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Top slicing relief for bonds taxation: the facts

Author Image The Technical Team
9 minutes read
Last updated on 6th Apr 2018

Overview

What you need to know about top slicing relief: how it works and more

Key points

  • Top slicing relief can assist in reducing the rate of tax charged on bond gains by applying a spreading mechanism
  • For a full surrender of an onshore or offshore bond, always top slice by the number of complete years back to commencement
  • Where there is an ‘excess event’ such as a part surrender gain then the rules are more complex

Why use top slicing relief

In our articles UK Investment Bonds: taxation facts and Taxation of Offshore Policies article we explained that chargeable event gains are generally treated as forming the highest slice of total income. A basic rate taxpayer can therefore be pushed into higher rate or a higher rate taxpayer can be pushed into additional rate. Top slicing relief may assist in reducing the rate of tax charged by applying a spreading mechanism. Please see also Top Slicing Relief Planning article.

With regard to basic/higher rate taxpayers, the implications of the Scottish Rate of Income Tax (SRIT) need to be addressed for Scottish taxpayers. SRIT applies to non-savings and non-dividend income with the personal allowance and thresholds and taxes on savings and dividends remaining a UK ‘reserved’ matter. The higher rate threshold for Scottish taxpayers is £43,430, which is below the £46,350 threshold in the rest of the UK. Nevertheless, given that the Scottish Parliament can only set the rates and the limits for non-savings and non-dividend income, then for savings, dividends and capital gains, it is necessary to ignore the Scottish threshold and refer to the UK limit instead.

Top slicing is a relief available if an investor:

  • Does not pay higher rate tax on other income (excluding the gain) but when the gain is added the investor becomes subject to higher rate tax, or
  • Does not pay additional rate tax on other income (excluding the gain) but when the gain is added the investor becomes subject to additional rate tax.

How spreading works

The key to a top slicing calculation is to divide the gain by the number of complete years. HMRC use 'N' to denote the number of complete years. 'N' which can never be less than one is calculated as follows:

 

Onshore

Offshore

Previous rule

Excess event period back to commencement, or for 2nd and later events, back to the last excess gain

Excess event period always back to commencement

Rule change in FA13

  • If time apportionment relief (TAR) does NOT apply the period is still back to  last excess gain, BUT
  • If time apportionment relief applies then for 2nd and later events, the period is back to commencement for reporting purposes.

As per s552(5)(e) ICTA 1988 the insurer will assume TAR does NOT apply for reporting.

  • If time apportionment relief (TAR) does NOT apply the period is now back to last excess gain,
    BUT
  • If time apportionment relief applies then for 2nd and later events, the period is back to commencement for reporting purposes.

HMRC confirmed non-UK insurers can assume TAR applies for reporting unless explicitly told TAR will not be claimed.

Full surrender

Always back to the commencement

Always back to commencement

Note that an ‘excess event’ arises on a part surrender or a part assignment. 

The Finance Act 2013 (FA 13) brought in updates to the chargeable events legislation in respect of time apportionment relief (TAR) to include onshore policies as well as offshore. Essentially, TAR was extended to policies issued by UK insurers on or after 6 April 2013 and to existing policies issued by UK insurers which are modified on or after that date. FA 2013 amended Section 536 (2) ITTOIA 2005 which  is a section dealing with top slicing rules. Under TAR, the chargeable gain may be reduced for tax purposes if the beneficial owner was not UK resident throughout the policy period. TAR applies by virtue of S528 ITTOIA 2005.

The effect of these changes on calculation events for UK resident individuals holding offshore policies who have been UK resident throughout is therefore as follows:

 Pre 06/04/13 policies

  • Number of top slicing years equals number of years since inception.

Policies made on or after 06/04/13 (or earlier policies varied etc. on or after that date)

  • Number of top slicing years equals number of years since previous event.

For those UK residents who have not been UK resident throughout such that TAR applies, then the number of years used remains the period back to commencement but that figure will be reduced to reflect periods of overseas residence.

When part of the gain falls into higher rate

HMRC adopt a six step procedure as follows:

Step one

Add the total gain onto the individual's total income and calculate how much of this falls into the higher rate tax band. Any gift aid payments must be disregarded both in this computation and in the remaining steps below.

If all of the gain falls in the basic rate band, or the higher band, then no top slicing relief is due and steps two to six are not needed.

Step two

Calculate the Step two liability which is simply the Step one amount of gain falling into the higher rate tax band x 20% (difference between higher and basic rate tax).

Step three

Calculate the 'annual equivalent' of the gain by dividing it by N (see earlier).

Step four

Add the total 'annual equivalent' onto the individual's total income. How much of this falls into the higher rate tax band?

Step five

Calculate the Step five liability which is a two step process. Firstly the Step four amount of 'annual equivalent' falling into the higher rate tax band x 20% (40%-20%), then multiply this amount of tax by N.

Step six

The amount of top slicing relief is the Step two liability less the Step five liability.

Appendix I & II contain worked examples of onshore and offshore bonds.

When part of the gain falls into additional rate

Top slicing relief is not just available to mitigate a higher rate liability arising on a chargeable event gain but is also available to mitigate an additional rate liability. In 2018/19, individuals with adjusted net income in excess of £150,000 are subject to additional rate tax of 45% on the excess (38.1% dividend additional rate).

Appendix III contains a worked example.

Two or more chargeable event gains the same tax year

In this case, the total gains are added together. The 'annual equivalent' is calculated separately for each gain, and then these annual equivalents are added together.

Example

£12,000 gain on Bond A arisen over four years. Annual equivalent = £3,000
£30,000 gain on Bond B arisen over six years. Annual equivalent = £5,000

Total gains = £12,000+£30,000 = £42,000.
Total annual equivalent = £3,000+£5,000 = £8,000.
Top slicing factor (N) = £42,000/£8,000 = 5.25 years. 

