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Investment bonds – tax on a chargeable event gain

Introduction

This briefing sets out how a chargeable event gain is taxed and how top-slicing relief is applied.


Core considerations

  •  Chargeable event gains are taxed as savings income. 
  • The gain will be taxed in the tax year the chargeable event falls which depends on whether it is a full encashment or a partial surrender in excess of the cumulative 5% tax deferred allowances.
  • The number of years for top-slicing relief will depend on whether the bond is onshore/offshore, when it was taken out and whether it is a full encashment or partial withdrawal. 
  • Top-slicing relief is given by carrying out a step-by-step calculation as covered in this briefing and in HMRC’s Insurance Policyholder Taxation manual. 
  • If the individual has spent time outside of the UK during the period in which they were the beneficial owner of the policy, they may be entitled to a time-apportioned reduction for the time they were non-UK resident.
  • It is not possible to offset a loss made on one investment bond against a chargeable event gain made on another however, deficiency relief may be available to reduce income subject to higher rate tax. 

Contents 

Taxation

Individuals only pay tax on their investment bond gains when a chargeable event occurs in the tax year of that event. Therefore, any tax payable will depend on when the chargeable event is deemed to have occurred.  
 
For a full encashment of segments or, the whole bond, the chargeable event will arise at that time and will be taxable in that tax year.  
 
If there is a partial surrender of more than the 5% accumulated allowance, this is taxable at the end of the policy year in question, and this means it could fall in a later tax year to when the withdrawal was made.  
 
There is also a special rule where a partial surrender is followed by a ‘terminal event’ (i.e., a full encashment) - known as the final policy year rule – and this is covered later in this briefing. 
 
Both onshore and offshore bond gains are taxed as savings income however, there are a couple of differences. 

  • Onshore bonds – chargeable event gains are subject to income tax and are taxed as the top part of income, after dividend income. The gain benefits from a 20% tax credit as the life company is treated as having paid corporation tax within the fund. 
     
  • Offshore bonds – chargeable event gains are also subject to income tax, however, are taxed before dividend income. The gain does not benefit from a tax credit as no tax is deemed to have been paid within the fund. 

The taxation of a chargeable gain can lead to a larger proportion of tax being paid in a single year and possibly at higher rates than would have been paid if the gains had been assessed on an annual basis. However, there is a remedy for this – known as ‘top-slicing relief.’ 

Top slicing relief

Top slicing relief usually applies when the full gain takes an individual into the higher rate or additional rate tax bracket. When the chargeable gain does not push the taxpayer into a higher rate tax bracket, there may be still be some top slicing relief available because of the personal savings allowance (PSA) and the starting rate for savings.  
 
The relief is an amount deducted from the final tax liability and is based on the difference between the tax on the full gain and the 'average' gain (or 'sliced' gain) over the number of years the gain has been made: 

  • For a full surrender of segments or the whole bond, divide the chargeable gain by the number of complete years the bond has been in force. Chargeable gains on death and assignment for money or money’s worth (consideration) are also divided by the complete number of years the bond has been in force.  
     
  • For a partial surrender, in excess of the cumulative 5% tax deferred allowance: 
    • for offshore bonds taken out prior to 6 April 2013, the chargeable gain is divided by the complete number of years the bond has been in force.
    • for offshore bonds taken out after 6 April 2013, the gain is divided by the complete number of years to the previous chargeable event.
    • for onshore bonds, the gain is divided by the complete number of years to the previous chargeable event. 

Entitlements, allowances and tax reliefs

The full chargeable gain is included to determine an individual’s total income and therefore may affect an entitlement to their personal allowance, personal savings allowance and certain benefits such as Child Benefit and Tax Credits.  
 
The full gain (rather than the top sliced gain) is always used when determining an individual’s eligibility for the: 

  • Personal Allowance -if the individual’s income, including any gain causes them to have income over £100,000, their personal allowance will be reduced by £1 for every £2 over this amount. This means that once total income exceeds £125,140 the personal allowance will be lost. It doesn’t mean that the individual will always have income tax to pay on any chargeable gain, as this will depend on their other income and whether the bond is onshore or offshore. 
     
  • Personal Savings Allowance (PSA)- depending on an individual’s income (including any gain), they may be able to receive some savings income tax-free. Basic rate taxpayers (including the gain) can receive up to £1,000 in savings income tax-free or £500 for higher rate taxpayers. There is no PSA  for additional rate taxpayers.
     
  • Starting rate for savings - this is available if an individual has non-savings income of less than their Personal Allowance (£12,570) plus £5,000 (2023/24). The starting rate for savings is currently 0%. Therefore, if an individual with no non-savings income has a chargeable gain of £17,570, there would be no tax to pay. 
For example

Pam has non-savings income of £15,070 and makes a chargeable gain of £3,500 on an offshore bond.

As Pam has non-savings income of £15,070, the starting rate band for savings is restricted to £2,500 (£5000 minus £2500 of non savings income above her personal allowance) and, as a basic rate taxpayer, Pam also has the personal savings allowance of £1,000 to use against the chargeable gain. This totals £3500 and means there would be no further liability to income tax on the chargeable gain of £3500.


How top slicing relief is given

Top slicing relief reduces the tax that would otherwise be payable. Several steps are involved in the calculation of the relief, which depends on whether there is a chargeable event during the tax year, or more than one.  

HMRC adopt a five-step process.  
 
Note that for the purposes of the top slicing relief calculation, basic rate tax treated as paid is deducted at Steps 2 and 4 below for both onshore and offshore gains.  


One chargeable event 

Step 1: 
Calculate the total taxable income for the year and identify how much of the gain falls within the starting rate for savings, personal savings allowance nil rate, basic, higher or additional rate bands as appropriate. Any gift aid payments must be disregarded both in this computation and in the remaining steps below.

