General proposals

4.1.1.1 The Consultation Document identifies a number of transitional adjustments that will arise from the timing and valuation differences between the current

regulatory regime treatment and the accounting rules that will apply under the new regime. The potential differences on transition are significant and therefore the 10 year spreading facility is very much welcomed by Industry.

4.1.1.2 It should be possible for companies to determine the transitional adjustments in practice and the expectation is that most companies will be able to prepare a reasonably detailed reconciliation between the closing regulatory balance sheet at 31 December 2012 and the accounts balance sheet at the same date. Such a reconciliation process will be expected to be sufficiently detailed and complete in order to assess how the various components should be treated for tax under the transition and agreed between company and HMRC (on the filing of the 2013 tax return).

4.1.1.3 The three identified transitional adjustment categories in the Consultation Document are DAC / DIR, untaxed surplus within court schemes and a „catch-all‟ residual adjustment category.

4.1.1.4 In the majority of cases, the transitional proposals to deal with DAC and DIR should not pose any problems in practice i.e. it should be possible to track the DAC / DIR balances as they unwind in the post-transition accounts and tax adjustments can be made accordingly. The same logic applies to purchased VIF which should be subject to similar transitional measures.

4.1.1.5 Equally, for the small number of companies subject to a court scheme, it will be necessary to discuss the detail of these on an individual basis with the CRM as part of the wider assessment of the overall transitional adjustment. It is anticipated that where a case can clearly be made that an untaxed amount (held in Form 14.51, say) is constrained under the terms of a scheme, then eligibility for the additional 2 year deferral will be made available.

4.1.1.6 For the residual category, a significant number of items are expected for most companies, to include surplus brought forward in Form 14.13, adjustment to investment values including structural assets, adjustment for technical provisions etc. A list of items identified to date is highlighted in the attached appendix along with the issues to be further addressed.

4.1.1.7 The appendix also highlights those areas which will require specific

transitional arrangements, for example, to deal with the transitional implications for those tax rules which will not survive into the new regime (e.g. FAFTS, formulaic apportionments) to cover the transitional implications of the likely loss of the LTF – SHF split, and to deal with any new rule for policyholder deferred tax deductions. Such rules would include whether any transition could be tracked on a factual basis or otherwise. The appendix puts forward skeleton proposals for these which, of course, will need further development and work over the course of the consultation including whether any transition can be tracked on a factual basis or otherwise. 4.1.1.8 The apportionment approach to apply to the transitional adjustments (to allocate across the different business categories) is likely to depend on the nature of the particular component involved. For example, it is likely that DAC or DIR, can be allocated on a factual basis, whilst for the removal of the book value election (Form 14.51) a more appropriate basis is likely to be the 2012 apportionment basis

including section 432CA. The appendix makes reference to the most likely allocation basis to apply to the various adjustments. Overall, the allocation rules for

transitional adjustments deemed to be brought into account as investment return should be based on apportionment fractions.

4.1.1.9 Turning to accounting standards, the question of what is possible in the year of transition (2013) is certainly not clear-cut. In this year, the accounts

measurement of trading profits may need to change as a result of the introduction of Solvency II unless the current Solvency I models are maintained. If there is change,

there are a number of options and companies have not yet determined which approach to adopt and may not for some months yet. It may be possible, for example, for companies to choose to change from a Phase I accounting policy to something more relevant and no less reliable or more reliable and not less relevant in respect of their valuation of long term insurance liabilities (e.g. Solvency II or some hybrid). There are a number of technical IFRS issues to overcome in this assessment, as well as practical and financial implications to consider, before any decision can be made. The timing for making such decisions for any company is certainly not imminent and more likely to be over the next 12 months.

4.1.1.10 Any adoption of IFRS Phase II (or Solvency II) will result in a further profit transition, attributable both to a different measure of policyholder liabilities being used and no explicit DAC. It is also the case that the treatment of the UDS under Phase II is not yet clear. It is a possibility that expected shareholder interests would be re-classed as equity, again resulting in a transitional spike.

4.1.1.11 In summary, there will be one or more accounting transitions in relation to the implementation of IFRS Phase II and possibly after interim use of Solvency II liability valuations (especially if certain aspects of Solvency II are on a delayed timetable). However, the timing of these further transitions is as yet unclear. On the assumption that the anticipated accounting changes do take effect in 2013 and/or early subsequent periods, the resulting transitional adjustments, particularly those arising in respect of balance sheet items treated as giving "residual" and thus spread adjustments on the tax transition, should be spread over the remaining period to 2022 (when the 10 year spread on the tax transition will cease).Such an approach would provide simplicity and a degree of coherence given that most groups are viewing Solvency II and IFRS Phase II in tandem and will no doubt adopt the new accounting bases at different times. This approach would also have the merit of dealing with the transitions of „like‟ items on a consistent basis so as to avoid one spike being spread and another spike on the same item (which may be in part a contra item) being taxed / allowed in a single year. Should the accounting changes take effect only in later accounting periods, the industry would doubtless wish to discuss more targeted transitional measures.