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UK single premium investment bond tax

In the following article, references to the current UK tax rates mean rates in the tax year ending on 5 April 2017 (tax year 2016/2017).

Old Mutual Wealth is liable to taxation in respect of the funds to which your client’s contract is linked. Although any taxation deducted cannot be recovered, a 20% tax credit is available (see below).

Rules for UK residents

UK capital gains tax (CGT)

There is currently no personal charge to CGT in connection with your client’s contract.

Policy gains

a. Basic points to note:

If your client is a UK resident throughout the period their contract is in force they will be liable to UK income tax in respect of any policy gains arising under the policies comprising their contract.

All gains will be free of basic rate income tax as tax had been deducted already. They will however be liable to 20% or 25% tax if their total taxable income, taking into account their policy gains after any ‘slice relief’ (see Higher rate income tax below), exceeds the higher and/or additional rate income tax thresholds.

The additional tax at 20% would be payable for taxable income in excess of £32,000, up to £150,000 and at 25% for taxable income above £150,000 in 2016/17.

An individual’s personal allowance will be lost in whole or part where the income exceeds £100,000. For the purposes of investment bond gains, the whole gain must be added to the individual’s income for the year of assessment to see whether the personal allowance is affected and not just the sliced gain.

Your client will be responsible for declaring the payment in their next self-assessment tax return to their local inspector of taxes and personally settling any liability.

Old Mutual Wealth will report certain payments and events affecting investors. However, it remains an obligation of the policyholder to report any gains that effect their income tax liability to HM Revenue & Customs irrespective of amount, even if they do not receive a tax return.

Policy ‘gains’ are taxed under special income tax rules for life assurance policies, not under the CGT rules which sometimes apply to investments.

b. When do ‘Gains’ arise?

Policy gains may arise in the following situations:

  • when withdrawals are taken from your client’s contract by partial surrender of the policies in their contract
  • when a withdrawal is taken by full surrender of one or more policies in their contract
  • when loans are made by Old Mutual Wealth (or by arrangement with Old Mutual Wealth) on security of the policies in their contract, although currently no such facility is available
  • when their contract is fully encashed, either on full surrender of all the policies or on the death of the relevant life assured
  • when their contract is assigned for consideration in ‘money or money’s worth’*.

* When at least one of the client's before the assignment is also a policyholder after the assignment this is known as a part assignment.

The contract is issued as a group of policies, so that when taking withdrawals from the contract, investors can either partially surrender all the policies or fully surrender individual policies to suit their particular tax position.

c. Partial surrender of policies

Withdrawals by partial surrender of policies and part assignment for consideration of money or money's worth, will not result in policy gains under the tax rules provided the amounts withdrawn or the amount of consideration do not exceed the tax deferred withdrawal allowance. Each policy in your client’s contract has its own separate allowance. For each premium under the policy concerned the allowance is 5% of the premium for the policy year in which it is paid and a further 5% allowance accrues at the start of each subsequent policy year for the next 19 years.
If investors exceed the 5% allowance, the whole of the excess will be treated as a policy gain, which will be deemed to arise on the last day of the policy year in which the excess occurs. The tax rules for calculating partial surrender gains ignore actual investment performance.

d. Full surrender of individual policies

The policy gain calculation on full surrender of a policy takes into account investment performance and any previous sums treated as partial surrender gains under the policy concerned.
The gain is the amount by which the proceeds from the policy, including any previous partial surrender proceeds, exceed the premium(s) and any previous partial surrender gains. If there is no excess then there is no gain and no charge to tax on full surrender of the policy.

e. Full surrender of the contract

On full surrender, the gain arising under the contract as a whole will be the sum of the full surrender gains under each of the policies then comprising the contract.

Basic rate income tax

If the gain when added to your client’s taxable income for the current tax year does not exceed the basic rate threshold (£32,000 for the 2016/17 tax year), then no further liability to tax arises.

If the gain when added to your client’s taxable income exceeds the basic rate threshold then the gain in excess would be liable to:

  • higher rate tax (40%) at the marginal rate (40% - 20%) or
  • if the gain is large enough, higher rate (40%) at the marginal rate of (40% - 20%) and additional rate tax (45%) at the marginal rate (45%-20%).

Top slicing relief as described below may be used to reduce or eradicate your client’s liability to higher rate (and where relevant additional rate) tax on the policy gain.

Higher rate income tax (HRT)

If your client’s taxable income in the tax year of the gain exceeds the basic rate threshold (£32,000 for the 2016/17 tax year) before adding the gain, but is not more than the higher rate threshold (£150,000 for the tax year 2016/17) after adding the gain, then the policy gain will be liable to higher rate tax.

  • If the gain when added to you client’s other taxable income does not exceed £150,000 the gain is liable to higher rate tax (40%) at the marginal rate of 20% (40% - 20%)

No top slicing relief is available on the policy gain as the whole gain sits within the higher rate band.

