Top slicing relief: uncertainty for taxpayers

Changes to top slicing relief (TSR) were announced on Budget Day 2020 (11 March 2020) as providing relief for taxpayers and promoting fairness.

Despite these changes, taxpayers who have paid income tax on certain types of insurance policies continue to face uncertainty about how much tax they should have to pay on their policies. In this briefing, we outline the changes and what they mean for taxpayers.

Chargeable events regime

The UK has a special tax regime for certain types of life insurance policies, life annuity contracts and capital redemption policies.

These policies can be issued by both UK and foreign life assurance firms and friendly societies.

The policies normally operate by the insurer taking a premium from the investor and then investing that premium in assets that can generate income or grow in value. This allows the policy to potentially grow in line with the underlying investments.

Rather than tax the policyholder on the underlying investments each year, the UK’s tax system charges the policy owner when ‘chargeable events’ take place, such as the death of the final person insured under the policy or when the policy is surrendered.

Chargeable event gains

When a chargeable event takes place, the insurer will normally issue the policy’s owner with a ‘chargeable event gains certificate’. This will include details of the gains to be disclosed to HM Revenue & Customs (HMRC) and the number of complete years the policy has been held.

The gains on these policies are treated as savings income and are chargeable to income tax rather than capital gains tax.

Policies issued by UK insurers normally come with a basic rate tax credit which will reduce the actual income tax payable. This is generally not the case for foreign insurers.

Top slicing relief

A problem with this system is that the entire gain, which may have arisen over many years, is taxed in just one tax year.

This could result in the owner being pushed into higher income tax brackets.

It could also result in the owner losing the benefit of their personal allowance and personal savings allowance, which can both be withdrawn for those with high incomes.

TSR is available to reduce the negative effects of what could be many years of growth being taxed in just one tax year.

The relief is complicated to calculate, but broadly attempts to cap the income tax payable on the chargeable event gains, to the income tax the owner would pay on the average (or top slice) of those gains, multiplied by the number of complete years the policy was held.

Marina Silver v HMRC

In 2019, HMRC lost a case before the First-tier Tribunal (FTT) which focused on how TSR is calculated.

A key issue in the case was whether or not Mrs Silver was entitled to have the personal allowance included when calculating the TSR.

Since 6 April 2010, a taxpayer’s personal allowance can be restricted if their taxable income exceeds £100,000.

Mrs Silver’s actual total taxable income after her chargeable event gains was well above this limit and therefore her personal allowance would normally have been nil.

However, when calculating TSR, the average (or top slice) of Mrs Silver’s chargeable event gains was well below this £100,000 limit.

HMRC argued that the personal allowance was not available when calculating TSR because Mrs Silver’s actual total income was well in excess of the £100,000 limit.

The FTT disagreed with HMRC and found that Mrs Silver was able to have her personal allowance restored for the purposes of calculating the TSR due. Therefore, Mrs Silver was entitled to an additional £22,007 of tax relief which HMRC had previously disallowed under its own previous calculation methods.

HMRC appealed this decision but withdrew its appeal after changes to TSR were announced on Budget Day 2020 (discussed below).

Changes to top slicing relief

On 11 March 2020, the Chancellor, Rishi Sunak, announced changes to how TSR would be calculated with effect from that date.

These changes put some of the FTT’s decision from the Silver case (discussed above) into legislation. However, there were other changes which mean that, in some cases, more tax could be payable than would otherwise be the case using the FTT’s methodology for calculating TSR.

Current uncertainty

Policy owners may have overpaid income tax ranging from hundreds to potentially tens of thousands of pounds if they have submitted tax returns based on HMRC’s method of calculating TSR before the 11 March 2020. It is also possible that they may have underpaid tax.

This will affect most policy owners as many commercial providers of tax return software use HMRC’s method for calculating TSR.

Overpaid income tax

HMRC is currently reviewing reported chargeable events since 6 April 2018 to see if taxpayers would pay less tax using the new rules announced on 11 March 2020 and is issuing refunds by concession.

But taxpayers cannot be sure they are getting the full tax refund they may be entitled to because HMRC is retroactively applying changes announced on 11 March 2020 rather than using the FTT’s methodology in the Silver case.

Taxpayers with chargeable event gains before 6 April 2018 are also overlooked by this process.

Underpaid income tax

If a tax return has been submitted correctly and on time using HMRC’s methods for calculating income tax but additional tax is due as a result of errors in how HMRC has calculated TSR, it is not expected that HMRC will collect the underpaid tax.

Next steps

If you believe you may have overpaid income tax, then it is currently possible to submit overpayment claims for 2016-17 and 2017-18.

It may also be possible to reclaim income tax for 2015-16 and earlier years, depending on the facts of the case.

Amendments to 2018-19 tax returns (to reclaim overpaid income tax) will need to be made in paper form, with an appropriate note explaining why HMRC’s online calculator could not calculate the correct income tax due.

In practice, a significant difference in income tax payable should only arise if there are also significant chargeable event gains.

Further help

We can help calculate if underpayments or overpayments of income tax have arisen based on the FTT’s decision on TSR in the Silver case.

We can also help prepare the appropriate submissions to HMRC to reclaim overpaid income tax as a result of differences in how TSR is calculated.

If you have any queries, please get in touch with your usual Saffery partner or contact Zena Hanks, T: +44 (0)117 906 4632.