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HMRC internal manual

General Insurance Manual

Equalisation reserves: the tax rules: shadow equalisation reserves

Regulatory returns may be prepared using a non-annual basis of accounting, but tax returns prepared on an annual accident year basis (see GIM3160).

In this case the equalisation reserve shown in the regulatory return will bear little relationship to the figures on which the rest of the computation of trading income is based, so the regulatory return figures are not used. Instead, the reserve is recalculated using the figures for premiums and claims used in the tax computation. Regulation 5 of the Regulations contains the power to construct a ‘shadow’ equalisation reserve using an annual accident year basis of accounting. Tax relief will be based on the net transfers in or out of this ‘shadow’ reserve rather than on the figures in the regulatory return. GIM7240 explains how shadow reserves are calculated.

‘Shadow’ equalisation reserves for tax purposes need to be calculated for the whole of the company’s business even if the regulatory returns are drawn up partly on an annual basis and partly on a funded basis, whenever tax computations are drawn up by reference to a ‘memorandum’ account on an annual basis.

Mix of non-annual basis and annual basis

There is no scope in the Regulations for a recalculation of the reserve if the tax computations are only partly drawn up on an annual basis. That is because the point of using a memorandum account for tax purposes is to enable figures to be finalised, and this objective would not be met if part of the tax calculations continued to follow the funded accounting.

So although tax computations will be found in which both annual and non-annual accounting appears, this will only take place where the computations use the same split between the two forms of accounting as is used in preparing the regulatory return, and there will be no need for a separate tax calculation of the equalisation reserve.