IPT part 3 - common, but expensive IPT errors

In our previous articles we’ve discussed why IPT is a cost for insurance intermediaries, and how this can be managed. We’ve also discussed potential financial risks for insurance intermediaries which arise from IPT, and how these can be reduced.

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Justine McInnes
Published: 05 Jun 2024 Updated: 05 Jun 2024
Business tax Tax

In this article we look at common types of IPT errors and how they can be avoided or identified. It’s worth noting that these errors work both ways: while they may result in IPT being underpaid, they frequently result in IPT being overpaid, resulting in IPT claim opportunities.

No IPT, 12% IPT, 20% IPT or IPT elsewhere?

As would be expected, it’s not just arithmetical IPT errors which occur; IPT legislation is complex and many errors arise because the identity or the location of a risk isn’t correctly identified. Looking at each of these in turn…

Identity of a risk

Say a car hire company (CH Ltd) arranges ‘gap’ insurance, underwritten by the insurer in our previous example, I Ltd, for those who take out a hire vehicle.  On the face of it, as the insurance relates to potential damage to a vehicle, and the insurance is being arranged via a supplier of vehicles, the anti-avoidance provisions kick in and the higher rate of IPT applies (20%).

For IPT purposes however, ‘gap’ insurance is regarded as insurance to cover a potential financial liability and as such it is subject to the standard rate of IPT (12%).

Location of a risk

Say our broker from our previous articles, B Ltd, arranges directors and officers (D&O) insurance for a global company which has its head office in the UK, G Ltd. The insurance relates to both staff located in the UK and those located outside the UK. While on the face of it, the whole premium amount is subject to UK IPT, where B Ltd can demonstrate that the directors and officers who are the subject of the insurance policy are located outside the UK for the purposes of IPT, IPT will not be due on the proportion of the premium which relates to these directors and officers.

B Ltd has read our previous article and knows that there is probably an IPT efficient way of apportioning the premium received between the different locations where the directors and officers work.

First of all however, B Ltd needs to work out where the directors and officers are located for IPT purposes. To determine this, B Ltd will need to refer to the rules set out in the Finance Act 1994. While these can be complicated, HMRC sets out helpful guidance on its interpretation of these rules in HMRC Notice IPT1.

It is also very important that B Ltd bears in mind that even where UK IPT isn’t due, there may well be IPT consequences in the overseas territories; in Austria for example, failure to account for IPT in certain circumstances can lead to criminal prosecution. B Ltd will therefore need to ensure that it is familiar with the IPT regimes in overseas territories.

Mid-term adjustments (MTAs)

While IPT calculations relating to MTAs are relatively straightforward in normal circumstances, the position is more complicated where, for example, adjustments are made to policies which attract more than one rate of IPT, the IPT rate changes, or fees associated with the MTAs are payable.

Say, for example, B Ltd arranges a combined life insurance and personal accident policy for GWP of £524 for a policyholder (P).

Having read our first article, B Ltd uses the most IPT efficient way of apportioning the premium between the exempt (life) element and the taxable (personal injury) element, with £300 being apportioned to the life element and £200 being apportioned to the personal injury element.

Six months later, P asks for amendments to the policy, resulting in P paying an additional £100 for the policy. This also results in the amount of premium which B Ltd can apportion to the life insurance element being reduced to £200, and £400 being apportioned to the personal injury element. GWP therefore increases to £648 and an additional payment of £124 is due. The temptation in these circumstances is to calculate IPT by applying 12% to the additional payment, therefore giving an IPT amount of £14.88. However, this doesn’t take the increased taxable and reduced exempt element into account. As a result, a ‘blended’ rate of 24% applies and the IPT due is £24.

Treating non-taxable amounts as subject to IPT and vice versa

In the absence of IPT reduction mechanisms, the general rule is that all amounts received from the insured in relation to taxable insurance policies are subject to IPT.

Say in the above example B Ltd also charges an administration fee of £50.  If the contracts aren’t ‘unbundled’ for IPT purposes, this is also subject to IPT at the standard rate. We often however see these fees, and other charges e.g. cancellation fees, being incorrectly treated as non-taxable. If this is a widespread issue, it can lead to a significant IPT bill for historical periods.

Premium adjustments and IPT error corrections

Apart from the more obvious challenge of ensuring that any premium adjustments and IPT refunds ‘flow through’ to the bordereau, there is also the challenge of ensuring that the correct mechanism for recovering overpaid IPT is applied. This is important because it determines whether or not the claim is ‘capped’.

Let’s say that in July 2024, B Ltd discovers that it has been incorrectly applying the 20% rate of IPT to CH Ltd’s ‘gap’ insurance policies.

This is an IPT ‘error’ and as a result, a claim for IPT can only be made for the IPT accounting period ending 30 September onwards. If the error is less than £50k it may be possible for I Ltd to adjust for the error on its IPT return, although I Ltd may submit an error correction notice if it prefers. If the error is more than £50k, I Ltd will have to submit an error correction notice.

Separately, say B Ltd sells a batch of home insurance policies, enters the IPT amounts on the bordereau correctly and I Ltd then accounts for this IPT on its IPT return. Following the submission of the IPT return however, some of the policies are cancelled and the premiums paid are refunded.

In IPT terms, the overpaid IPT isn’t the result of an error but rather the result of the parties agreeing that the premium amount should be repaid. As a result, the IPT which has been overpaid can be added to the next IPT return as an IPT credit – therefore reducing the amount of IPT on that IPT return.

Inclusive or exclusive?

Another relatively common error which arises is that the amount received is treated as IPT exclusive when it should be treated as IPT inclusive, and vice versa, resulting in overpayments and underpayments of IPT. Where the GWP amount is reported i.e. the full amount paid by the customer, the IPT inclusive fraction should be applied. For policies which are subject to an IPT rate of 12%, this is 3/28 and for those which are subject to an IPT rate of 20%, this is 1/6.

The takeaway

In the world of IPT, very little is at it seems and it is important to bear this in mind when deciding whether IPT is due on a transaction, and if so, at what rate. Where possible, point of sale systems should be set up to allow for ‘blended’ rates and also to flag transactions where the IPT amount looks unusual e.g. if it doesn’t equate to 3/28 or 1/6 of the total amount received.

If you would like to discuss any of the above please do get in touch with your usual contact or Justine McInnes.

Coming up

In our next article we will be looking at why the need to account for IPT at 20%, and the need to register for IPT is often missed, and how this risk can be managed.

Visit our Insurance Premium Tax (IPT) page

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Tax legislation

Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. You should always seek appropriate tax advice before making decisions. HMRC Tax Year 2024/25.

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.