regulation 25 of the 1996 Regulations for the purposes of the abstract of the periodic actuarial valuation report. Schedule 4 included Forms 46 to 49 (inclusive) and Forms 51 to 58 (inclusive) where appropriate.
Actuarial Investigation
(46) An actuarial investigation was to be carried out annually. Where such an investigation had been carried out, or when an investigation in respect of Long Term Business was made with a view to distributing surplus, an abstract of the report of the investigation was required to be made (section 18(1)(b) ICA 1982 and Regulation 25 of the 1996 Regulations, and Rules 9.4 and 9.31 of IPRU (INS)).
Form 58
(47) Form 58 "Valuation result and distribution of surplus" was a requirement of paragraph 22 of Schedule 4 of the 1996 Regulations. A Form 58 was to be prepared in respect of each separate fund for which surplus was to be determined, but also in respect of each "part of a fund for which surplus is determined."
(48) The actuarial investigation allowed for the determination of the surplus of assets over liabilities for each category of surplus determined and the identification of how much of that surplus had been distributed to the policyholders and shareholders. Form 58 provided for the calculation of the proportion of the total surplus distributed which was allocated to policyholders to be shown. This ensured publication, in this part of the Regulatory Return, of sufficient information to allow any interested party to confirm that the distribution of surplus was appropriate given the position of the relevant fund or part of a fund, and was consistent with the insurer's articles of association.
(49) Life insurers were also frequently required to complete more than one Form 58. The Instructions set out in Schedule 4 of the 1996 Regulations required separate Forms 58 for each fund and each part of a fund for which there is a determination of surplus. There was no requirement for a summary Form 58, but the total of the relevant lines for the relevant Forms 58 prepared for each fund (but not for part funds) fed through to the total liabilities on Form 14.
Memorandum Form 40
(50) As part of the actuarial investigation, where any rights of any policyholders to participate in profits related to profits from particular parts of a fund within the LTIF, the Appointed Actuary had to produce a revenue account in the format of Form 40 (the "memorandum Form 40") for each such part except where such information is provided elsewhere (Regulation 25 and Paragraph 13 of Schedule 4 of the 1996 Regulations and subsequently Appendix 9.4 of IPRU (INS)).
(51) In the majority of FSA returns for life insurance companies with a mixed and with-profits/non-profit fund, a memorandum Form 40 would not be required as the with-profits rights would not be restricted to only part of the fund.
The Society's Returns
(52) The Society submitted Regulatory Returns based on its position as at 31 December each year and in the format prescribed by the 1996 Regulations and subsequently IPRU (INS).
(53) For the Period of Dispute and since 1984, the Society filed (as part of its Regulatory Return), a Form 40 for each year in respect of each of its funds set out below:
(a) The L&A Fund;
(b) The PHI Fund; and
(c) The CR Fund.
(54) Form 40 was also included in the Regulatory Return in respect of the Pensions Fund Management Fund for the years 1983 to 2000 (inclusive). The Form 40 submitted for the Pensions Fund Management Fund for each of the years 1993 to 2000 (inclusive) was blank since, as indicated in paragraph 28(e), the Society reinsured the risks of such policies with another group company and there was no net revenue in any line on Form 40. During the Period of Dispute the Society prepared a Form 41 for each of the funds set out in paragraph 12 above. The Society also prepared a Form 42 in respect of each of these funds with the exception of the CR Fund for 2002 and the PFM Fund for 1999 and 2001 onwards.
(55) For the Period of Dispute and since 1984, the Society has also filed (as part of its Regulatory Return) a summary Form 40 in respect of the whole of the the Society's LTIF.
(56) A key feature of the Society's Articles of Association is that with-profits policyholders have a defined participation in the surplus arising from part of a fund, plus a further discretionary participation in respect of (part of) the remainder of the fund. The fund in question is the L&A Fund. This is different to the more usual situation whereby policyholders have a defined participation in the surplus of the whole of a fund. In this respect, The Society's Articles of Association have been and continue to be relatively unusual.
(57) As the L&A Fund related partly to with-profits policies and partly to non-profit policies and with-profits policy holders are entitled to participate only in surplus arising from the with-profits part of the fund, the Appointed Actuary (as part of the abstract of the report on the actuarial investigation) prepared a memorandum Form 40 for the with-profits part of the L&A Fund (in accordance with Schedule 4 of the 1996 Regulations and subsequently Appendix 9.4 of IPRU (INS)) within the abstract of the Appointed Actuary's report in relation to the Society's LTIF to 31 December in each year."
