IPTM3597 - Calculating gains - recalculating a wholly disproportionate gain under ITTOIA05/S507A and S512A: examples
The examples below are hypothetical and are only intended to give an indication of the factors that HMRC may consider. They should not in any way be regarded as model answers to a particular situation nor the ‘correct’ way to deal with similar cases. Real-life cases will have many other factors to take into account and each will be considered in the light of all relevant facts.
In each of these examples it is assumed that the gain does not form part of arrangements for obtaining a tax advantage for any person.
Example A
Policyholder A invests £300,000 in 100 identical life insurance policies on 1 May 2018. She withdraws by way of part surrenders across all policies £200,000 on 7 August 2018 and a further £6,000 on 10 December 2018. Under S507 the taxable gain arising at the end of the insurance year (i.e. 30 April 2019) is £191,000 (i.e. £206,000 withdrawn less the £15,000 5% deferred tax allowance – see IPTM1510) giving rise to an income tax liability of over £70,000. The actual economic gains on the part of the policies surrendered as at 7 August and 10 December 2018 is calculated as totalling £1,500. On 1 September 2021, an application under S507A is received from the policyholder together with supporting documentation.
Decision: As the application was received within the time limit allowed it is accepted for consideration. It is decided that the gain is wholly disproportionate as the £191,000 gain is out of all proportion to the underlying economic gain. It is a very large percentage of the premium paid and furthermore it results in a significant tax charge for the policyholder. It is therefore decided that the just and reasonable basis for the gain would instead be the actual economic gain. The S507 gain of £191,000 arising on 30 April 2019 is then replaced with a gain of £1,500.
Example B
Policyholder B invests £100,000 in a life insurance policy on 5 April 2018. On 15 December 2018 she withdraws by way of part surrender £15,000, giving rise to a gain under S507 of £10,000 (i.e. the £15,000 withdrawn less the £5,000 5% deferred tax allowance) with a resulting tax charge of £2,000. The economic gain on the policy as a whole at the end of the year was £2,000, meaning the actual economic gain on the part surrendered is £295. On 14 October 2019, an application under S507A from the policyholder is received by HMRC together with supporting documentation.
Decision: As the application was received in time, it is accepted for consideration. It is decided that the gain is not wholly disproportionate. This is because whilst the £10,000 gain is far in excess of the underlying economic gain of £295, it is not a large percentage of the premium paid nor is the tax chargeable significant. No recalculation is made and the gain of £10,000 stands.
Example C
Policyholder C invests £100,000 in a life insurance policy on 13 December 2019. On 17 August 2027 he withdraws, by way of part surrenders, £80,000 from the policy giving rise to a gain under S507 of £40,000 on 12 December 2027 (i.e. the £80,000 withdrawn less the £40,000 5% deferred tax allowance for eight years). The economic gain on the part surrendered as at 17 August 2027 was £29,250.
On 16 March 2028 an application under S507A from the policyholder is received by HMRC together with supporting documentation.
Decision: As the application was received in time, it is accepted for consideration. It is decided that the gain is not wholly disproportionate. Whilst the £40,000 gain is a large percentage of the premium paid it is not wholly disproportionate to the underlying economic gain of £29,250. No recalculation is made and the gain of £40,000 gain stands
Example D
Policyholders D1 and D2 invest £80,000 in a UK life insurance policy on 10 April 2019. On 19 January 2021 they withdraw £35,000 giving rise to a gain of £27,000 (i.e. £35,000 withdrawn less the two years 5% deferred tax allowance of £8,000). The underlying economic gain is just £1,000. Each policyholder is liable for tax on a gain of £13,500 arising on 9 April 2021. The effect of top slicing relief and the non-repayable basic rate tax credit mean only £2,000 of the gain is chargeable at higher rates. On 1 March 2025 a joint application under S507A from the policyholder is received by HMRC together with supporting documentation.
Decision: As the application was received in time, it is accepted for consideration. It is decided that the gain is not wholly disproportionate. The gain is out of all proportion to the underlying economic gain and is a large percentage of the premium paid. However it has not resulted in a significant tax charge for either of the policyholders. No recalculation is made and the gain of £27,000 stands.
Example E
Policyholder E invests £100,000 in a life insurance policy on 15 June 2018. On 20 November 2018 they withdraw £20,000 and on 1 June 2019 a further £25,000. This gives rise to a gain of £40,000 on 14 June 2019, on which tax of £15,000 is payable. As at 20 November 2018 there is no underlying economic gain on the policy but at 1 June 2019 it is £4,000. On 13 December 2019 an application under S507A is received by HMRC with supporting documentation.
Decision: As the application was received in time, it is accepted for consideration. It is decided that the gain is wholly disproportionate as the £40,000 gain is out of all proportion to the underlying economic gain. It is a large percentage of the premium paid and furthermore it results in a significant tax charge for the policyholder and the withdrawal of child benefit for the year. It is therefore decided that the just and reasonable basis for the gain would instead be the actual economic gain. There is no gain on the first part surrender. On the second part surrender the gain is:
| Value of part surrender | £25,000 |
|---|---|
| Less | |
| Premium related to that part surrendered | (£23,810) |
| [Premium x Value of part surrender/Value of whole policy] | |
| [£80,000 x £25,000 / £84,000] | |
| Underlying economic gain on part surrendered | £1,190 |
The gain of £40,000 is replaced with a gain of £1,190.