UK investment bonds: taxation facts
What you need to know about the taxation regime for UK Investment Bonds.
- Tax is only payable when a gain is calculated on a chargeable event
- Where the policyholder is a company, then the chargeable event rules do not apply
- Part surrenders of up to 5% of accumulated premiums can be taken without any immediate tax charge
- Where there has been a part surrender, a calculation must be made at the end of the ‘insurance year’ to see whether a gain has arisen, and if so its amount
- It is important that any chargeable event gain is attributed to the correct person and in this regard, special rules apply for bonds held by trustees
- Chargeable event gains on UK bonds are not liable to basic rate tax
- It is important to understand eligibility for deficiency relief and time apportionment relief
What is an investment bond?
HM Revenue & Customs (HMRC) define an investment bond in its Insurance Policyholder Taxation Manual (IPTM) as:
In this article we will consider how UK investment bond gains are taxed for individuals, personal representatives and trustees. The relevant legislation is contained in Chapter 9 of the Income Tax (Trading and Other Income) Act (ITTOIA) 2005. Where the policyholder is a company, then the loan relationship rules apply instead (see the article Corporate owned bonds).
Chapter 9 comprises Sections 461 to 546 and from outset, S461(1) makes it clear that gains are charged to income tax. Only in certain specific circumstances will a charge to capital gains tax arise. This is explained below.
UK investment bonds are not 'qualifying' policies for UK tax purposes and therefore chargeable event gains can arise at any time which contrasts with the position for qualifying policies where broadly, only gains in the first ten years are taxable.
HMRC succinctly state that the chargeable event regime proceeds by
- Identifying a 'chargeable event'
- Calculating the gain arising
- Attributing the gain to a chargeable person
Accordingly this article will follow that guidance and sets out the position for bonds effected after 19 March 1968.
Identifying Chargeable events
Tax is only payable when a gain is calculated on a chargeable event. The following are chargeable events:
- Death giving rise to benefits
- Assignment of all rights under the policy for money or money's worth
- Maturity (if appropriate)
- Certain part surrenders and part assignments
- Policy loans
- Surrender of all rights under the policy
- Classification of the policy as a personal portfolio bond
If it does not give rise to benefits, then death is not a chargeable event. For example consider a bond with two lives assured which is structured to pay out on second death - on that basis, death of the first life assured does not trigger a chargeable event.
An assignment not for value (i.e. not for 'money or money's worth') does not trigger a chargeable event. Therefore, gifting a bond does not create a chargeable event. This provides tax planning opportunities (see the article UK Investment bonds: taxation planning ideas).
Specific assignments which are not for money or money's worth
- Between spouses or civil partners living together.
- By way of security for a debt, for instance to a lending bank.
- On the discharge of a debt secured by policy, for instance reassignment by the bank when the loan is paid off.
S487 ITTOIA 2005
Assignments in connection with divorce
An assignment is not for money or money's worth where the Court has made an Order:
- Formally ratifying an agreement reached by the parties that deals with the transfer of assets including the policy, or
- For ancillary relief under the Matrimonial Causes Act 1973 (or financial provision under the Family Law (Scotland) Act 1985) which results in a transfer of rights under the policy from one spouse to another.
There will be a Court Order for almost every divorce or dissolution involving property.
Where the life office knows that an assignment has taken place as part of a divorce or dissolution settlement, it is entitled to assume that the assignment was not for money or money's worth. This means that no chargeable event certificate will be issued.
Change of policy terms
Where the terms of a policy are changed, those changes may be so fundamental as to end the old contract and bring into existence a new policy in substitution. If so, the ending of the old policy is treated as a full surrender with chargeable event consequences. Such a change may be by agreement between the policyholder and the life office or by the exercise of an option in the original policy. In contrast, a variation of a policy has no chargeable event implications for a bond. HMRC consider a variation to be a change in terms that falls short of a fundamental reconstruction.
Whether a change to a policy is fundamental is a question of contract law and depends on the particular facts and circumstances. HMRC however provide some general principles in IPTM 8110. Although this guidance specifically applies to qualifying policies, it has application to non-qualifying bonds also.
Changes which are regarded as fundamental include:
- Addition or removal of a life assured under the policy.
- Changing the contingency on a joint policy so that death benefits are paid on the death of the last survivor rather than on the first death, or vice versa.
