.png)
.png)
I have been asked to assist relevant to the taxation liabilities of executors concerning a reasonably wealthy individual who died 18 months ago. The deceased person held a number of with profit bonds which resulted in chargeable events on death. The chargeable event certificates show a surrender value or policy value at or very close to the date of death.
I have been asked to assist relevant to the taxation liabilities of executors concerning a reasonably wealthy individual who died 18 months ago. The deceased person held a number of with profit bonds which resulted in chargeable events on death. The chargeable event certificates show a surrender value or policy value at or very close to the date of death.
The executors are aware that when the policy proceeds are actually paid out (this has been anything up to 12 months since the death), the estate has actually received a greater or lesser value than the surrender value or policy value on death. This is quite routine according to the life assurance offices. For instance, a policy with an 'at death' value or surrender value at, say, £50,000 has actually been realised six months later at a value of, say, £52,000.
The surrender value or policy value on death has been reported on the individual person's income tax return up to the date of death. Therefore we believe that the executors' liabilities to tax 'commence' with the probate value. Is this correct?
We are led to believe that the value realised, which may be different from the surrender value or policy value on death, carries with it an untaxed profit or loss which does not have to be reported by the executors on estate income tax returns. It is this void effect for capital gains tax and income tax which we would like readers' observations on. Is our understanding correct?
(Query T15,977) - Bereaved.
I can confirm that where, in connection with a policy of life assurance, a chargeable event occurs by reason of the death of the life assured, the chargeable gain is calculated by reference to the surrender value of the policy immediately before death, in accordance with section 541(1)(a), Taxes Act 1988.
Section 547(1)(a) provides that where immediately before the happening of the chargeable event in question the rights conferred by the policy are vested in an individual as beneficial owner, the amount of the gain shall be deemed to form part of that individual's total income for the year in which the event occurred. This gain is thus income of the deceased and should be reported on the deceased person's income tax return for the tax year of death.
With-profits bonds are normally issued as unitised contracts. There are several reasons why the amount actually payable to the personal representatives will be different from the value on which the gain calculation is based:
* The death benefit is normally expressed as 101 per cent of the bid value of the units. As with any life policy, this 1 per cent mortality benefit is not subject to income tax.
* The life office may pay a death benefit determined by reference to the price of units at the date of notification of death. If unit prices have risen in the period between the date of death and the date of notification of death, this will be reflected in the amount paid.
* If death occurs in the first five years of the policy term, the surrender value may reflect an early encashment penalty, whereas the death benefit will not.
* The surrender value of the policy immediately before death may include a market value adjuster, whereas this is not normally imposed on payment of a death claim.
* Interest is normally added from the date the policy ceases to be linked to the with-profits fund to the date of payment of the claim. This interest will, of course, be income of the estate but will normally be paid after deduction of basic rate tax, satisfying the personal representatives' liability to tax.
There appears to be no provision for charging this additional element of gain to income tax. The proceeds of life assurance policies are also exempt from capital gains tax. This is certainly the accepted view of the industry.
In addition, where the death benefit is determined by reference to the price of units at the date of notification of death, in certain circumstances a proportion of the gain may also escape a charge to inheritance tax.
Assume that the life office pays out a death benefit equal to 101 per cent of the bid value of the units allocated to the policy, determined by reference to the unit price at the date of notification of death. The informal view of the Revenue would appear to be that the value for inclusion in the estate for inheritance tax purposes is 101 per cent of the bid value of the units at date of death, i.e. the price used to determine the unit price is purely for administrative convenience and incidental to the market value of the policy and the only increase to be taken into account for the purposes of section 171, Inheritance Tax Act 1984 is the additional 1 per cent payable by reason of the death.
If this view is correct, a delay in notification of death in a rising market could result in an element of totally tax-free profit! - Professor McGonagall.
The policies in question are classified as 'non-qualifying' policies and as such are subject to the particular taxation régime detailed in section 541, Taxes Act 1988; capital gains tax is not applicable in the circumstances outlined by 'Bereaved' (section 210, Taxation of Chargeable Gains Act 1992).
Where, as in the present case, death gives rise to benefits payable under the policy, section 541 requires that a 'policy gain' be calculated, which is then subjected to income tax charged as the deceased's income for the income tax period ending at the date of death; top slicing relief is applied, and the chargeable slice of the policy gain added to the deceased's other income for the relevant period to discover the amount of extra tax payable by reason of its addition. If the addition of the sum does not give rise to anything but tax at the basic rate, no tax is payable. If, however, extra tax is payable, the amount of that tax is then calculated, an average of that tax rate ascertained, the basic rate deducted and the resulting rate applied to the whole gain.
The key issue in dealing with 'Bereaved's' query is in the statutory methodology applied in calculating the 'policy gain', as it is this gain, and nothing further, that is brought into tax charge. Section 541 stipulates that on a death the policy gain is the amount by which the surrender value of the policy immediately before the death plus relevant capital payments, such as bonuses, exceeds the total amount paid by way of premiums together with any sums already treated as gains on earlier partial surrenders or assignments. However, the chargeable event régime does not seek to tax profit arising from the date of death, described in the Inland Revenue Assessment Procedures Manual (at paragraph AP3137) as the 'mortality profit' - hence the requirement only to take into account the surrender value immediately before the death.
Thus, were a non-qualifying policy to have a surrender value immediately before death of £10,000, a death benefit of £20,000 paid several months later, and a total premium on the policy paid by the deceased of £4,000, the chargeable policy gain is £6,000; the mortality profit of £10,000 is not taxable. - Legal Eagle.
Editorial note. Section 547(1)(c), Taxes Act 1988 contains a provision to treat policy gains as income in the hands of personal representatives. Paragraph 3258 of the Assessment Procedures Manual states that this is applicable in cases where a policy on the life of another passes into an estate. Presumably 'Bereaved's' policies ceased to have a life assured at the time of the death, which is perhaps why section 547(1)(c) does not apply to them.
