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Top-slicing relief – don’t shortcut the calculation

If you are feeling confused on how to calculate top-slicing relief on bonds, this article should provide you with some clarity. We also have a new detailed guide available, and an online tool, providing you with additional support.

There has been some confusion in the market on how the personal allowance, personal savings allowance (PSA), and the starting rate of tax, interact with bond gains and in particular top-slicing relief.

This confusion came to a head when an article in Taxation magazine implied HMRC were themselves calculating the relief incorrectly. HMRC replied to the writer of the article confirming how the relief worked, in particular with the personal savings allowance, whilst also admitting some scenarios had received the incorrect tax treatment in the self-assessment process.

Having reviewed the HMRC response it is clear that the only way to calculate the relief available on a bond gain is to perform the calculation in full rather than using a shortened version, which would have previously provided the same outcome prior to the introduction of the personal savings allowance.

Relief allows gains to be annualised

As a reminder, top-slicing relief allows a gain made on an investment bond (both onshore and offshore) to be ‘annualised’ to allow the policyholder to pay tax at a rate equivalent to the rate that would have applied if the gain had been taxable in each year it was made - rather than all in one year.

The calculation is often simplified to provide a quick view of the tax payable however this can provide an incorrect outcome, particularly with the starting rate for savings and the personal savings allowance interacting with chargeable event gains.

Misconceptions about top-slicing relief exist

Often you will hear the following statements about the relief:

‘If the gain doesn’t move a taxpayer from one band to another then no relief is available’

‘No relief is available if the taxpayer already pays higher rate’

‘If the slice fits in basic rate then basic rate applies to the whole gain above allowances’.

Depending on the scenario these high level statements can be incorrect. This is particularly prudent with offshore bond gains where no basic rate tax credit is available for a basic rate liability. An example can help demonstrate why a shortened calculation can produce an overstated level of relief:

 

Offshore bond gain, slice within basic rate

£5,000 earnings
£60,000 gain over 10 years (£6,000 slice)

One might describe top slicing as avoiding higher rate tax here and therefore basic rate is payable on the gain above allowance. This looks like this in 2019/20:

£7,500 of gain @ 0% within PA
£5,000 of gain @ 0% within starting rate
£500 of gain @ 0% within PSA
The rest at 20% gives you £47,000 x 20% = £9,400 tax on bond gain – but is this right???

 

There are a few bits of key legislation (ITTOIA 2005) that are crucial to remember when performing the full top-slicing relief calculation:

Section 531 (1):
Section 530 (Income tax treated as paid) does not apply to gains from the kinds of policies and contracts specified in subsection (3)*, except for the purposes of calculating relief under section 535 (top-slicing relief).

*subsection 3 includes foreign policies/offshore bonds

Section 536 (1) step 2:
Find the relieved liability on the annual equivalent by:

(a) calculating the individual's liability (if any) to income tax on the annual equivalent, on the basis that:

  • (i) the gain from the chargeable event is limited to the amount of the annual equivalent, and
  • (ii) the highest part assumptions apply (the gain should be treated above all other income), and

(b) subtracting the amount of income tax at the basic rate on the annual equivalent which the individual is treated as having paid under section 530(1).

So these two bits of legislation confirm the following:

  1. When working out top-slicing relief for an offshore bond you include a basic rate credit within the calculation
  2. When working out top-slicing relief you deduct this credit at full gain level and a proportion of it at sliced level

This is what the full calculation from our example looks like:

£7,500 of gain @ 0% within PA   = £0
£5,000 of gain @ 0% within starting rate   = £0
£500 of gain @ 0% within PSA   = £0
£32,000 @ 20%   = £6,400
£15,000 @ 40%   = £6,000
    = £12,400
Minus’ tax credit’ of £10,500*   = £1,900 ‘further tax’ above 20% of gain

 

*The tax credit is reduced by any part of the gain falling within the personal allowance. Here £7,500 is within personal allowance therefore the taxable gain is £52,500 of which 20% is £10,500. 

If we look at tax on the slice, this will be £0 as £6,000 sits within personal allowance (you would then multiply the slice tax by the number of years but this is still £0 in this example) so the top-slicing relief is £1,900 i.e. the difference in further tax on the full gain and the further tax on the sliced gain.

So the actual tax payable is £10,500 (£12,400 - £1,900 relief) not the £9,400 that a shortcut approach might provide.

 

Our chargeable event gain - income tax calculator can help

The full calculation can be time-consuming, so we have devised a calculator that can help with this. You can use this with your clients to look at managing money out of their investments or to look at the tax payable on gains already realised. Using the example above the calculator provides the following output:

£5,000 earnings with £60,000 offshore bond gain over 10 years

You can see that the full liability is £12,400, with relief of £1,900. The tax due after the relief is £10,500 as shown above.

To find out more, please download our new guide, or take a look at the online tool.

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