Ch7: Sec 6 BLAGAB Minimum Profit

[kntg24]

Hi. I have read through the section and here are some questions i would like to clarify.

1. In Sec 6.2, “BLAGAB trade profit is adjusted for the shareholders’ share of dividends to ensure a like for like comparison with the I-E computation which excludes dividends, whilst retaining the elements of dividends in the BLAGAB trade profit which are included in the assets which support policyholder liabilities”?
Does it mean since I-E excludes dividends, in order to compare apple to apple, BLAGAB trade profit will need to exclude dividends as well. However when we calculate policyholder taxable amount, dividends will need to be included in the BLAGAB trade profit?

2. Why “when BLAGAB losses arise, there will be no shareholders’ share?” In Sec 6.1, “if the minimum profits test is bite, all taxable income will be considered as shareholder profit”? Aren’t these two statements contradict? And, if there will be no shareholders’ share, does that mean only policyholder will need to pay for tax?

3. Understand that by carrying forward the loss from year t-1, the profit arise in year t will be used to offset year t-1 losses thus lower tax payable in year t (due to lower profit). But, how does this “increases shareholders’ share and increases the profit taxed at shareholder rate and reduces the amount taxed at policyholder rate”?

4. Why “if basic rate of income tax is higher than corporate tax, we do not see BLAGAB trade losses offset or surrendered”? What’s the difference compared to carried forward to offset future BLAGAB trade profit?

I am really confused for this chapter. Thanks in advance for any replies.

 

[kntg24]

5. In Sec 6.3, “If there are BLAGAB losses in that period, the minimum profit test does not bite. If the minimum profit test does not bite, the company is said to be XSI.”
XSI happens when I-E is positive. If I-E is positive, why will there be BLAGAB losses?

 

[Lindsay Smitherman]

Hi - probably the first place to start is to make sure that you are comfortable with the basics of taxing BLAGAB business in a proprietary company.

BLAGAB business should be taxed on I-E, but there is a minimum amount of tax that HMRC is prepared to accept so the minimum profits test is imposed. This (broadly) means that the taxable amount is the higher of I-E and profit.

The taxable amount is split into two parts: the shareholder share and the policyholder share. The shareholder share equals the minimum profit. The policyholder share equals any excess of the total taxable amount over this, ie policyholder share = {I-E minus minimum profit} if this is a positive amount.

The shareholder share is taxed at the corporation tax rate. The policyholder share is taxed at the policyholder rate = the base rate of income tax. The insurance company pays all of this: tax on the shareholder share AND tax on the policyholder share.

If the minimum profit is the higher of the two figures (and so the taxable amount = minimum profit), the company can carry forward the excess of minimum profit over I-E into the next tax year - this is called 'excess E'.

I'll now work through each of your questions in turn.

 

[Lindsay Smitherman]

1. In Sec 6.2, “BLAGAB trade profit is adjusted for the shareholders’ share of dividends to ensure a like for like comparison with the I-E computation which excludes dividends, whilst retaining the elements of dividends in the BLAGAB trade profit which are included in the assets which support policyholder liabilities”?
Does it mean since I-E excludes dividends, in order to compare apple to apple, BLAGAB trade profit will need to exclude dividends as well. However when we calculate policyholder taxable amount, dividends will need to be included in the BLAGAB trade profit?

Because the taxable amount is the higher of I-E and minimum profit, we need to make sure that the minimum profit amount is calculated on a like for like basis. As you say, 'I' excludes dividends - therefore we should exclude dividends from minimum profit too.

However, we only deduct the shareholders' share of dividend income from the profit figure. We don't deduct the policyholders' share. For example, thinking about unit-linked products, the liabilities to policyholders will increase by dividends received into the unit fund. Therefore we need to keep those dividends in the 'investment return' part of the profit calculation, because we have the offsetting reduction in profit due to the increase in liabilities (arising from the dividends increasing the unit fund value). This is an example of the consistency point raised in the separate thread:

https://www.acted.co.uk/forums/index.php?threads/ch7-taxation-on-non-blagab.17229/

Fortunately for SA2 purposes we don't need to worry about exactly how the dividends are split into shareholder and policyholder components!

 

[Lindsay Smitherman]

2. Why “when BLAGAB losses arise, there will be no shareholders’ share?” In Sec 6.1, “if the minimum profits test is bite, all taxable income will be considered as shareholder profit”? Aren’t these two statements contradict? And, if there will be no shareholders’ share, does that mean only policyholder will need to pay for tax?

When BLAGAB losses arise, 'minimum profit' is set to zero.

The minimum profit test is said to 'bite' when profit is the higher of the two amounts being compared, ie profit > {I-E} and therefore the taxable amount = profit.

As noted in the simplified explanation of BLAGAB taxation a couple of posts above, the shareholder share = the profit amount. So if taxable amount = profit (ie minimum profit test is biting), this means that 100% of the taxable amount is allocated as shareholder share.

If minimum profit = 0, shareholder share = profit = 0.