(1) It would not be in accordance with the 1996 Regulations for the Society to have prepared two Forms 40 for the L&A Fund, one for the with-profits part and the other for the non-profit part.
(2) The Form 58 for the with-profits part of the L&A fund was required to demonstrate to policyholders, and also to the regulator, that the Articles of Association and the requirements of ICA 1982 had been complied with. The memorandum Form 40 for the with-profits part of the L&A Fund is not necessary for the preparation of the Form 58 for the with-profits part; it merely contains backing information for the Form 58. It is not clear why the Regulations required the memorandum Form 40. It merely provides potentially useful supporting information by verifying the "fund carried forward" shown at the beginning of the with-profits Form 58. The with-profits memorandum Form 40 is not accompanied by other supporting forms, such as memorandum Forms 41 (premiums) or 42 (claims).
(3) The memorandum Form 40 is not subject to audit. Forms 40 were subject to audit and so the apportionment between various funds of the long term business fund is audited.
(4) The only other company known to Mr Jenkins with profit sharing similar to the Society's was Eagle Star. Its articles provided for a fixed policyholder participation in the with-profits fund and a discretionary participation in the remainder. This was well-known in the industry. Memorandum Forms 40 were prepared by Eagle Star but the format was slightly different from Form 40, splitting the LTIF between the with-profit part, the non-profit part and the total. While the entries corresponded to Form 40, the narrative for them did not follow Form 40: for example "Bonus in reduction of premiums" instead of "Other expenditure," and "Transfer to statement of other income and expenditure" instead of "Transfer to (from) non-technical account."
(5) Shareholder Retained Capital forms part of the long-term fund (it represents profits on non-profit business that could have been distributed to shareholders but have not been). The shareholders' fund is outside the Society's LTIF.
(6) Individual assets were not segregated between the with-profits or non-profits part of the L&A Fund. A proportion of each pool of assets would have been referable to each. Pools of different assets would have different proportions held in each part taking into account the differing characteristics of with-profits and non-profit policies.
(7) The normal method used by insurance companies is that with-profit policyholders participate in the overall surplus of the fund in which the policy is written so that they share in the surplus arising from any non-profit policies in that same fund. The Society used a different method with the with-profits policyholders participating in 90% of the profits from with-profits policies and until 1996, at the discretion of the directors, which was in practice exercised, participating in part of the profits referable to non-profit policies. The articles were changed in 1996 to provide that with-profit policyholders in the L&A Fund were entitled to not less than 90% (and in the period concerned the figure was in fact 90%) of the profits arising from with-profit policies only. The other 10% and the profit arising from non-profit policies in the L&A Fund were transferred to the profit and loss account for the benefit of shareholders. On the change to this method in 1996 a sub-fund ("the 1996 Subfund") with a then value of £200m was created within the non-profit part of the L&A Fund in which the with-profits policyholders could benefit. At the time the board indicated that it did not anticipate that profit distributions to with-profits policyholders would be made out of the 1996 Subfund for the foreseeable future and no distributions were in fact made before the end of the Period of Dispute. The reason for the change was because under s 30 ICA 1982 the percentage of profits allocated to with-profits policyholders cannot be varied by more than 0.5% per annum. The effect was that prior to the 1996 changes, the rate of distribution of profits from non-profit business was controlled by bonus distributions on with-profits business, which caused practical problems for the Society.
"(1) Subject to the provisions of this section, profits arising to an insurance company from pension business shall be treated as income within Schedule D, and be chargeable under Case VI of that schedule, and for that purpose –
(a) that business shall be treated separately, and
(b) subject to paragraph (a) above, and to subsection (3) below, the profits therefrom shall be computed in accordance with the provisions of this Act applicable to Case I of Schedule D.
…
(3) In making the computation referred to in subsection (1) above—
(a) sections 82 and 83 of the Finance Act 1989 shall apply with the necessary modifications and in particular with the omission of all references to policyholders (other than holders of policies referable to pension business) and of the words "tax or" in section 82(1)(a);".