Step 2:  
Calculate the total tax due on the gain across all tax bands. Deduct basic rate tax treated as paid to find the individual’s liability for the tax year.
 
Step 3:  
Calculate the annual equivalent of the gain. The annual equivalent is calculated by dividing the gain by the number of complete years that can be used for top slicing (see above).  
 
Step 4:
Calculate the individual’s liability to tax on the annual equivalent. For gains arising on or after 11 March 2020, the personal allowance is recalculated where appropriate. The amount of the savings starting rate and personal savings allowance used in the top slicing relief calculation are set by virtue of the taxpayer’s adjusted net income for the tax year. They are not adjusted to calculate the notional tax due on the ‘sliced gain’. Deduct basic rate tax treated as paid on the annual equivalent and multiply the result by the number of top slicing years. This gives the individual's relieved liability.

Step 5:  
Deduct the individual’s relieved liability at step 4 from the individual’s liability at step 2 to give the amount of top slicing relief due.  
 

Example: partial encashment 

Mrs Durant invests £100,000 into an onshore investment bond on 1st March 2016. She then leaves the fund untouched until July 2021 when she makes a partial withdrawal of £50,000. This means the chargeable event arises at the end of the policy year on the 28 February 2022 – i.e the 2021/2022 tax year. 

Her total income, consisting of salary for that tax year is £50,670. 

Accumulated Allowance £100,000 x 5% x 5 years = £25,000 
Excess £50,000 - £25,000  = £25,000 chargeable gain 

To calculate the tax: 

Step 1 
Total taxable income is £75,670 (£50,670 + £25,000) 
Personal Allowance is £12,570 
Personal Savings Allowance (PSA) is £500 
Step 2 - Tax on gain of £25,000    
PSA   
£500 x 0%
£0
Higher Rate Tax 
£24,500 x 40% 
£9,800
Total  
 
£9,800
Deduct basic rate tax £25,000 x 20% 
  (£5,000)
 
 
£4,800 

Step 3 - Annual Equivalent

£25,000/ 5 years = £5,000 
        Step 4 - Tax on ‘annual equivalent’ gain £5000        
 
                 
        PSA         
£500 x 0%
        £0        
        Higher Rate Tax                                                                               £4,500 x 40%         £1,800        
        Total                    £1,800        
        Deduct basic rate tax £5,000 x 20%          
 
(£1,000)
£800
Multiply by number of years (5)        £4,000
Step 5 - Top Slice Relief
£4,800 (from step 2) less £4000 (from step 4) = £800

Total tax payable on chargeable gain

Tax on chargeable gain   £9,800 
Less notional credit   (£5,000) 
Less Top Slice Relief   (£800) 
Income Tax payable on Chargeable gain   £4,000 

Tax on final encashment

The tax is calculated using the same five step process after the chargeable gain is calculated: 
 
[amount paid out + all partial encashments] less [premiums paid + all chargeable excesses]
 

Example: final encashment

Mrs Durant invests £100,000 into an onshore investment bond on 1st March 2016. She then leaves the fund untouched until July 2021 when she withdraws £50,000 (resulting in a £25,000 chargeable gain at the end of the policy year, 28 February 2022). She then fully surrenders the bond in October 2023 for £82,500. Her total income for that tax year is £71,300. 
 
The chargeable gain is [£82,500 + £50,000] – [£100,000 + £25,000] = £7,500
 

Step 1 

Total taxable income is £78,800 (£71,300 + £7,500)

Personal Allowance is £12,570

Personal Savings Allowance is £500

Step 2 - Tax on gain    
PSA  
£500 x 0%
£0 
Higher rate
(£7,000 x 40%) £2,800
Total
  £2,800
Deduct basic rate tax £1,500 x 20% (£1,500)
    £1,300
Step 3 - Annual Equivalent
£7,500 / 7 years = £1,071.43 
Step 4 - Tax on gain    
PSA 
£500 x 0%
£0
Higher Rate Tax 
£571.43 x 40%
£228.57
Deduct basic rate tax at 20%
  (£214.29)
    £14.29
     
Multiply by number of years (7) 
 
£100 
Step 5 - Top Slice Relief
£1,300 (from step 2) less £100 (from step 4) = £1,200

Total tax payable on chargeable gain

Tax on chargeable gain   £2,800 
Less notional credit  (£1,500)
Less Top Slice Relief  (£1,200)
Income Tax payable on Chargeable gain   £100

If Mrs Durant’s bond had instead been an offshore bond, there is no tax deemed to have been deducted in the fund and so the notional tax credit of £1,500 would not be available. This means there would be tax of £1,600 (i.e. £2,800 - £1,200).
 

Multiple chargeable events

In cases where there is more than one chargeable event gain a similar process needs to be followed but with one extra step as outlined in HMRC’s manual.
 

Time-apportioned reductions

If the policyholder has spent time outside of the UK during the period they were the beneficial owner of the policy, they may be able to proportionately reduce the amount of the chargeable gain by the amount of time they were resident outside the UK.
 

Losses

It is not possible to offset a loss made on one investment bond against a chargeable event gain made on another. Nor is it possible to offset a loss against an individual’s other income. However, there is a form of loss relief – known as ‘deficiency relief.’ 
 
Deficiency relief is only available to individuals where the owner of the bond is a higher/additional rate taxpayer, and there is a loss on full encashment of the bond, and there had been a previous chargeable excess gain on a part surrender on that same bond. The effect of the relief is to reduce income subject to higher rate tax. 
 
The amount of the relief is based on the lower of: 

  • the amount of the previous chargeable excess gain, and 
  • the amount of the loss 

 
HMRC’s Insurance Policyholder Taxation Manual has more information on deficiency relief. 

 

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