Taxation and trusts update: TRS further regulations, options for loss of mental capacity and more

 

• Government Debt Crosses The £2,000,000,000,000 Barrier
• Teenagers to obtain access to Child Trust Funds for first time
• New fuel rates for company cars
• Statutory Residence Test - International tax clarifications due to coronavirus
• Online probate applications may become mandatory for professionals
• Trust Registration Service - Further regulations: now might be a good time to establish by-pass trusts
• Next stage of support for mortgage borrowers: FCA proposals
• Increased capital allowances for expenditure on non-residential structures and buildings – Updated guidance
• What are the options if the settlor of a trust or a trustee loses mental capacity?
• Settlor of a trust losing capacity
• A trustee losing capacity
• What if the settlor or trustee has made a power of attorney?
• The impact of chargeable event gains on the availability of the personal allowance

 

Government debt crosses the £2,000,000,000,000 barrier

Yes, you did count correctly – there are twelve zeroes after the two.

The Public Sector Finances data released by the Office for National Statistics (ONS) on Friday 21 August were notable mainly for that £2tn figure. It is no surprise, given that the June figure for public sector net debt (PSND) was £1.983.8tn, but moving from £1. something to £2. something makes good headlines. In reality, the July numbers were slightly better – or perhaps that should be not as bad – as had been expected:

• The public sector net borrowing requirement (PSNBR) in July 2020 is estimated to have been £26.7bn, against a £1.6bn surplus a year ago (July tax receipts are usually boosted by payments on account). Although the monthly borrowing was the fourth highest on record since records started in 1993, there is some solace that it was slightly less than the Office for Budget Responsibility (OBR)’s central scenario projection of £28.4bn and the market’s average estimate of £28.6bn.

• For the first four months of this financial year, total borrowing amounted to £150.5bn. The ONS has reworked last month’s statement to say that this cumulative figure is ‘£128.4bn more than in the same period last year and the highest borrowing in any April to July period on record (records began in 1993), with each of the months from April to July being records’. However, there is an element of good news from the OBR: as the graph above shows, the £150.5bn figure is £28.7bn below the OBR’s central scenario projection. Unfortunately, about £13bn of that difference is attributable to a difference in accounting approaches to the various Government-backed loan schemes. The OBR allows for projected write-offs – hence increased debt – while the ONS is still in the process of incorporating these in its data.

• The uncertainty of the initial estimates for monthly borrowing figures was again underlined, with the April-June figures revised down by a cumulative £4.1bn. The ONS attributes the drop largely to “stronger than previously estimated tax receipts and National Insurance contributions”.

• Overall Government debt rose to £2,004.0bn, £227.6bn (12.8%) higher than a year ago. As a percentage of UK GDP debt rose to 100.5% in July: a year ago it was 80.1%. Revisions to earlier data in 2020 mean that the ONS now says July 2020 marks “the first time [the ratio] has been above 100% since the financial year ending (FYE) March 1961’.

• Self-assessed income tax receipts were £4.8bn in July 2020, £4.5bn (48%) less than in July 2019, because of the option given to defer payments on account until 31 January.

In the circumstances it is surprising that the reduction was not greater. The OBR had reckoned that 90% of tax due would not be paid. As the OBR hints, those constructively ambiguous words on the HMRC website telling taxpayers “you can still make the payment by 31 July 2020 as normal if you’re able to do so” clearly worked…

The graph may seem to suggest that Government finances are better than expected. However, add in the loan provisions missing from the ONS data and there is less of a gap before the inevitable adjustments arrive in future months.

Source: ONS 21/8/20 OBR 21/8/20 - Public sector finances, UK: July 2020

Teenagers to obtain access to Child Trust Funds for first time

HMRC recently published a press release stating that millions of teenagers will be able to access the funds held in their Child Trust Fund (CTF) account for the first time from 1 September 2020. It is anticipated that around 55,000 accounts will mature each month.

Since 2002, around 6.3 million CTF accounts have been set up, roughly 4.5 million by parents or guardians and a further 1.8 million set up by HMRC where parents or guardians did not open an account. This means some children may not be aware that there is an account in their name.  However, HMRC has created an online tool to help individuals to find out where their account is held.