"(1) The following provisions of this section have effect where the profits of an insurance company in respect of its life assurance business are, for the purposes of the Taxes Act 1988, computed in accordance with the provisions of that Act applicable to Case I of Schedule D.
(2) So far as referable to that business, the following items, as brought into account for a period of account (and not otherwise), shall be taken into account as receipts of the period -
(a) the company's investment income from assets of its long-term business fund, and
(b) any increase in value (whether realised or not) of those assets.
If for any period of account there is a reduction in the value referred to in paragraph (b) above, (as brought into account for the period), that reduction shall be taken into account as an expense of that period."
Section 83A defines the expression "brought into account" in s 83 (references below to s 83 and 83A are to those sections of the Finance Act 1989). This section was amended in the middle of the period relevant to this referral. In 1999 and 2000 section 83A provided as follows:
"(1) In sections 83 to 83AB "brought into account" means brought into account by an account which is recognised for the purposes of those sections.
(2) Subject to the following provisions of this section and to any regulations made by the Treasury, the accounts recognised for the purposes of those sections are -
(a) a revenue account prepared for the purposes of the Insurance Companies Act 1982 in respect of the whole of the company's long-term business;
(b) any separate revenue account required to be prepared under the Act in respect of a part of that business.
Paragraph (b) above does not include accounts required in respect of internal-linked funds.
(3) Where there are prepared any such separate accounts as are mentioned in sub-section (2)(b) above, reference shall be made to those accounts rather than to the account for the whole of the business.
(4) If in any case the total of the items brought into account in the separate accounts is not equal to the total amount brought into account in the account prepared for the whole business, there shall be treated as having been required and prepared a further separate revenue account covering the balance."
In accordance with the practice described in paragraph 2(19) above the Society decided how much surplus was required to pay the appropriate bonuses to with-profit policyholders. This was achieved by bringing sufficient investment gains into account.
"(2) Subject to the following provisions of this section and to any regulations made by the Treasury, the accounts recognised for the purposes of those sections are –
(a) a revenue account prepared for the purposes of Chapter 9 of the Prudential Sourcebook (Insurers) in respect of the whole of the company's long-term business;
(b) any separate revenue account required to be prepared under that Chapter in respect of a part of that business.
In paragraph (a) above "the Prudential Sourcebook (Insurers)" means the Interim Prudential Sourcebook for Insurers made by the Financial Services Authority under the Financial Services & Markets Act 2000. Paragraph (b) above does not include accounts required in respect of internal-linked funds."
"17. (1) Every insurance company to which this Part of this Act applies shall, with respect to each financial year of the company, prepare a revenue account for the year, a balance sheet as at the end of the year and a profit and loss account for the year, or, in the case of a company not trading for a profit, an income and expenditure account for the year.
(2) The contents of the documents required by subsection (1) above to be prepared shall be such as may be prescribed, that regulations may provide for enabling information required to be given by such documents to be given instead any note thereon or statement or report annexed thereto or may require there to be given in such a note, statement or report such information in addition to that given in the documents as may be described.
…
(4) If a form is prescribed -
(a) for any such document as aforesaid or,
(b) as that in which information authorised or required to be given in a statement or report annexed to any such document is to be given or,
(c) for a certificate to be so annexed,
the document shall be prepared, the information shall be given or, as the case may be, the certificate shall be framed, in that form.
"8. The revenue account to be prepared by every company under section 17(1) of the Act –
…
(b) in the case of a company carrying on long term business, shall comply with the requirements of schedule 3 below and shall be in Form 40 so, however, that -
(i) every such company shall prepare a separate account in Form 40 in respect of each long term business fund maintained by it; and
(ii) where there is more than one fund for ordinary long-term insurance business or for industrial assurance business, the company shall also prepare a summary of Form 40 for ordinary long term insurance business or for industrial assurance business, as the case may require.
A separate account in Form 40 is therefore required for each part of the LTIF, plus a summary Form 40 with the totals. In the Society's case these are the four funds referred to in paragraph 2(12) above of which the L&A Fund is one. The contents of a Form 40 is summarised in paragraph 2(41) above. Of particular relevance are the following lines:
12. Investment income receivable before deduction of tax
13. Increase (decrease) in the value of non-linked assets brought into account
14. Increase (decrease) in the value of linked assets
15. Other income (included from 2003-04)
18. (1) Every insurance company to which this part of this Act applies which carries on long-term business –
(a) shall, once in every period of 12 months, cause an investigation to be made into its financial condition in respect of that business by the person who for the time being is its actuary under section 19(1) below or any corresponding enactment previously in force; and
(b) when such an investigation has been made, or when at any other time an investigation into the financial condition of the company in respect of its long-term business has been made with a view to the distribution of profits, or the result of which are made public, shall cause an abstract of the actuary's report of the investigation to be made.
