For this week's article, I will continue to look at some of the less well known aspects of single-premium bond taxation. My last article considered the situation where a client has gains under a bond and also chargeable gains liable to capital gains tax.
However, in the current difficult investment conditions, many clients may find it a luxury to have such problems. The recent depressed stockmarket conditions have led to reductions in the value of investments and thus the reality may well be that, rather than having gains under their bonds, many clients are in the unhappy position of having made losses.
If this is the case, what, if anything, can be done from a taxation viewpoint with these so-called “economic” losses?
The treatment of economic losses is not covered in the chargeable event legislation. There is no provision for such losses. The only relief available is under section 549 of the Income & Corporation Taxes Act 1988. This is considered later.
The Inland Revenue's view is that if there is no gain, it is a “nothing” for tax purposes. Neither individuals, trustees nor companies may claim relief for any economic loss suffered under a bond. Nor may losses from one bond be set off against gains on other bonds.
It is worth mentioning that this treatment of economic losses under bonds can be contrasted with the treatment of losses under collective investments (for example, unit trusts/Oeics).
Collective investments are, of course, subject to the capital gains tax regime, so that where a loss arises on a disposal, such loss can be set against chargeable gains made on other disposals in the same tax year. Any unrelieved losses can be carried forward and set against subsequent years' chargeable gains.
S.549 deficiency relief
The deficiency relief provided by section 549 of the Income & Corporation Taxes Act 1988 may reduce the higher-rate tax liability of an individual if a chargeable event brings the policy to an end and there have been “excess” gains on part surrenders in earlier years of assessment.
The relief must not exceed the total gains on the part surrenders in the earlier years of assessment, so the section does not provide relief for any economic loss. An example might help in these circumstances:
An individual invests £10,000 in a bond and takes a part surrender of £9,000 at the end of year one. The part surrender gives rise to a chargeable gain of £8,500 (that is, the excess over the 5 per cent pa allowance). At the end of year three, the policy is fully surrendered for £500.
The formula used on final surrender is: (a + b) – (c + d), where
a = current surrender value (£500),
b = previous part surrender (£9,000)
c = investment (£10,000),
d = previous chargeable gain (£8,500)
(£500+£9,000) – (£10,000+£8,500) = loss of £9,000
As mentioned earlier, section 549 relief is restricted to the chargeable gains in earlier years of assessment, so an amount of £8,500 (that is, equivalent to the previous chargeable gain) would be relievable against the individual's income for higher-rate (but not basic rate) tax purposes.
Finally, some advisers have in the past sought to utilise s.549 deficiency relief in arrangements which seek to combine the advantages of independent taxation of husbands and wives with the rules relating to part surrenders from bonds.
This planning is sometimes recommended where one spouse is a 40 per cent taxpayer and the other is a non, starting or basic-rate taxpayer and purports to work as follows:
The lower taxpaying spouse effects the bond and takes a large part surrender from it. This creates a large chargeable gain at the end of the policy year but no tax charge arises as the gain does not cause taxable income to exceed the basic rate limit. After the end of the policy year in which the part surrender occurred, the bond is assigned to the higher-rate taxpaying spouse, which is not a chargeable event. In the tax year following that in which the part surrender gain arises, the higherrate taxpayer surrenders the bond, which creates a loss which can be offset against income liable to higher-rate tax.
It is known that the Revenue does not generally accept that these arrangements are effective in avoiding income tax and is likely to examine any such sequence of transactions very closely. This sort of strategy is not for the faint-hearted.