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Chargeable event gains - Who is assessed and liable for tax?

Income tax can be charged on gains treated as arising from certain life assurance policies, capital redemption policies and annuities.

In this article and the next article we consider the circumstances in which persons are assessed on those gains and so may be liable for the payment of any income tax.  The articles will not cover annuities or company-owned policies (gains to UK companies are taxed under the loan relationship rules) and the expression 'life assurance policies' includes capital redemption policies.

INTRODUCTION

Chargeable event gains made under life assurance policies owned by individuals, or held on non-charitable trusts established by an individual, are potentially subject to income tax.

An investment gain (called a 'chargeable event gain') can arise when a chargeable event occurs.  (See section 2 below).  Special rules apply in the calculation of chargeable event gains (CEGs). 

For example, in calculating a CEG which arises on death, the surrender value immediately before death is used, not the amount of the death benefit paid - this ensures any mortality profit is not taxed. Also a withdrawal of up to 5% of the premium can be taken, tax-deferred, for 20 years but when a termination chargeable event  occurs any such withdrawals are added back to calculate the overall gain on the policy.  Another example of a special calculation is where non-resident relief could apply.  In which case, broadly, the amount of the CEG is reduced to reflect any period during the currency of the policy for which the person liable for payment of the tax was not resident in the UK.

CEGs arise primarily under non-qualifying policies.  All policies issued on or after 18 November 1983 by offshore companies are non-qualifying.  Policies issued by a UK company can be qualifying or non-qualifying.  For a policy to be qualifying then, broadly speaking, the premiums must be regular and paid at least annually, there must be at least a minimum prescribed sum assured payable on death and there must be a premium payment term of at least 10 years. All gains arising under a qualifying policy will, in most cases, be free of income tax.  By its very nature a single premium investment bond is therefore a non-qualifying policy.

BACKGROUND 

The following 6 occasions are chargeable events under section 484(1) Income Tax (Trading and Other Income) Act (ITTOIA) 2005. On the happening of one of these events, a UK income tax charge can arise on a non-qualifying policy. 

(i) The death of any life assured that gives rise to the payment of benefits under the policy.

(ii) The maturity of the policy. 

(iii) The full surrender of the policy.

(iv) The assignment of the whole of the rights under a policy for consideration in money or money's worth.  

(v) Part surrender or assignment of part of the rights under the policy for consideration where:-

(a) the amount payable by way of surrender exceeds the total of unused 5% allowances as calculated under section 507 ITTOIA 2005, or

(b) on assignment the surrender value of the policy before assignment less the value of the interest retained by the assignor exceeds the total of unused 5% allowances as calculated under section 507 ITTOIA 2005.

(vi) A notional chargeable event will arise at the end of the policy year in relation to certain personal portfolio bonds. 

The CEG legislation is contained in Chapter 9 Part 4 ITTOIA 2005, and categorises the persons liable for income tax as individuals, personal representatives and trustees. In the remainder of this article we look at the position where a policy is not held under trust which means the liability for the payment of any income tax can fall on an individual or personal representatives. 

In the next article we will look at the position where a policy is held under trust - here the liability could fall on an individual or trustees.

WHERE A POLICY IS NOT HELD UNDER TRUST

(a) Where a policy is owned by a UK resident

Apart from gains arising on the assignment of part of the rights under a policy for consideration which are assessed to tax on the assignor (further consideration of this is beyond the scope of this article), gains are assessed on the person who beneficially owns the rights under the policyimmediately before the happening of the chargeable event.

  • In the case of an own life own benefit policy - this will be the policyholder.
  • In the case of a life of another policy - this will be the grantee (policyholder).
  • In the case of a policy which has been assigned by way of gift - chargeable events after the assignment - this will be the assignee.
  • In the case of a policy assigned for consideration in money or money's worth and the assignment itself gives rise to a chargeable event, this will be the assignor. On any subsequent dealings by the assignee giving rise to a chargeable event - the assignee will be assessed.
  • In the case of a policy held as security for a debt, this will be the debtor.

