B.3.2.1.2 Adjustment of the custody account at the beginning and end of the year of taxation (Sections 4(3) and (4) of PAL)

Contributions made in the year of taxation must be added to the policy's beginning-of-year custody account. See Section 4(4).

The policy's end-of-year custody account must also be adjusted.

The adjustment of the policy's end-of-year custody account takes place under Section 4(3) of PAL by:

1. adding disbursements made during the year,

2. adding tax amounts withheld under Section 21(2) of PAL,

3. adding payment of risk premium for the insurance cover, including any negative risk bonus,

4. adding payment of cost premium, including any negative cost bonus and fees in relation to the ongoing administration of the policy or the surrender of the policy,

5. possibly reducing the custody account by any bonus which is attributable to sources other than surplus yield on the investment activity of the life insurance company etc. compared with the assumptions made in the technical basis (interest bonus),

6. adding bonus which has not been added to the policy's custody account but in some other way is linked to the policy or the pension fund plan. Bonus is added unless it is attributable to sources other than surplus yield on the investment activity of the life insurance company etc. compared with the assumptions made in the technical basis (interest bonus),

7. adding increases and deducting decreases in special bonus provisions linked to the policy or the pension fund plan,

8. adding disbursements made during the year including any tax amounts withheld under Section 21(2) of PAL which, in accordance with the pension plan, are disbursed from funds from the investment yields of the life insurance company etc. directly to the beneficiary,

9. adding an amount corresponding to the reduction of the value of the custody account as a result of the lapse of the policy without disbursement,

10. reducing the custody account by the increase in the provision and adding the reduction in the provision as a result of the occurrence of the insured event, and

11. reducing the custody account by payments made for guarantees for policies without entitlement to interest bonus.

Re no. 1. Disbursements made during the year

The basis of taxation is not to be reduced in connection with the disbursement of amounts from the custody account to the person liable to taxation. Gross disbursements must therefore be added to the end-of-year custody account; i.e. the amount before withheld income tax or tax under PBL.

The provision does not comprise disbursement in connection with surrender covered by Section 4(3), Item 9 of PAL.

Example

Gross disbursement DKK 1,000

Tax withheld under PBL DKK 400

Disbursement to the pension saver DKK 600

DKK 1,000 is added to the basis of taxation.

Re no. 2. Tax amounts withheld under Section 21(2) of PAL

The addition to the custody account etc. constitutes a net addition as tax on yields from pension plan assets in insurance and pension fund plans is levied prior to yields or special bonus provisions being added to the custody account.

In order to obtain the correct basis of taxation, the net increase in the custody account must be converted to a gross increase. The withheld tax amount must therefore be added to the value of the custody account at the end of the year of taxation.

Re nos. 3 and 4. Risk and cost premium

A decrease in the value of the custody account as a result of the payment of a cost or risk premium must be eliminated so that the payment of these costs does not reduce the basis of taxation.

Negative bonus, which e.g. can occur in respect of paid-up policies without cost contribution, must also be eliminated. Negative bonus thus does not reduce the basis of taxation.

The negative cost and risk bonus which is to be added to the custody account is made up of the difference between the agreed premium (1st order) and the amount withdrawn from the custody account (2nd order).

Re no. 5. Bonus from surplus from the risk and cost elements

The end-of-year custody account can be reduced by a positive bonus from sources other than surplus yield on the investment activity of the life insurance company etc. compared with the assumptions made in the technical basis (interest bonus).

This means that the end-of-year custody account can be reduced if it can be documented that the bonus is attributable to a surplus from the risk and cost elements.

Such documentation can e.g. take place according to the same division/calculation as in the chief actuary's report.

This means that, for each group of policies, the savers' end-of-year custody accounts can, as a maximum, be reduced by an amount which is attributable to the surplus for the year from

the risk elements (risk bonus) corresponding to 1st-order risk premiums less the actual risk expenses and
the cost elements (cost bonus) corresponding to 1st-order cost premiums less the actual costs.

If it can also be documented that bonus added is attributable to non-added risk and cost surplus from previous years, the end-of-year custody account can be reduced by such a bonus.

As concerns the option of exemption for providers in relation to changes in respect of cost and risk bonuses, cf. the following excerpts from the comments on Section 4(3), Item 7 in L 10 of 28 November 2007 quoted below:

"In connection with the transition to taxation under this Act, the provider shall have the right to choose to be exempt in relation to any changes which are attributable to cost and risk bonuses. Such choice shall require that the provider can document the composition of the special bonus provisions distributed on interest, risk and cost bonuses. In relation to providers which have chosen exemption in relation to changes which are attributable to risk and cost bonuses, the clients will, in an increase situation, thus only be liable to taxation on the part of the increase which is attributable to interest bonus. In the event of decreases in special bonus provisions, the clients will only obtain a deduction for the part of the decrease which is attributable to interest bonus, i.e. a deduction shall only be granted in situations in which the provider has utilised special bonus provisions composed of interest bonus to cover losses, whereas the clients will not be able to obtain a deduction for an amount corresponding to the part which is attributable to cost and risk bonuses transferred in the current year and previous years. Where the pension provider chooses exemption in relation to changes which are attributable to cost and risk bonuses, such choice shall be binding."

Re no. 6. Bonus not added to the custody account

Bonus which is not added to the pension plan holder's custody account, but which is attached to the custody account by virtue of being included in the policy's surrender value, must be included when determining the basis of taxation and must be added to the value of the end-of-year custody account. This does not apply, however, if it can be documented that bonus is attributable to surplus from the risk and cost elements.

