Proposed changes to the taxation of unit linked capital insurance - but the product’s fundamental attractiveness remains intact
Shares and other investments held through fund accounts are currently taxed as capital income at a rate of 25%, with a proposed reduction to 24% in 2017. Taxation does not occur until withdrawal or termination of the fund account, and the policyholder may change the underlying portfolio without triggering taxation of acquired returns. Directly owned shares are however taxed with an effective rate of 28.75%, which the Ministry has proposed to increase to 29.76% in 2017.
The Ministry suggests that with effect from 1 January 2018, equity investments held through fund accounts shall be taxed in the same manner as other equity investments when the insurance element is “small”, i.e. when the fund account’s insurance element is less than 50%. This would imply that investments through fund accounts loses a tax advantage, and that such investments will be afforded a somewhat more equal treatment with direct investments in individual stocks or investment funds.
Fund accounts’ fundamental attractiveness, however, will remain intact, even after the proposed changes. In our view, the product will continue to be an appropriate tool for a variety of different types of investors, depending on their objectives, investment preferences and underlying portfolio composition.
The Ministry of Finance’s hearing note in brief
The Ministry of Finance’s suggests that fund accounts with a small insurance element will be subject to the rules for taxation of investment funds pursuant to section 10-20 of the Norwegian Tax Act. This means that all payments from such fund accounts that are not related to termination of the insurance agreement shall be taxed in the same manner as payments from investment funds (i.e. UCITS and other collective investment funds).
Upon termination of the insurance contract a tax realization settlement will be carried out, similar to the realizations of an interest in investment funds. This means, in brief, that distribution from fund accounts with more than 80% share interest will be taxed as dividends, while distribution from fund accounts with less than 20% share interest will be taxed as income from interests. The share interest is calculated using the ratio between the value of shares and other securities as per 1 January in the tax year. As for shares, a dividend tax exemption (Norwegian: skjermingsfradrag) will be awarded on the equity portion.
The new rules are proposed implemented by the inclusion of a new tenth paragraph in section 10-20 of the Tax Act, entering into force on 1 January 2018, to give insurers and investors time to adapt to the new rules.
The deadline for the submission of comments on the hearing note is 1 February 2017.
Our view on the proposed rules
It has long been expected that the Ministry of Finance would clog the differences between the taxation of fund accounts and taxation of equity investments through investment funds and other structures. The Ministry’s proposal entails a tightening of the current taxation rules relating to fund accounts with a “small” insurance element, and is in our opinion a reasonable proposal.
Whether there is a more in-depth analysis behind the stipulated threshold of insurance element is uncertain, given that the Ministry has not explained the proposed threshold further. We do not know whether the Ministry has considered whether it is legally entitled to set such a threshold within the framework of the EEA Agreement and the principles of free movement of services and capital. The threshold of 50% is presumably set to affect all fund accounts in the market, so that these will be subject to the new taxation rules from 1 January 2018.
Fund accounts with an insurance element of at least 50%, however, will remain taxable according to the rules currently in force. To our knowledge no such fund accounts are offered in the Norwegian market today, but this may change in the near future. Investors should therefore make a cost/benefit-analysis in relation to fund accounts structured with/without at least a 50% insurance element, measured against the investor’s individual requirements and their underlying portfolio composition.
Even with the proposed tightening of the taxation rules, fund accounts will still be an attractive product for many different types of investors. The product is suitable for saving for retirement and generational changes, especially in HNW families where the need for tailor made products is often greatest. The product has great flexibility so that investors and life insurance companies have great opportunities to tailor the product and the underlying portfolio relative to the investor’s needs. The product will also contain a standard dividend tax exemption (Norwegian: skjermingsfradrag), anonymity for investors, creditor protection through the use of depositary banks, and no exit tax on emigration, as well as several other features for fund accounts which we do not detail further here. We therefore believe that fund accounts offered by life insurers that allow tailoring will still be a useful instrument in wealth structuring.