REV BN 27: Avoidance using Life Insurance Policies

Who is likely to be affected?

1. Individuals who own life insurance policies, capital redemption policies and life annuity contracts where there has been both a change of ownership and there have been earlier gains on the policy or contract.

General description of the measure

2. The measure amends the rules on deficiency relief, which may be available to an individual to set against their income taxed at the higher-rate when a policy comes to an end. It removes the opportunity for individuals to use life insurance policies to manufacture deficiency relief in order to avoid higher-rate tax.

Operative date

3. To all policies and contracts made on or after 3 March 2004. It will also apply to all existing policies and contracts which are assigned in part or whole, or become used as security for a debt, or into which policyholders choose to pay further premiums, on or after 3 March 2004. This measure has already been announced in News Release 12/04 on 3 March 2004, published on the Inland Revenue web-site at www.inlandrevenue.gov.uk

Current law and proposed revisions

4. Deficiency relief is a tax relief available to an individual who owns a life insurance policy, life annuity contract or capital redemption policy if the final computation of gain when the policy or contract comes to an end shows a deficiency. Relief is restricted to the amount of gains that arose on earlier part surrenders or part assignments of the rights conferred by the policy or contract. The relief reduces an individual’s liability to tax on their income at the higher rate. There is currently no requirement that those earlier gains formed part of the income of the same individual who is entitled to the deficiency relief. It is possible, for instance, that the policy may have been owned by a different person when the earlier gains arose.

5. Under the proposed revision, the amount of deficiency relief allowable against an individual’s income will be further restricted to the amount of gains which formed part of that same individual’s total income in an earlier year of assessment.

6. The measure will apply to all life insurance policies, capital redemption policies and life annuity contracts made on or after 3 March 2004.

7. It will also apply to existing policies and contracts:

• where the benefits secured are increased on or after that date, either by a variation of the policy or contract or by the exercise of rights conferred by the policy or contract. This means that the measure will apply to any policies into which the policyholder chooses to pay additional premium on or after 3 March 2004;
• where all or part of the rights conferred by the policy or contract are assigned on or after 3 March 2004. This applies whether or not the assignment is for money or money’s worth; or
• where all or part of the rights conferred by the policy or contract become held as security for a debt on or after 3 March 2004.

8. If there is a deficiency when a policy or contract ends, and all of the gains made over the life of the policy have formed part of the income of the individual entitled to the deficiency, then the computation of deficiency relief will be unaffected by the new legislation.

Further advice

9. If you have any questions about this change, please contact Daniel Berry on 020 7438 7343 or Jon Sherman on 020 7438 7338.

www.inlandrevenue.gov.uk