Tax factsheet Single premium life insurance bonds

Transcription

1 Tax factsheet Single premium life insurance bonds The rules relating to the taxation of single premium life insurance bonds are complex. This factsheet outlines the tax treatment where a policy is held by an individual. It does not consider the position where a policy is held in trust. The rules on Personal Portfolio Bonds are not covered, as these are subject to a different tax regime. General overview y Single premium life insurance bonds are non-qualifying policies for UK tax purposes. Qualifying policies do not generally give rise to taxable gains. y A policy is usually segmented into a certain number of units. Each segment is treated as a separate policy for tax purposes. y Income and gains accruing within the policy are not subject to tax until a chargeable event (see below) occurs, thus achieving a deferral of tax. y Profits arising on a chargeable event are referred to as gains. These gains are subject to income tax, but not capital gains tax. y Gains arising on UK bonds carry a notional basic rate tax (20%) credit. This means that basic rate taxpayers will have no additional liability if the gain falls within the basic rate band. The notional tax cannot be refunded if an individual s tax liability is lower than the notional credit, if, for example, they have unused personal allowances. y The notional tax credit is also available in relation to overseas bonds where the insurance company is situated in another EEA country and pays a comparable level of EEA tax (at least 20%). Overseas policies issued by an overseas insurance company that do not meet these criteria do not carry any tax credit. In these cases, the gains are subject to basic rate tax, higher or additional rate tax, depending on the circumstances. y Gains are taxed on an arising basis regardless of where the policyholder is domiciled. The remittance basis does not apply to the chargeable event legislation. y Top-slicing relief may be available to reduce the rate of tax payable on the gain where the policy has been held for at least two years. y Non-residence relief (also referred to as time apportionment relief) may be available to reduce the gain in respect of any periods of ownership during which the individual was non-uk resident.

2 Chargeable events A chargeable event can arise on a life insurance policy in the following circumstances: y Full surrender of the policy; y Maturity of the policy; y Death giving rise to benefits; y Certain policy loans; y Assignment of the whole policy for money or money s worth; or y Certain partial withdrawals where the 5% facility is exceeded (see below). HMRC also considers that where the terms of the policy have been changed, so that there is a fundamental reconstruction of the contract, the policy terminates and a new one begins. This is treated as a full surrender of the contract and a chargeable event may occur. A common example of a fundamental reconstruction is the addition or removal of a life assured under the policy. An assignment by way of gift is not a chargeable event. Partial withdrawals An individual can withdraw up to 5% of the original investment in each policy year without any immediate liability to tax. A policy year ends with the 12-month anniversary of the date on which the contract was taken out. Withdrawals within the 5% limit are treated as withdrawals of the original capital. This facility therefore allows an individual to withdraw 5% of the original investment each year for 20 years without suffering an income tax charge during this time. If the 5% facility is not used in any given year, it can be carried forward year-on-year. For example, if no withdrawals are made in policy year one, the 5% is carried forward so that in year two 10% can be withdrawn with no immediate liability to tax. If no withdrawals are made in year two, the individual has a cumulative allowance of 15% in year three, and so on. If an individual withdraws in excess of the 5% annual cumulative amount, the excess over 5% is subject to income tax. This is often referred to as an excess event. The excess is taxable regardless of the growth within the policy, so a situation can arise where tax is payable on a gain that does not reflect the economic gain within the policy. The gain on an excess event is treated as having arisen at the end of the policy year, so that it is taxable in the UK tax year in which the last day of the policy year falls. For example, an excess event which occurs on 3 February 2014 during a policy year ended 5 June 2014 would be taxable in the 2014/15 tax year. Where there is a top-up (an additional premium is paid into the same policy) the insurance year is unaffected. This means that a top-up made late in the insurance year will accrue a 5% allowance for that year. Termination of policy Where a chargeable event arises on the termination of a policy (eg maturity, surrender or death) the gain is chargeable in the tax year in which the event takes place, not by reference to the policy year end. The formula for calculating the gain on a final chargeable event is as follows: Value on final event + previous partial withdrawals - premiums paid - previous excess gains already charged to UK tax For example, an individual invests 100,000 in a single premium life insurance bond. He withdraws 5% each year in the first five years with no immediate liability to tax. In year six he withdraws 15% and suffers an income tax charge on the excess 10% ( 10,000). He continues with 5% withdrawals for the next two years, and then surrenders the bond in year nine for 200,000. The chargeable event gain on surrender is calculated as follows: Partial withdrawals from the policy are tax deferred, not tax free, since any amounts withdrawn are added to the proceeds when calculating the chargeable event gain on maturity or full surrender.

3 Surrender proceeds 200,000 Add: previous withdrawals 50, ,000 Less: initial investment (100,000) Less: excess already taxed (10,000) Chargeable event on surrender: 140,000 Non-residence relief The gain on a chargeable event may be reduced in respect of any periods of ownership during which the policyholder was non-uk resident. Prior to 6 April 2013, this relief was only available for overseas policies. However, it was extended to UK policies issued on or after 6 April 2013, or policies issued before this date where, after 6 April 2013, the policy is either: y varied so as to increase the benefits, y assigned (in whole or in part), or y becomes held as security for a debt In addition, for both UK and overseas policies the policy must not, at any time, have been held by an offshore trust or by a foreign company or institution. Where a policy has been held by such a structure, no matter how short the period, non-residence relief is completely lost. There is no facility for apportionment of the relief. Where non-residence relief is available, the gain is reduced by the number of days the policyholder was non-resident as a proportion of the total number of days the policy has been held. Example: A policy is issued for 100,000 on 1 February The individual policyholder is not UK resident from 1 April 2005 to 1 July 2010, but is UK resident for all other periods of ownership. On 1 April 2014 the policy is surrendered for 200,000, with no previous withdrawals having been made. The chargeable event is calculated as follows: Surrender proceeds 200,000 Less: cost (100,000) Gain before relief 100,000 Non-residence relief (63/170 months)* (37,059) Chargeable gain: 62,941 *Relief should be calculated in terms of days, but for the purposes of this example, the calculation is based on months. Top-slicing relief Where, as a result of a chargeable event, a portion of the gain falls into the higher or additional rate tax band, the taxpayer can claim top-slicing relief, so that the gain is taxed at lower rates than if the entire gain was simply added to the taxpayer s other income arising in that year. In other words, the gain is treated as accruing over the life of the bond. For the purposes of top-slicing relief, the gain is divided by the number of full policy years the policy has been owned, to give the value of one slice. This slice is then added to the taxpayer s other taxable income for that year. The effective rate of tax attributable to that slice (calculated as the top slice of income) is then applied to the whole gain. Taking a simple example, a gain of 15,000 is realised and the taxpayer has an unused basic rate band of 5,000. If the full gain were added to their other income, the 5,000 falling into the basic rate band would be taxed at 20%, and the remaining 10,000 would be taxed at the higher rate of 40% (less a 20% tax credit if a UK bond). However, if the policy has been held for five years, top-slicing relief operates so that when one slice ( 3,000) is added to the taxpayer s other income, this falls wholly within the individual s basic rate band. In this instance, the entire gain is taxable at 20% (since the effective rate of tax for one slice is 20% and this rate is then applied to the whole gain). If it is a UK bond, the tax liability would be covered by the 20% credit, so that no further tax would be due.

4 Top-slicing relief is also available in relation to excess events on policy withdrawals over the 5% cumulative facility. Top-slicing relief is not available for any complete years that an individual has been non-uk resident. So, if a policy has been held for 10 years, and the individual was non-uk resident for four complete years, the gain is divided by six to calculate one slice. If the individual is an additional rate (45%) taxpayer before the chargeable event gain is taken into account, then topslicing relief can have no effect. Non-residents Generally, where a gain arises to an individual who is not UK resident, the gain is not chargeable to UK income tax. However, if the individual is temporarily non-resident (broadly, he has been non-uk resident for less than five years), the gain will be chargeable to income tax in the year he resumes UK residence, with the possibility of non-residence relief, as described above. Special rules may apply where an excess event took place whilst an individual was non-uk resident and full surrender takes place subsequently at a time when he is UK resident. Age allowance Top-slicing relief must be ignored for age allowance purposes. The full gain before top-slicing relief is treated as income of the taxpayer in calculating whether any additional age allowance is available. Losses Generally, losses arising on a final event (maturity, death or full surrender) cannot be offset against other taxable income. Neither can a loss on one policy be offset against a gain on another. However, where a loss arises on a final event and gains have been taxed on earlier excess events, a relief known as deficiency relief may be due and further advice should be sought. Non-UK domiciled individuals Gains on life insurance policies are taxed on an arising basis. The remittance basis of taxation does not apply. Therefore, a UK resident but non-domiciled individual claiming the remittance basis will be liable to UK tax on a chargeable event gain arising on an overseas policy, regardless of whether the proceeds are remitted to the UK. Planning with life policies Partial surrender across all segments or full surrender of units? Where an individual wishes to make a withdrawal from their life insurance bond, they usually have the option of taking a partial withdrawal across all segments (under the 5% facility) or surrendering individual policy segments. The tax implications of both options need to be considered in order to determine which is the most tax efficient way forward in relation to their particular circumstances. Assignment for no consideration Since a gift of a policy for no consideration does not trigger a chargeable event, it may be advantageous to consider gifting a policy (or segments of a policy) to other family members, such as a spouse or adult children, particularly where they have unused personal allowances or pay tax at a lower rate. The inheritance tax implications of such a gift will need to be considered. Partial withdrawal giving rise to a large gain If a large partial withdrawal has been made, perhaps without the benefit of professional advice, and results in a significant chargeable event gain which, due to the operation of the 5% rule, does not correspond with the economic performance of the bond, it may be possible to mitigate the tax liability provided action is taken before the end of the tax year.

5 Anti-avoidance Anti-avoidance provisions apply where artificial steps are inserted into an arrangement involving a life insurance policy and the purpose of the arrangement is to generate an artificial loss on surrender. Whilst the anti-avoidance legislation is designed to prevent specific abuse of the tax rules, taxpayers should take care to ensure that they do not inadvertently fall within the antiavoidance rules. This factsheet is based on law and guidance at 1 July Contacts Bournemouth +44 (0) Bristol +44 (0) Edinburgh +44 (0) Geneva +41 (0) Guernsey +44 (0) Harrogate +44 (0) High Wycombe +44 (0) Inverness +44 (0) London +44 (0) Manchester +44 (0) Peterborough +44 (0) Zurich +41 (0) The firm is regulated for a range of investment business activities by the Institute of Chartered Accountants in England and Wales. Saffery Champness is a member of Nexia International, a worldwide network of independent accounting and consulting firms. No responsibility for loss occasioned to any person acting on or refraining from action as a result of the material in this factsheet can be accepted by Saffery Champness. J5559