At the start of 2017, it is perhaps a good time to reflect on one of the most important developments of the last year with respect to the life sector. I am referring to the Upper Tribunal case concerning Mr Lobler and HM Revenue & Custom’s response to the consultation on the 5% tax-deferred entitlement that followed.
First, a reminder of the brief details of the case and the outcome. Lobler had purchased a life assurance bond in 2006 with an Isle of Man life company and had taken a series of large withdrawals by way of partial surrender across all policies under his bond.
Under the current legislation, contained in chapter nine, part IV of the Income Tax (Trading & Other Income) Act 2005, a policyholder is entitled to take up to 5% of the premium paid each year without an immediate charge to tax.
Any 5% entitlement not taken in one policy year can then be used in a subsequent year. Any withdrawals taken by a policyholder are then subsequently brought back into charge in the final surrender calculation of the bond (or any policy segment).
The use of partial surrenders can be a good tax-planning strategy, allowing policyholders to defer tax on the withdrawals until a later time. However, where the total withdrawals taken in any policy year exceeds the entitlement in that year, a chargeable event (excess event) will occur that will be equal to the amount to which the withdrawal exceeds the cumulative 5% entitlement.
Importantly, this excess has no correlation to the actual gain within the policy. This means in certain circumstances, as in the case of Lobler, it is possible for disproportionate gains to occur under existing chargeable event legislation.
Lobler took several withdrawals in 2007 and 2008 that far exceeded the 5% entitlement for those policy years. These withdrawals created huge excess chargeable events for those tax years. Lobler took no advice before these withdrawals, assuming no tax would arise because he had not withdrawn more than he had paid in.
As a result, he did not initially report the tax on his self-assessment for the relevant year on the basis that he did not believe they were taxable.
The Isle of Man insurer was still obliged to report the chargeable gains to Lobler and HMRC under the chargeable event reporting requirements. HMRC subsequently opened enquires in relation to Lobler’s self-assessment returns for the years ending 5 April 2007 and 2008. On the closure of enquiries, it amended the assessments to include amounts to be treated as ‘income’ after the withdrawal from the policies.