Tony Wickenden: The options on the table for chargeable gains

Tony Wickenden

Last week I looked at the consultation on the proposed change to the taxation of part surrenders and part assignments for value under life assurance policies.

The need to do this has arisen from the risk of the creation of disproportionate taxable chargeable event gains occurring. While this is not a subject of huge concern to the population at large it is an issue that, when it goes wrong, can really cause a problem to the policyholder.

Encouragingly, HM Revenue & Customs has focused solely on “problem resolution” and not strayed over into any further areas of reform. HMRC also notes the importance (in deciding on a course of action) of taking account of the impact on insurers.

In my next couple of articles, I will draw extensively on the consultation document, in particular explaining how the three options put forward for consideration would work.

Following initial dialogue with policyholder representatives, the industry, their representative bodies and the tax profession, the Government has identified the following desirable outcomes from any options for change:

  • The prevention of disproportionate gains arising from any part surrender or part assignment for value of a life assurance policy – for both new and existing policies.
  • The maintenance of a tax-deferred allowance, which is popular and widely understood by policyholders.
  • Changes that are simple to administer and understand.
  • As few systems changes as possible for insurers.
  • An appropriate period of time for insurers to implement the change and explain it to policyholders.
  • A straightforward as possible transition from the current rules to the new rules.
  • Avoidance of wholesale changes to the tax rules for life assurance policies.
  • New tax avoidance opportunities are not created.

With all of these factors in mind, the Government has come up with the following three options:

  • Taxing the economic gain
  • The 100 per cent allowance
  • Deferral of excessive gains

All of these options are designed to ensure disproportionate gains could no longer arise, and also maintain a tax-deferred allowance. The Government recognises there are likely to be differing trade-offs in respect of the other desirable outcomes for each option.

So let’s look first at taxing the economic gain. This option would retain the current 5 per cent tax-deferred allowance but would bring into charge a proportionate fraction of any underlying economic gain whenever an amount in excess of 5 per cent was withdrawn.

One possible method of calculating the gain in such circumstances would be to deduct a proportionate part of the premium from the amount withdrawn. This deductible amount would be calculated by applying the formula A/(A+B) to the available premium paid, where A equals the amount withdrawn and B equals the policy value immediately after the withdrawal.

The available premium would be the policy premiums paid less the sum of earlier withdrawals to date, which did not exceed the 5 per cent tax-deferred allowance, and any premiums deducted in earlier A/(A+B) calculations.

The formula would only be applied where withdrawals in excess of the cumulative 5 per cent tax-deferred allowances are taken. Withdrawals below this level would simply be deductible, in full, from the available premium. The premium used in any gain calculation cannot reduce the gain below nil.

Although this would require a calculation for each withdrawal, any gains arising in the insurance year would be aggregated and treated as arising at the end of that insurance year. The overall total of the gains could then be reported on one chargeable event certificate to be delivered to the policyholder (and if total gains in the year exceed half the basic rate limit, to HMRC) by the insurer within three months from the end of that insurance year.

A gain arising under this option would always be an appropriate fraction of the policy’s economic gain. Unlike the current rules, if the policy was not in profit, no gain could arise from an excess event. I will take a look at the other options next week.

Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn