Min profit test

[Himanshu Sikri]

Hi,

Can anyone help me with the formula of calculating the the min profit amount which is used in the minimum profit test?

Thank you.

 

[Lindsay Smitherman]

It's basically the same formula as for the accounting profit calculation for non-BLAGAB (as set out in Ch 7 Section 4.1) - with a few tweaks (as are outlined in Ch 7 Section 6.2)

 

[Himanshu Sikri]

Ok got it, thank you.

• Shareholders share is calculated by computing the BLAGAB trade profit/loss using a very similar basis as that used for the non BLAGAB and then making some adjustment
  • Deduct p/h share (any current and deferred tax)
  • Adjusted for shareholders' share of dividends (we have to add it)
  • Shareholder losses in the group or in the company may be used against the shareholders share of I-E profits, subject to the new rules on use of current year losses to offset profits in other years

 

[Lindsay Smitherman]

Hi: almost ...
The s/h share of dividends is deducted from the minimum profit (not added) before this amount is compared against I-E. This is because dividends are excluded from I-E and we want to be comparing like-for-like.

 

[Himanshu Sikri]

Okay, thank you for pointing out.

 

[Studystuff]

Hi Lindsay,

I just wanted to confirm on the above. In keeping with the terminology used in the Core Reading, is it not more correct to say that minimum profits amount should be defined as above but with NO adjustments for dividends? And then Minimum profit - dividends = shareholder share?

Then in the minimum profits test we compare minimum profits vs adjusted I-E (including dividends)... If this test doesnt bit we tax the S/H share are the corporation tax rate and: "unadjusted I-E" less "shareholder share" at the P/H rate?

 

[Lindsay Smitherman]

Yes, technically the 'minimum profit test' as defined in the Core Reading takes that approach. But it fundamentally doesn't matter either way. We either compare adjusted minimum profit = {minimum profit - dividends} with I-E, or we compare minimum profit with adjusted I-E = {I-E plus dividends}. Both will give us the same answer for which is higher, and therefore whether minimum profit bites or not.

Since the taxable amounts are the adjusted minimum profits and the unadjusted I-E (ie both excluding dividends), I think it's easier to think of the comparison as using the first of these two approaches [and it also more readily addressed the question in the thread above].

For the purposes of the SA2 exam, I think it also reduces the risk of taxing the wrong amount after performing the test!

 

[Studystuff]

Thanks so much. I agree with all of the above.

 

[prachi]

Hi,

I understand that we deduct the the shareholder share of dividend from trading profit to reach the minimum profit. This is done so that I-E and minimum profits are comparable.
However, the I-E include more adjustment like unrealized gains on equities is excluded, Acquisition cost is spread over ...
So does these adjusted are not made to minimum profit as well for apple to apple comparison?

Another query I have relates to page 20 of chapter 6 ,eg of XSE
1. Due to significant fall in market value of bonds
2. If company is new and expenditures are large.
How these two impacts min profit test?

Thanks.

 

[Lindsay Smitherman]

I understand that we deduct the the shareholder share of dividend from trading profit to reach the minimum profit. This is done so that I-E and minimum profits are comparable.
However, the I-E include more adjustment like unrealized gains on equities is excluded, Acquisition cost is spread over ...
So does these adjusted are not made to minimum profit as well for apple to apple comparison?

I think you would need to ask a tax accountant about this if you wanted a definitive answer! Bear in mind that the Core Reading on taxation is no longer UK specific and so now has a lot less detail about the BLAGAB calculations than previously. In fact it doesn't mention the deduction of shareholders' share of dividend income any more. So you shouldn't be expected to know these sorts of details for the exam, and certainly not details of tax legislation beyond what is mentioned in the Core Reading.

But FWIW (for interest) trading profit is taken from the company's statutory accounts, and typically acquisition expenses would be spread in those accounts (eg through a 'deferred acquisition cost' or similar, or via the CSM mechanism in IFRS 17). The spread wouldn't be exactly the same as under tax rules for 'E', but there is spread. Similarly, unrealised losses / gains on equities would not necessarily be brought through into profit in the accounts. Also bear in mind that most of the unrealised losses / gains on equities would belong to the policyholders, and so don't come through into profit anyway (they would be offset in the profit calculation by an increase in unit reserves for UL business or, for WP business, in asset shares and hence WP reserves).

 

[Lindsay Smitherman]

Another query I have relates to page 20 of chapter 6 ,eg of XSE
1. Due to significant fall in market value of bonds
2. If company is new and expenditures are large.
How these two impacts min profit test?

The minimum profit test bites when minimum profit > I minus E.

If I is very low and/or E is very high, I minus E will be very low (even negative) and hence it is more likely that minimum profit will exceed it.

 

[Manisha]

Hi team
I’m not able to understand the concept for one of the core reading questions -
Core reading says that XSE may arise due to the fall in the value of bonds..
My query is why fall in the MV of equities is not given as an example of why a company might become XSE?
Could someone please help me with this. Thanks!

 

[Lynn Birchall]

Hi - remember we're thinking about a fund with an 'I-E' taxation basis here. Exactly what is included in I would depend on the particular jurisdiction, but unrealised gains on equities are often excluded. So, an increase in MV of equities would only be a cause if the company had sold those equities.
Hope that helps!

 

[Manisha]

Hi - remember we're thinking about a fund with an 'I-E' taxation basis here. Exactly what is included in I would depend on the particular jurisdiction, but unrealised gains on equities are often excluded. So, an increase in MV of equities would only be a cause if the company had sold those equities.
Hope that helps!

Yes, Thank you so much.