There has been a lot of discussion recently at tax conferences on the ability of somebody to take account of withdrawals from single-premium life insurance policies – sometimes called capital investment bonds – as part of their income in determining whether they qualify for the normal expenditure out of income exemption in section 21 Inheritance Tax Act 1984.
The background to this speculation was a presentation made by a senior Inland Revenue official at a tax conference in 2005. Following that presentation, he apparently wrote a letter, in connection with singlepremium bonds, in which he said “regular withdrawals of 5 per cent per annum then, so long as the capital of the bond is maintained, the presumption must be that the withdrawals are income”.
At the time, it was our belief that this was a somewhat surprising statement from HM Revenue and Customs although the “so long as…” proviso did at least presumably mean that the facts of each case would need to be taken into account.
The reasons why some viewed this as a surprising confirmation from HMRC were as follows:
(i) Whilst it is accepted that the word “income” is not defined in section 21 or section 272 IHT Act 1984, given that this is a taxing statute one would expect it to have a “tax meaning”.
(ii) Even if the capital value of the bond is maintained after the withdrawal, it is not necessarily the case that withdrawals, reflect only income arising on the investments underlying an individual’s single-premium bond. Indeed, the statutory hypothesis, underlying the well known 5 per cent withdrawal rule, is that the withdrawals are capital, not income.
(iii) From a tax and, indeed, a legal standpoint, a life insurance policy, such as a single-premium bond, is treated as a non-incomeproducing investment. The policyholder has rights under a contract of life insurance which he can exercise from time to time by, for example, making a part-surrender. However, the policyholder has no entitlement to the underlying income of the investment fund that belongs to the life office.
The income tax legislation recognises this by use of the chargeable-event legislation which treats chargeable-event gains as income.
HMRC replied as follows:
’It is our view that the regular withdrawals of 5 per cent of the premium from a single- premium insurance bond are payments of capital and, as such, they do not fall within the description of income for the purpose of the section 21 IHTA 1984 exemption. ’We are aware that contrary opinions have been expressed in the insurance industry and we intend to make our position clearer in an update to the guidance in the Inheritance Tax Manual in due course.’
Our view at the time was that, in light of the points made above, we believed it may be over-optimistic to rely on this earlier HMRC statement in all cases where a claim is being made for the normal expenditure exemption if part of the donor’s “income” arises from withdrawals from a singlepremium bond and it is those withdrawals which cause the policyholder to maintain his standard of living and/or are used to make the gift.
However, this issue has recently surfaced again, with a number of commentators continuing to suggest that a 5 per cent withdrawal from a single-premium bond could count as income for the purposes of the normal expenditure out of income exemption.
Therefore, in order to obtain clarity, we wrote to HMRC to ask for an authoritative statement on the issue and they have replied as follows: “It is our view that the regular withdrawals of 5 per cent of the premium from a singlepremium insurance bond are payments of capital and, as such, they do not fall within the description of income for the purpose of the section 21 IHTA 1984 exemption.
“We are aware that contrary opinions have been expressed in the insurance industry and we intend to make our position clearer in an update to the guidance in the Inheritance Tax Manual in due course”.
HMRC’s view on this subject looks clear and hopefully this will now bring clarity to this issue. Persons who are seeking to make regular gifts out of income with a view to using their normal expenditure out of income exemption should not therefore take account of withdrawals from singlepremium bonds in determin-ing their level of income.