 

[Lindsay Smitherman]

3. Understand that by carrying forward the loss from year t-1, the profit arise in year t will be used to offset year t-1 losses thus lower tax payable in year t (due to lower profit). But, how does this “increases shareholders’ share and increases the profit taxed at shareholder rate and reduces the amount taxed at policyholder rate”?

This is talking about the impact of the 50% restriction rule on losses carried forward. Companies used to be able to carry forward 100% of losses, but relatively recent rules have reduced that to (broadly) 50%. The point about the impact on tax is comparing what is now the case to what would have been the case had this change not been made.

Consider the situation where the minimum profits test is not biting, so the co is taxed on I-E (which is higher than profit).

This amount is split into:
Shareholder share = profit, taxed @ corporation tax rate.
Policyholder share = {I-E - profit}, taxed @ policyholder tax rate.

If the company is no longer able to offset 100% of its losses against 'profit' due to the 50% restriction, then 'profit' will be higher than it would have been. So the shareholder share is higher and the policyholder share lower.

 

[Lindsay Smitherman]

4. Why “if basic rate of income tax is higher than corporate tax, we do not see BLAGAB trade losses offset or surrendered”? What’s the difference compared to carried forward to offset future BLAGAB trade profit?

Yes, we have scratched our heads over this paragraph too! Suffice it to say that this result arises from some more detailed (and not at all intuitive) tax accounting rules which the Core Reading doesn't go into. There is a specific rule which effectively means that a company taking this route would end up with more of its taxable amount being allocated as policyholder share than shareholder share. In the past, this would have been favourable for the company - because corporation tax rates (suffered by the shareholder share or by profits arising in non-BLAGAB) have typically been higher than the policyholder basic rate of income tax. However, in the more recent past the opposite has become true and so this rather obscure rule means that this is no longer a good option. I wouldn't worry about this detail - as long as you understand the basic principles about the separation of the BLAGAB taxable amount and the different tax rates that are used.

 

[Lindsay Smitherman]

And, if there will be no shareholders’ share, does that mean only policyholder will need to pay for tax?

Be very careful here: it isn't the policyholder paying for this BLAGAB tax. The company pays all of this tax, whether calculated on the shareholder share or on the policyholder share. [Of course it will probably decide to pass on the cost of the tax to the policyholders through premium rates and charges, but the company still has to pay this amount to HMRC itself.]

 

[Lindsay Smitherman]

5. In Sec 6.3, “If there are BLAGAB losses in that period, the minimum profit test does not bite. If the minimum profit test does not bite, the company is said to be XSI.”
XSI happens when I-E is positive. If I-E is positive, why will there be BLAGAB losses?

I think you might be getting causation the wrong way round here. Also bear in mind that there are differences between approaches for mutuals and proprietaries.

A mutual company (where there is no 'profit' as such) is said to be XSI if I-E is positive.
A proprietary company is said to be XSI if the minimum profit test does not bite, ie I-E > profit.

[So if there are BLAGAB losses in a proprietary and therefore minimum profit is set to zero, we can see that the second statement would be the same as the first: the company will be said to be XSI if I-E>0. However, if there is a BLAGAB profit we need more than just I-E to be positive for the company to be called XSI: I-E also has to exceed the minimum profit amount.]

 

[Lindsay Smitherman]

Hope the above is helpful. If you are finding this chapter difficult (understandably so!) then I would recommend either tutorials or the SA2 Online Classroom. In both, we walk through the principles to help with understanding BLAGAB (and non-BLAGAB) taxation, including an example calculation.

 

[kntg24]

Thanks for the detailed explanation. I understand the concept better now. Will consider your suggestions on the tutorials / Online Classroom. Have a good day

 

[User 1234]

I think you might be getting causation the wrong way round here. Also bear in mind that there are differences between approaches for mutuals and proprietaries.

A mutual company (where there is no 'profit' as such) is said to be XSI if I-E is positive.
A proprietary company is said to be XSI if the minimum profit test does not bite, ie I-E > profit.

[So if there are BLAGAB losses in a proprietary and therefore minimum profit is set to zero, we can see that the second statement would be the same as the first: the company will be said to be XSI if I-E>0. However, if there is a BLAGAB profit we need more than just I-E to be positive for the company to be called XSI: I-E also has to exceed the minimum profit amount.]

Thanks, so can I understand it as below?
Mutual

• I-E>0, the company is XSI
• I-E<0, the company is XSE

Proprietary company
When I-E>0, a) there are BLAGAB Losses, minimum profit is set to zero, minimum profits test does not bite, the company is XSI. b) there is BLAGAB profit: if I-E < profit, the test bites, company is XSE; if I-E > profit, the test does not bite, the company is XSI.

Where I-E<0, the company is XSE

 

[Lindsay Smitherman]

Hi - yes that's right!

For the proprietary, you don't really need a separate case (a) or the final statement though. Minimum profit cannot be less than zero, so if there are BLAGAB losses then we just have the statements as in case (b) but with 'profit' = 0.