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Chartered Insurance Institute
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Chargeable event gains - Who is assessed and liable for tax? Part 2

In Part 1 of this series of 2 articles we explained that chargeable event gains made under life assurance policies (which includes capital redemption policies) owned by individuals or held on non-charitable trusts established by an individual, are potentially subject to income tax. In that article we examined the position where a life assurance policy is not held under trust.

In this article, Part 2, we will examine the position where a life assurance policy is held under trust.  This will cover policies held in non-charitable trusts and policies held in charitable trusts where the charity trustees take out the policy.

Introduction

When a policy is held under trust the income tax liability on a chargeable event gain can fall on an individual, trustees or beneficiaries depending on the circumstances.

Under trust law the person who creates a trust is generally known as a ‘settlor’.  In the chargeable events legislation instead of ‘settlor’ the expression ‘creator’ is used, a creator being anybody who has added property to the trust. In the remainder of this article we will use the expression “settlor”, being the most commonly used of the two expressions in practice.

Where a policy is held under a trust which is not a bare (absolute) trust

The Finance Act 1998 amended the rules relating to the taxation of gains arising under a trust policy.  On the happening of a chargeable event on or after 6 April 1998 gains are assessed on the following persons:

(i) Settlor UK resident in the tax year in which the chargeable event occurs

On the happening of a chargeable event, when the settlor is alive gains will be assessed to tax on the settlor.

The settlor would also be assessed to tax on a chargeable event gain if the trustees encash the policy at any time in the tax year in which the settlor died.

(ii) Settlor died in a previous tax year or is non-UK resident, trustees are UK resident (UK trust)

Where the policy is held under trust and immediately before the chargeable event in question occurs the settlor is not resident in the UK or died in a previous tax year , chargeable event gains will be assessed on the trustees at the rate of 45% if they are resident in the UK for income tax purposes at that time.  For a UK policy, where the trustees are resident in the UK, they would be entitled to a credit for basic rate (20%) tax.  This will reduce their liability to 25% of the gain. 

Where a chargeable event gain is assessed to tax on trustees who are resident in the UK, the special 25% (ie 45% less 20% tax credit) trust rate will not apply to the first £1,000 of gross income in a tax year.  This £1,000 band is known as the “standard rate” band and income which falls within the band is taxed at 7½% if it is dividend income or 20% for other income.  For a trust whose sole asset is a life assurance policy the first £1,000 of chargeable event gain in a tax year will therefore be free of tax for a UK policy after the 20% tax credit, and taxed at 20% as other income for a non-UK policy.

If a mix of income is received by the trust then the order in which the standard rate band is allocated is

(a) first, income subject to default basic rate income tax at 20% (ie all income other than dividend income), which includes chargeable event gains on life assurance policies then

(b) dividend income

Where a settlor has created more than one trust, the £1,000 standard rate band is apportioned amongst them equally subject to a minimum standard rate band of £200 for any one trust.

(iii) As in (ii) above but where the trustees are non-UK resident (offshore trust)

In the circumstances in (ii) above but the trustees are non-UK resident for income tax purposes, any chargeable event gains will be treated as income of the trustees for the tax year in which the chargeable event occurs for the purposes of Chapter 2 of Part 13 of the Income Tax Act 2007.  The effect of this is that the gains are added to the pool of trust income available for distribution and attribution to UK resident beneficiaries who receive payments out of the trust – section 732 Income Tax Act 2007. This means that, to the extent there is undistributed income in the trust, such payments would be treated as income and assessed to tax on the beneficiary in the tax year of receipt. This means that top-slicing relief would not be applicable because the beneficiary is treated as receiving income from the trust.  Nor would the 5% annual allowance be available to the beneficiary.

(iv) ‘Dead settlor trust’

Where a chargeable event occurs on or after 6 April 1998, the trust was established before 17 March 1998 and the creator (or at least one of them if more than one) died before 17 March 1998 then the “dead settlor” rule will apply and gains will escape the tax charge provided:

  • the chargeable event occurs in a tax year following that in which death occurred;
  • the policy commenced before 17 March 1998;
  • the policy was owned by the trust before 17 March 1998; and
  • the policy has not been enhanced in any way on or after 17 March 1998.