(2) An investigation to which subsection (1)(b) above relates shall include -
(a) a valuation of the liabilities of the company attributable to its long-term business; and
(b) a determination of any excess over those liabilities of the assets representing the fund or funds maintained by the company in respect of that business and, where any rights of any long-term policyholders to participate in profits relate to particular parts of such a fund, a determination of any excess of assets over liabilities in respect of each of those parts.
(4) For the purposes of any investigation to which this section applies the value of any assets and the amount of any liabilities shall be determined in accordance with any applicable valuation regulations.
(5) The form and contents of any abstract under this section shall be such as may be prescribed."
25. Save in relation to paragraph (b) below, for the purposes of section 18 of the Act (periodic actuarial investigation of company with long-term business) ordinary long-term insurance business and industrial assurance business shall be treated separately and the abstract of the report of the actuary on long-term business–
(a) shall comply with the requirements of schedule 4 below and shall contain the information (together with such of Forms 46 to 49 and 51 to 58 as may be appropriate) specified in that schedule;"
Schedule 4 to the 1996 Regulations (headed "Abstract of valuation report prepared by the appointed actuary") provides:
"All the Forms included in the part of the return to which this Schedule relates (forms 46 to 49, 51 to 58, 60 and 61) are to be laid out as shown in he Schedule, except that the instructions to Forms need not be reproduced.
…
The following information shall be given, the answers being numbered to accord with the numbers of corresponding paragraphs of this Schedule.
…
13. Where any rights of any policyholder to participate in profits relate to profits from particular parts of a long-term business fund –
(a) a revenue account in the format of Form 40 for each such part except where such information is provided elsewhere; and
(b) the principles and methods applied in apportioning the investment income, increase or decrease in the value of assets brought into account, expenses and taxation between each part, where these particulars are not provided elsewhere."
Form 40 is not one of the forms listed in Regulation 25 but the information to be given includes a revenue account "in the format of Form 40" (known as, and referred to below as, a memorandum Form 40) where policyholders have rights to participate in profits relating to profits from particular parts of a LTIF. In the Society's case this means that a memorandum Form 40 has to be prepared for the with-profits part of the L&A Fund since the with-profits policyholders have rights to participate in that part only of the L&A Fund. As the Society's actuarial investigation indicates, the with-profit policyholders may at the discretion of the directors participate in the 1996 Subfund but no memorandum Form 40 was prepared in respect of that subfund. This was because the with-profits policyholders did not have rights to participate in surplus from that subfund.In the Society's return for 1999 which was used as a sample during the hearing the answer to para 13(b) explained that:
"…Investment income and realised and unrealised investment appreciation arising within the internal linked funds are allocated directly to those funds. The balance of investment income is apportioned between the with-profits part of the life and annuity fund and the remainder of the long term business funds using mean funds as a basis, and excluding the internal linked funds from the calculation. The increase or decrease in the value of non-linked assets brought into account in each fund or part of a fund has regard to the nature of the changes in the long term liabilities of that part of the fund…".
"(1) Subject to (2), for each with-profits fund[1], except where such information is provided elsewhere in the return –
(a) a revenue account in the format of Form 40 with a supplementary note stating the amount, if any, of investment income relating to linked assets included in line 12; and
(b) a statement of liabilities and margins in the format of Form 14 with a supplementary note stating the amount, if any, of the increase or decrease, as the case may be, in the value of non-linked assets."
Contentions of the parties
(1) Section 83(2) (as originally enacted) stated:
"(2) except in so far as regulations made by the Treasury otherwise provide, in subsection (1) 'brought into account' means brought into account in the revenue account prepared for the purposes of the Insurance Companies Act 1982."
This identified by reference to "the revenue account prepared for the purposes of the ICA 1982," the items (i.e. Lines 12 to 14 of Form 40)[2] that were to form the basis of the amount entering the Case I computation.
