Tony Wickenden: How HMRC could use deferral of excess gains

Tony Wickenden 700x450

Over the past few weeks I have examined two of the three options put forward by HM Revenue & Customs in a consultation for changing the basis of taxation for part surrenders and part assignments for value. This week, I will look at the third, which is based on the deferral of excess gains.

This option would maintain the current method for calculating gains but, if the gain exceeds a pre-determined amount of the premium (e.g. a cumulative 3 per cent for each year since the policy commenced), the excess would not be immediately charged to tax. Instead, it would be deferred until the next part surrender or part assignment.

The gain arising from the next part surrender or part assignment would be increased by the amount of the deferred gain from the earlier event. If this total gain exceeded the pre-determined amount, then the excess part of it would be deferred again (and so on).

On maturity or full surrender, the policy gain would be calculated by deducting premiums and gains (whether deferred or not) from total policy withdrawals and any deferred gains would be charged to tax. However, if the calculation on maturity etc. did not result in a gain, the deferred gains would be reduced by the amount by which premiums and earlier gains exceed withdrawals (a policy deficiency).

If the policy was assigned, any held over amount would remain with the policy, in the same way other policy attributes (e.g. premium paid) would follow the policy.

For part surrenders and part assignments this option would not give rise to gains that are linked to the policy’s underlying economic gain but it would ensure that disproportionately large gains could not arise on these events.

One example follows for both a part surrender and a part assignment to illustrate how this option might work.

Policy history

A policyholder invests £100,000 in a life insurance policy on 1 January 2018.

On 17 August 2019 he sells a 50 per cent share in the policy to his business partner when the policy is worth £105,000.

On 16 April 2020 the policyholders withdraw £100,000 from the policy by way of a part surrender. On 10 August 2021 they fully surrender the policy for £32,000.

Assume that the pre-determined amount above which gains are held over has been set at a cumulative 3 per cent of the premium paid.

(i) Insurance year two (1 January 2019 to 31 December 2019)

Under the current rules the cumulative 5 per cent deferred tax allowance is £10,000 (i.e. 5 per cent of the £100,000 premium for two years). As the policy is worth £105,000 when part assigned, the value of the part sold is £52,500.

The gain arising on the assignor is:

  • Value of part sold = £52,500
  • Cumulative 5 per cent allowance = £10,000
  • Gain = £42,500

However, in order to defer excessive gains, the maximum gain that can be brought into charge is 3 per cent of the premium for each of the first two policy years: i.e. £6,000. This £6,000 gain arises on 31 December 2019. The remaining gain of £36,500 is deferred until the next calculation event.

(ii) Insurance year three (1 January 2020 to 31 December 2020)

The joint policyholders have withdrawn £100,000 by way of a part surrender and therefore a gain calculation is required. The gain arising under the current rules is:

  • Value of part surrender = £100,000
  • Cumulative 5 per cent allowance (£15,000 – £10,000 used) = £5,000
  • Gain = £95,000

The £95,000 gain and the £36,500 deferred gain are crystallised, giving a total gain of £131,500. The maximum gain that can be brought into charge is the pre-determined cumulative 3 per cent limit since the last excess event: i.e. £3,000. A gain of £3,000 (£1,500 for each policyholder) is brought into charge on 31 December 2020. The deferred gain is the difference: i.e. £128,500.

(iii)  Insurance year four (1 January 2021 to 10 August 2021)

The policy is fully surrendered for £32,000 on 10 August 2021. The gain on full surrender is:

  • Total cash withdrawals (£32,000 + £100,000) = £132,000
  • Premium = £100,000
  • Earlier gains (£6,000 + £3,000 + deferred gain of £128,500) = £137,500
  • Gain on full surrender = Nil

A policy deficiency arises if cash withdrawals are less than the total of premiums paid and earlier gains. On 10 August 2021 the policy deficiency is £105,500 (i.e. £132,000 less the £100,000 premium and the £137,500 earlier gains). The deferred gains are brought into charge after being reduced by this policy deficiency:

  • Deferred gain = £128,500
  • Less: Deficiency = £105,500
  • Gain arising on 10 August 2021 = £23,000


The total gains arising are £6,000 + £3,000 + £23,000 = £32,000. This equals the economic gain from the policy.

The consultation closes on 13 July. Options will be reviewed in the light of representations received. The Government expects to publish its response within 12 weeks of the end of the consultation and to include legislation for the preferred option in Finance Bill 2017.

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