(b) Where a policy is owned by a non-UK resident individual

The position where a chargeable event gain occurs when the person who beneficially owns the rights under the policy is non-UK resident is modified by section 465 ITTOIA 2005.   Under section 465, HMRC will not seek tax where an individual is not resident in the UKat any time duringthe tax year in which the chargeable event occurs.  If they are resident for part of the tax year and the split year rule applies, a gain arising during the part of the tax year in which the individual is UK resident will be taxed.

If a policy is effected by an individual when they are UK resident and a CEG arises when that individual is "temporarily non-UK resident", the CEG is calculated as if the individual had been UK resident.  The CEG is assessed on the individual in the tax year during which the individual returns to the UK. 

An individual is temporarily non-UK resident if all of the following conditions are satisfied:-

(i) They are only UK resident for a residence period and immediately following that period one or more residence periods * occur for which they are not solely UK resident; and

(ii) In 4 or more of the 7 tax years immediately preceding the year of departure from the UK the individual is either only UK resident for the tax year (or the year must have been a split year that included a residence period for which the individual is only UK resident); and

(iii) The temporary period of non-UK residence is 5 years or less

* A residence period is normally a tax year.  However, when a tax year is a split tax year (ie. an individual is UK resident for part of a tax year and overseas resident for the remainder) the UK part and overseas part of the split year are treated as separate residence periods.

c) Where a policy is held under multiple ownership

Where a policy is owned by two or more individuals who are accountable for the payment of tax on a chargeable event gain, (such individuals are said to have a "relevant interest"), such as two individual beneficial owners, each such owner is treated as the sole owner of the policy as regards their share of the gain.  Any CEG is apportioned between the owners in proportion to their interests in the policy.  Such an apportionment is also necessary where the same individual has different relevant interests in the same policy.  In applying these provisions where a policy is used as security for a debt or debts, any CEG is apportioned on the basis of the share of the actual debt or debts for which each debtor is responsible.

The above provisions would seem to apply only where ownership is on a tenancy in common basis.  Where beneficial ownership of the policy is on a joint tenancy basis then, for chargeable event purposes, each joint owner is treated as owning an equal share of the rights under the policy and as a consequence any CEG will be apportioned amongst the beneficial owners equally.

(d) Where a policy is held by  personal representatives

Where the life assured is different from the person who beneficially owns the rights under the policy, or the policy is a capital redemption policy which has no life assured, then the policy will continue in force following the death of the person who beneficially owns the rights under the policy.

In this situation the policy will pass into the estate of the deceased and the personal representatives (PRs) will hold the rights in the policy.  The PRs could then vest the legal title to the policy in the beneficiary entitled under the Will.  This action would not give rise to a chargeable event and any subsequent CEGs would be assessed to tax on the beneficiary.

Alternatively, the PRs could encash the policy during the administration of the estate.  In this case the PRs would be liable for income tax at 0% (UK policy) or 20% (offshore policy) on any CEG.

On distribution of the cash proceeds to the beneficiary under the Will any CEG would be treated as income of the deceased's estate.  The CEG would be treated as ordinary income in the hands of the beneficiary with a tax credit for any tax paid by the PRs on an offshore policy and a 20% tax credit on a UK policy.  As the CEG is treated as estate income top-slicing relief would not be available.

(e) Non-resident relief and top-slicing relief

These two reliefs are only available where the person assessed to tax on a CEG is an individual.

For information on non-resident relief please refer to section 1 above. 

Top-slicing relief is the mechanism which is used to determine whether any higher/additional rate income tax liability is payable on a CEG by, broadly, averaging the CEG over the number of complete years for which a policy has run. 

For a termination event, such as death, years are counted from inception of the policy.  For policies under which an excess arises (ie. when withdrawals in a policy year exceed cumulative unused 5% annual allowances for that year), years for top-slicing relief are measured from inception of the policy for the first excess, and for second and subsequent excesses years are counted since the last excess.

In the next article we will cover the position where a policy is held under trust.