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Thursday, 18th April 2024
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Finance Bill imposes extra tax burden on resident assurance policyholders Back  
New measures contained in the Finance Bill 2005 surprised the life assurance industry by changing the definition of a chargeable event for policies linked to funds. Jim Murphy writes that this will increase the tax payable by Irish resident policy holders, while increasing unnecessarily the administrative burden on non-resident policy holders.
Life assurance taxation – a Finance Bill surprise!
The recently published Finance Bill 2005 contained a significant surprise package for the life assurance industry. The proposed new measure aims to accelerate the tax take for the Exchequer where Irish resident policyholders are concerned and has the effect of introducing an unnecessary administrative burden where non-resident policyholders are concerned.

Before considering the proposed new measure, it is worth outlining the current taxation basis that applies for life assurance business in Ireland.

Current taxation basis
Since 2001, a ‘gross roll-up’ system of life assurance taxation has applied in Ireland. Under this system, income and gains are accumulated gross of tax within life assurance funds until a tax event is triggered on the happening of a ‘chargeable event’ – effectively when money is paid out of a policy on maturity or surrender or if a policy is assigned.

For policyholders resident in Ireland, tax is payable on any policy gains at the standard rate of income tax plus an additional levy of 3 per cent at the time a chargeable event occurs i.e. a total rate of 23 per cent currently.

For policyholders resident outside of Ireland, policy proceeds are paid gross of Irish tax provided that the life assurance company is in possession of a non-resident declaration form at the time of payment (on the basis that the policyholder will be subject to personal tax where he/she is resident). However, where a non-resident declaration has not been obtained, the life assurance company is required to deduct Irish tax at source.

Proposed new measure
Section 38 of the Finance Bill 2005 proposes to extend the definition of a chargeable event for policies linked to funds to include either the ending of a fixed investment period where one exists (as defined by the Bill) or switching between funds after five years. For example, a roll-over of one tracker bond investment to another within a whole of life wrapper would in future trigger a tax event. Similarly, a switch from one unit-linked fund to another within an open-ended single premium investment policy would trigger a tax event, where the switch takes place after five years from inception of the policy.

Whilst the definition of ‘fixed investment period’ is somewhat unclear, the intentions are quite clear – to accelerate the tax take for the Exchequer. In the absence of the proposed new measure, it would be possible for a policyholder to invest in a life assurance policy and to defer payment of tax indefinitely. However, the views of the Department of Finance on this situation were summed up in the media quote, ‘this is not in the spirit of the scheme’.

Surely, however, a key feature of a gross roll-up tax system is the ability to defer tax and was this not recognised at the outset when the additional levy of 3 per cent was introduced?

Rumours abound!
Various rumours have abounded as to the real reasons for the proposed new measure, including the populist Special Savings Incentive Account (SSIA) angle! The first wave of SSIAs are due to reach their fifth anniversary in April 2006 and it has been speculated that the Department of Finance doesn’t want to miss out on a tax take on the fifth anniversary for whole of life assurance policies, but in reality the Exchequer won’t lose out under the current system anyway.

A more likely reason stems from the change in the way that life assurance companies have packaged tracker bonds since 2001. Prior to gross roll-up, most tracker bonds were written for fixed investment periods, at the end of which policy proceeds were paid out to policyholders. Following the changeover to gross roll-up, life assurance tracker bonds have been written as open-ended policies but linked to fixed term funds. As each tracker funds matures, the proceeds are then rolled over to a new fund within the life assurance policy. Under this approach, policyholders do not pay tax until proceeds are finally taken from the life assurance policy – a legitimate deferral of tax but ‘not in the spirit of the scheme’?

By contrast, the bulk of unit-linked investment policies were written on an open-ended basis pre-gross roll-up and so the Department could reasonably have predicted that this business would continue to be written on an open-ended basis under gross roll-up and factor this into the timing of expected future tax takes.

A hammer to crack a nut?
If tracker bonds have indeed been the root of the Department’s ire, a more focused measure would seem to be appropriate compared with the current Section 38 wording. The current wording means that any discretionary fund switches after five years will trigger a chargeable event.

This means that a key benefit of unit-linked policies will become a disadvantage overnight… and not just for new policies; existing policies will also be affected as Section 38 effectively has retrospective effect. For example, if a policyholder chooses to switch from a European equity fund to a US equity fund after five years, a chargeable event will in future be triggered if the Finance Bill goes ahead unamended. If there are gains on the policy and the policyholder is an Irish resident, Irish tax will be payable at that point. This raises all sorts of questions:

- What if a loss is made at the time of the switch? Currently, there appears to be no provision to offset such losses against gains elsewhere.

- Similarly, what if the US equity fund performs dismally and wipes out the gains previously made on the European equity fund?

- Why five years? If the switch took place one day before the fifth anniversary, no chargeable event would arise and no tax would be payable?

- What would be the administrative costs of implementing the new measures and who will ultimately pay them?

- Why charge an additional 3 per cent tax levy if deferral of gains is no longer allowed? (This question applies equally for tracker bond business.)

For a non-resident policyholder, such a simple switch request would trigger a requirement to complete a non-resident declaration where one had not previously been completed, or else suffer Irish tax deduction at source! This conflicts with the previously agreed (and sensible) position between industry and Revenue, which allows life insurers the option to seek a non-resident declaration either at point of sale or else at the point when policy proceeds are paid out.

In many cases, companies have opted for the latter approach on the basis that policyholders can change residence during the life of a policy. However, Section 38 of the Finance Bill would essentially remove this option on practical grounds and whilst companies could change procedures for new policies without significant upheaval, the situation would unfortunately not be as straightforward for existing policies.

In summary, Section 38 of the Finance Bill came as quite a surprise to the life assurance industry and would have far reaching implications for the industry if it were to be enacted as drafted. At the time of going to press, we understand that industry is due to meet with the Department of Finance to try to better understand the source of the Department’s concerns regarding ‘the spirit of the scheme’. Hopefully, arising from this, we will see an amended version that addresses the concerns of the Department whilst recognising the commercial and practical considerations for the industry of any proposed changes.

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