Additional rate income tax (ART)

If your client’s taxable income in the tax year of the gain exceeds the higher rate threshold (£150,000 for the tax year 2016/17) before adding the gain, then the policy gain will be liable to additional rate tax (45%) at the marginal rate of 25% (45% - 20%).

No top slicing relief is available on the policy gain as the whole gain sits within the additional rate band.

Top slicing relief

The top slicing relief provisions may avoid or reduce your client’s liability to higher rate tax (and where relevant additional rate tax) in respect of the policy gains where their other taxable income falls within the basic rate threshold.

Each policy gain arising in the tax year, net of any time apportionment relief, is divided into a ‘slice’ by reference to the appropriate slice relief period for the policy concerned.

Where there is more than one policy gain in the same tax year, each policy gain ‘slice’ is determined and then all slices are added together.

For example, if your client has gains under two policies, each with a slice relief period of 5 years and the gain under each policy is £2,000 (total gains £4,000), the ‘slice’ for each gain will be £400 (£2,000/5) and the total (aggregate) slice would be £800 (£400 + £400).

For a gain under an onshore policy, the slice relief period is the number of complete policy years from the date the policy commenced to the date of the chargeable event when the gain arises. However, in the case of excess events (part surrenders and part assignments for consideration), if the current event follows one or more previous excess events, the slice relief period is the number of complete years from the last excess event to the date of the chargeable event when the current gain arises.

The aggregate slice is then added to your client’s taxable income for the current tax year, and the amount that exceeds the basic rate threshold is the taxable amount of the slice. Where part of the aggregate slice still exceeds the higher rate tax threshold, this amount will be liable to tax at the marginal rates. These tax liabilities then need to be multiplied by the number of complete years for the slice relief period. This provides the aggregate slice tax amount.

You then calculate tax on the policy gains for the tax year and deduct the aggregate slice tax amount from the entire gain tax to arrive at the top slicing relief available.

This amount can then be deducted from the tax liability calculated for the policy gains in that tax year.

Examples

Higher rate tax only

John’s taxable income in the current tax year is £31,500. He has made one gain of £8,000 when he surrendered the policy. The policy had completed 10 whole years before John surrendered it.

Tax on whole gain added to taxable income:

  Amount of Gain Tax rate Tax on Gain Marginal Rate
(less BRT 20%)
Further tax payable
Basic rate liability (up to £32,010) £ 500 20% £100 0% £0
Higher rate liability (£32,011 to £150,000) £7,500 40% £3,000 20% £1,500
Totals £8,000   £3,100   £1,500


Tax on slice when added to taxable income:
Slice is £8,000/10 = £800

 

Amount of Gain Tax rate Tax on Gain Marginal Rate
(less BRT 20%)
Further tax payable
Basic rate liability (up to £32,010) £500 20% £200 0% £0
Higher rate liability (£32,011 to £150,000) £ 300 40% £120 20% £60
Totals £800   £320   £60 x 10 = £600


£1,500 – £600 = Top slicing relief of £900 available.
Total tax liability:

£500 x 20% = £100
£7,500 x 40% = £3,000
  £3,100
   
Less Basic Rate Tax liability (8,000 x 20%* £1,600
Less top slicing £900
   
Further tax due on gain £600


*If this were an offshore bond, the Basic Rate tax liability would be payable and therefore would not be deducted.

Additional rate tax

Mary’s taxable income in the current tax year is £30,000. She has made one gain of £360,000 when she surrendered the policy. The policy had completed three whole years before Mary surrendered it.
Tax on whole gain added to taxable income:

  Amount of Gain Tax rate Tax on Gain Marginal Rate
(less BRT 20%)
Further tax payable
Basic rate liability (up to £32,000) £ 2,000 20% £400 0% £0
Higher rate liability (£32,000 to £150,000) £118,000 40% £47,200 20% £23,600
Additional rate (£150,001 +) £240,000 45% £108,000 25% £60,000
Totals £360,000   £155,600   £83,600


Tax on slice when added to taxable income:
Slice is £360,000/3 = £120,000

  Amount of Gain Tax rate Tax on Gain Marginal Rate
(less BRT 20%)
Further tax payable
Basic rate liability (up to £32,000) £ 2,000 20% £ 400 0% £0
Higher rate liability (£32,000 to £150,000) £118,000 40% £47,200 20% £23,600
Totals £120,000   £47,600   £23,600 x 3 = £70,800


£83,600 – £70,800 = Top slicing relief of £12,800 available.
Total tax liability:

£2,000 x 20% = £400.00
£118,000 x 40% = £47,200
£240,000 x 45% = £108,000
  £155,600
   
Less Basic Rate Tax liability (£360,000 x 20%)* £72,000
Less top slicing £12,800
   
Further tax due on gain £70,800

 

*If this were an offshore bond, the Basic Rate tax liability would be payable and therefore would not be deducted.

The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth's interpretation of the relevant law and is correct at the date shown at the top of this article. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual Wealth cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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