As will be widely known chargeable event gains arising on life
assurance policies, capital redemption policies and purchased life
annuities are subject to income tax under the chargeable events
In this article we consider certain less common aspects of the
chargeable event rules as they apply to life assurance policies.
For this purpose life assurance policies can be split into three
categories - exempt policies, qualifying policies and
Any gain arising on anexemptpolicy is exempt from income tax.
Exempt policies include certain policies taken to cover a repayment
mortgage, excepted group life policies and life policies issued in
connection with a registered pension scheme.
In most cases, any gain arising under aqualifyingpolicy will
normally arise free of income tax in the hands of the
policyholder. A policy is a qualifying policy if it satisfies
the qualifying rules set down in the Income and Corporation Taxes
A policy which is neither an exempt policy nor qualifying policy
is anon-qualifyingpolicy. The main disadvantage of such a
policy is that on the happening of a chargeable event any gain that
arises may be liable to an income tax charge on the
The prime examples of non-qualifying policies are those issued
from outside the UK (non-UK policies) and single premium policies -
the prime example of these being investment bonds - which we call
"Bonds" in this article - which are issued by UK or non-UK
For the sake of convenience we use the expressions "UK Bond" and
"non-UK Bond" in this article because these are the types of policy
under which gains most often arise, but what follows applies
equally to non-qualifying polices which are not Bonds.
Multiple chargeable event gains
In this section we consider the top-slicing relief situation
when chargeable event gains arise on more than one Bond in the same
A client has two Bonds which he has fully encashed in tax year
2015/16. Both are UK Bonds although the principles explained
in this section apply equally to non-UK bonds. Bond A had
been in force for 10 complete years and produced a chargeable event
gain of £24,000. Bond B, which had been in force for 4
complete years, gave rise to a gain of £3,600. The client's
estimated taxable income (after deductions and allowances) for
2015/16 is £30,285 and he wishes to know what his prospective
liability to income tax would be on the chargeable event
gains. This means that after addition of the unreduced
chargeable event gains totalling £27,600 the client would be a
higher rate taxpayer (with £57,885 taxable income) so will benefit
from top-slicing relief.
When a chargeable event gain arises under one non-qualifying
policy, such as a Bond, the fractional gain, calculated by dividing
the chargeable event gain by the number of complete years the Bond
has been in force, is treated as the most highly taxed part of
income for that tax year. This gives effect to top-slicing
relief. Higher rate tax, less an amount equal to the basic
rate of tax (i.e. 40%-20% in tax year 2015/16), on the fractional
chargeable event gain is then calculated and multiplied by the
number of complete years the policy has been in force to determine
the amount of tax due on the whole chargeable event gain.
Where chargeable event gains arise in the same tax year on two or
more Bonds, the fractional gain for each Bond is calculated.
The total amount of the fractional gains is then added to taxable
income and tax at 20% (ie. 40% higher rate less 20% basic rate) is
calculated on the excess of the total fractional gains over the
basic rate limit.
In the example above, the fractional gain under Bond A is £2,400
(£24,000 ÷ 10) and under Bond B £900 (£3,600 ÷ 4). Total
fractional gains are therefore £3,300.
Adding £3,300 to taxable income of £30,285 gives an amount of
£33,585 on which tax is £360 [that is £33,585 less the basic rate
limit of £31,785 x 20%]. The average rate of tax on the
fractional gains is therefore 10.91% (360 ÷ 3,300).
The average rate of tax (i.e. 10.91%) is then applied to the
fractional gain under each Bond and each answer is multiplied by
the number of complete years for which that Bond has been in force
to give the amount of tax due on the whole gain for that
Thus for Bond A, tax payable on the chargeable event gain would be
£2,400 x 10.91% x 10 = £2,618.40. For Bond B, tax would be £900 x
10.91% x 4 = £392.76. Therefore, total tax payable would be
The same calculation is undertaken for non-UK Bonds but the figure
for the number of complete years in the calculation is reduced,
broadly, by the number of complete years, if any, during which the
policyholder was not resident in the UK during the currency of the
Bond. In addition, of course, 20% basic rate tax would also
be due on the whole chargeable event gain.
Non-uk bonds denominated in a foreign
When a UK resident investor takes out a non-UK Bond it may be
denominated in sterling or in a foreign currency. For the purposes
of calculating a chargeable event gain where the non-UK Bond is
denominated in sterling throughout, the position is
straightforward, ie. the chargeable event gain calculation is
carried out in the usual way and the investor will be subject
toUKincome tax in accordance with their own tax position.
Where the non-UK Bond is denominated in another currency, HMRC
gives guidance in its Insurance Policyholder Taxation Manual
(IPTM3700). In these circumstances, for the purposes of the
chargeable event gain calculation, the gain should be computed in
the foreign currency and then converted to sterling at the exchange
rate applicable at the date of the chargeable event. But what
happens if a non-UK Bond is taken out in, say, sterling but changes
to a foreign denominated currency before encashment?
In this case, the position is less straightforward as there
appears to be no set practice in terms of how the currency
conversion should be applied when calculating a chargeable event
gain. However, we understand that HMRC takes the view that
each element should be converted to sterling using the exchange
rate at the time of the chargeable event and the gain calculated
accordingly. This means that if at the time the non-UK Bond is
encashed it is denominated in a foreign currency, the investor must
convert the surrender value into sterling prior to calculating the
chargeable event gain. By adopting this approach, a sterling
acquisition cost is compared with sterling disposal proceeds to
produce a sterling gain (or loss).