- Adding to a policy that previously lacked it, disability or critical illness cover that would bring the policy to an end if paid, or removing such cover completely from a policy.
- Making a number of changes simultaneously which separately may not be fundamental but together make a substantial difference to the contract.
In general, life offices won't permit fundamental changes to the policy to be made. Such fundamental changes would normally be prohibited by the policy terms and conditions.
Part surrenders - the 5% rule
Any part surrenders (or part assignments) will have a knock on effect when calculating gains on subsequent chargeable events upon:
- Death giving rise to benefits
- Assignment for money or money's worth
- Maturity (if appropriate)
- Surrender of all the rights under the policy
- In other words, when these subsequent events occur, previous part surrenders or part assignments are swept up into the gain calculation described later
Part surrenders are very common (part assignments less so), and therefore we will consider part surrenders firstly.
A part surrender will trigger a chargeable event gain if it exceeds a certain limit. Part surrenders of up to 5% of accumulated premiums can be taken without any immediate tax charge (S507 ITTOIA 2005). Withdrawals are tax deferred and not tax free (unless by the time the deferred charge is triggered, the circumstances of the person chargeable have changed so that no tax is payable).
Where there has been a part surrender, a calculation must be made at the end of the 'insurance year' to see whether a gain has arisen and if so its amount. An 'insurance year' which is sometimes called a policy year, begins on the day a policy is taken out and on the same date in subsequent years. It ends on the day before the anniversary of the start date and each subsequent year.
A policy taken out on 3 June 2013 will have an insurance year ending on 2 June 2014. The second insurance year begins on ends on 3 June 2014 and ends on 2 June 2015 (and so on).
A gain will only arise if, at the end of the insurance year, the part surrender value(s) received exceeds the total allowable element. Each premium payment into a bond provides a tax deferred withdrawal allowance equal to 5% of the payment in the year in which it is paid and the next 19 policy years. Any allowance not used can be carried forward for use in subsequent years. An investor can therefore withdraw 5% of a single premium investment each year for 20 years without a chargeable event occurring.
Example of insurance years and the cumulative 5% allowance
Single premium of £100,000 paid 1 January 2018
- 01/01/18 to 31/12/18 - No part surrenders
- 01/01/19 to 31/12/19 - Part surrender £9,000 on 30/06/19
A calculation is performed at 31/12/19 which shows that the proceeds of £9,000 are less than cumulative allowances of £10,000 (£5,000 + £5,000).
No chargeable event gain arises at 31/12/19 and the unused allowance of £1,000 can be carried forward.
Assume now that there is a further part surrender of £8,000 on 30/09/20. The part surrender therefore occurs in the third insurance year.
A calculation is performed at 31/12/20 which shows that the proceeds of £8,000 exceed cumulative allowances of (£1,000 (b/f) + £5,000).
A chargeable event gain arises at 31/12/20 of £2,000. This falls in tax year 2020/21.
Where a policy is topped-up or incremented within that same contract then that amount will trigger its own 5% allowance starting in the insurance year in which the increment occurs.
Example of a ‘top-up’ and the cumulative 5% allowance
Assume Premium of £50,000 paid on 30 June 2018.
Increment of £20,000 on 3 August 2019 (occurs in insurance year ending 29/06/20)
30/06/18 to 29/06/19 - 5% allowance = 5% of £50,000
30/06/19 to 29/06/20 - 5% allowance = 5% of £50,000 + 5% of £20,000
The maximum allowance is 100% of any premium. The allowance will not accrue after 20 insurance years have elapsed but any unused allowance can be carried forward beyond that point. For example:
Assume Premium of £100,000 paid on 12 November 2014.
An investor could withdraw 2.5% in insurance year ended 11 November 2015 and for the next 39 insurance years without a chargeable event gain arising.
If, in the 41st insurance year a further part surrender of £2,500 was taken then that would give rise to a gain of £2,500 as the 5% allowances would have been fully exhausted.
As stated earlier, an assignment for money or money's worth is a chargeable event. A part assignment for money or money's worth is therefore a chargeable event dealt with under the part surrender rules. A part assignment for money or money's worth is unusual but might, for example, occur on divorce without a court order.
A part surrender occurs where one of the assignors (original owners) is also one of the assignees (new owners).
Example where there is a divorce with no court order
Jack and Jill jointly invest £100,000 in a bond on 1 October 2018.