(2) Section 432B(2) (as introduced by FA 1990):
"Where in addition to the revenue account prepared for the purposes of the Insurance Companies Act 1982 in respect of the whole of any business carried on by a company there are prepared for the purposes of that Act revenue accounts relating to parts of the business, amounts referred to in sections 432C to 432E shall, so far as they relate to those parts, be ascertained by reference to the latter accounts rather than by reference to the former."
This confirmed that s 83(2) referred to the single or Summary Form 40 prepared under s 17 ICA 1982 (see paragraph 9 above) and Regulation 8(b) of the 1983 Regulations:
"The revenue account required to be prepared by every company under section 17(1) of the Act—
…
(b) in the case of a company carrying on long term business, shall comply with the requirements of Schedule 3 below and shall be in Form 40 so, however, that—
(i) every such company shall prepare a separate account in Form 40 in respect of each long term business bund maintained by it, and
(ii) where there is more than one fund for ordinary long term insurance business or for industrial assurance business, the company shall also prepare a summary form for ordinary long term insurance business or for industrial assurance business, as the case may require."
(3) In determining what part of the items brought into Lines 12 to 14 of the Society's Summary Form 40 were referable to life assurance business or any class of life assurance business, s 432B(2) directed that the apportionment provisions of ss 432C to E were to operate by reference to revenue accounts "prepared for the purposes of that Act" in respect of a part of the LTIF (see (2) above).
(4) Under s 83(2) and s 432B(2), "the revenue account prepared for the purposes of the Insurance Companies Act 1982" in respect of the Society's LTIF is the account required to be prepared under s 17(1) ICA 1982 and correspondingly a revenue account "prepared for the purposes of that Act" in respect of a part of the LTIF is an account similarly so required. In this respect s 17 ICA 1982 indicates that for something to be a revenue account, where a particular form is prescribed by Regulations, it must be "in that form" (s.17(4) ICA 1982, see paragraph 9 above), i.e. to be a revenue account the document must be "in Form 40", (see Regulations 5 and 8(b) of the 1983 Regulations with my added italics):
"5. Every account, balance sheet, note, statement, report and certificate, required to be prepared by a company pursuant to section 17(1), (2), and (3) of the Act shall be prepared in the manner hereinafter specified and shall fairly state the information provided on the basis required by these Regulations.
6(1) the balance sheet required to be prepared by every company under section 17(1) of the Act shall comply with the requirements of Schedule 1 below and shall be in Forms 9 to 15…
7. The profit and loss account required to be prepared by every company under section 17(1) of the Act shall comply with the requirements of Schedule 1 below and shall be prepared in Form 16.
8. The revenue account required to be prepared by every company under section 17(1) of the Act—
(a) …
(b) in the case of a company carrying on long term business, shall comply with the requirements of Schedule 3 below and shall be in Form 40…[See (2) above for Regulation 8(b) in full]
[The later 1996 Regulations retained the same wording in regs 5, 6 and 7 but reg 8 starts "The revenue account to be prepared by every company under section 17(1) of the Act…," thus dropping the reference to required.]
(5) In 1995, Parliament moved the provisions dealing with separate revenue accounts in respect of parts of the Society's LTIF out of the apportionment provisions of s 432A to E into the substantive provision of s 83 which operates to identify the line 12 to 14 items which form the basis of the amounts to be taken into the Case I computation as receipts to the extent referable to particular business:
"(2) So far as referable to that business, the following items, as brought into account for a period of account (and not otherwise), shall be taken into account as receipts of the period -
(a) the company's investment income from assets of its long-term business fund, and
(b) any increase in value (whether realised or not) of those assets."
(6) In doing so, Parliament chose to strengthen the link between tax provision and section 17 ICA 1982 by enacting section 83A to replace the original s 83(2):
"(1) In sections 83 to 83AB "brought into account" means brought into account by an account which is recognised for the purposes of those sections.
(2) Subject to the following provisions of this section and to any regulations made by the Treasury, the accounts recognised for the purposes of those sections are -
(a) a revenue account prepared for the purposes of the Insurance Companies Act 1982 in respect of the whole of the company's long-term business;
(b) any separate revenue account required to be prepared under the Act in respect of a part of that business."
