LAM04210 - Calculating ‘E’ adjusted BLAGAB management expenses: Step 3: General Annuity Business: FA12/S83

Payments to policyholders or annuitants are not within the definition of ordinary BLAGAB management expenses in FA12/S77. In certain circumstances, though, FA12/S83 provides for a deduction as ‘E’ for what is effectively the part of the annuity payment that is income as opposed to a repayment of capital.

These rules only apply to a qualifying BLAGAB annuity defined in FA12/S83(3) as:

  • referable to BLAGAB. Most annuities written by life companies are pension annuities and would not be within the BLAGAB rules.
  • paid under a contract made in an accounting period beginning on or after 1 January 1992 (pre 1992 contracts are dealt with under FA191/SCH7/PARA16(1)).

The aim is to mirror the treatment for income tax purposes, where the capital element received by the annuitant is not taxed. As the income element is taxed on the annuitant, the company can obtain a deduction as BLAGAB expenses.

The capital element of a BLAGAB annuity is determined in accordance with the purchased life annuity legislation at ITTOIA05/S717ff.

Steep reduction annuities FA12/S84

The rules for determining the capital elements in ITTOIA05/S717ff are modified if the annuity is a ‘steep-reduction annuity’. This is an anti-avoidance provision introduced in FA1997 to target artificial exploitation of the purchased life annuity rules in ITTOIA05/S724.

The essential element of such an annuity is a payment provided for by the annuity contract which, as compared with any previous payment, represents a ‘substantial reduction’. ‘Substantial reduction’ is not defined. A reduction of less than 20% would not normally be regarded as substantial, but that would have to be judged in the light of all the circumstances, including whether it was one of a series of reducing payments.

Although it would be simpler to compare one single payment with any other, there are ways in which that could be exploited, and ways in which it could give an unfair result. For example, an annuity may provide an annual payment but be varied to provide a monthly payment, where the monthly payments are one-twelfth of the previous annual payments. If the payments are considered in isolation, there would be a steep reduction. If, however, an annuity provides for (say) 5 annual payments of £100,000 followed by a payment of £100,000 after 50 years, there would never be a payment which by itself represented a substantial reduction compared with any previous single payment, but the economic effect of the annuity is much the same as if small payments were made annually from year 6 to year 50. The legislation therefore provides that where there are different intervals between annuity payments the comparison is based on the annualised rate of accrual FA12/S84(2) and (3).

In the case of a steep-reduction annuity, the annuity is treated as two, one consisting of the unreduced payments, and the other consisting of the rest FA12/S83(6). The consideration for the annuity is apportioned between the two deemed annuities on a just and reasonable basis FA12/S83(5)(b). If there is more than one steep reduction, the annuity is carved up into as many separate annuities as are necessary FA12/S83(7).

Payments made in respect of pre-1992 contracts FA12/S85

Where an insurance company makes a payment in respect of a general annuity under a group annuity contract made in an accounting period which began prior to 1 January 1992 but it was only in an accounting period beginning on or after 1 January 1992 that that annuity first impacted the company’s liabilities, the payment is treated as if the contract was made in an accounting period beginning on or after 1 January 1992 and is thus within the scope of FA12/S83.

Similarly, where a reinsurer makes a payment in respect of a general annuity under a reinsurance treaty made in an accounting period which began prior to 1 January 1992 but it was only in an accounting period beginning on or after 1 January 1992 that that annuity first impacted the reinsurer’s liabilities, the payment is treated, as regards the reinsurer, as if it was made in an accounting period beginning on or after 1 January 1992 for the purposes of FA12/S83(3)(b).