On 1 November 2019, when the surrender value is £106,000, the bond is assigned into the sole ownership of Jill as a result of a divorce with no court order. A chargeable event gain arises at 30 September 2020 as follows:
- Surrender value of rights being assigned: £53,000
- Cumulative 5% allowance: £10,000
- Gain assessable on Jack: £43,000
Death, maturity, full surrender or assignment
A chargeable gain is calculated as follows:
- Death - if surrender value immediately before death plus any previous capital payments, exceeds total premiums paid plus total gains on previous part surrenders or part assignments
This has the effect of confining the gain to investment growth and excluding the life risk element
- Assignment - if assignment consideration plus any previous capital payments, exceeds total premiums paid plus total gains on previous part surrenders or part assignments.
If the assignment is between connected persons, then market value is substituted (unless there was no consideration so the assignment was not a chargeable event).
- Maturity or surrender - if amount paid out plus any previous capital payments, exceeds total premiums paid plus total gains on previous part surrenders or part assignments.
Proceeds from previous part surrenders are therefore added back into the gain calculation as 'previous capital payments'. Similarly, an earlier inducement paid by an insurance company to enter into the policy would be added back although trivial amounts can be disregarded (benefits other than cash less than £30).
Example of withdrawals within 5% limits followed by a full surrender
Premium of £100,000 paid on 30 April 2014
Withdrawals of 5% (i.e. £5,000) on 1st June, 2014, 2015, 2016, 2017, 2018
Surrendered 20 April 2020 for £107,000
No chargeable events arise in the insurance years ended 29 April 2015 to 29 April 2019 inclusive since the withdrawals are within 5% of premium limits
Chargeable event gain calculation on 20 April 2020
Previous capital payments (£5,000 x 5)
Less premium paid
Less gains on previous part surrenders
Gain arising at 20 April 2020
Example of withdrawals exceeding 5% limits followed by a full surrender
Premium of £100,000 paid on 30 April 2014
Withdrawals of 5% of premium on 1st June, 2014, 2015, 2016, 2017.
Withdrawal of 8% of premium on 1st June 2018.
Surrendered 20 April 2020 for £104,000
No chargeable events arise in the insurance years ended 29 April 2015 to 29 April 2018 inclusive since the withdrawals are within 5% of premium limits.
In policy year ended 29 April 2019, the withdrawal of £8,000 exceeds the available 5% allowance and therefore a gain of £3,000 arises on 29 April 2019.
Chargeable event gain calculation on 20 April 2020
Previous capital payments (£8,000 +(£5,000 x 4))
Less premium paid
Less gains on previous part surrenders
Gain arising at 20 April 2020
It should be noted from above that where the cumulative 5% allowance is exceeded, the resultant gain bears no correlation to the economic performance of the bond. Instead the gain is simply a mechanical calculation comparing the part surrender proceeds to the 5% allowance. This can be simply illustrated by the following example:
Premium of £200,000 paid on 1st February 2020.
In the first insurance year 01/02/20 to 31/01/21, the investor unexpectedly takes a part surrender of £150,000. The chargeable event gain calculation is as follows.
Chargeable event gain arising at 31/01/21
Large part surrenders can therefore create unintended adverse tax consequences and it may therefore be more beneficial for an investor to fully surrender individual segments or policies within the bond than take a partial surrender across all the segments. This is possible because an investment bond is typically divided up equally between a number of identical, but distinct and self-contained policies. Documentation will uniquely designate each policy by appropriate sub-numbering. This therefore gives the investor the choice of fully surrendering a number of smaller policies or taking a part surrender across all the policies.
Note that legislation has been introduced (S507A ITTOIA 2005) allowing a person who has made a part surrender or part assignment giving rise to a gain under S507 to apply to HMRC to have the gain reviewed if they consider it is wholly disproportionate. Applications must be made in writing and received within 4 years after the end of the tax year in which the gain under S507 arose. A longer period may be allowed if the officer agrees. If the officer considers that the gain is disproportionate, then the gain must be recalculated on a just and reasonable basis. The legislation came into force on 16 November 2017.
See the article UK Investment bonds: taxation planning ideas. This also considers the situation where a partial surrender gain occurring on the last day of the insurance year is followed by a full surrender in the same tax year. This can be used as a method of avoiding/escaping a large tax charge on a partial surrender gain.
