On 16 March 2020, the Prudential Regulation Authority (PRA) published  the policy statement Solvency II: Adjusting for the reduction of loss absorbency where own fund instruments are taxed on conversion (PS7/20). PS7/20 provides feedback to responses to a consultation paper with the same title (CP26/19). It also contains the PRA’s final policy in an updated supervisory statement Solvency II: The quality of capital instruments (SS3/15).


In CP26/19 the PRA proposed to update SS3/15 to add an expectation that insurers would deduct from their own funds the maximum charge before set off of any prior year losses generated on conversion of a restricted Tier 1 (rT1) capital instrument when:

  • they include in their own funds external rT1 capital instruments that convert to ordinary shares on trigger; and
  • that instrument has a conversion share offer (CSO) mechanism in its terms.

An exception to this proposed expectation would be in the event that the insurer had provided the PRA with a properly reasoned independent tax opinion from an appropriately qualified individual, taking into account HMRC precedent, statements and guidance that no tax charge will arise on trigger. The PRA would generally expect such an opinion to be provided at least 30 days before issuance.

The PRA proposed in CP26/19 that the maximum tax charge generated on conversion would be calculated as: the instrument’s face value multiplied by the prevailing corporate tax rate. The only time this would not be the case would be if the terms of the instrument had a minimum CSO price, in which case the maximum tax would be calculated as the instrument’s face value less this guaranteed CSO price multiplied by the tax rate.

Changes to draft policy

After considering the responses, the PRA has made the following changes to the draft policy and will reflect these in the updates to SS3/15:

  • as an addition to the expectations proposed in CP26/19: where any CSO mechanism is included within the terms and conditions (T&Cs) of an instrument, a firm may calculate its own funds without making an adjustment for tax and still be consistent with our expectations despite the absence of a tax opinion at the point of issuance, provided that a certain condition is included in the T&Cs of that instrument. Namely, that it is prevented from exercising the CSO unless, at least 10 days prior to exercise it has obtained a properly reasoned, independent tax opinion from an appropriately qualified individual that confirms that the action will not cause a tax charge to arise.
  • Notwithstanding the change above, where a firm chooses to obtain a tax opinion at the point of issuance, the PRA expects the firm to provide the opinion to the PRA at least 10 days before issuance.
  • The PRA’s expectation as to how to calculate the maximum tax charge has been amended to reflect the fact that the cash paid on exercise of a CSO will never be below the face value of the ordinary shares into which the instrument converts.
  • The PRA has clarified that a tax opinion obtained at issuance may be used for more than one issuance provided the T&Cs pertaining to the CSO are identical and the provider of the tax opinion remains independent and confirms to the PRA in writing that, taking into account any subsequent HMRC precedent, statements and guidance, their tax opinion remains valid.
  • The PRA has amended the expectation to refer to the tax opinion being provided by a ‘properly qualified person’ to make clear that the opinion can be signed in the name of an incorporated or unincorporated body, notwithstanding that the qualification will pertain to one of the employees of that body.

The PRA will keep the policy under review to assess whether any changes would be required due to  changes in the UK regulatory framework at the end of the transition period, including those arising once any new arrangements within the European Union take effect.

The changes outlined in this PS took effect upon publication on 16 March 2020.

View: PRA publishes Policy Statement PS7/20 – Solvency II: Adjusting for the reduction of loss absorbency where own fund instruments are taxed on conversion