Life Assurance Bonds – Taxation of Trustees
Information in this article should not be taken or relied upon as personal financial advice. Any individual requiring information or advice on their own specific circumstances or on their own account should contact a suitably qualified professional.
This article continues the series on the subject of life assurance bond taxation and should be read with the earlier more general articles, as some of the basic points about the methodology of the tax calculation will not be repeated (top slicing, 5% withdrawals etc.).
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Certain older trusts can benefit from rules applicable at the time the policy was settled which results in income tax on chargeable gains being avoided altogether on grounds that the settlor was already deceased (what are generally called the “dead settlor” rules), but that situation is ignored for purposes of this article. To benefit from the old rules, the trust would need to have been created before 17th March 1998 and the settlor to have died by then.
The Gain to be Taxed
It is worth re-stating that a chargeable event will occur on full surrender, partial surrender or death of the life assured if that triggers a claim and also on assignment for monies worth. The chargeable gain is calculated according to which of those events has occurred.
For partial surrenders (not assignment out of whole segments or sub-policies), in excess of the permitted 5% per annum tax deferred allowance, the gain to be taxed will be the excess of the withdrawal above the allowance unused to date. Note that the gain is taxed in the tax year in which the policy year ends, which may be different to the tax year when the funds are actually taken.
For a full surrender, the gain is the proceeds plus any withdrawals already paid less the amount invested and any other gains that have fallen into account. On death, the full surrender calculation is used, although the surrender value at the date of death is treated as being the notional and taxable proceeds, as opposed to any death benefit actually paid. Assignment for monies worth results in the same treatment as a full surrender, with the amount of consideration being taken to be the surrender value.
Interest in Possession or Discretionary Trusts
In situations where a gain is incurred by the trustees the liability for the gain depends on whether or not the settlor is still alive.
If the settlor is alive and a UK resident in the year of assessment, the settlor will be assessed. If the gain arises in the same tax year as the settlor dies, the liability still sits with the settlor’s estate. However, the settlor has the right to claim the tax back from the trustees. If that right is waived, then the amount of the tax remains within their estate and that waiver may itself count as a chargeable lifetime transfer for Inheritance Tax purposes.
The amount of tax will be dependant on the settlor’s tax status, so for onshore bonds it may be an extra 20% for high rate tax payers or 30% for additional rate tax payers. The full gain (not top sliced) will also impact on other tax calculations relating to personal allowances such as the age related and married couples allowances. For offshore bonds the full rate of savings tax applicable to the settlor will be applied (ie from 0% in rare cases to 50%, as applicable). Top slicing relief, explained in previous articles, is available to restrict the impact of the gain on the taxpayer’s liability to higher and additional rate taxes.
If the settlor is a non UK resident or died in a previous tax year, the trustees will be taxed on the gain at 50% except for an amount covered by the modest standard rate band for trusts. With onshore bonds, again a 20% credit is allowed. If there are no UK trustees, then HMRC will look to tax the beneficiaries, to the extent that they actually benefit from the trust’s gain. Top slicing relief is not available to trustees or beneficiaries if they fall to be taxed.
Absolute or Bare Trusts
As might be expected, gains will normally be assessed on the beneficiaries in such cases, except where the parent was the settlor and the beneficiaries are minors, in which case the parent settlor will be assessable, unless the gain is unusually trivial.
It is worth restating that the relevant tax regime, chargeable events, falls under the Income Tax sections of the relevant taxation statutes, as sometimes using phrases such as “chargeable gains” results in an understandable but incorrect assumption that a capital tax is being discussed.
In cases where the trust is an absolute Discounted Gift Trust and the settlor is alive, it is possible that the trustees are making surrenders to meet the settlor’s retained or “carved out” rights, in which case the settlor will be assessed on the gain on that part.
The same points made above about the rates of tax for onshore and offshore bonds and the potential loss of personal tax allowances will be applicable.
Who pays the tax on chargeable gains from life assurance bonds held by trustees depends on the type of trust and the rules are reasonably logical if one bears in mind that HMRC do not want to see trusts blatantly used to move tax liabilities away from an identifiable taxpayer. Practitioners can improve the outcome for their clients by taking care with the timing and form of surrenders and where possible ensuring that the change of ownership of a bond as a trust asset is dealt with before surrender takes place.
It will also be sensible to take care to check the dating of the original settlement if the settlor is deceased, given the possibility that the previous “dead settlor” provisions might apply.
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