Post death appreciation or depreciation
In a draft version of the Insurance Policyholder Taxation Manual, HMRC state the following:
Except where the policy is a group life policy, a death paying benefits will bring the policy to an end. In computing the chargeable event gain on death, it is necessary to bring in the surrender value immediately before death. However, the insurer may not be informed of the death until some time later and in the meantime the value of the policy used in determining the final payment from the policy may have changed. This is likely to be the case with a unit-linked policy where the payment is based on the value of the units.
How any post-death appreciation or depreciation is treated for tax purposes depends on the terms of the contract. If the death benefit is defined by reference to the unit price at the date of notification of death to the insurer then any post-death appreciation or depreciation is disregarded for tax purposes. If the death benefit is defined by reference to the value on date of death then any additional payment is likely to be interest and must be treated as such, including deduction of basic rate tax where appropriate. In both cases, the amount to be taken for chargeable event purposes in computing and reporting the gain should follow the insurer’s practice in determining what the surrender benefits would be on the day of death. This will normally be the value of the units on the day of death or on the day before death.
In no circumstances can there be any kind of subsequent surrender chargeable event after a death bringing a policy to an end.
A part surrender for chargeable event purposes arises where the life company makes a loan under a policy (issued after 27 March 1974) to a person who would, if a gain arose under the policy, be chargeable under the chargeable event regime.
This applies where a loan is made under an arrangement with the insurer, and is treated as made to a person if it is made at their direction, so including third party loans. Any unpaid interest added by the life office to the loan account will be treated as further loans and thus part surrenders. Repayments are treated as additional premiums.
In certain circumstances there is an exception for a loan in respect of a policy made before 14 March 1989.
Where calculations indicate that a gain arises at the end of the insurance year due to a part surrender or part assignment, and earlier in that insurance year there has been a part assignment for value or a part surrender followed by a gifted assignment then the transaction based rule applies. This ensures that the gain in cases of earlier assignment is charged on the correct person - the assignor - not the person who owns the policy at the end of the insurance year. It applies whether or not the earlier assignment gave rise to a chargeable event gain. Each such part surrender or part assignment for value ('relevant transaction') is treated as a chargeable event in its own right occurring when it happens rather than at the end of the insurance year (although the gain is still charged by reference to that year). If more than one relevant transaction occurs during an insurance year then a calculation needs performed for each in turn.
Attributing the gain to a chargeable person
An individual is chargeable under the chargeable event regime if UK resident in the tax year in which the gain arises and:
• beneficially owns the policy
• the policy is held on a non-charitable trust which the individual created, or
• the policy is held as security for the individual's debt.
The question of domicile is irrelevant in the context of the chargeable event regime. Gains are chargeable under the rules regardless of whether the proceeds have been remitted to the UK.
Where the bond is owned jointly, the gain will be split in the same proportion as ownership. It is not relevant who the proceeds are actually paid to. If the owners are spouses or civil partners, each will be taxed on half the gain unless the policy is held in unequal shares, and a declaration is made under S282B ICTA 1988 to be taxed on actual shares.
Where the beneficial owner is also the sole life assured then the policy ends on death. Any chargeable event gain will be that of the deceased person and not that of the personal representatives (although they administer the affairs of the deceased). The gain is therefore assessed as part of the deceased's taxable income for the tax year of death. If however the bond continues due to the existence of a surviving life assured then see the personal representatives section below.
For a trust held policy, assuming the individual who created it is not 'absent' (i.e. non UK resident or dead) then that person is chargeable. 'Creator' has a wide meaning and includes any person who settles property on the trust. For example, where a person pays sums to the trustees to use as current or future premiums for a policy held in the trust, that person is a creator of the trust.
Example of settlor being taxable
John takes out an investment bond and assigns it into a discretionary trust. Subsequently the bond is encashed when John is still alive and UK resident.
John is chargeable on the gain.
Examples of gains arising in tax year of death versus gains arising in later years
Jo takes out an investment bond where she is the sole life assured. She assigns it into a discretionary trust. When Jo dies the chargeable event gain occurring on her death is charged on her.
Where the gain arises after the end of the tax year in which the creator died, the trustees will be taxable on the gain (subject to the transitional 'dead settlor' provisions below).
Jack took out an investment bond in 2010. The lives assured are him and his son. He assigned it into a discretionary trust. Jack dies on 1st May 2020 and the bond continues due to the existence of the second life assured.
