IPTM1310 - Development of policyholder taxation: chargeable events

FA68 introduced a distinction between qualifying and non-qualifying policies. Very broadly, this recognised the development of a growing distinction between ’protection type’, and ’investment type’ life assurance products.

This distinction is a difficult one to draw because there is a continuous spectrum between pure protection, or term, insurance at one extreme, and investment policies where the life protection element is essentially a formality. It was held by the Court of Appeal in the insurance case of Fuji Finance Inc v Aetna Life Insurance Co Ltd & Another that even a policy that offered no mortality benefit, but paid out on death only the value of the underlying investments, is life assurance if it is sold by a life insurance company.

By 1968 it was recognised that large amounts of investment were flowing into short-term, investment-orientated policies, often single premium based. This called into question both the granting of relief and the practice of relying on the insurer’s policyholder slice of tax to satisfy the policyholder’s liability. By that is meant that insurers pay tax on the part of their profits attributable to the policyholders’ investment return. In 1968, this tax was broadly equivalent to the standard rate of income tax, predecessor of the basic rate, charged on those profits. It meant that surtax payers, the equivalent of those liable at higher rate, enjoyed a significant advantage.

The solution to what were seen as anomalies was to restrict premium relief to qualifying policies and to introduce what is sometimes now called an ’exit charge’ to surtax, now higher rate tax, when certain events take place that result in the realisation of value from a policy. The definition of these ’chargeable events’ varies depending on whether or not the policy is a qualifying one, and qualifying policies often escape charge altogether.

The main conditions, described in more detail at IPTM2020 and IPTM8005 onwards, are

• minimum 10 year policy term
• broadly even spread of premiums, payable at least once a year
• originally for endowment policies, and from 1976 for term and whole of life policies, a minimum sum assured equal to 75% of the premiums payable for the duration of the contract.

To meet industry concerns, and to prevent avoidance, the rules were and are complex.