Under the current law, there is no tax charge when a policy matures if the policyholder exercises an option to re-invest all the proceeds of the maturing policy in a new policy with the same insurer. This relief, in section 540(2) ICTA 1988, in effect means that the time of chargeable event is deferred until the encashment or maturity of the new policy.
Some policyholders have used this rule in conjunction with the 5% tax-deferral rule to defer tax on the gain at maturity even when they have made part withdrawals before they exercise the option. Indeed, the policyholder could in theory withdraw more than the initial premium via the 5% rules without facing a tax charge because the 5% allowance would be based on two premiums – the premiums paid to effect the policy in the first place and the premium to the new policy on maturity of the first policy.
To counteract this a new measure is proposed which, subject to transitional provisions, will apply to policies which mature on or after 9 April 2003.
The proposed revision repeals the rule that allows the gain arising on the maturity of one policy to be deferred when all the policy proceeds are re-invested in a new policy under a maturity option. It ensures that the policyholder may never use the 5% tax deferral rule to withdraw more than the original premium without a tax charge.
A transitional measure ensures that policyholders who exercised a maturity option before 9 April 2003, or whose policy matures before 1 May 2003, may defer the gain on maturity provided the insurer retains all sums payable under the old policy on or after 9 April 2003 for re-investment in the new policy.
The Inland Revenue describe this as a simplification on the basis that there is no good reason for investors to have two different methods they can use to defer their liability to tax when they want to keep their money with the same insurer allowance.
They take the view that life insurance investors will, as now, be able to defer any tax liability until they obtain value from the policy by extending the policy term and so deferring maturity.