Those who adopted a child or were given parental responsibility through a Court will be contacted with further information. In cases where there is no person with parental responsibility available to manage the CTF, the account is managed on the child’s behalf by a charity – The Share Foundation. HMRC will work closely with the Foundation to help children in need of further support.

Source: https://www.gov.uk/government/news/teenagers-to-get-access-to-child-trust-funds-for-first-time

New fuel rates for company cars

HMRC has announced the new fuel rates for company cars applicable to all journeys from 1 September 2020 until further notice.  The rates per mile are based on fuel prices and adjusted miles per gallon figures.

For one month from the date of the change, employers may use either the previous or the latest rates. They may make or require supplementary payments, but are under no obligation to do either. Hybrid cars are treated as either petrol or diesel cars for this purpose.

Rates from 1 September 2020:

Engine size	Petrol	LPG	Engine size	Diesel
1,400 cc or less	10p	7p	1,600 or less	8p
1,401cc to 2,000cc	12p	8p	1,601cc to 2,000cc	10p
Over 2,000cc	17p	12p	Over 2,000cc	12p

For earlier rates please see our bulletin of 28 May 2020.

Advisory Electricity Rate

The Advisory Electricity Rate for fully electric cars is 4p per mile.

Electricity is not a fuel for car fuel benefit purposes.

Source: HMRC Guidance: Advisory Fuel Rates – dated 26 August 2020. 

Statutory Residence Test - International tax clarifications due to coronavirus

As a result of the pandemic HMRC has recognised that it may be difficult for individuals to move freely to and from the UK and, in some cases, individuals may need to stay in the UK unexpectedly.

In light of this, the statutory residence test (SRT) legislation allows for a day spent in the UK due to exceptional circumstances beyond your control, which prevents you from leaving the UK, to be disregarded. In practice, whether days spent in the UK can be disregarded due to exceptional circumstances will always depend on the facts and circumstances of each individual case. It will therefore be vital for individuals to keep records and documents to support any claim where they wish for days to be disregarded due to exceptional circumstances.

HMRC has published answers to the following questions to help determine the position.

1. Are travel restrictions due to the COVID-19 pandemic counted as exceptional circumstances for the statutory residence test?

2. What does HMRC mean by closure of international borders?

3. What happens if I spend more than 60 days in the UK because of COVID-19, will I become UK resident for tax purposes?

4. Does UK wide Government advice on self-isolation mean that exceptional circumstances apply?

5. I’ve had to work remotely in the UK because I could not get back to my country, do the exceptional circumstances apply to me?

6. I am non-UK tax resident, but my parents, spouse and children live in the UK, Will I be made tax resident in the UK if I come to the UK during the COVID-19 pandemic?

7. I came to the UK to support my vulnerable family members who needed assistance during the COVID-19 pandemic. Would this be considered an exceptional circumstance?

8. For the purposes of the family tie, are children under 18 years old still considered in full-time education although schools were currently shut due to the COVID-19 pandemic?

9. I am normally non-resident for UK tax purposes. My company have asked me to come to the UK to work because of COVID-19. How will this impact my residence status?

10. How will exceptional circumstances apply to individuals working abroad on a split tax year basis, where their employer has told them to come back to the UK?

11. As a trustee of a non-UK resident trust, if I am unable to leave the UK due to COVID-19 travel restrictions, how will my presence in the UK affect the trust?

Company residence

12. Have HMRC considered the situation where people are working in a country they are not usually in and their company changing residence as a result of place of central management and control?

Domicile and deemed domicile

13. If I was planning to leave the UK during 2020-2021 so that I do not become deemed domiciled in 2021-2022, but I am unable to do so because of the restrictions currently in place, how am I affected?

Remittance basis

14. Is there any relief for non-UK domiciled UK tax residents who need to bring foreign income or gains (FIG) taxed on the remittance basis to the UK to support their business?

FIG brought to the UK to support an eligible target company during the COVID-19 restrictions can benefit from Business Investment Relief (see RDRM34300 onwards). FIG brought to the UK to support your self-employment business is a chargeable remittance.

15. I usually carry out the duties of my employment both in the UK and abroad. I am non-UK domiciled and the duties I carry out abroad are taxed on the remittance basis. If I am unable to travel due to travel restrictions, how will I be taxed if I carry out my overseas duties in the UK?

