Writing for Taxation magazine’s Readers’ Forum, BKL tax consultant Terry Jordan responds to a reader’s query about the tax treatment of beneficiaries in respect of the encashment of a life insurance bond.
‘Peter died in 2017 leaving his entire estate to a trust of which his wife Clara was the life tenant and his two adult nephews, Fred and George, the beneficiaries. Clara died in January 2022, leaving no assets of her own. At her death the trust ceased and the assets are to be equally split by the nephews (based on the amounts involved no IHT liability is anticipated).
Peter and Clara were both UK resident and domiciled but Fred and George have always lived in France, where they are tax residents. Peter’s estate solely comprised of £150,000 in cash, with which the trustees acquired a life insurance bond from a UK provider shortly after Peter’s death.
The bond, insured on the lives of Fred and George, was last month encashed for £185,000 and with the surrender being a ‘chargeable event’ (under TA 1988, s 552) the policy provider calculated a gain of some £35,000 crystalised on the surrender, with a notional tax at the basic rate of 20%.
The tax treatment on the beneficiaries in respect of the encashment of the bond is not clear to me. Will they benefit from the capital gains tax uplift now Clara has passed away (which would eliminate the gain almost in full)? Or are the nephews subject to income tax at their marginal rate on their full share of the gain? As EU residents they qualify for a UK personal allowance/exempt amount which should mitigate any liability.
I would appreciate readers’ comments.’ Query 19,984 – Sovereign.
Terry Jordan’s reply: Fred and George are not liable to UK tax but will need French tax advice.
‘We are told that when Peter died in 2017 his will created what is now called an immediate post-death interest for his widow, Clara. On the figures it seems that inheritance tax is not of concern.
The will trustees invested in a (non-qualifying) life insurance bond. There are many advantages to trustees investing in a life assurance investment bond but the taxation of such bonds continues to cause some confusion.
Although reference is made to ‘gains’ realised on encashment the charge to tax on ‘chargeable events’ is to income tax and not capital gains tax. Accordingly, there was no uplift to market value on Clara’s death as there would have been on assets within the scope of CGT. As the lives assured were Fred and George, Clara’s death did not of itself occasion a chargeable event; that occurred when the bond was encashed. By then the trustees would have been holding as bare trustees for Fred and George who became absolutely entitled on their aunt’s death.
When bonds are held on non-charitable trusts the gains are taxed on the settlor if he is available to be charged. Perhaps counter-intuitively a settlor is charged if gains are realised by the trustees in the tax year of death, even if the settlor is no longer living. Those provisions are not in point here.
As stated in HMRC’s Insurance Policy Taxation Manual at IPTM3734 when a gain arises from a UK policy and the individual is not resident in the UK, the gain is not subject to tax in the UK. However, this does not apply if the period of non-UK residence is temporary.
Fred and George are long-term residents of France and so are not liable to tax here and it is not necessary to consider ‘top-slicing’ relief. They will, however, need advice on French taxation.’
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