GIM7180 - Equalisation reserves: the tax rules

When the equalisation reserve rules were introduced, under normal Case I principles, transfers to or from an equalisation reserve were not deductible or chargeable in computing taxable profits. This was based on the long held rule of tax law that neither a profit nor a loss could be anticipated. (See BIM31100 for a discussion of the influence of later tax cases on this view.) It was also the case that such transfers would not be based on any reliable calculations of the losses in question. In addition, they would simply be an application of profit and it could not be said that the profits were misstated without the deduction.

Tax legislation was introduced in 1996 as ICTA88/S444BA to ICTA88/S444BD, and the Insurance Companies (Reserves) (Tax) Regulations 1996 (SI1996/2991) to prescribe certain tax reliefs and charges. The Regulations apply for accounting periods ending on or after 23 December 1996.

The basic principles involved in computing tax relief are straightforward. The equalisation reserve (or reserves if the company carries on both credit insurance and other business) will be calculated according to the supervisory rules outlined in the previous paragraphs. Net transfers into each reserve are allowed as a deduction in computing the profits of the insurer’s trade. Net transfers out of each reserve are treated as a receipt of the trade whether they are triggered by excessive claims or by an alteration in the maximum reserve level.

For business other than credit insurance it is only the final net figure transferred in or out that is relevant for tax purposes, not any transfers in or out in the computational stages. This is the figure which is referred to in ICTA88/S444BA (2) and ICTA88/S444BA (3) as “the amounts which, in accordance with equalisation reserves rules (“section 34A regulations” for periods ending before 1 December 2001), are transferred into [or out of] the equalisation reserve in respect of the company’s business for the accounting period in question”. For credit insurance transfers in and out cannot occur in the same year, even at the computational level.

The additions and deductions that are authorised by ICTA88/S444BA are made in the Case I (or exceptionally Case V) computation of trading profit. They therefore have no effect on the tax liability of companies that conduct the whole of their business on a mutual basis, for whom there is no such computation. See GIM7360 below where part of the business is mutual.

In the example in GIM7110 a deduction in the Case I computation would be given for the net transfer into the reserve of £76k.

It is possible that a company supervised by the FSA will choose to set up an equalisation reserve that is greater than the amount required by the regulations. Historically such voluntary reserves have been mainly confined to mutual companies, where they have no effect on the tax liabilities, and it is unlikely that proprietary companies will wish to exceed the minimum requirement. If, exceptionally, they do so, the “excess” reserve will need to be separately identified in the shareholder accounts, and calculations relating to it should not be included on the forms 37 to 39 in the FSA return. There should, therefore, be no difficulty about separating out the calculations relating to the statutory reserve. No tax deduction is available for transfers in to a voluntary reserve, and transfers out are not taxable.