Tax is levied on bonus which is included in the surrender value of the person liable to taxation irrespective of how it is utilised (taking out supplementary insurance, cash bonus, bonus accumulation etc.).

Re no. 7. Bonus provisions

Increases in special bonus provisions attached to the policy, i.e. included in the surrender value, must be added to, and decreases must be deducted from, the value of the end-of-year custody account.

Special bonus provisions included in the surrender value are

individual special bonus provisions and
allocated collective special bonus provisions.

Non-allocated collective special bonus provisions are not included in the basis of taxation under Section 4 of PAL.

In order to describe how special bonus provisions can be built up, the following excerpts from the comments on Section 4(3), Item 7 of PAL in L 10 of 28 November 2007 are quoted below:

"As from 1 January 2002, Danish life insurance companies and lateral pension funds (nationwide occupational pension funds) have been able to choose to build up special bonus provisions of their realised results. Previously, the bonus funds could only be added to the custody account or to the collective bonus potential. The special bonus provisions can be included in the capital base and make it easier for the life insurance companies/pension funds to comply with the solvency requirements. Special bonus provisions are subject to a higher risk than the other insurance-related provisions as they are provided as security on a par with the equity and can be utilised to cover all types of losses on all the activities.

Special bonus provisions will be built up on the basis of the realised results, cf. Sections 134 and 138 of the Danish Financial Business Act. A company which chooses to build up special bonus provisions shall either link the funds to the policies individually or collectively in such a way that the individual policy's share with related yields can be calculated at any time. The terms and conditions of the special bonus provisions furthermore stipulate that the share of the special bonus provisions linked to the individual policy shall be transferred to the policy no later than at the time of disbursement of benefits. Individual special bonus provisions and allocated collective bonus provisions shall be included in the surrender value, cf. Sections 134 and 138 of the Danish Financial Business Act, and shall therefore be included in the basis of taxation.

Special bonus provisions can also be built up through contributions from equity. For such non-allocated collective special bonus provisions, it is possible for the company to lay down more detailed rules on the allocation of such funds to the policyholders, including that they be allocated to the policyholders in future and not immediately. The other terms and conditions set out in Sections 134 and 138 shall be met. The non-allocated collective special bonus provisions which have been built up through contributions from equity can thus be non-allocated in the sense that the allocation mechanism in respect of the collective funds to the policyholder will only take place on a regular basis in future over a specified number of years. Non-allocated collective special bonus provisions shall not be included in the basis of taxation under Section 4. The non-allocated collective special bonus provisions are gradually allocated to the policyholders via a transfer to the individual special bonus provisions, and only at such time shall they be included in the calculation of the surrender value and thus be included in the basis of taxation. The calculation mechanism which allocates the non-allocated collective special bonus provisions to the policyholders either immediately or on a regular basis in future over a specified number of years shall be reported to the Danish Financial Supervisory Authority (Finanstilsynet) as part of the technical basis, cf. Section 20 of the Danish Financial Business Act. Pursuant to the bill, the person liable to taxation shall thus include in the basis of taxation any increase in the share of the special bonus provisions linked to the policy of the person liable to taxation and, similarly, a reduction of this shall reduce the basis of taxation correspondingly."

Re no. 8. Disbursements made directly from investment yields

The provision concerns, among other things, the so-called pensioner allowance. A pensioner allowance is typically disbursed immediately and directly from the investment gain for the year. The funds therefore are not necessarily added to the custody account. According to the provision, the pensioner allowance is included in the basis of taxation.

Re no. 9. Lapse of the policy without disbursement

If the policy is surrendered or lapses without disbursement, the value of the custody account drops to zero. The reduction of the custody account is neutralised when determining the basis of taxation so that tax continues to be levied on possible yields in the part of the year of taxation in which the policy exists.

Re no. 10. Increase and reduction of provisions

The custody account is adjusted for an increase in the value of the custody account corresponding to the capital at risk as a result of the occurrence of the insured event (jump in reserves). For example in relation to annuities, this prevents that tax is levied on the mortality profit which stems from funds already taxed.

The realisation of an interest or benefit guarantee is not considered an occurrence of the insured event.

An adjustment must also be made for a decrease in the value of the custody account as a consequence of a reduction of the provisions, e.g. in connection with the lapse of retirement pension in the event of death.

No adjustment must be made for an increase in the value of the custody account, however, if a choice is made for a policy containing benefits with entitlement to disability pension providing a regular income and/or premium exemption to be covered by Section 4(6) of PAL. See B.3.2.3, Special conditions in relation to policies with entitlement to disability pension providing a regular income or premium exemption

Re no. 11. Guarantees in respect of policies without entitlement to interest bonus (Section 4(3), Item 11 of PAL)

For a number of pension savings plans, including unit-linked plans, a guarantee in relation to the yield on the plan can be obtained against payment of a premium. The guarantees often reduce the risk of loss associated with investing in assets the yields on which are added to the plan.

If, instead of paying for a guarantee, the saver reduces his or her loss risk by investing in less risky assets, the expected yield will typically be lower. This means that the expected basis of taxation is also reduced.

Premiums paid for such guarantees are deducted from the end-of-year custody account and thus reduce the basis of taxation. In terms of taxation, there is thus no difference between the two methods of reducing the loss risk.

See section B.3.1, Basis of taxation in respect of plans with life insurance companies and pension funds, for a further description of pension plans with Danish insurance companies and pension funds.