In particular—
(a) Section 83A(2)(a) continued to use the language ("prepared for the purposes of the Insurance Companies Act 1982") previously found in s 83(2) and s 432B(2) (both as originally enacted) to describe the Summary Form 40;
(b) Parliament did not, however, adopt the same language ("prepared for the purposes of that Act") in s 83A(2)(b), as it had previously used in section 432B(2) and as it could equally have used in s 83A(3)(b);
(c) Instead Parliament chose to refer in section 83A(2)(b) to a "separate" revenue account "required to be prepared under that Act".
(7) In doing so, Parliament was explicitly adopting the language of, and reinforcing the link with s 17 ICA 1982 (see s. 17(2), "required by subsection (1) to be prepared") and the Regulations made pursuant to section 17 (see Regs 5 and 8 of the 1983 Regulations, "Every account ... required to be prepared by a company pursuant to section 17(1)" and "The revenue account required to be prepared by every company under section 17(1) of the Act" and "every such company shall prepare a separate account in Form 40").
(8) At the same time, for the avoidance of doubt, Parliament explicitly stated that s 83A(2)(b) did not include accounts in respect of internal linked funds, being the only other document in prescribed form (Form 51) that might conceivably be said to be a revenue account required to be prepared by section 17 ICA 1982.
(9) The memorandum Form 40 is not a "separate" revenue account "required to be prepared" under the ICA 1982 in the relevant sense because—
(a) Even though the Regulatory regime may require a company (such as the Society) to prepare a memorandum Form 40 in the particular circumstances of its case, the memorandum Form 40 is not a "separate" revenue account "in Form 40" which is "required to be prepared" as Regs 5 and 8 envisage in respect of the revenue accounts that every company must prepare as its fund structure dictates.
(b) A memorandum Form 40 is not a revenue account as such because it is not a document prepared "in that form", i.e. "in Form 40" but need only be prepared "in the format of Form 40" and then only if the information within it is not provided elsewhere.
(c) As Mr Jenkins' evidence (supported by Mr Gibson) shows, the memorandum Form 40 in this case is a subset of the L&A Form 40 prepared to provide certain information supplementing the with-profits Form 58 which demonstrates that the company has met its bonus obligations to policyholders. It is not an integral part of the "regulatory" financial statements upon which the company's tax computation might be expected to be based.
(10) Sections 83 and 83A are designed to identify items (in lines 12 and 13 of Form 40) that must be taken into account as receipts in a Case I computation. The normal starting point for a Case I computation is the business accounts prepared in accordance with best current accounting practice. By the years in dispute, this approach had received statutory recognition in section 42 FA 1998:
"(1) For the purposes of Case I or II of Schedule D the profits of a trade, profession or vocation must be computed [originally on an accounting basis which gives a true and fair view; from 2002 in accordance with generally accepted accounting practice], subject to any adjustment required or authorised by law in computing profits for those purposes."
[However, subs (5) provides:
"This section does not affect provisions of the Tax Acts relating to the computation of the profits of …companies carrying on life insurance…"]
There is no requirement that business accounts must be audited before they can be accepted for tax purposes. However, the inclusion of revenue accounts in Form 40 as part of the core accounting and financial records of the business in respect of which the directors must certify that they have maintained proper accounting records (para 1, Sch 6 to the 1996 Regulations) and the auditors must certify have been properly prepared (para 11) (neither of which certificates extend to a memorandum Form 40) support the conclusion that section 83A(2) envisages a revenue account in Form 40 but not a memorandum Form 40.
(11) None of the amendments after 1995 of s 83 or 83A and none of the stylistic and linguistic developments that occurred on the adoption of the 1996 Regulations in place of the 1983 Regulations or on the adoption of Chapter 9 of IPRU (INS) in place of the 1996 Regulations leads to a different conclusion. [The terminology of the 1996 Regulations is retained: "Every account, balance sheet, note, statement, report and certificate, required to be prepared… (Rule 9.11 of Chapter 9); "The balance sheet required to be prepared…" (Rule 9.12(1)); "The profit and loss account required to be prepared…" (Rule 9.13); "The revenue account to be prepared…" (para 9.14).]
(1) The issue on this referral is whether the memorandum Form 40 which the Society was required to prepare under paragraph 13(a) of Schedule 4 to the 1996 Regulations (and paragraph 13(1)(a) of Appendix 9.4 to IPRU (INS)) fell within s 83A(2)(b). In other words, was it a separate revenue account required to be prepared under the ICA 1982 (or under Chapter 9 of IPRU (INS)) in respect of a part of the Society's long-term business? The answer to that question is clearly that it was such a revenue account.