When top slicing relief doesn't apply

Top slicing relief is available to mitigate a higher rate or additional rate income tax liability arising as a result of a chargeable event gain being added to the taxpayer's total income. It does not:

  • Assist taxpayers already liable to tax at the higher rate before the chargeable event gain is added to their income.
  • Reduce income for the purposes of child or working tax credits (instead the full amount of the gain is included).
  • Reduce income below £100,000 to preserve full entitlement to the personal allowance.
  • Apply to personal representatives, corporate's or trustees. However, for the avoidance of doubt where a gain arises on a trust held policy and the creator is chargeable then that person would be eligible for top slicing relief. In contrast, where the creator is deceased or non resident and the trustees are non resident then a UK beneficiary receiving a benefit from the trust is taxable on that amount - if so, top slicing relief is not available.
  • Apply to annual gains that arise on 'personal portfolio bond events.'

Self Assessment

HMRC Helpsheets 320 and 321 help investors fill in the relevant boxes in their tax return for gains on UK life insurance policies and foreign life insurance policies respectively. The Helpsheets are available from HMRC

Gains on UK policies are inserted into the 'Additional information' pages of the tax return. The full amount of the gain should be returned together with the number of complete years. This information is available from the chargeable event certificate issued by the insurer. If the individual is due any top slicing relief it will then be automatically calculated using the information provided.

Gains on foreign policies are inserted into the 'Foreign' pages of the tax return. A chargeable event certificate might not be available showing the gain if the policy was taken out before 6 April 2000, and for later policies the reporting requirements are not as onerous as those for UK policies. Nevertheless it remains the responsibility of the investor to report gains under self assessment principles.

HMRC - Insurance Policyholder Taxation Manual
HMRC - Self assessment guidance

Example of top slicing relief for an onshore bond

Anne has a taxable salary in tax year 2018-2019 of £32,900 (after personal allowances) and a chargeable event gain of £24,000 on the surrender of an investment bond that she had held for just over eight years. The basic rate band for 2018-19 is £34,500.

Her tax liability for 2018-19 before top-slicing relief is:


Salary (after personal allowance)

£32,900

Chargeable event gain

£24,000

 

£56,900

Tax @20% on £32,900

£6,580

Tax @ 0% on £500 (PSA) 

£0

Tax @ 20% on £1,100

£220

Tax @ 40% on £22,400

£8,960

Total liability

£15,760

Calculation of Relief 

Step one

Anne's taxable income (including the chargeable event gain) is £56,900. The portion of the chargeable event gain falling into the higher rate band is £22,400 (£56,900 - £34,500).

Some top-slicing relief will be available.

Step two

The Step two liability = £22,400 x 20% = is £4,480. 

Step three

The 'annual equivalent' of the gain £24,000 / 8 = £3,000.

Step four

The 'annual equivalent' + taxable income = £3,000 + £32,900 = £35,900. Therefore £1,400 falls into the higher rate band (£35,900-£34,500).

Step five

The additional tax on the Step four portion is £1,400 x 20% = £280. When multiplied by N, this totals £2,240.

Step six

Top slicing relief = £4,480 - £2,240 = £2,240.

Summary

Anne's liability after top-slicing relief is £15,760 - £2,240 = £13,320.

The basic rate credit is £24,000 @ 20% = £4,800.

The overall liability is reduced to £13,520 - £4,800 = £8,720.

Example of top slicing relief for an offshore bond

If we took the last example of Anne, but instead the bond had been offshore, steps one to six (above) would be identical.

Anne's liability after top slicing relief would be £15,760 - £2,240= £13,520

There is no reduction in her liability since no basic rate credit is due for an offshore bond.

Example of top slicing relief for an onshore bond with additional rate tax due

Bridgit has a (gross) salary in tax year 2018-2019 of £32,500 and a chargeable event gain of £160,000 on the surrender of an onshore bond that she had held for just over eight years.

Her total income is greater than £100,000 so the basic personal allowance is reduced to zero.

Her tax liability for 2018-19 before top-slicing relief is:


Salary

£32,500

Chargeable event gain

£160,000

 

£192,500

Tax @ 20% on £32,500 

£6,500

 

 

Tax @ 20% on £2,000

£400

Tax @40% on £115,500

£46,200

Tax @45% on £42,500

£19,125

Total liability

£72,225

Calculation of Relief

Step one

Bridgit's taxable income (including the chargeable event gain) is £192,500. The portion of the chargeable event gain falling into the higher rate band is £115,500 and the portion of the gain falling into the additional rate is £42,500.

Some top-slicing relief will be available.

Step two

The Step two liability = £115,500 x 20% =

£23,100

Plus £42,500 x 25% =

£10,625

Total Step two liability

£33,725

Step three

The 'annual equivalent' of the gain £160,000 / 8 = £20,000.

Step four

The 'annual equivalent' + taxable income = £20,000 + £32,500 = £52,500. Therefore £18,000 falls into the higher rate band (£52,500 - £34,500).

Step five

The higher rate tax on the Step four portion is £18,000 x 20% = £3,600. When multiplied by N, this totals £28,800.

Note that none of the annual equivalent falls into the additional rate band but if it did, the sum at this stage would include that amount x 25%.

Step six

Top slicing relief = £33,725 - £28,800 = £4,925

Summary

Bridgit's liability after top-slicing relief is £72,225 - £4,925 = £67,300

The basic rate credit is £160,000 @ 20% = £32,000.

The overall liability is reduced to £67,300 - £32,000 = £35,300.

Labelled Under:
Investment bonds

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