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Partial surrender of insurance bond caused immediate tax charge (First-tier Tribunal)
Practical Law UK Legal Update 1-517-2514 (Approx. 4 pages)
Partial surrender of insurance bond caused immediate tax charge (First-tier Tribunal)
by PLC Private Client
| Published on 17 Jan 2012 • England, Wales |
The First-tier Tribunal has held that where there is a partial surrender of an insurance bond consisting of a number of individual life insurance policies (segments), the default position in general law is that there is a partial surrender of each segment (horizontal surrender) rather than a total surrender of a number of segments (vertical surrender). (Rogers v HMRC [2011] UKFTT 791 (TC)). (Free access.)
Speedread
The First-tier Tribunal (Tax Chamber) has held that where there is a partial surrender of an insurance bond consisting of a number of individual life insurance policies (segments), the default position in general law is that there is a partial surrender of each segment (horizontal surrender) rather than a total surrender of a number of segments (vertical surrender).
The point is important because horizontal surrender may, as in this case, generate an immediate income tax liability that could be avoided by a vertical surrender. This results from the complex rules in Chapter 9 of Part 4 of the Income Tax (Trading and Other Income) Act 2005. Insurance bonds are often recommended by financial advisers to taxpayers who want to have access to their investment without an immediate tax charge, as tax is deferred on withdrawals of up to 5% of premiums paid. Segmented policies are used both to avoid the sometimes harsh effects of partial surrender and for estate planning reasons. The decision is a reminder that practitioners advising on a surrender should ensure that this is made in the most tax-efficient way if the client needs additional funds. (Rogers v HMRC [2011] UKFTT 791 (TC).)
Background
For information about the income tax rules on chargeable events in relation to life insurance policies, see:
- R Maas, Anti-Avoidance Provisions: Chapter 11 - Transactions involving Life Assurance (Bloomsbury Professional, 2011).
Decision
The First-tier Tribunal (Tax Chamber) has held that where there is a partial surrender of an insurance bond consisting of a number of individual life insurance policies (segments), the default position in general law is that there is a partial surrender of each segment (horizontal surrender) rather than a total surrender of a number of segments (vertical surrender). This principle is based on the equitable maxim of "equality is equity" and will apply unless either the contractual documents or the facts of what actually took place (to the extent consistent with the contractual documents) indicate that there was a vertical surrender.
Comment
The point is important because horizontal surrender may, as in this case, generate an immediate income tax liability that could be avoided by a vertical surrender. This results from the complex rules in Chapter 9 of Part 4 of the Income Tax (Trading and Other Income) Act 2005.
Insurance bonds are often recommended by financial advisers to taxpayers who want to have access to their investment without an immediate tax charge, as tax is deferred on withdrawals of up to 5% of premiums paid. They are often used as part of a discounted gift scheme (see Legal update, High Court overturns the Special Commissioner's decision on the value of a "discounted gift": Background on discounted gift schemes).
It is easier to avoid exceeding the 5% limit if policies are segmented and vertical surrender is used. This is because the sometimes harsh effects of partial surrender can be avoided altogether (if all segments surrendered are surrendered in full) or at least reduced (if some segments are surrendered in full and only one partially surrendered, in order to achieve a surrender of a specified amount). Segments are also useful in estate planning because separate segments are easier to assign to different beneficiaries in a tax-efficient way.
The decision is a reminder that practitioners advising on any surrender should ensure that this is made in the most tax-efficient way. In this case, the tribunal found on the facts that the taxpayer had failed to elect for a vertical surrender as allowed by the terms of the bond, so a horizontal surrender had taken place on the basis of both the contractual documents and the general law.
Source
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