The rules for calculating the gain on a part surrender or a part assignment of a life assurance policy or a capital redemption policy can result in a substantial taxable gain in excess of the 5% tax deferred allowance as shown in the case of Joost Lobler v HMRC (20 March 2015) UKUT152. In this case, the Upper Tribunal ruled that the remedy of rectification could only be used in the limited circumstances where the court deemed that the error (in selecting a part surrender withdrawal method instead of the full surrender of individual policies method) is of a sufficiently serious nature.
Following this case, HMRC consulted on three alternative calculation methods to calculate the gain on a part surrender or a part assignment of a life assurance policy or a capital redemption policy.
HMRC has subsequently decided to follow suggestions made by respondents to the consultation and will retain the existing methods for calculating part surrenders and part assignments. Instead, a more informal process will be adopted which allows a policyholder who has made wholly disproportionate gains to apply to HMRC to have their gain recalculated on a just and reasonable basis.
This article provides an overview of the new application process introduced in the Finance Bill 2017 which a policyholder must follow to have their gains on a part surrender or a part assignment recalculated by HMRC.
Who can apply to have their gains recalculated?
Interested persons can apply to HMRC to have the gain reviewed if they consider that the gain is wholly disproportionate.
An interested person is one who is liable to the gain on a part surrender or a person who has made a part assignment for consideration or who would be liable to the gain if the policy was fully surrendered immediately after.
The explanatory notes to the Finance Bill 2017 states “If A assigns part of their policy to B, then A is an interested person if they would be liable to tax on the gain. B is also an interested person if they would be liable to tax if the policy were fully surrendered immediately after and a gain arose.”
If there are two or more interested persons, then the application must be made jointly.
When must the application be received by HMRC?
The application must be in writing and be received by HMRC within 4 years after the end of the tax year in which the gain arose. A longer period may be allowed if HMRC agrees.
For example, As the event date for part assignments and part surrenders is the last day of the policy year. If a life assurance policy commenced on 11th April 2017, the last day of the policy year would be 10th April 2018. The 10th April 2018 falls within the tax year 6th April 2018 to 5th April 2019.
Therefore, the application must be submitted by 5th April 2023.
When do the new rules take effect from?
The new rules take effect from 6 April 2017.
What factors will HMRC take into account to determine whether the gain is wholly disproportionate?
There is a non-exhaustive list of the factors HMRC may take into account to determine if the gain is wholly disproportionate. This list includes:
- The economic gain on the rights surrendered or assigned;
- The amount of the premiums paid under the policy or contract; or
- The amount of tax that would be chargeable if the gain was not recalculated.
However, wholly disproportionate is a high threshold to meet before the gains will be recalculated. The explanatory notes to the Finance Bill 2017 state “This legislation is expected to have limited application as it is considered that wholly disproportionate gains will arise very infrequently.”
What happens if HMRC deem that the gain is wholly disproportionate?
If HMRC deem that the gain is wholly disproportionate then the gain will be recalculated on a just and reasonable basis. The just and reasonable gain should then be used in by the policyholder in future final event chargeable event calculations. All necessary adjustments and repayments of income tax will also be permitted as a result of the recalculation.
HMRC will notify the applicant (or each applicant where the application is made jointly) of the result of the recalculation of the gain.
Where an individual has recovered tax from trustees and their income tax liability has been reduced following a recalculation, the individual is required to repay the trustees the difference between what was recovered and the revised entitlement to recover following the recalculation.
When does a recalculation not need to be made?
A recalculation does not need to be made where:
- HMRC deem that the gain is not wholly disproportionate; or
- If the gain arises as a result of a transaction or series of transactions where the main purpose or one of the main purposes is to obtain a tax advantage for any person.
The Finance Bill 2017 provides a limited opportunity to allow a small number of policyholders who make a part surrender or a part assignment of their policies and inadvertently generate a wholly disproportionate gain to apply to HMRC to have the gain recalculated on a just and reasonable basis.
However, whether HMRC will allow a recalculation will depend on the specific facts of each case.
With appropriate financial advice the generation of a wholly disproportionate gain could be avoided. Therefore, we strongly recommend that taxpayers seek advice before selecting their withdrawal method or completing an assignment deed. Our withdrawal form and assignment deeds contain this recommendation.