If the trustees encash the bond prior to 6 April 2021, the gain will be chargeable on Jack (the deceased).
If the trustees encash post 5 April 2021, the gain will be chargeable on the trustees.
Trusts with more than one creator
Each person is treated as the sole settlor of a separate share proportionate to the property each contributed/provided (S472 ITTOIA 2005). For example:
Bill contributes £20,000, and Ted contributes £60,000 to a trust. Any chargeable event gains will be split 25% to Bill and 75% to Ted.
Also: In 2010, Bill and Hilary jointly set up an investment bond under a discretionary trust. Bill dies one year later but the bond continues with Hilary as the surviving life assured. In 2020/21 the trustees encash the bond. The gain is chargeable as follows:
- 50% on the trustees
- 50% on Hilary
Recovery of income tax from trustees
Where a policy is held on non charitable trust and an individual is liable for tax, then that person may recover the tax from the trustees. The individual may ask HMRC to certify the amount recoverable (S538 ITTOAI 2005). If the settlor does not recover the tax, then that 'omission to exercise a right' would be a transfer of value for IHT purposes (though perhaps exempt within the annual exemption).
UK resident trustees are liable if immediately before the chargeable event they are UK resident and the person who created the trust is non-UK resident or dead.
If both the trust and the policy were in existence before 17 March 1998 and at least one of its creators was an individual, and one of the creators died before 17 March 1998.
Then, provided the policy has not been varied on or after 17 March 1998 to increase benefits or extend its term, there is no charge on the trustees (the 'dead settlor' rule).
If the trustees cannot be charged because they are not resident in the UK then the anti avoidance provisions of S740 ICTA 1988 are applied with certain modifications. The result is that a UK beneficiary receiving a benefit under the trust from the gain will be taxable on that amount with no top slicing relief or basic rate credit.
Personal representatives pay income tax at 20% (and 7.5% for dividend income). They are not entitled to a Personal Allowance, Personal Savings ‘Allowance’, 0% Savings Rate Band or a Dividend ‘Allowance’.
Personal representatives cannot be Scottish taxpayers, chargeable to Scottish income tax, as this status applies only to individuals. A beneficiary who is a Scottish taxpayer in receipt of savings income from a deceased estate will be chargeable to main UK rates of income tax, or Scottish rates in respect of non-savings income. These principles also now apply to Welsh income tax.
When income arising during the administration period is distributed to a beneficiary, then the beneficiary will include the gross equivalent in his/her tax return. The personal representatives will provide the beneficiary with Form R185 (Estate Income), showing the amount of estate income paid to that beneficiary and the amount of tax suffered on that income.
In the case of a bond, the personal representatives might encash where the beneficial owner has died but the bond has continued due to the existence of another life assured. Any chargeable event gain arising on the encashment by the personal representatives will be treated as income of the estate and the personal representatives will be liable to tax on that gain. See S466 ITTOIA 2005. There will be no top slicing relief available.
An encashment gain on an offshore bond will be taxed on the personal representatives at 20%. With a UK bond there will be no tax to pay due to the tax deemed suffered within the fund. When the bond proceeds are later distributed to the beneficiary, the personal representatives will provide an R185 to that person (see above). The beneficiary will then include the gross amount in their tax return. See S649 ITTOIA 2005. The beneficiary is then assessed as receiving estate income rather than incurring a chargeable event gain. If there is more than one beneficiary then appropriate amounts will be attributed to each. The beneficiaries are entitled to a 20% credit in respect of the tax already suffered whether the bond was onshore or offshore. Top slicing relief is not available to beneficiaries as they are taxable under estate income rules rather than chargeable event rules. Whether further income tax is payable by a beneficiary, or not, depends on the personal tax situation of each person.
Alternatively, the personal representatives may consider assigning the bond to the beneficiary(s). Such an assignment would not trigger a chargeable event as it would not be for money or money’s worth. Top slicing relief could then apply to future encashment gains. For complex estates with multiple beneficiaries, the strategy of assigning the bond (or segments within it) to those beneficiaries may be more complicated than a simple encashment by the personal representatives.
A bare trust is one in which each beneficiary has an immediate and absolute title to both capital and income. The beneficiaries of a bare trust have the right to take actual possession of trust property (assuming they are of age).
