Outcome of an HMRC consultation on part surrenders and part assignments of life insurance policies.

In May 2006, Mr Lobler invested $1.4m (£930,000) in an offshore life bond which consisted of 100 segments. Half the funds invested derived from savings and the sale proceeds of the family home, the remaining half was borrowed. He made two large withdrawals within two years of making the investment. Unfortunately, Mr Lobler on both occasions he chose the option on the withdrawals forms to make partial withdrawals across all the policy segments rather than to encash individual policy segments. The outcome of this was that he was taxed on an artificial gain based on the amount withdrawn less the annual allowance of 5% of the premiums originally paid, rather than the actual gain on the amounts withdrawn.

Mr Lobler appealed against the HMRC decision, but although he had the sympathy of the First Tier Tax Tribunal, his appeal was dismissed. In his judgment, Judge Charles Hellier acknowledged that it was “an outrageously unfair result” but HMRC was acting in accordance with the rules. On appeal the Upper Tax Tribunal allowed Mr Lobler rectification putting him in the tax position he should have been in if he had encashed full segments and so taxed on the actual gain on the funds withdrawn. What was also significant was the Upper Tax Tribunals severe criticism of the chargeable event tax legislation which led to the Government in April 2016 launching a consultation on proposals to change the current rules. The government suggested three possible options:

• A 100% allowance – no gain would arise until all of the premiums paid has been withdrawn.
• Taxing the economic gain – the current 5% tax deferred allowance would remain but if a greater sum was taken a proportionate fraction of any economic gain would come into charge.
• Deferral of excessive gain – maintain the current method of calculating the gain but the amount of gain that could be brought into charge on a part surrender would be limited to a predetermined amount of the premium. Any deferred gains would be brought into charge on full surrender.

HMRC has now published its response to the consultation. The 100% allowance option, being the most generous and simple to understand, was the most favoured by respondents. However, HMRC has decided not to go for any of the three but has come up with an alternative option.

In future, any policyholder who finds they have generated a totally disproportionate gain can simply apply to have the gain recalculated on a just and reasonable basis. Applications will be required in writing and received by an officer of HMRC within two years after the end of the insurance year in which the gain arose.

Please note that PFP are not taxation advisers, and independent taxation advice should be sought prior to acting on any information given.