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HMRC internal manual

General Insurance Manual

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Taxation of the investment return: investment gains: accounting periods beginning before 1 January 2002: the realisation basis

Up to 1997

The rule that account may be taken of a change in value of the investments of an insurer as a trading receipt but not before they are actually realised (the ‘realisation basis’) is derived from case law that predates the accounting practice of re-valuing investments annually (on a mark to market basis). This practice is now enshrined in the Insurance Accounts Directive and the reporting Regulations SI2008/410 (see GIM2020).

The Revenue’s view up to 1997 was that the realisation basis remained good law for insurance companies, despite the trend towards a mark to market basis for accounting purposes. The 1995 ABI SORP, whilst requiring mark to market for accounting, did not require profits or losses to be taken to the profit and loss account. It was believed that, as with the distinction between capital and revenue, this was an example of a judge-made rule for measuring profit for tax purposes that took precedence over accounting practice.

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After 1997

After 1997 there were three major developments:

  • The enactment of FA98/S42, which made clear that accounts showing a true and fair view should be used as the basis for taxing the profit or loss of a trade, subject to any adjustments required by law. FA98/S42 applies to periods of account beginning on or after 7 April 1999.
  • The publication of the ABI SORP in December 1998 which made it mandatory for investments to be accounted for on a mark to market basis. Specifically, paragraph 232 required any unrealised profit or loss arising from a comparison of opening and closing fair values to be taken to technical or non-technical account, and thus to form part of the profits of the period. This applied to accounting periods ending on or after 31 December 1998.
  • The decision in Herbert Smith v Honour 72TC130 in February 1999, which conclusively overturned the view that judge-made principles could be relied upon to take precedence over accounting rules where there is no over-riding tax law. Lloyd J said that generally accepted accounting principles embodied these rules so far as it was necessary to take them. So, for example, a provision for future losses could not be said to anticipate them if the calculation of the provision was in accordance with accounting standards and principles.

Taking these factors together, the principle was established that for periods to which the 1998 ABI SORP applied and subsequently, mark to market or fair value accounting was the only valid and acceptable basis to follow for tax purposes if that basis was used in the accounts. It was not acceptable under FA98/S42 to make adjustments to the accounting profit to remove unrealised gains or losses, namely, to use the realisation basis. This change of view was announced in a Press Release published on 1 August 2001. However, published guidance until that time had proceeded on the footing that realisation had continued to be an acceptable basis. To deal with this, at the same time as the Press Release, draft clauses were published sanctioning the realisation basis as an acceptable and valid basis for tax for an insurance company until the first period of account to begin on or after 1 January 2002. There was, though, nothing in these rules that prevented a company from changing to follow mark to market for tax purposes from an earlier date. More detail at GIM5190.

The opportunity was also taken to ease the transition for companies in the accounting period in which they began to follow mark to market for tax purposes. More detail at GIM5200.