Presumably, if a non-UK Bond is taken in a foreign currency and
subsequently denominated in sterling, the acquisition cost would be
converted to sterling using the exchange rate at the time of the
If a UK Bond is denominated in a foreign currency then the above
rules would equally apply.
Trusts with more than one creator
In this section we look at the assessment to tax on a chargeable
event gain in the situation where a trust has more than one
creator. For these purposes, anybody who contributes property to a
trust is a trust creator.
Say individual X establishes a trust. Then individual Y effects a
Bond and assigns it to the trust established by individual X.
Sometime later a part surrender is taken from the Bond which gives
rise to a chargeable event gain. Both X and Y are alive and UK
resident at the time the chargeable event gain arises so any
chargeable event gains would be taxed on the trust creators. In
this situation, how is the chargeable event gain assessed to
In the case under consideration, there is a trust with multiple
creators - X and Y. Any chargeable event gains will be split
between them in the proportions in which the trust property derived
from X's contribution and Y's contribution. If, for example,
X set the trust up with £10,000 and the same day Y assigns a Bond
worth £40,000 to the trust, subsequent chargeable event gains will
be apportioned 20% to X and 80% to Y. If X dies and a couple
of years later a chargeable event occurs then 20% of the gain will
be assessed on the trustees in respect of X's contribution and 80%
on Y. In other words, the trust has to be treated in effect
as two trusts with two different creators but with any chargeable
event gains apportioned between both trusts.
Where the additional payment (£40,000 in the above example) is
made after the trust is created, the basis of apportionment will be
established at the time the additional payment is made. In
the above example, say the £40,000 Bond is assigned into the trust
5 years later, when the trust had grown to £20,000 in value, the
apportionment would be ⅓: ⅔ (ie. £40,000: £20,000).
Bond encashment on the death of a sole
We recently had a query which involved a sole owner
(policyholder) under a last survivor non-UK Bond who died testate
in December 2015 leaving two surviving lives assured. Her
husband is an executor of her estate. We were asked to
outline the income tax implications where:-
(i) The executors
encash the Bond.
(ii) The executors
assign the Bond to the deceased's husband.
(iii) The executors assign the
Bond equally to three adult children.
Before considering (i) to (iii) the general point has to be made
that the executors have a duty to administer the Bond for the
beneficiary(ies) entitled under the terms of the Will.
Therefore, it will only be possible to take the action under (ii)
or (iii) if the husband or three adult children, as the case may
be, are entitled under the Will.
If they are not so entitled then they could become entitled
- under a deed of variation; or
- if the estate has been left subject to a Discretionary Will
Trust they are named amongst the beneficiaries and the trustees (ie
usually the executors) make an absolute appointment of benefits to
them and assign the Bond to them as appropriate.
We now consider the proposed actions (i) to (iii) in
(i) Encashment by the
The position envisaged here is that the executors encash the Bond
with a view to paying the surrender proceeds to the
beneficiary(ies) entitled to the Bond (or the proceeds of the Bond)
under the deceased policyholder's Will rather than simply encashing
the Bond to satisfy certain cash legacies.
If at the time of surrender of the Bond the administration of the
estate has not yet been completed (which was the position in the
case in question as confirmed to us by the solicitors dealing with
the estate), the executors hold the rights in the Bond.
On encashment of a non-UK Bond by the personal
representatives the chargeable event gain would be subject to a 20%
income tax charge on the personal representatives. This is
because under section 466(2) ITTOIA 2005, in cases where
section 531(3)(b) ITTOIA 2005 applies (ie. the Bond is a
non-UK Bond), the gain is treated as income of the personal
representatives and is therefore taxed at the basic rate
On distribution of the proceeds to the beneficiary, the chargeable
event gain would be treated as estate income in the hands
of the beneficiary. The trustees must therefore provide the
beneficiary with form R185 (Estate Income) which identifies the
source of the income received. The gain is treated as estate
income of the beneficiary even though proceeds from the Bond are
capital. This is because the income of personal representatives
forms part of the aggregate income of the estate - section
664(2)(e) ITTOIA 2005.
This means the chargeable event gain will be taxed at 40% if the
beneficiary is a higher rate taxpayer or 45% if the beneficiary is
an additional rate taxpayer. HMRC will allow the beneficiary a
20% tax credit for the tax suffered by the personal
representatives. As the gain is treated as estate income,
top-slicing relief would not be available - compare this with the
position in (ii) and (iii) below.
The tax position for a UK Bond would be the same as above except
that the personal representatives would have no basic rate income
tax liability and the beneficiaries would therefore have no 20% tax
(ii) and (iii) Assignment by the executors
As an alternative, under (ii) the executors could vest legal title
in the husband. This would not give rise to a chargeable
event as no consideration is involved. The husband could then
encash his Bond in his personal capacity with the benefit of
top-slicing relief if appropriate. However, if the husband were a
higher rate/additional rate taxpayer on vesting then he
could instead consider deferring encashment if his tax rate is
likely to reduce in the future ie he becomes a basic rate or
In connection with the position in (iii), it might be difficult
to assign a Bond equally between beneficiaries unless it is
segmented. The problem of the Bond not being segmented (ie.
it is not issued as a number of identical smaller policies) could
possibly be overcome by assigning the Bond into a bare trust for
the equal benefit of those beneficiaries although this slightly