Mrs Adams left the residue of her estate to such of her grandchildren as were alive at the date of her death. She directed that the funds should not be paid to the grandchildren until they respectively attain age 18 years.
All such grandchildren are entitled to an equal share in the residue of the estate. There are no other conditions that they must fulfil before they become entitled. The direction about payment does not affect this basic position.
The beneficiaries have a vested interest and the trust is a bare trust.
The taxation of bare discounted gift trusts is covered here
Other than discounted gift trusts, regardless of age, chargeable event gains will be taxed on the beneficiary of a bare trust subject to one exception. That exception relates to the parental settlement provisions under S629 ITTOIA 2005 where gains are taxed on the parent. This applies where
- the settlor is a parent
- the beneficiary is a minor child or step child of the settlor (who is neither married nor in a civil partnership). A step child includes the child of a civil partner.
- the total chargeable event gains plus all other income of a child from settlements by that parent exceed £100 in any tax year
Chargeable event gains on UK bonds are not liable to basic rate tax. The individual or trustee who is liable for tax under the chargeable event regime is treated as having paid tax at the basic rate on the amount of the gain. This reflects the fact that the funds underlying a UK policy are subject to UK life fund taxation. Any gain is exempt from capital gains tax gains unless the policy was acquired for actual consideration. See the capital gains tax section below.
In broad terms:
- Basic rate taxpayers are not subject to further tax on the gain
- Higher rate taxpayers are subject to 20% tax on the gain
- Additional rate taxpayers are subject to 25% tax on the gain
- The amount subject to tax is not 'grossed up'
It is not as simple as that, however, since 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 therefore assist in reducing the rate of tax charged by applying a spreading mechanism, see our Top Slicing Relief article for more information. Even when the chargeable event gain does not move a taxpayer from a lower tax rate into a higher tax rate, there may be still be some top slicing relief available.
Note that under the Scottish rate of income tax (SRIT) measures, the Scottish Parliament can only set the rates and limits for non-savings and non-dividend income. Similarly, in Wales, the Welsh Government has the power to set the rate of income tax applicable to non-savings, non-dividend income only.
Chargeable event gains (without top slicing) are included in an individual's income when assessing entitlement to personal allowances (see our Personal Allowance article for more information). Withdrawals within 5% limits do not affect personal allowance entitlement.
Where there is a bond gain and a capital gain in the same tax year, then the capital gain is ignored when calculating the tax due on the bond (but when calculating the capital gains tax liability, the top sliced gain is included as income when determining capital gains tax rates).
- Basic rate applies on gains up to £1,000, where this hasn't already been set against other non-savings income, otherwise
- The rate applicable to trusts applies (45%) meaning that a 25% liability arises for a UK bond.
Example of trustee tax liability on a UK Bond gain
In 2020/21, the trustees of the Morrissey Will trust surrender a UK bond purchased in 2011 and realise a gain of £50,000. This is the sole investment of the trust.
Tax is payable as follows: £49,000 @ 25% = £12,250.
The first £1,000 of gain covered by the trust's basic rate band.
Therefore, a gain of up to £1,000 could result in no tax charge for a UK bond. Top slicing relief cannot be used for this purpose.
In view of the 45% rate of tax which applies, planning opportunities arise for trustees to consider an assignment of the bond or of specific segments to beneficiaries prior to encashment. This is covered in the article UK Investment Bonds: taxation planning ideas.
There is no relief under the chargeable event regime in any circumstances for an investment loss sustained on a bond. Neither can a loss on one bond be set against a gain on another. For example:
Stephen invests £100,000 in a UK investment bond. He takes no withdrawals and subsequently encashes it for £90,000.
There is no loss of £10,000. Instead, for chargeable event purposes this represents a £Nil gain.
However, 'deficiency relief' under S539 ITTOIA 2005 may be available (to individuals only), when a policy comes to an end.
Deficiency relief is given as a tax reduction from the individual's income tax liability for the year, but unless income is liable at higher rate or dividend upper rate (not additional rate) on some income, there will be no tax reduction and deficiency relief will be of no benefit.
Entitlement to deficiency relief arises as follows:
- the calculation of the gain on the final chargeable event (death, maturity, full surrender) shows a negative amount
- one or more gains arose on 'excess events' in earlier tax years on which the same individual was liable, and
- the individual is the chargeable person (ie would have been liable had the calculation shown a gain)
The amount of deficiency relief will be the lesser of the deficit calculated in the final chargeable event calculation, and the total of gains on previous 'excess events' which formed part of the total income of the same individual who is now benefiting from the relief.
