When it comes to clients with investment bonds, advisers have several techniques up their sleeves to avoid unnecessary taxation and charging.
But one of these tactics – top-slicing – has become slightly less productive for offshore bonds in certain situations thanks to a little known change by HM Revenue & Customs which went under the radar in 2013.
How top-slicing works
Gains on investment bonds are added to other taxable income, which means a client could be taken to a higher tax band than they would usually pay. These gains build up as years go by, which can make it unfair to add all the gain to other income in one tax year.
Top-slicing relief allows clients to annualise the gain made on an investment bond so that the rate of tax applicable is calculated as if an element of the profit had been made each year the bond was held.
Top-slicing works by taking the gain and dividing it by the complete years the bond has been in place, which creates a “slice”. The slice is then added to the individual’s income for the tax year to calculate the amount of income tax due on that slice.
So, let’s say Doris has an offshore bond she has owned for four years and the gain is £24,000. The top sliced gain is £6,000 or £24,000/4. Say her other income is £43,000, including savings interest using the personal savings allowance, then her tax return would initially look like this, prior to top slicing relief:
£11,500 within personal allowance, so taxed at 0 per cent = £0
£31,500 within basic rate band, so taxed at 20 per cent = £6,300
£2,000 within basic rate band, so taxed at 20 per cent = £400
£22,000 within higher rate band, so taxed at 40 per cent = £8,800
Total = £15,500 (£9,200 for bond gain)
To calculate top slicing relief, you then complete the following steps:
1: Calculate the “further tax” due on the gain. This is the amount of gain falling into the higher rate band and is multiplied by the difference between the higher and basic rates, that is, 20 per cent of £22,000 = £4,400.
2: Calculate the annualised gain £24,000/4 = £6,000.
3: Assess how much of this amount falls within higher rate band, that is, £2,000 falls in basic rate band and £4,000 falls in the higher rate.
4: Calculate how much further tax is due on the annual amount and multiply by the number of years you sliced the gain by, that is, the further tax (20 per cent) on the £4,000 is £800, then multiply by the number of years, 4 = £3,200.
5: Top slicing relief is then the further tax on the full gain (£4,400) minus the further tax on the annual gain, multiplied by the number of years (£3,200). In the example, the relief is £1,200.
So, for a total tax bill of £15,500 the client can reduce this by £1,200, leaving a total of £14,300 to pay, of which £8,000 relates to the bond gain.
Changes to time apportionment relief were introduced on 6 April 2013 as a result of a consultation in August 2012. The consultation did not mention the impact these changes would have on top-slicing relief for offshore bonds. However, HMRC has recently clarified these details.
Where previously offshore bonds could always top slice back to inception on final events and excess events (exceeding the 5 per cent tax deferred allowance), the changes now limit the ability to slice excess events for bonds taken out or added to on or after 6 April 2013.
For these bonds, the number of years is the lesser of the number of years since inception or the number of years since a similar event, that is, the last excess event. This brings offshore bonds taken out on or after 6 April 2013, or those added to from this date, in line with onshore bonds, which have always had this rule.
The biggest impact will be on clients who exceed the 5 per cent allowance which can be withdrawn tax deferred each year on an offshore bond. Previously, the excess could be sliced back to inception. However, from April 2013, such excesses could no longer be sliced at all. It will also mean your clients will need to carefully consider if they want to top up an older bond as the original treatment on excess events could be lost.
For instance, say Dean has an offshore bond that he withdraws 7.5 per cent income from a year. Dean therefore exceeds the 5 per cent allowance by 2.5 per cent every year. Previously, the longer the bond was in force the more years this excess gain could be sliced over.
This provided additional oppor-tunities above an onshore bond to pay tax at a lower rate on the excess where the full excess moved the individual from basic to higher or higher to additional rate tax.
So if Dean took out the offshore bond on or after 6 April 2013, or added to an older bond on or after this date, the number of years on these excess gains is limited to one, as the excess occurs each year.
Rachael Griffin is tax and financial planning expert at Old Mutual Wealth