Double Taxation

16. I live abroad with my family and I am treaty resident in an overseas country. Will there be any impact on me as I have been stranded in the UK due to travel restrictions?

17. How will the employment article within a treaty be applied while I am working in the UK but for an overseas employer?

Online probate applications may become mandatory for professionals

One of the areas hit by Coronavirus delays has been probate, which is required in most cases before a personal representative can deal with the administration of an estate. Even before the recent announcement some of the processes for dealing with estates of deceased persons have been simplified.

By way of background, the delays began in 2019 when a proposal to significantly increase probate fees led to a surge of applications in a short space of time. This coincided with the HM Court and Tribunal Service (HMCTS)’s modernisation programme, which saw 18 sub-registries being closed. There was a huge backlog as a result, meaning that applications took months to process, as opposed to weeks.

The knock-on effect was the delays in submitting inheritance tax (IHT) returns and tax payments.

Needless to say, the problems became even worse as the pandemic struck - with reduced staff, social-distancing and working from home.

Furthermore, in the height of lockdown, physical valuations of properties by agents and surveyors (necessary for some estates) were not available due to social-distancing restrictions.

Registering the death

As indicated above, the Government has addressed some of the issues resulting from COVID. For example, before the pandemic, deaths had to be registered at the local register office by someone physically attending the office. With lockdown and social-distancing measures, face-to-face registrations were no longer possible and registration offices closed.

The Coronavirus Act 2020 now allows ‘remote registrations’. GPs are able to certify a death without physically attending and can send an electronic copy of the Medical Certificate Confirming cause of Death directly to the specified registrar, without the informant needing to collect it. Likewise, informants can provide details required for the register entry over the phone or online, without needing to physically attend a registration office.

Electronic signatures

Usually, personal representatives of an estate are required to physically sign the probate application before it can be submitted. In the time of social distancing this poses practical difficulties, particularly where there are multiple personal representatives. To address this difficulty and to avoid any additional delay, HMCTS has agreed to temporarily accept electronic signatures instead.

HMRC has also confirmed that it will accept electronic signatures on IHT forms where previously ‘wet’ signatures were required. It has also started to send IHT421 (IHT receipts) directly to HMCTS, in order to process applications quicker and reduce delays.

Online probate service

The online probate application service has been available for personal applications since late 2016, and was extended to professionals in 2017, initially only on a pilot basis to specially invited law firms. It was made available to all practitioners in October 2019. Some problems have been reported by practitioners, mainly relating to the interaction between HMCTS and HMRC when IHT421 forms are issued.

The new consultation notes that moving to an online process offers professional users cost and time savings and a more efficient and reliable system, along with a secure means of sending and immediate recording of receipt. Moreover, the system is accessible at any time. Applications can be tracked and monitored, and the risk of making errors on applications should be reduced.

By making the process mandatory for professionals HMCTS expects to generate savings of £20 million over a ten-year period. The reform will also see the closure of most district probate registries.

A small number of probate grant processes are to be exempted from the mandatory online application process. These include certain cases where multiple applicants are entitled under intestacy; grants to attorneys where the attorney is not already a registered probate professional and trust corporation applications.

You can read the consultation document here. The consultation closes at 11:59pm on 10 September 2020.

The professionals generally welcome the proposals to modernise and enhance the probate system; however, online applications may not be appropriate in all circumstances.

As of the end of June 2020, according to the Government figures, probate applications are typically taking 5-6 weeks to process, with 4,000-5,000 processed each week.

Source: STEP News: England and Wales professionals could be required to apply for probate grants online – dated 10 August 2020.

Trust Registration Service - Further regulations: now might be a good time to establish by-pass trusts

As part of the implementation of the Fifth Anti-Money Laundering Directive, the regulations dealing with the registration of trusts under the Trust Registration Service (TRS) are to be tightened.

Currently, only trusts with a tax liability need to be registered.

Going forward it is intended that all express trusts should be registered, irrespective of whether they have a tax liability. And, in broad terms, all existing trusts should be registered by 10 March 2022. 