(v) Trusts created by another trust

Where a policy is held on non-charitable trusts and there is no individual or person on whom to assess any chargeable event gain, for example if the creator of the trust was itself a trust, any tax charge falls on the trustees of the “new” trust. This rule only applies to a policy issued on or after 9 April 2003, or a pre 9 April 2003 policy which has been varied on or after 9 April 2003 so as to increase the benefits or extend its term, or a pre 9 April 2003 policy under which there has been an assignment of the rights or a share of the rights to a non-charitable trust on or after 9 April 2003.

(vi) Charitable trusts

Where a chargeable event gain arises under a policy held on charitable trusts with UK resident trustees, tax is due at the basic rate of 20% which means for a UK policy there would be no liability to tax after taking account of the 20% tax credit – section 467(7) ITTOIA 2005.  Where a policy is held on charitable trusts by non-UK resident trustees section 468(1) ITTOIA 2005 provides that any benefit received by a UK resident can be taxed on the basis outlined in section 2(iii) above under section 732 Income Tax Act 2007.  As indicated here chargeable event gains are not exempt from tax as are most items of charitable income.  In addition, the acquisition of a life policy by a charity can affect the tax treatment of the charity’s other income as the purchase of a life policy does not count as qualifying expenditure. 

(vii) Trusts with multiple settlors

Where a trust has more than one settlor (creator) then any chargeable event gain is apportioned between the settlors – section 472 ITTOIA 2005.

Each settlor is treated as the sole settlor of a separate share of the policy.  In the case of a husband and wife the share would usually be 50/50 if they applied for the policy jointly.   In other cases it would be based on the contribution made.  The chargeable event gain would be split between settlors based on the amount of the trust property (the policy), represented by their share of the contributions, at the time the chargeable event occurred.

Where there are different settlors at different times then the apportionment has to be made on a ‘just and reasonable basis’. 

Where a policy is held under a bare (absolute) trust

For tax years up to and including 2006/07, where a policy was held subject to a bare trust and the beneficiary had attained age 18, the gain was assessed on the beneficiary.  Where the beneficiary under such a trust was aged under 18 gains were assessed on the person who created the trust. 

Following a change in HMRC’s view of the tax position following legal advice, which was announced in November 2008, from tax year 2007/08 onwards chargeable event gains are taxed as the income of the beneficiary irrespective of the beneficiary’s age in all cases except those where the parental settlement provisions, in section 629 ITTOIA 2005, will apply.  These provisions apply where:

  • the beneficiary is a minor who is unmarried and not in a civil partnership; and
  • the settlor is a parent of the beneficiary; and
  • the chargeable event gain plus (all other income arising from gifts made by the same parent to that minor) exceed in total £100 gross in the tax year in question.

So, if the £100 limit is exceeded in such circumstances, because chargeable event gains will be treated as income, the £100 parental settlor rule will apply and all income that arises during the settlor’s lifetime which is taxable under this rule will be taxed on the parental settlor.  HMRC has confirmed that chargeable event gains that arise after the settlor’s death (irrespective of the tax year) will be taxed on a beneficiary who is a minor unmarried child of the settlor and not in a civil partnership. 

The right to recover tax paid from trustees

The right to recover tax paid from trustees is conferred by statute in section 538 ITTOIA 2005.  This statutory right of recovery is extended to individuals, and not merely to individuals who created the trust.  Where the settlor does not exercise this statutory right to recover tax due then he is treated as making a gift to the trust equal to the amount of the tax due.  It may be the case that some trusts exclude the right to recover tax. 

Non-resident relief and top-slicing relief

For non-resident relief to apply for a policy under trust, the liability for the payment of tax on the chargeable event gain must fall on an individual (or the trustee of a deceased individual) – not trustees

The circumstances in which a trustee can be liable for tax in respect of a deceased individual arise when

  • the policy is held subject to a non-charitable trust; and
  • the deceased individual was UK resident when they died; and
  • the settlor died in an earlier tax year

Top-slicing relief will only apply in respect of a policy under trust when the liability for the payment of tax on the chargeable event gain falls on an individual.  Top-slicing relief will not be available when the liability for the payment of tax falls on trustees.