Example of deficiency with no restriction
Fred who is a UK resident took out a policy on 5 October 2016 with a premium of £20,000. Insurance years will therefore end 4 October 2017 and so on.
27 September 2018 – withdrew £8,000 by a part surrender triggering a gain of £6,000 (£8,000 less 2 x 5% of £20,000). This was included in taxable income in 2018/19.
14 November 2020 – surrendered the policy for £13,000. The chargeable event calculation is:
Surrender Proceeds £13,000 + previous withdrawals £8,000 less premium paid £20,000 less previous gain £6,000 = (£5,000).
Deficiency is therefore £5,000. There is no restriction since it is less than the previous gain of £6,000.
Fred's only taxable income (after personal allowances) in 2020/21 is employment income breaching the higher rate threshold by £3,300.
The amount of Fred's taxable income falling in the higher rate tax band is £3,300, which is relieved by deficiency relief of £3,300. Effectively, the basic rate band is extended by £3,300 so that an additional £3,300 of Fred's employment is taxed at basic rate rather than higher rate.
The balance of the deficiency relief is £1,700 and this cannot be used in this tax year, or carried forward or back to other tax years.
Example of deficiency which is restricted
Assume the same facts as above except that the policy was surrendered for £10,000.
The chargeable event calculation would be:
Surrender Proceeds £10,000 + previous withdrawals £8,000 less premium paid £20,000 less previous gain £6,000 = (£8,000).
Deficiency would be restricted to £6,000 (i.e. total previous gains).
Time Apportionment Relief
Traditionally, this relief applied only to offshore policies - a chargeable gain for an offshore policy being reduced for tax purposes if the policyholder was not UK resident throughout the policy period.
The relief has now been 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.
The relief is considered in our article Taxation of Offshore Policies.
Capital gains tax
A gain made under a UK bond is not subject to capital gains tax unless it has at any earlier time been acquired by any person for actual consideration.
For example, a policyholder may have sold the bond to someone wishing to buy it as an investment. In such circumstances the aim of the capital gains tax legislation is that any gains made on the bond after it has been sold should be chargeable, just as gains on any other type of financial instrument that might be held as an investment are chargeable.
Broadly, the effect therefore is that a bond is exempt from capital gains tax in the hands of the person who takes it out, and anyone who acquires it from the original policyholder by way of a gift, or an unbroken chain of gifts. Once 'actual consideration' has been given for the bond, the exemption is lost and any gain on a subsequent disposal is chargeable. The capital gain would be calculated by deducting purchase price from disposal proceeds. Receipt of the sum assured or surrender proceeds would both count as disposal proceeds. In addition, premiums paid by the new owner would be deductible as would any incidental costs of acquisition or disposal.
Any consideration paid between spouses or civil partners does not count as 'actual consideration'. In addition consideration given on an approved post marriage /civil partnership disposal does not count (ie where the disposal is made to a former spouse or civil partner in consequence of the dissolution or annulment of a marriage or civil partnership and duly authorised by an appropriate court, or similar body).
The disposal of a second hand investment bond can therefore generate an income tax liability under the chargeable event gain rules and a capital gain under capital gains tax rules. The interaction between income tax and capital gains tax was considered in the 2007 case of Drummond v HMRC where a small chargeable event gain arose on the surrender of a second hand life policy. The Court of Appeal concluded that in the capital gains tax computation on disposal, the chargeable event gain should be excluded from the disposal proceeds to avoid double taxation. However, for disposals on or after 9 April 2003 the amount of any loss for capital gains tax purposes is restricted to that which the taxpayer really incurred (this does not have any effect at all on the capital gains tax position of the acquiring person).
Example showing tax position of second hand owner who acquired the policy for money or moneys worth
Bob purchased an investment bond for £39,000 at arm's length. He then paid a further premium of £500 while holding the policy. Shortly afterwards he sold the bond at arm's length for £40,000.
Assume that a chargeable event gain of £2,000 arises on which he is taxed under the income tax rules (computed by reference to the sale proceeds and the premiums paid under the policy by both the taxpayer and the previous owners of the policy).
