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I act for a client whose wife recently died quite suddenly. The wife had taken out a number of single premium life policies. One was in her name and invested in Equitable Life. Shortly before her death, she chose to cut her losses and cancel the investment. She received 90 per cent of the original funds invested. (The policy was only three years old at the time.) Had a gain been made this would have been a chargeable event, but how should it be treated in these circumstances?
I act for a client whose wife recently died quite suddenly. The wife had taken out a number of single premium life policies. One was in her name and invested in Equitable Life. Shortly before her death, she chose to cut her losses and cancel the investment. She received 90 per cent of the original funds invested. (The policy was only three years old at the time.) Had a gain been made this would have been a chargeable event, but how should it be treated in these circumstances?
A more profitable policy was made some years earlier and matured on the wife's death. The policy was written in trust and our client is the named beneficiary. Who is liable for the tax payable on this chargeable event; our client or the trust? I am not sure that the trust is a discretionary trust and therefore cannot see whether it can have any higher rate tax liability.
Can readers advise?
(Query T16,066) - Ni.
Although 'Ni' states that, at the time it was cancelled, the Equitable Life policy was worth 90 per cent of the original funds invested, it is not clear whether any benefits had previously been withdrawn from the policy during its three-year history. If, say, 5 per cent of the original investment had been withdrawn by part surrender during each of those three years, a gain equal to 5 per cent of the amount invested would have been triggered when the 90 per cent final withdrawal was taken, as a total of 105 per cent of the original investment would have been withdrawn.
On the assumption that the wife was the original beneficial owner of the policies in question, the benefits will be free of personal liability to capital gains tax by virtue of section 210, Taxation of Chargeable Gains Act 1992. The way in which chargeable gains under life policies are assessed to income tax is dealt with by section 539 et seq, Taxes Act 1988. Section 543 states how the gain is calculated but, unfortunately, no allowance is available in respect of investment losses. However, when a policy comes to an end, corresponding deficiency relief for higher rate income tax purposes is available under section 549, although this is applicable only where excesses have previously arisen under section 546 and these total more than the actual gain. Such excesses will occur where withdrawals are taken by part surrender and exceed the cumulative annual 5 per cent allowance provided by section 546.
If the wife cancelled the policy after 5 April 2002, Equitable Life would have issued a chargeable event certificate to her if a gain had been triggered under section 552 (as amended by paragraph 18 of Schedule 28 to the Finance Act 2001). If no gain had been triggered, however, no certificate would be issued and no relief would be available for any loss.
As far as the more profitable policy is concerned, even though the policy is subject to a trust, the gain will be deemed to form part of the wife's total income under section 547(1)(a), as she was the individual who created the trust. In accordance with section 541(1)(a), the gain will be based on the surrender value immediately before the death. Any additional benefits payable as a result of the death will be free of personal liability to income tax. It is not clear from the query whether this policy is onshore or offshore. Any gain from an offshore policy will be subject to income tax at the taxpayer's relevant marginal rate, unless it is covered by section 553(6A) (broadly, the policy has been issued by an insurer resident in the European Economic Community and which suffers tax on its life funds at a rate of at least 20 per cent).
Any gain from an onshore policy (or a policy covered by section 553(6A)) will also be subject to income tax at the taxpayer's relevant marginal rate, but with the benefit of a basic rate tax credit. Thus, in the tax year of her death, if the wife's total income including the chargeable gain does not exceed the higher rate threshold, there will be no personal income tax liability. If her total income excluding the chargeable gain exceeds the higher rate threshold, tax of 18 (40 - 22) per cent will be due. If her total income before the gain is added does not exceed the higher rate threshold, but her total income including the gain does, then relief can be obtained from section 550. This relief (commonly known as 'top slicing relief') allows the gain to be divided by the number of complete years that the policy has been in force, calculating the income tax rate for that slice and then applying that rate to the whole gain. This will result in reduction or, in some cases, elimination of the tax liability. This relief is also available for offshore policies in the same circumstances, although it will serve to reduce or eliminate the higher rate liability only.
Finally, if the wife was entitled to either children's tax credit or a higher income tax personal allowance by reason of her age, this could be reduced or eliminated by reason of the gain. The whole gain would have to be used for this purpose, rather than the 'top sliced' gain, although Richard Curtis submits an interesting argument to the contrary in his excellent article in Taxation on 1 August 2002 ('L.A. Shakedown' at pages 481 to 484). - Widow's Mite.
The surrendering of the three years old Equitable Life single premium life policy (usually called a 'single premium bond') by the client's wife before her death is under section 546(4)(a), Taxes Act 1988 treated as the final year of the policy. Although not mentioned, it is assumed that no previous withdrawals from the policy resulting in chargeable event gains have been made. Therefore as the loss arises on full surrender and there have been no previous years gains on the policy, then there is no relief for the loss. It also should not be entered on the deceased's tax return to the date of death. A loss on one policy cannot be set off against a gain on another policy. Section 549(1) 'Certain deficiencies allowable as deductions' covers this, as does the Revenue's Assessment Procedures Manual at paragraph 3196 'Losses - There is no relief under the chargeable event legislation for a loss in connection with a policy of life insurance. A loss on one policy cannot be netted-off against a gain on another policy. In this and in almost every other respect, each policy of life insurance is considered separately under the chargeable event régime. It is only at the point at which gains are added to total income … at which the results for a number of policies of life insurance are brought together'.
Paragraph 3197 continues 'Corresponding deficiency deductions - This is not a relief for losses (see paragraph 3196 above) and any reference to a loss should be avoided as it would be misleading. The purpose of the relief is to ensure that the gains assessed on earlier part withdrawals do not exceed the overall gain on the policy. A deduction may be due only:
* on termination of a policy on death, surrender or maturity; and
* if there has been an excess gain (or gains) on a previous part withdrawal(s) …'.
Regarding the profitable policy held in trust, under section 547(1)(a), Taxes Act 1988 '… if, immediately before the happening of the chargeable event in question, the rights conferred by the policy or contract were … held on trusts created by an individual …, the amount of the gain shall be deemed to form part of that individual's total income for the year in which the event happened …'. Therefore the chargeable event gain attaches itself to the estate of the client's wife, as settlor of the trust. Although the tax liability therefore falls on the wife's estate, the executors/personal representatives may reclaim from the trustees the amount of tax paid as the result of the chargeable event gain. Section 551(1), Taxes Act 1988 is the relevant section here: 'Where -
(a) an amount is included in an individual's income by virtue of section 547(1)(a); and
(b) the rights … in question were held immediately before the happening of the chargeable event on trust, the individual shall be entitled to recover from the trustees, to the extent of any sums, or to the value of any benefits, received by them by reason of the event, an amount equal to that (if any) by which the tax with which he is chargeable for the year of assessment in question, reduced by the amount of any relief available under section 550 ("Relief where gain charged at higher rate") in respect of the amount so included, exceeds the tax with which he would have been chargeable for the year if that amount had not been so included'.
It should also be remembered that in calculating the gain one has to take into account the effect that any top-slicing relief may have on the final liability. - N.K.
Editorial note: 'Boogles' suggested that the following Revenue information provides assistance with regard to this query:
* Page 8 of the Revenue's Help Sheet IR320, Gains on life insurance policies, explains what to do when a loss actually arises. Corresponding deficiency relief is shown at box 12.9 or there is an unrelievable loss.
* Page 5 of Help Sheet IR320 addresses the question of 'Whose gain is it?'
* Paragraph T23 of the Revenue's CTO Advanced Instruction Manual considers the inheritance tax implications of life policies within trusts.
