GIM4070 - Taxation of general insurance: annual accounting: UPP
Unearned Premium Provision
This provision is the proportion of premium income relating to
periods of risk after the accounting date, which are deferred to
subsequent accounting periods. The tax treatment of this reserve
goes back to the case of The Sun Insurance Office v Clark (6TC59)
in 1912. The company succeeded in claiming a deduction for an
amount equal to 40% of premiums, and it became common for insurance
companies to claim such a deduction. Until 1985 the Revenue allowed
a deduction for a UPP equal to 40% of premiums, even if this
exceeded the amount of the UPP in the accounts. The use of the 40%
figure was rationalised on the basis that 20% of premiums would be
absorbed by the commission and other costs of acquiring the
business, and that the remaining 80% would meet the cost of claims,
leaving the insurer to make its profit from the return on invested
premiums. So, since the “average” policy is taken out
midway through the year, 40% of premiums will be equal to the
unexpired risk.
As insurers began to replace provisions calculated as a crude
40% of premiums with more accurate methods of time-apportionment of
premiums, such as the “24ths” basis, it was
increasingly common for the 40% deduction claimed in the tax
computation to exceed the UPP in the accounts. In 1985 the Revenue
gave notice that the 40% method was no longer acceptable for tax
purposes. However it still saw the underwriting year basis as the
one correct method of accounting for insurance business, and the
UPP as a provision for unexpired risks. The Revenue’s
attitude after 1985 was, therefore, that the UPP (plus the amount
of any separate unexpired risks provision) was tax-deductible only
to the extent that it could be justified by reference to a sound
estimate of the company’s unexpired risks.
Following the publication of the 1990 SORP which recommended
that premium income should be deferred by the creation of a
provision for unearned premiums, the Revenue announced in 1992 that
it was able to accept the deductibility of a UPP on the basis that
it should in future be treated as a forward spread of premiums.
Unearned Premium Provision: tax treatment
Until the IAD, the deferral of acquisition expenses was often netted off against the UPP. This was outlawed following the amendments to Schedule 9A CA 1985 that implemented the IAD in the UK ( GIM2030). Paragraph 44 of Part I of Schedule 9A CA 1985 provides that
- UPP shall in principle be computed separately for each insurance contract, although statistical methods may be used where they give approximately the same results as individual calculations
- the pattern of risk varies over the life of the contract shall be taken into account.
In accordance with cases such as Johnston v Britannia Airways
(67TC99) and Gallagher v Jones (67TC77), and FA98/S42 (for periods
of account beginning after 6 April 1999), it is a general principle
that a Case I computation must follow the results of the accounts,
provided there is no over-riding tax provision. This is of course
subject to the requirement that the accounts are in accordance with
generally accepted accounting practice (GAAP). For insurance this
includes the SORP. Movements in the UPP are therefore
deductible/taxable for tax purposes provided that the UPP,
including the apportionment of premiums and the deferral of
acquisition expenses, is calculated in accordance with GAAP. The
tax deduction cannot exceed the provision made in the accounts;
The UPP is not subject to the rules in FA00/S107 on excessive
or inadequate reserves (
GIM6320).
Unearned Premium Provision: exchange gains and losses
The UPP is treated as a qualifying liability under the Forex legislation in Chapter 2 Part 2 FA 1993 (Regulation 2(1)(a) Exchange Gains and Losses (Insurance Companies) Regulations 1994 – SI1994/3231). For accounting periods beginning on or after 1 October 2002, the UPP is treated as a money debt, exchange gains and losses on which fall within the loan relationships legislation (FA96/S100 (11)(b)(i)).
