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Tony Wickenden: A targeted solution to part surrenders and assignments

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Last week I considered the background to the consultation and resulting draft Finance Bill clauses on the taxation of part surrenders and assignments under life assurance policies.

Following cases where the chargeable event gain arising on a large part surrender was disproportionate to the economic gain in the policy, the Association of British Insurers issued guidance to its members raising awareness of the problem. To be fair, even ahead of this guidance, many had already introduced standard practice to question any such part withdrawal requests, suggesting the whole policy (segment) encashment route where available.

Nevertheless, HM Revenue & Customs’ consultation put forward three possible alternatives for the taxation of part surrenders and assignments. These were as follows:

1: Taxing the economic gain: Retains the 5 per cent tax-deferred allowance but brings in a proportionate fraction of any underlying economic gain whenever a part surrender or part assignment takes place.

2: The 100 per cent allowance: Increases the 5 per cent tax-deferred allowance to 100 per cent, thereby deferring any gain until the policyholder has fully withdrawn the premium invested.

3: Deferral of excessive gains:
Defers gains above a pre-determined amount until the next part surrender or part assignment (when it could subsequently be deferred again if it exceeds the pre-determined amount).

Some expressed surprise that reform was proposed for what was perceived as not being that prevalent a problem. But overall there was a general happiness all three methods would provide protection in cases where the gain arising on part surrender or assignment would otherwise exceed the amount of economic gain in the policy.

Responses to the consultation were published on the day of the Autumn Statement. Of the three options presented, the preference was for number two: the 100 per cent allowance. Respondents considered this option to be the easiest to explain to new and existing policyholders, the simplest in terms of the transitional arrangements required and the least costly to implement.

Policyholders could easily calculate what gains would arise as  – for part surrenders, for example – only a record of premiums paid and amounts withdrawn would need to be kept. This option would allow policyholders flexibility in accessing cash from their policy without requiring any valuations.

That said, some respondents suggested this option was not fully aligned with the medium to long-term nature of life assurance policies. They also warned some could be disadvantaged by bunching gains towards the end of the policy’s life, resulting in a higher overall rate of tax being chargeable.

In fact, there was a clear preference for a more targeted solution that would avoid wholesale changes to the tax rules while providing an appropriate remedy for those who generated disproportionate gains.

The road less travelled

Many responses – particularly from insurers – commented on the fact the current tax rules had been in place for over 40 years, so are well established and widely understood by most policyholders and their advisers. The vast majority of these policyholders have a long-term expectation of how these products work and any widespread change may not be welcome.

Some respondents felt industry and regulatory changes, including widespread adoption of the ABI’s aforementioned guidance, had reduced the incidence of disproportionate gains to just a handful of policyholders each year.

Alternative options were offered. These included allowing policyholders who had mistakenly generated disproportionate gains a period of time to provide alternative instructions to their insurers, or for HMRC to allow such gains to be recalculated on a different basis for tax purposes.

Respondents stated this would ensure the vast majority of policyholders would be unaffected by change. As such, they would not have to understand a new tax regime or how any transition would work. Insurers argued this would dispense with the need to make costly changes to their IT systems.

Having considered the responses, the Government has decided not to legislate any of the three options presented in the consultation. Instead, it will accept an alternative proposal put forward by the industry.

This will allow the small number of policyholders that inadvertently generate a “wholly disproportionate” gain to apply to HMRC to have the gain recalculated on a “just and reasonable” basis. More detail on this next week.

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

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