Clarity on earlier bond encashments

The issue

“Everyone loves a top-slicing relief calculation”, said nobody ever.

Calculations for tax payable on onshore and offshore bond encashments can be extremely complicated and advisers often rely on their software to give them the correct answer. As the legislation is particularly complex, if advisers do ‘brave it’ and undertake the calculation themselves, they may rely on the HMRC manuals to give guidance. Unfortunately, as we originally contested and as recent tax cases have ascertained, HMRC’s manuals and the software calculations do not align with the legislation for gains that arose pre 11 March 2020.

If we roll back to May 2019, our Tax Bite (‘Top-slicing relief – latest developments’) highlighted the Marina Silver v HMRC Commissioners case, which was decided in favour of the taxpayer. This found that the taxpayer was allowed a personal allowance when calculating the tax payable under the top-slicing calculation (which included the much lower average annual chargeable event gain), even if the total income (which included the full chargeable event gain) exceeded the level at which the personal allowance was tapered or removed.

HMRC went to appeal but then withdrew at the last minute and subsequently changed the legislation in Finance Act 2020 for future gains, to limit (to some extent) the application of that case. Specifically, the new legislation does not allow other reliefs such as the personal savings allowance to be reinstated, or to apply reliefs in the most beneficial order. It does allow the personal allowance to be claimed though, where relevant.

Despite losing the case, HMRC have still refused historical overpayment claims on the basis that the incorrect calculations followed “practice generally prevailing” and also argued that the other changes (non-reinstatement of other reliefs and no beneficial ordering) in Finance Act 2020 were retrospective! Essentially, they were ‘having their cake and eating it’. This has caused problems for taxpayers attempting to reduce their tax liabilities in line with the case result.

The latest decision

Fortunately, another case, Judges, has just been won by the taxpayer (judgement delivered on 18 February 2022).This will be extremely helpful to those taxpayers frustrated by HMRC’s obstinacy in respect of these earlier gains.

The three major points that were decided are:

1. The Finance Act 2020 changes only affect encashments post 11 March 2020;
2. The ability to set your allowances and reliefs in the most beneficial way possible against your income, applies both in the calculations with the full gain and the average annual gain (i.e., the two comparable calculations are undertaken in a similar way) on gains realised to 11 March 2020;
3. The personal savings allowance, starting rate band for savings, personal allowance and any other income tax reliefs or allowances, must be included in the average annual gain calculations for gains realised before 11 March 2020.

One further point is that the beneficial ordering of reliefs/allowances must be done before any notional tax paid (20%) by the onshore bond is deducted. In other words, the income tax liability, rather than the income tax payable, must be minimised. This has some strange results in that:

1. It can offer much higher top-slicing relief for gains arising before 11 March 2020;
2. It can result in greater tax payable, compared to HMRC’s self-assessment calculator (on which most tax software will be based) for gains post 11 March 2020. However, until we have access to the full case analysis it is unclear exactly how the reliefs and allowances must be applied for gains after 11 March 2020.

Forbes Dawson view

This is a long-standing saga in a complicated area of the legislation, where HMRC have been digging their heels in and refusing to accept the previous judgement. Hopefully, this now settles the issues once and for all for those earlier encashments. It will also be necessary to revisit and to fully understand the effect the Finance Act 2020 has on these calculations going forward; don’t rely on previous understanding as that may be incorrect.

Practically, a review should be undertaken of any bond encashments made in the tax years 2017/18 to 11 March 2020. Under the usual four year window, taxpayers have until 5 April 2022 to file an overpayment claim for 2017/18.

 

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