Insurance loophole plugged by Customs: Nic Cicutti on the measures that will prevent consumers saving VAT by paying in advance

POLICYHOLDERS hoping to sidestep the new 2.5 per cent insurance tax for at least one year will find a combination of Customs and Excise and insurance companies standing in their way.

Customs officials have moved swiftly to plug a loophole that could have allowed people to beat the tax by paying several years' insurance premiums in advance.

A similar option has allowed gas and electricity users to avoid next month's 8.5 per cent VAT bill. By paying enough in advance, they will also be able to stave off next year's VAT increase to 17.5 per cent.

But an Excise spokesman said this week that anti-avoidance measures had been put in place, preventing advance payment of insurance premiums.

'They will be able to avoid the tax for only one year if they have to take out a policy just before the tax is introduced in October,' he added.

Norwich Union said anyone cancelling car insurance to start a new policy just before 1 October, when the tax is introduced, would find they had to pay a penalty anyway.

For someone with three months of the policy to run, only 10 per cent of the premium would be refunded. 'If we take a typical pounds 250 policy, that would mean losing pounds 45 to avoid paying pounds 6.25.'

In many cases, refunds would not include commissions of up to 17 per cent paid to brokers who sold the policies.

Martin Long, chief executive of Churchill Insurance, a direct insurance company, added: 'Apart from any cancellation penalties, people would find they don't qualify for that year's no-claims discount if they cancel early. You won't find insurance companies recommending that to their policyholders.'

Insurance companies have been able to wring a small concession from the Government. Anyone taking out a policy before October will not have to pay tax for the rest of the year even if they pay by instalments.

Original proposals were that companies hand over the tax for the period in which it was owed as soon as a policy was written, rather than when the money came in. This would have meant companies paying the tax up-front or scrapping instalments altogether.

Despite this small victory, millions of motorists, homeowners and other policyholders will face a small increase on all general insurance cover, including cars, household and contents, electrical warranties and travel insurance. The Government last week agreed to cut the tax rate from 3 to 2.5 per cent of premiums.

The slight reduction will make almost no difference to those who visit their local brokers to get cover, but it may help those who use direct insurance companies such as Churchill and Direct Line.

This is because the original 3 per cent tax rate was net of brokers' commission payments. Brokers earn between 13 and 17 per cent on the policies they sell.

Had the Chancellor's 3 per cent proposals been implemented this October, a pounds 250 policy arranged through a broker might have earned 15 per cent commission, or pounds 37.25.

The 3 per cent tax would have been levied on the remaining pounds 212.75, a charge of pounds 6.36. Meanwhile, a non-commission paying direct insurer, who deals with clients by phone, would have had to charge an extra pounds 7.50.

The new - gross tax - arrangement means 2.5 per cent is levied. On a pounds 250 policy, this adds pounds 6.25 to everyone's bill.

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