However, following consultation, HMRC has announced that it is intended that there will be some exclusions from the regulations. For example, it is proposed that trusts of registered pension schemes, and life policies that provide only protection benefits, will not need to be registered. Also, it has been suggested that existing trusts that hold less than £100 of assets will not need to register – at least until that trust receives further assets.

The last proposed exemption may be particularly useful for by-pass trusts – those trusts that are established with a very low asset value (say £10 or a covenant to pay £10) and then exist as a vehicle to possibly receive further more substantial death benefit from a registered pension scheme at a later date.

It would seem from the consultation document that provided such trusts are established before the new regulations are implemented, such a by-pass trust will be exempt from registration – at least until such time as it receives other assets. By implication by-pass trusts established after the new regulations are implemented will be registerable – even if holding nominal assets. 

It remains unclear exactly when the 2020 regulations will come into force as these are being created by way of a Statutory Instrument, which is subject to the sifting procedure in Parliament. This is a special procedure for EU legislation, and the date on which the regulations will come into force will only become clear once the procedure has been completed.

Next stage of support for mortgage borrowers: FCA proposals

The FCA originally published Mortgages and Coronavirus guidance on 20 March 2020 and it was subsequently updated on 4 June and 16 June 2020.

On 26 August the FCA published additional draft guidance for firms, intended to ensure that consumers – both those who have benefited from payment deferrals under the current guidance who continue to face financial difficulties, as well as those whose financial situation may be newly affected by coronavirus after the current guidance ends - get the support they need in these extraordinary times.

The current guidance will continue to provide support for those impacted by coronavirus until 31 October 2020 – with consumers able to take a first or second three-month payment deferral. The FCA expects the current guidance to expire on 31 October but will keep this under review depending on how the wider situation develops.

The new draft guidance proposes that firms should consider the appropriateness, and use, of a range of different short and long-term support options to reflect the specific circumstances of their customers. This could include extending the repayment term or the restructuring of the mortgage. Where consumers need further short-term support, firms should offer arrangements for no or reduced payments for a specified period to give customers time to get back on track.

The FCA is proposing that firms contact their borrowers in good time before the end of a payment holiday, and work with them to come up with a tailored plan to help get them back on track. Firms should not take a ‘one size fits all’ approach. Under the proposed guidance, firms should prioritise giving tailored support to borrowers who are at most risk of harm, or who face the greatest financial difficulties. 

Firms should also provide borrowers with the support they need in managing their finances, including through self-help and money guidance, and refer borrowers to debt advice if this meets their needs and circumstances.

Where borrowers require further support from lenders, either at the end of payment holidays under the FCA’s guidance, or where they are in need of support for the first time, this would be reflected on credit files in accordance with normal reporting processes. This will, says the FCA, help to ensure that lenders have an accurate picture of consumers’ financial circumstances and reduce the risk of unaffordable lending. The FCA wants firms to be clear about the credit file implications of any forms of support offered to borrowers.

Stakeholders have not been given long to make comments on this draft guidance – the deadline was 5pm on Tuesday 1 September 2020.

You can read the new draft guidance here.

Source: FCA News: FCA proposes the next stage of support for mortgage borrowers– dated 26 August 2020.

Increased capital allowances for expenditure on non-residential structures and buildings – Updated guidance

As mentioned last August, a capital allowance was introduced in the October 2018 Budget for new non-residential structures and buildings (SBA). It applies to eligible construction costs incurred on or after 29 October 2018.

It applies at an annual rate on a straight-line basis as follows: 

Corporation tax	Rate
29 October 2018 to 31 March 2020	2%
1 April 2020 onwards	3%

 

Income tax	Rate
29 October 2018 to 5 April 2020	2%
6 April 2020 onwards	3%

From 1 April, or 6 April, 2020, as appropriate, all businesses that bring into qualifying use a non-residential structure or building, where all the contracts for construction works were entered into on or after 29 October 2018, will be able to claim the new rate of 3% per year.

In addition, businesses that were entitled to claim the SBA for structures or buildings that were brought into use between 29 October 2018 and 1 April 2020, for corporation tax, or 6 April 2020, for income tax, can claim the new 3% rate from the operative date.

Businesses whose chargeable period spans 1 April (corporation tax) or 6 April (income tax), may claim 2% per year for days in that period before the operative date and 3% for days thereafter.

