This wasn’t mentioned in the Chancellor’s speech, but draft legislation has been produced to insert a clause into S536 and S537 of the Income Tax (Trading and Other Income) Act 2005, which deals with calculating an individual’s liability for tax on an investment bond, and the application of “top slicing”.
Investment bonds are a non-income producing asset, so generate no tax liability unless there is a “chargeable event”. In the event of a chargeable event, the gain is realised and is treated as income for the purpose of taxation. In view of the fact that investors could be disadvantaged by being taxed in a single year on gains that have accrued over a period of time, ‘top slicing relief’ spreads the gain over a number of years and aims to tax the “slices” as opposed to the full gain.
The idea is that a taxpayer will only have a higher rate liability on the gain realised if any of the “top slice” of the gain falls into the higher rate tax bracket.
For example:
A UK investment bond is held for just over 18 years, then surrendered in March 2020. The gain on the bond value over the period was £180,000. The bond owner has other taxable income of £30,000.
If the full gain was added to the individual’s income, the majority of the gain would be subject to tax based on the higher rate. Due to top slicing, however, the top slice gain is only £10,000 therefore does not extend into the higher rate, and so there is no higher rate tax liability.
Impact on the Personal Allowance
The personal allowance is the first part of taxable income on which no tax is paid – currently it is £12,500. This allowance is tapered away, however, where taxable income exceeds £100,000. For every £2 over, the Personal Allowance is reduced by £1.
To date HMRC have taken the view that the full (pre top slice) gain of an investment bond is considered when determining if the individual will lose any of the personal allowance. In our example, therefore, the individual would completely lose their personal allowance. As a result, some of the top slice gain would fall into the higher rate band, and they would have a higher rate liability. It has been argued that this approach is rather unfair, as was highlighted in the 2019 court case Marina Silver v The Commissioners for HMRC.
The impact of the proposed changes
The amended legislation will result in top slicing being applied before determining if the gain removes any of the personal allowance. This was also the outcome of the Silver v HMRC case. This is therefore a much improved position for investment bond holders, especially for larger bonds which have been held for many years.