The 'normal' computation for capital gains tax purposes is:
Less gain subject to income tax
Less allowable expenditure
Bob has not actually made a loss. In economic terms his position is as follows
Less allowable expenditure
The result therefore is that there is no gain or loss on the disposal for capital gains tax purposes and the restriction made to the loss has no bearing on the £40,000 cost of the policy to the person who bought the policy.
If the premium paid by Bob had been £1,500 instead of £500, then the first computation would produce a loss of £2,500 (assuming the same £2,000 chargeable event gain). The second computation would produce a loss of £500. On this basis, the loss for capital gains tax purposes would be restricted to the smaller figure of £500.
Chargeable event certificates
When a chargeable event occurs the life company must provide a certificate to the 'appropriate policyholder' specifying certain information about the event and the gain unless the insurer is satisfied that no gain arises on the event. On all chargeable events other than part assignments, the 'appropriate policyholder' is the policyholder immediately before the happening of the chargeable event. With a part assignment, the appropriate policyholder is any person who is both a policyholder immediately before the assignment and an assignor.
The reporting regime simply requires a life company to provide information to policyholders as it will always know the identity of the policyholder. It will not necessarily know who is the chargeable person, for instance where the policy is held on trust, and it is not required to establish this information.
Where a policy is held on trust, the policyholder is the body of trustees If there is more than one trustee then the life company only needs to send a chargeable event certificate to the first named trustee, or to whichever trustee it holds an address. Trustees should forward certificates to the chargeable person where that is not themselves.
Where there is more than one appropriate policyholder, the life company is required to deliver a certificate to each of those policyholders except where it has not been provided with an address for that policyholder. Each certificate should have the names of all the policyholders on it. Joint policyholders living at the same address will typically receive only one certificate with both names on it.
Where a gain arises on a policy held in the estate of a deceased individual, the life company only needs to send one certificate to the first named personal representative of the estate, or to one for which it has an address.
Where the policy has come to an end due to the death of the policyholder, the appropriate policyholder is the deceased person. To avoid distress, HMRC allows the life company to address the certificate to whoever is dealing with the estate of the deceased if the insurer has that information.
Except where the chargeable event is a whole assignment for money or money's worth, the information to be provided on the certificate is
- policy number
- nature of the chargeable event
- date of the chargeable event*
- the amount of the gain
- the 'number of years' for the purpose of top-slicing relief
- the amount of income tax treated as paid at the basic rate on the gain
* where the chargeable event is a part surrender or part assignment the date of chargeable event would be the date on which the insurance year ends.
Where the chargeable event is a whole assignment for money or money's worth, the life company is not required to report the amount of gain on the assignment or the amount of income tax treated as paid. Instead, it must also report the premiums or consideration paid and other information on the history of the policy listed to assist the liable person to calculate the gain.
The life company must deliver a chargeable event certificate to the policyholder within a certain period, depending on the nature of the chargeable event.
Maturity or full surrender of the policy
- three months of the date of the event.
Excess events (occurring on the last day of the insurance year)
- three months from the date of the chargeable event (i.e. end of insurance year)
Death or whole assignments for money or money's worth
- three months from the date it receives written notification of the event.
Insurers must also provide information about chargeable events and gains to HMRC, but only where the gain is larger than a certain amount, or where the chargeable event is a whole assignment.
Chargeable event certificates must be supplied by the life company to HMRC where the value of the gain, when aggregated with any connected gains, exceeds half the 'basic rate limit'.
Although insurers are not required to report gains to HMRC which are equal to or less than half the basic rate limit, nevertheless they may do so as an administrative convenience.
Insurers must supply details to HMRC in all cases where the chargeable event is a whole assignment for money or money's worth, whatever the size of the gain.
The time limits for insurers to deliver certificates to HMRC reporting events and gains are different from those for delivering certificates to policyholders, An insurer always has at least as long, and in most cases longer, to report events to HMRC as it does to report to policyholders.
The general rule is that an insurer must deliver the chargeable event certificate to HMRC within three months of the end of the tax year in which the chargeable event occurred. This however may be extended in certain circumstances.
Finally, a chargeable event certificate that has been delivered to a policyholder or HMRC may subsequently be found to be incorrect. An example of this is where a subsequent termination of the policy causes the reported event and gain to be superseded. Please see Tax Planning With UK Investment Bonds article for an example.
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