The 2% per year rate will apply to the whole or part of chargeable periods in relation to days before 1 April, or 6 April, 2020, as appropriate.

The 3% per year allowance reduces the time it will take to relieve qualifying expenditure from 50 years to 33 and one third years.

The structure must be used for a qualifying activity, which is taxable in the UK.

Qualifying activities are:

• any trades, professions and vocations;

• a UK or overseas property business (except for residential and furnished holiday lettings);

• managing the investments of a company; and

• mining, quarrying, fishing and other land-based trades such as running railways and toll roads.

HMRC’s updated guidance can be found here. 

Source: HMRC Updated Guidance: Claiming capital allowances for structures and buildings – dated 14 August 2020.

What are the options if the settlor of a trust or a trustee loses mental capacity?

At Technical Connection we are seeing an increasing number of queries related to the incapacity of settlors and/or trustees. Many of these involve trusts set up some years ago and often missing adequate and important provisions dealing with incapacity.

It may become impossible for decisions to be made or even to make withdrawals from a trust investment where signatures of all the trustees will normally be required before a transaction can take place. Statutory provisions will then apply and, in some cases, it will be necessary to make an application to the Court.

The following is based on English law.

Settlor of a trust losing capacity

As long as the settlor was capable when they set up a trust, the trust will be valid. However, the settlor will often retain certain powers under a trust. For example, the settlor may be the appointor under the trust. What happens if there is a suspicion that the settlor is becoming or has become incapable? 

Since, generally, any powers reserved to the settlor will be expressly reserved in the trust deed, ideally the trust deed should specifically deal with such a situation arising under the trust.

For example, a trust will typically provide that the settlor will have certain powers during their lifetime. The possibility of the settlor becoming incapable can be easily dealt with when the trust deed is being drafted by including a proviso in the trust that the settlor’s powers will apply ‘during lifetime and while the settlor is of full capacity’, with the term “capacity” defined by reference to the Mental Capacity Act 2005 (where English law applies).

When setting up a new trust it is therefore important to ensure that the trust deed includes the provisions dealing with incapacity. If there are no such provisions included in the trust deed, and the settlor is also a trustee (as will usually be the case) there may be a statutory alternative, as explained below, to appoint a new trustee in place of such a settlor.

However, if certain powers are reserved to the settlor as the settlor (whether he or she is a trustee or not), then removing the settlor as trustee under the statutory provisions will not help with, say, the power to appoint benefits (if the trust deed does not deal with the settlor’s incapacity). Depending on what powers the trustees have in such a case, it may not be possible to avoid going to Court.

A trustee losing capacity

Because, under English law, trustees must act unanimously, what if one of them has become incapable? Ideally, the trust deed should include a power (given to the settlor or co-trustees) to remove/replace an incapable trustee. If the trust does not provide for such a situation, we need to rely on the statutory provisions and, in some cases, it may become impossible for the trustees to make decisions without an application to the Court.

Section 36(1) Trustee Act 1925 should be of assistance. This provides, inter alia, that:

“Where a trustee, … is unfit to act or is incapable of acting;  

then, subject to the restrictions imposed by this Act on the number of trustees,

• the person or persons nominated for the purpose of appointing new trustees by the instrument, if any, creating the trust; or

• if there is no such person, or no such person able and willing to act, then the surviving or continuing trustees or trustee for the time being, or the personal representatives of the last surviving or continuing trustee; may, by writing, appoint one or more persons … to be a trustee or trustees in the place of the trustee … being unfit or being incapable”.

Note that to fall within the definition of “incapable of acting” the trustee in question must lack personal capacity for the purposes of the Mental Capacity Act 2005.

What this means in practice is that as long as there is at least one capable trustee, it should be possible to replace the incapable trustee without having to go to Court except where the trustee being replaced has some beneficial interest in the trust property when an application to the Court of Protection will be needed (section 36(9) TA 1925) and except where the appointment is contested.

A further possibility, if it is not possible to use the above-mentioned section 36, is provided by section 41 of the Trustee Act 1925 under which a Court may ‘whenever it is expedient to appoint a new trustee or new trustees, and it is found inexpedient, difficult or impracticable so to do without the assistance of the court, make an order appointing a new trustee or new trustees either in substitution for or in addition to any existing trustee or trustees, or although there is no existing trustee.’ An application under section 41 must be made to the Chancery Division of the High Court.

