In April, HM Revenue and Customs (HMRC) published a consultation paper unveiling an overhaul of rules governing the part surrender and part assignment of life insurance policies.
As a result, the tax office set out three proposals, of which only one would be implemented, including taxing the economic gain; deferring any excessive gains; or introducing a 100% allowance to replace the current annual 5% tax free withdrawal.
100% allowance?
After consulting with the international life insurance industry, the rule changes were expected to be to be announced in early October.
It has since been delayed and is now likely to be unveiled in the UK chancellor’s first Autumn Statement next month.
Speaking to International Adviser, Jones said he expects the UK to either pick the 100% allowance option or leave the rules as they are but allow for providers to correct case where a ‘mistaken’ withdrawal leads to a huge tax bill.
“HMRC will either choose the 100% allowance proposal, or do nothing other than to come up with a process to allow restitution if it goes wrong,” said Jones.
The reforms are intended to redress the unfair tax bills which some individuals face if they withdraw money from an offshore bond in the wrong way, said HMRC.
Lobler case
It is based on the 2007 case of Dutch national Joost Lobler, who was ordered by HMRC to pay $560,000 (£390,418, €495,000) in tax on the $1.42m he withdrew from a life insurance policy he set up with Zurich Life just two years earlier.
Lobler took his case court and eventually won.
Retribution process
Rachael Griffin, head of product law and financial planning at Old Mutual Wealth, said she would prefer HMRC to approve a case-by-case rectification process for withdrawals which cause unexpected tax bills, or failing that, the 100% allowance.
Griffin has previously described the other two proposals – taxing the economic gain and the deferral of excessive gains – too complicated, requiring complex calculations.
“As the issue effects a small number of policyholders each year our favoured outcome would be the ability for a ‘mistaken’ withdraw to be rectified, subject to HMRC approval. Otherwise, the 100% option,” she said.
Current rules
HMRC estimates that around 600 UK policyholders are at risk of facing hefty tax liabilities if they make large withdrawals from offshore life bonds, which are often made up of a series of single-life insurance policies, through part surrender across all the policies in the wrapper.
Investors can either convert one of the policies into cash or convert segments of the bond and just pay income tax on any gain it has made – usually at their top rate of income tax. Or they can encash all the segments and pay income tax on the total gain in the bond.
As a general rule of thumb, it is more tax efficient to withdraw money (over and above the annual 5% allowance) through surrendering individual policy segments rather than taking the money through a partial surrender across all policies.
Finance bill
David Downie, technical manager at Standard Life International said he expects the rule changes to be published in the draft legislation of Finance Bill on 5 December and called for a “clear and easy” rectification process.
The bill is the legislation, released annually, for delivering new tax proposals set out by the chancellor in the Autumn Statement and the Budget, which takes place in March.
“We are hoping for a sensible solution when the Finance Bill is published on 5 December which gives the right customer outcomes but without adding further complexity to the chargeable event rules.
“The Association of British Insurers’ (ABI) ‘best practice’ on surrenders should mean the number of cases where unexpected gains from part-surrenders is minimal.
“And a clear and easy to follow rectification process would provide peace of mind for anyone who slips through the net,” he said.
HMRC was contacted for comment at the time of publication.
