The taxation of chargeable event gains arising on UK and offshore bonds can be complicated in certain situations.
In saying that, I think two facts are fairly clear, writes Graeme Robb, senior technical manager at Prudential UK.
First, gains on UK bonds aren’t liable to basic rate tax. Individual clients liable for tax are treated as having paid basic rate tax on the amount of the gain.
This reflects the fact that the funds underlying a UK policy are subject to UK life fund taxation.
Second, in contrast, we know that offshore bonds can be issued by life companies based in jurisdictions which impose no tax on the income and gains of the underlying funds – ie ‘gross roll-up’.
All well and good, but how does this square with the comment on page 3,840 of HM Revenue & Custom’s Insurance Policyholder Tax Manual that says: “Note that for the purposes of the top slicing relief calculation, basic rate tax treated as paid is deducted at steps two and four below for both onshore and offshore gains.”
Look at the law
So, do you deduct a basic rate credit even for an offshore bond gain?
Yes, you do.
Although that may seem counter-intuitive, there is a rational explanation provided by tax law.
Reading tax law can be daunting, but in this case it’s quite simple as we have just two sections to consider.
First, section 530 of the Income Tax (Trading and Other Income) Act (ITTOIA) 2005 simply tells us that individuals and trustees are treated as having paid tax at basic rate on bond gains.
There is no distinction between UK and offshore bond gains. Although that might seem odd, any confusion is cleared up by the following section, S531, which tells us that S530 doesn’t apply to offshore bond gains except for the purposes of calculating top slicing relief (TSR).
Put it into context
What’s happening, therefore, is that these sections ensure consistency for TSR purposes between UK and offshore bond gains but otherwise ensure that only gains on UK bonds are not liable to basic rate tax.
A simple example might help.
In 2020/21, Anne from Leeds has a salary after personal allowance of £35,900 ($43,829, €40,573). She surrenders an offshore bond held for eight complete years and realises a gain of £24,000.
Step one: calculate Anne’s liability before TSR
|Source||Sum £||Band||Rate %||Tax due £|
|Offshore bond gain||500||Personal Savings Allowance||0||0|
|Offshore bond gain||1,100||Basic Rate||20||220|
|Offshore bond gain||22,400||Higher Rate||40||8,960|
Step two: calculate Anne’s liability on just the bond gain
As you can see from the above table, her tax liability on just the bond gain is £220 +£8,960 = £9,180
Despite it being an offshore bond, remember that tax law tells us to deduct the basic rate credit of £4,800 – £24,000 at 20%. Her liability on the bond gain is therefore £4,380.
Step three: calculate the slice
That is simply £24,000 / 8 = £3,000.
Step four: calculate Anne’s liability on just the £3,000 slice
|Source||Sum £||Band||Rate %||Tax due £|
|Offshore bond slice||500||Personal Savings Allowance||0||0|
|Offshore bond slice||1,100||Basic Rate||20||220|
|Offshore bond slice||1,400||Higher Rate||40||560|
Her tax liability on just the slice is £220 + £560 = £780.
Again, we deduct a basic rate credit of £600 – £3,000 at 20%. That gives us a figure of £180 which we multiply back up by eight years to arrive at a figure of £1,440 representing her liability on the slice.
Step five: TSR due
The TSR due is simply the step two figure of £4,380 less the step five figure of £1,440 = £2,940.
Let’s summarise Anne’s situation.
Her total tax liability before TSR was £16,360. If we then deduct TSR of £2,940 we arrive at a figure of £13,420.
If Anne’s bond had been a UK bond rather than an offshore bond, then the TSR remains identical but you simply need to knock off the bond basic rate credit of £4,800 from the tax liability so that it drops from £13,420 to £8,620.
So, as you can see, we have consistency for TSR purposes between UK and offshore bond gains but it remains the case that only gains on UK bonds are not liable to basic rate tax since offshore bonds enjoy ‘gross roll-up’.
This article was written for International Adviser by Graeme Robb, senior technical manager at Prudential UK