5.2.1 Second Hand Endowment Policies
Two measures are proposed by the Government to combat the loss of tax by persons investing in traded endowment policies.
(a) Avoiding CGT
It is well known that where a person buys an endowment policy (a "second hand endowment" or "traded endowment policy") and that policy remains a qualifying policy, then the only tax charge that will arise when the policy matures is that of capital gains tax and frequently the investor will have his annual CGT exemption available to him to absorb gains. The reason that the investor will potentially be subject to CGT is because the investor is not the original beneficial owner and acquired his rights for consideration in money or moneys worth (section 210 Taxation of Chargeable Gains Act 1992).
However where an investor, having bought the policy, then transfers ownership to his/her spouse, then the new owner will not have acquired his/her interest in money or money's worth and so there will be no CGT charge on maturity nor any income tax charge if the policy remains a qualifying policy.
For disposals after 9 April 2003, a new measure will apply which will prevent this planning opportunity by imposing a charge in such circumstances. This will mean that a gift of a second hand endowment policy from a husband to wife will not mean that the policy falls out of charge to CGT in the wife's hands.
The new rules will also cater for more complex situations where the rights or any interests in them have at any stage been bought second-hand.
The measure will however ensure that in three circumstances, the tax-free status of the rights conferred by a policy or contract is preserved when the rights are transferred from one person to another otherwise than as a gift. The circumstances are where consideration is given on a transfer between:
- husband and wife;
- a former husband and wife under the terms of a divorce settlement; or
- two companies within the same group of companies in circumstances where the no gain/no loss rule in section 171(1) TCGA applies.
(b) Creating Artificial Losses
In cases where a second hand endowment policy is a non-qualifying policy, two tax changes can in theory apply - one under the chargeable event income tax rules and another under the CGT rules. To prevent double taxation, the rules state that the income tax rules take precedence and that any amounts brought into account in calculating income tax are deducted when undertaking the CGT calculation.
This can result in two planning implications:-
- if a basic rate taxpayer encashes the policy, he may well have no income tax liability if he remains a basic rate taxpayer after the top sliced gain is added to taxable income - yet the full chargeable event gain can still be offset for CGT calculation purposes
- the deduction of amounts used to calculate income tax chargeable gains which act as a credit in calculating CGT can result in an artificial CGT loss which does not reflect the economic reality of the situation. This loss can be offset against other chargeable gains of the investor and so reduce overall taxation by more than should have been available.
The new provisions will ensure this does not happen by restricting the amount of the capital loss for tax purposes to the amount of the economic loss (if any). This means that it is only this restricted amount (if any) that is available for set-off against capital gains.