Tony Wickenden: How HMRC could reform chargeable gains

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Last week I looked at the first of three options put forward in a HM Revenue and Customs consultation for changing the taxation of part surrenders and part assignments for value, which is based on taxing the economic gain. The consultation document puts forward two examples to show how this could work: one for a part surrender and one for a part assignment for value.

Example one: part surrender

Policy history

A policyholder invests £100,000 in a life insurance policy on 1 January 2018. She withdraws £4,000 on 7 August 2018, a further £4,000 on 10 December 2018, £30,000 on 1 February 2020 and fully surrenders the policy for £68,000 on 1 May 2024. Gains arise as follows:

(i)        Insurance year one (1 January 2018 to 31 December 2018)

The £4,000 withdrawal on 7 August 2018 is below the 5 per cent tax deferred allowance of £5,000. No gain calculation is required but the available premium for subsequent calculations is reduced from £100,000 to £96,000. Following the £4,000 withdrawal on 10 December 2018 the 5 per cent tax deferred allowance for the year is breached and a gain calculation is required.

If the policy value immediately after the withdrawal is £94,000, the gain calculation is:

  • Withdrawal from the policy = £4,000
  • Less: deductible premium
    *** Available premium x A/(A+B)
    *** £96,000 x £4,000/(£4,000+£94,000) = £3,918
  • Gain arising on 31 December 2018 = £82

As premiums of £3,918 have been used in this calculation the available premium for subsequent gain calculations is reduced to £92,082 (i.e. £96,000 less £3,918).

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

The £30,000 withdrawal on 1 February 2020 exceeds the accumulated 5 per cent tax deferred allowance of £10,000 (i.e. £15,000 less £5,000 used in the first insurance year). A gain calculation is therefore required. If the policy value immediately after the withdrawal is £80,000 the gain calculation is:

  • Withdrawal from the policy = £30,000
  • Less: deductible premium
    *** Available premium x A/(A+B)
    *** £92,082 x £30,000/(£30,000+£80,000) = £25,113
  • Gain arising on 31 December 2020 = £4,887
  • The available premium is reduced by £25,113 to £66,969

(iii)      Insurance year seven (1 January 2024 to 1 May 2024)

The policy is fully surrendered on 1 May 2024 for £68,000. The current tax rules for events that bring a policy to an end still apply and the gain is:

  • Total cash received (£68,000 plus earlier withdrawals of £38,000) = £106,000
  • Less: premium paid = £100,000
  • Difference = £6,000
  • Deductible gains on earlier excess events (£82 and £4,887) = £4,969
  • Gain arising on 1 May 2024 = £1,031

Summary

The gains arising from the policy on earlier excess events (£82 and £4,887) and on surrender (£1,031) equal the £6,000 economic gain from the policy.

Example two: part assignment

Policy history

On 1 January 2018 four individuals jointly invest £25,000 each in a life insurance policy. On 11 May 2018 the policy has a surrender value of £104,000. One of the individuals (the “assignor”) sells their 25 per cent share of the policy for £26,000 to another individual.

(i)        Insurance year one (1 January 2018 to 31 December 2018)

On 11 May 2018 one of the four policyholders has made a part assignment for money. The assignor’s share of the surrender value exceeds 5 per cent of the premium paid and so a gain calculation is required.

For part assignments for money or money’s worth the same A/(A+B) formula is used to calculate the deductible premium but A = the surrender value of the part sold, and B = the surrender value of the remainder.

In this case:

A = £26,000 (that is, 25 per cent of the policy’s surrender value of £104,000); B = £78,000 (that is, 75 per cent of the policy’s surrender value of £104,000)

The gain calculation is:

  • Value of 25 per cent share of policy = £26,000
  • Less: deductible premium
    *** Available premium x A/(A+B)
    *** £100,000 x £26,000/(£26,000+£78,000) = £25,000
  • Gain arising to the assignor on 1 December 2018 = £1,000

For future excess events the available premium will be £75,000 (i.e. the £100,000 premium less £25,000 used in this calculation).

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