There is also another option provided by section 20(1) of the Trusts of Land and Appointment of Trustees Act 1996 which may be relevant to some trusts. Under this Act the beneficiaries of a trust may give a written direction appointing a new trustee if:

(a)       a trustee lacks capacity (within the meaning of the Mental Capacity Act 2005) to exercise his or her functions as a trustee,

(b)       there is no person who is both entitled and willing and able to appoint a trustee under section 36(1) of the Trustee Act 1925, and

(c)       the beneficiaries under the trust are of full age and capacity and (taken together) are absolutely entitled to the property subject to the trust.’

Clearly, therefore, there are some remedies available to deal with the incapacity of a trustee using the statutory provisions. However, if a client needs to resort to these, it would be necessary to seek professional advice and assistance in the preparation of an appropriate deed. Obviously, this would involve costs. If an application to the Court (especially the High Court) is needed, there will be an inevitable delay as well as higher cost.

Clearly, the best option is to ensure that the trust deed includes all the relevant powers to remove/replace incapable trustees.

What if the settlor or trustee has made a power of attorney?

One of the questions frequently asked at Technical Connection is whether an attorney, say under a Lasting Power of Attorney (LPA), can act on behalf of a trustee (or an executor).

The short answer is that, although an attorney has wide powers to deal with the donor’s personal financial affairs and their investments, an attorney cannot act on behalf of the donor when the donor is acting as trustee.

There are some provisions, though, allowing a trustee to delegate their powers. The important one, especially now when some trustees while mentally capable may not be able to exercise all of their functions because of self-isolating or social distancing, is in section 25 Trustee Act 1925. This enables a mentally competent trustee to delegate authority to act to another person for a maximum of 12 months. A special form of power of attorney is needed for this. However, the attorney automatically loses the authority to act on behalf of a trustee if that trustee loses mental capacity.

Note that special provisions apply if the incapable trustee also has a beneficial interest in land held subject to the trust (e.g. a life tenant occupying a house held in trust). In this case, the attorney (under an Enduring Power of Attorney (EPA) or LPA) can step into the incapable trustee‘s shoes to act as trustee but only in relation to that land, or capital proceeds from, or income from, that land (section 1(1) Trustee Delegation Act 1999).

Any adviser dealing with estate planning should be aware of the rules applying when a person loses capacity as well as the rules applying to powers of attorney. In particular, those advisers who deal with trustees or who assist with dealing with estates of deceased clients also need to have some knowledge of what happens if any relevant party loses capacity.  

Any adviser who recommends a life assurance policy as part of inheritance tax (IHT) planning also needs to be familiar with certain fundamentals of trusts. When a trust of a life assurance policy is being set up, this will often be a “standard” draft provided by the life office. Naturally, not all these trusts are the same. At this stage it is important to check that the proposed draft trust includes all the relevant express provisions so that should, for example, one of the trustees lose capacity, there will be no need to involve the Court.

For existing trusts, if there is a known risk that a settlor who is a trustee or another trustee is in danger of losing mental capacity it is preferable for them to resign and a new trustee to be appointed. If a trustee has already lost capacity, then all the above considerations will apply.

The impact of chargeable event gains on the availability of the personal allowance

A top-sliced gain can only be used for the purposes of determining the personal allowance when calculating the tax on the top-sliced gain in the top-slicing relief calculation – it cannot be used to preserve the personal allowance in any other situation

The Budget 2020 introduced provisions, (now incorporated in Finance Act 2020), which change the way in which the availability of the personal allowance is determined in cases where an individual realises a chargeable event gain under a life assurance policy such as a single premium Investment Bond (Bond). This change may, in certain circumstances, increase the amount of top-slicing relief available to a policyholder in relation to the chargeable event gain on a Bond. However, it is important to note that the encashment of the Bond will still mean that the full chargeable event gain will be included in determining the amount of the policyholder’s personal allowance for the purpose of calculating tax on their total income. So, in some cases (and despite the Budget change) the encashment of a Bond can cause a reduction in the personal allowance that is set off against total income. 

How does this change affect other tax calculations?

A key point to remember on all this is that, although one now uses the top-sliced gain in calculating income tax on the top-sliced gain (and so the top-slicing relief) the full chargeable event gain is still used to calculate tax on the policyholder’s total income.

Therefore, a Bond encashment with a full chargeable event gain that when added to the policyholder’s other income causes their adjusted net income to exceed £100,000, will still mean that they suffer a reduction in their personal allowance.

Example – Henrietta

Henrietta has earnings of £45,000 in tax year 2020/21. She has no other income. 

She decides to encash her UK investment bond which she has held for 8 full years and realises a chargeable event gain of £80,000.  

First, we need to ascertain Henrietta’s total income in 2020/21. This is:

 

	£
Non-savings income	45,000
Savings income	0
Offshore chargeable event gains	0
Dividends	0
Onshore chargeable event gain	80,000
	125,000

We now adopt the 6 stage process:

(1)        Calculate income tax on all income

We need to calculate tax on all of her income. To do so, we need to check to see whether she loses any personal allowance and how much personal savings allowance (PSA) is available.

Henrietta’s adjusted net income is £125,000 so she is not entitled to any personal allowance.

She is a higher rate taxpayer and so qualifies for a PSA of £500.

Source	Non Savings £	Savings £	Dividends £	Onshore Bond £	Tax £
Gross earnings	45,000
Savings Interest		0
Offshore CEG		0
Dividends			0
Onshore CEG				80,000
TOTAL	45,000	0	0	80,000
Less Personal Allowance	0
Taxable income	45,000	0	0	80,000
Tax on earnings: 0 – £37,500 @ 20%					7,500
Tax on earnings: £7,500 @ 40%					3,000
Tax on CEG: £500 @ 0% (PSA)					0
Tax on CEG: £79,500 @ 40%					31,800
Tax on total income					£42,300

Note: Based on this part of the calculation, Henrietta has lost all of her personal allowance.

(2)       Calculate higher rate income tax on the chargeable event gain

Income tax on chargeable event gain =

£42,300 (total tax) less £10,500 (tax on earnings) = £31,800

Then deduct the basic rate tax credit on the Bond

(£80,000 @ 20%) = £16,000

Total higher rate tax on whole chargeable event gain £15,800

(3)       Calculate the top-sliced gain

£80,000 ÷ 8 = £10,000

(4)        Calculate income tax on the top-sliced gain

In this part of the calculation, we need to calculate tax on her income and top-sliced gain. To do so, we need to check to see whether she loses any personal allowance using the top-sliced gain. Note that this is the only time that the top sliced gain is used to determine the personal allowance.

Henrietta’s adjusted net income is deemed to be £55,000 so she retains her personal allowance.

She is still deemed a higher rate taxpayer and so qualifies for a PSA of £500.

Tax on top-sliced gain

					Tax £
Tax on earnings: 0 – £12,500 @ 0% (personal allowance)					0
Tax on earnings: £32,500 @ 20%					6,500
Tax on CEG: £500 @ 0% (PSA)					0
Tax on CEG: £4,500 @ 20%					900
Tax on CEG: £5,000 @ 40%					2,000
Total tax on income					£9,400

Income tax on top-sliced chargeable event gain =

£9,400 (total tax) less £6,500 (tax on earnings) = £2,900

Less basic rate tax credit (£10,000 x 20%) = £2,000

Higher rate tax on top-sliced gain £900

Higher rate tax on whole gain (x 8) £7,200

 

 

(5)        Top-slicing relief

£15,800 – £7,200 = £8,600

 

(6)       Total income tax due for the year

Tax on earnings £10,500

Tax on bond encashment: £31,800

    Less top-slicing relief £8,600

    Less notional basic rate tax credit

    on Bond gain £16,000                                    

                                                         £24,600          

Tax on Bond gain                                £7,200

Notes:

1. Personal allowance still lost for set off against total income (earnings and Bond gain).
2. This has resulted in additional income tax payable of £4,000 (£10,500 – £6,500) on earnings.
3. Average rate of tax charge on Bond gain is £7,200 / £80,000 = 9%
4. Total effective rate of tax on Bond gain is £11,200 / £80,000 = 14% (due to loss of personal allowance)