Part ii. It says the results of being taxed on a gross I - E basis would be higher investment return? Can someone explain this. In the notes when it explains the I - E and the components in I it says investment income from real estate, gilts and bonds. Is this the net investment income or gross income? How does the tax normally work? Also in this question - it says the gross investment income can be passed to the policyholder tax free. But the company still pays tax on it so there is a mismatch there. How would the company allow for that tax in the pricing?
The Incomes are Gross of tax. That is why dividend income (usually termed Franked Investment Income) is excluded because its already been taxed at source so including it will be double taxation. Realized Chargeable Gains are also pre-Capital Gains Tax but after indexation relief. The company can do what ever it likes with premiums i.e. to say it can decide to impute a tax into the premiums or pass the whole gross returns to policyholders. However a proper business decision will consider adequacy of the resulting premium, competitiveness, impact on volumes etc. In setting premiums for a new product say, it will usually consider its overall tax position. If it's in XSI tax position then it will use Net of Tax Returns together with Net of Tax Expenses. I.e. its getting relief for expenses. If its XSE then it will use Gross of Tax Returns and Gross of Tax Expenses. i.e. its assuming no relief of expenses. The Net/Net will result to lower premiums than the Gross/Gross so the ultimate choice really depends on the company's intentions, pricing strategy, competition etc. It may alternatively consider the policy on standard alone basis: Initially policy likely to be XSE due to development cost etc so Gross/Gross (as described above) is used and then later when it turns XSI it switches to Net/Net. Hopefully you find it useful.
