Estate planning bonds

[Nonimous]

Client died in 2008 having put money in an Isle of Man estate planning bond.

This has now been encashed by the trustees (who did not ask for professional advice first, but hey...)

Since it was a discretionary trust and the policy was cashed in by the trustees in a tax year after the one in which the settlor died, the chargeable gain is taxable on the trustees, with £1000 at 20% and the rest at 50%. I'm about 99% sure I am OK so far but would appreciate any points anyone else has.

Now. Since we have income on a tax return, with income tax charged, does this mean that there is or can be an income distribution to the beneficiaries, so that at least some of that 50% can be got back? I appreciate that notional tax is generally nonrefundable thus could not be used to 'frank' distributions, but as mentioned earlier, this policy was in the Isle of Man, thus no notional tax was deducted at source.

[Anthony Nixon]

Yes you are right.

The tax paid on encashing the bond forms part of the trustees’ tax pool. It falls within Type 1 in ITA s498 (not Type 3A which applies to tax on gains on UK policies where there is a credit for basic rate) because of ITA ss 481 and 482 (where it is Type 7 in s 482).

To give them the benefit of the tax credit you need to ensure that the beneficiaries receive their payments as income (ITA 2007 s493). It may be useful to spread the payments over this and the next tax year to get the maximum credits for the beneficiaries, depending on their individual tax positions.

If you would like to discuss this further, do get in touch.

Anthony Nixon CTA TEP Solicitor
Partner, Thomas Eggar LLP, Southampton and Chichester
anthony.nixon@thomaseggar.com
023 8083 1224

[maths]

Anthony

May I raise one or two issues as I'm not sure I agree with your comments.

The "chargeable event" legislation deems what would otherwise be a "capital receipt" as income and an income tax charge arises; in this case on the trustees.

However, any distributions made by the trustees to a beneficiary would, i suggest, be a capital and not income distribution on the part of the recipient beneficiary. Even if the trustees make distributions over a period of time this will be insufficient to turn capital into income.

Certainly my understanding, with one or two exceptions, is that distributions out of capital are regarded by HMRC as capital on the part of the beneficiary.

If the trust was a life interest trust the life tenant would not be entitled to any part of the chargeable gain arising from the chargeable event.

I would appreciate your comments.

[tax_schmax]

A word of caution. There are a few insurers on the Isle if Man who offer very spohisticated IIP trusts designed to be used with a hybrid endowment / life assurance bond structures. It could be that this is one such plan. If you are able to be more specific in relation to the bond / trust, I may be able to put you in touch with either the architect of the plan or someone equally close to the structure.

[Nonimous]

Looking now at TSEM 3767 and TSEM 3220, it would appear that the life insurance gain is a capital distribution since it is only regarded as income for tax purposes.

[Nonimous]

Taxschmax, it's a fairly mainstream insurer's bond.

[Anthony Nixon]

Just because something is described as a gain does not mean that it is necessarily a CAPITAL gain.

Certainly the repayment of the original purchase price of the investment bond is capital.

But there is nothing to stop trustees treating the gain as an income receipt, if that is what they consider it to be, and recording it in the trust accounts as income. After all, there is no other income from the bond.

Neither TSEM 3767 nor 3220 says that gains from investment bonds are to be treated by trustees as capital, and both sections of the manuals would be wrong to do so.

3220 only refers to “capital items” in its heading and this must be a form of shorthand for “what might be thought of as capital items”.

3767’s example is a premium on a lease which is a completely different concept.

And there is the recent case of Taube, ruling that a special dividend received by trustees was income, not capital, even though its value was equivalent to the entire market value of the shares.

If the trustees take the decision to credit the gain on the bond to income account and distribute it to the beneficiaries from income, there is nothing that the Revenue can object to.



Anthony Nixon

[maths]

I still disagree with Anthony Nixon’s comments.

A life policy (bond) is a capital asset although not a chargeable asset for CGT purposes (TCGA 1992 s210) and accordingly any “gain” arising thereon is not subject to CGT; it is certainly not income and hence the need for special legislation which deems the “gain” to be income for income tax purposes.

The nature of the “gain” is a capital receipt and cannot simply be credited to an income account by the trustees enabling payments to beneficiaries to then be treated as income receipts.

The Taube case is of no help re the current discussion.

[Nonimous]

TSEM3220 does however state that gains on foreign life insurance policies are capital items taxed as income.

[Nonimous]

and I had always understood that insurance bonds and the like were classed as non-income-producing anyway?
My tax software will allow me to distribute this gain as income, but it seems highly debatable as to whether it should!