In the March Budget, the Government announced its intention to change the tax rules for calculating chargeable event gains on part surrenders and part assignments for value under life assurance policies.
The announcement of this consultation flew a little under the radar, even for financial planners, with all the excitement over the reduced capital gains tax rates, the start of the personal savings allowance and the introduction of the new dividend taxation rules.
The issue the consultation is addressing is that under the current chargeable event provisions, when a part surrender is made, chargeable event gains can arise which are disproportionate to the policy’s underlying economic gain.
Following the Budget announcement, HM Revenue & Customs has released a consultation document looking at ways in which the current position can be improved so the “disproportionate gains” position cannot arise in the future.
The background to this issue is artificially high chargeable event gains on life assurance policies can arise, especially where a large part surrender is taken early in the lifetime of the policy. This is because the gain on a part surrender is calculated as the excess over the “5 per cent allowances”. This can result in income tax liabilities for a higher rate taxpayer, even though the investment has shown little or no growth in reality.
The inequity of this aspect of the chargeable event regime was highlighted in the March 2013 Joost Lobler case, where the First-tier Tribunal was sympathetic to Lobler’s position (he was effectively bankrupted by the tax liability) but could not find a way to resolve the problem because, as a matter of strict law, he had been correctly taxed on the transactions.
The First-tier Tribunal described the decision against Lobler as “repugnant to common fairness”. On appeal in April 2015, however, the Upper Tribunal overturned the First-tier Tribunal decision by applying the doctrine of rectification and ruling Lobler was entitled to be taxed on the basis he made a full surrender of the policies instead of part surrenders. This resulted in no chargeable event gain.
The consultation, which runs until 13 July, invites views on three options for change designed to ensure disproportionate gains that do not reflect the economic reality of the situation no longer arise for both new and existing policyholders, while maintaining the familiar and popular 5 per cent tax-deferred allowances. These options are:
Taxing the economic gain: This option would retain the current 5 per cent tax-deferred allowances but would bring into charge a proportionate fraction of any underlying economic gain whenever an amount in excess of the 5 per cent allowances was withdrawn.
The 100 per cent allowance: Under this option no gain would arise until all the premium(s) paid have been withdrawn, after which all withdrawals would be taxed in full, effectively changing the current cum-ulative annual 5 per cent tax-deferred allowances into a lifetime 100 per cent tax-deferred allowance. This is the simplest of the three options.
Deferral of excessive gains: This more complicated option would maintain the current method for calculating gains but would limit the amount of gain that could be brought into charge on a part surrender (or part assignment for value) to a pre-determined amount of the premium (for example, a cumulative 3 per cent for each year since the policy commenced). The remaining gain would then be held over until the next part surrender or part assignment when the process would begin again until final surrender when all deferred gains would be brought into charge.
The consultation document sets out the options in detail, with comprehensive examples illustrating how they would work in practice, and considers the potential impacts on policyholders and insurers. HMRC examples can be found in the document Part Surrenders and Part Assignments of Life Insurance Policies, published on 20 April, and I will look at these next week.
The options will be reviewed in the light of representations received and a response will be published in the autumn with a view to including legislation for the preferred option in the Finance Bill 2017.
In the meantime, insurance companies and advisers should follow the guidance in the “best practice” guidance note issued by the Association of British Insurers on 14 October 2015.
It would be unusual if the changes did not involve system changes for the life insurance sector and very possibly add further complexity to the legislation – the extent of such complexity depending upon which option is implemented.
The new rules are to apply to both new and existing policies, as a result of which any transitional rules are likely to have at least some level of complexity. There is, however, no reference in the consultation document to transitional provisions.
Tony Wickenden is joint managing director of Technical Connection. You can find him tweeting @tecconn