(2) First, there can be no doubt that it was a "revenue account". Schedule 4 paragraph 13(a) makes that clear. Secondly, was it required to be prepared under ICA 1982? Again, there can be no doubt about that. The requirement is contained in the 1996 Regulations. However, those regulations were made under the ICA 1982. The Society does not appear to be contending that there is any distinction between the Act and the regulations. Equally, it is clear that it was required to be prepared under Chapter 9 of IPRU (INS). Thirdly, the revenue account must be in respect of a part of the Society's long-term business. That condition is also plainly satisfied. It is difficult, therefore, to see in what way the revenue account in question does not satisfy section 83A(2)(b).
(3) The Society appears to make two points. The first point is that the revenue account in question was not prepared under section 17 of ICA 1982. However, section 83A does not mention section 17 but rather the ICA 1982 as a whole. This point seems inapplicable to the later periods where the requirement is under IPRU (INS). Secondly, the memorandum Form 40 was not required as "an accounting requirement". Again, section 83A does not mention accounting requirements. The Society appears to recognise that the relevant revenue account was required under section 18 of the 1982 Act (and IPRU (INS)). Section 18 is just as much a part of the ICA 1982 as section 17. Therefore, the revenue account in question was plainly required under the ICA 1982. It was equally plainly required under IPRU (INS). Indeed, this does not seem to be disputed.
(1) Issue 2 does not arise based on the Society's view on Issue 1. The Society's view on Issue 1 also disposes of the legislative "gap" that otherwise arises on HMRC's view of Issue 2.
(2) If nevertheless the Society is wrong on Issue 1, then in enacting ss 83A(3) and (4) Parliament must have envisaged a situation in which the total of lines 12 to 14 [3] in all the separate revenue accounts (including the memorandum Form 40) exceeded the figure in lines 12 to 14 of the Summary Form 40.
(3) In that situation Parliament prescribes that the total of lines 12 to 14 in the separate revenue accounts (including the Memorandum Form 40) plus the deemed revenue account "required and prepared" under s 83A(4) should equal the amounts show in lines 12 to 14 of the Summary Form 40. This is consistent with s 83(2) as originally introduced which only referred to lines 12 to 14 of the Summary Form 40.
(4) Arithmetically, the only way to achieve the result the legislation prescribes is through the deemed "negative" revenue account for which the Society contends to generate a negative figure in lines 12 to 14 corresponding to the positive figure in lines 12 to 14 of the memorandum Form 40 and eliminating "double counting." Further, and contrary to HMRC's argument, the legislation clearly envisages that the provisions of sections 432C to 432E should be applied separately to any such deemed revenue account, rather than it merely negativing part of the entries of one of the existing revenue accounts.
(1) The Society says that, if the total amount brought into account in the separate Forms 40 is greater than the total amount brought into account in the Form 40 in respect of the whole of the Society's long-term business, section 83A(4) must be given a peculiar construction. The effect of this construction is apparently to result in a deemed revenue account in negative figures which somehow cancels out the memorandum Form 40. It is claimed that this ensures that the total amount brought into account in the four separate Forms 40 recognised by section 83A(2)(b) and the Form 40 treated as required and prepared by section 83A(4) is equal to the total amount brought into account in the Form 40 prepared for the whole of the long-term business. This argument is misconceived.
(2) Section 83A(4) is dealing with the situation in which the total of the items brought into account in the separate accounts is less than the total amount brought into account in the account prepared for the whole business. In such circumstances, there is deemed to be required and prepared a further separate revenue account "covering the balance". The Society wishes this deemed revenue account to come into existence when the total of the separate accounts is greater than the account for the whole business and to be negative in amount. The effect of this is, on the Society's case, to reduce the total of the items brought into account in the separate accounts rather than to cover the balance.
(3) Sub-section (4) does not, on its wording, provide that the total of the separate accounts is always to be adjusted so as to be the same as the account for the whole of the business. The apparent purpose from the wording of the section is to ensure that the total of the separate accounts is always at least as great as the account for the whole of the business. There is nothing in sub-section (4) which prevents the total of the separate accounts being greater than the account for the whole of the business.
(4) The deemed negative revenue account would consist of components which are unreal. For example:
(a) the mathematical reserves (Form 58 line 21) are negative so that liabilities become assets;
(b) the bonuses at form 58 lines 41 and 43 are negative although there is no mechanism for policyholders to return bonuses; and
(c) there are no actual policyholders with policies in the deemed account which means it is impossible to determine whether apportionment should be under s 432C/D or 432E i.e. by reference to non-profit or with-profits policies.
(5) Even if one accepts the premise of the Society's argument (i.e. that one can have a negative revenue account), it does not follow that it should cancel out the Memorandum Form 40. This would result in the same distortion between pension business and BLAGAB results from ignoring the memorandum Form 40 under the first issue. The correct tax result would be achieved if the deemed negative revenue account cancelled out the with-profits element of the Form 40 for the whole of the L&A Fund. This would leave that Form 40 comprising only non-profit business to which section 432C/D could be applied.
(6) Notwithstanding that HMRC's argument on interpretation set out above is the correct interpretation of s 83A(4), it is and was HMRC's policy intention that under 83A one should ignore any duplication of the with-profits Fund and apply the appropriate tax treatment to the with-profits and non-profit parts of the L&A Fund – i.e. sections 432E and 432C/D respectively. This is certainly how HMRC has approached the matter in correspondence – albeit such a proposal was unacceptable to the Society.
Reasons for the decision
"13. Where any rights of any policyholder to participate in profits relate to profits from particular parts of a long-term business fund –
(a) a revenue account in the format of Form 40 for each such part except where such information is provided elsewhere;…".
IPRU (INS) is similar; the following is contained in a list of 23 items:
"13(1) Subject to (2), for each with-profits fund[4], except where such information is provided elsewhere in the return –
(a) a revenue account in the format of Form 40 with a supplementary note stating the amount, if any, of investment income relating to linked assets included in line 12…"
The draftsman has been careful to describe it as a revenue account in the format of Form 40, suggesting that he did not intend it to be treated as a real Form 40, for which the expression "in form 40" is used (reg 8(b) of the 1996 Regulations; rule 9.14(b) of IPRU (INS)). There is no need to provide a memorandum Form 40 if (or to the extent that) the information is provided elsewhere in the return. The replies to the list of information that is required are given by the appointed actuary in narrative form and the memorandum Form 40 is described as an attachment to this. There is no requirement to audit a memorandum Form 40 as there is a real Form 40, although I do not regard this as particularly important. All these factors point to the subsidiary nature of the requirement to prepare the memorandum Form 40, even though it is not in doubt that there is a requirement to prepare it. The explanation in reply to para 13(b) of Sch 4 to the 1996 Regulations explains how the various items in the memorandum Form 40 are apportioned to with-profits policies; for example for 1999, as set out in paragraph 12 above: "The increase or decrease in the value of non-linked assets brought into account in each fund or part of a fund has regard to the nature of the changes in the long term liabilities of that part of the fund."
(1) Which of the revenue accounts prepared by [the Society] in relevant years are "recognised" for the purposes of section 83A(2) Finance Act 1989, and in particular which, if any, such accounts are "required to be prepared" for the purposes of section 83A(2)(b) of that Act?
Answer. The following: the revenue account in respect of the whole of the long term business; the revenue account in respect of the Life and Annuity business; the revenue account in respect of the Permanent Health Insurance business; and the revenue account in respect of the Capital Redemption Business; but not the memorandum Form 40 in respect of the with-profits part of the Life and Annuity business.
(2) If the revenue account in respect of the with-profits part of the Life and Annuity business is "required to be prepared" and is therefore "recognised" for the purposes of section 83A, how are subsections (3) and (4) of section 83A to be construed and applied in the circumstances of [the Society's] case?
Answer. In view of my answer to issue 1 this issue does not arise.
JOHN AVERY JONES
TRIBUNAL JUDGE
RELEASE DATE: 06 Aug 2009
(As amended under Rule 37)
Note 1 A footnote states: “With-profits fund includes subfunds (whether notional or real).” [Back] Note 2 From 2003-2004 the lines covered were expanded to include line 15 “other income”, s. 83(2)(d) FA 1989. [Back] Note 4 A footnote states: “With-profits fund includes subfunds (whether notional or real)” [Back]