Skandia is liable to taxation in respect of the funds to which your client’s contract is linked. Although any taxation deducted cannot be recovered, a 20% tax credit is available (see below).

Policy gains

a. Basic points to note:

If your client is a UK resident throughout the period their contract is in force they will be liable to UK income tax in respect of any policy gains arising under the policies comprising their contract.

All gains will be free of basic rate income tax as tax had been deducted already. They will however be liable to 20% or 30% tax if their total taxable income, taking into account their policy gains after any ‘slice relief’ (see Higher rate income tax below), exceeds the higher and/or additional rate income tax thresholds.

The additional tax at 20% would be payable for taxable income in excess of £37,400, up to £149,999 and at 30% for taxable income above £150,000 in 2010/11.

In 2010/11, an individual’s personal allowance will be lost in whole or part where the income exceeds £100,000. For the purposes of investment bond gains, the whole gain must be added to the individual’s income for the year of assessment to see whether the personal allowance is affected and not just the sliced gain.

Your client will be responsible for declaring the payment in their next self-assessment tax return to their local inspector of taxes and personally settling any liability.

Skandia will report certain payments and events affecting investors. However, it remains an obligation of the policyholder to report any gains that effect their income tax liability  to HM Revenue & Customs irrespective of amount, even if they do not receive a tax return.

Policy ‘gains’ are taxed under special income tax rules for life assurance policies, not under the CGT rules which sometimes apply to investments.

b. When do ‘Gains’ arise?

Policy gains may arise in the following situations:

• when withdrawals are taken from your client’s contract by partial surrender of the policies in their contract
• when a withdrawal is taken by full surrender of one or more policies in their contract
• when loans are made by Skandia (or by arrangement with Skandia) on security of the policies in their contract, although currently no such facility is available
• when their contract is fully encashed, either on full surrender of all the policies or on the death of the relevant life assured
• when their contract is assigned for consideration in ‘money or money’s worth’.
  The contract is issued as a group of policies, so that when taking withdrawals from the contract, investors can either partially surrender all the policies or fully surrender individual policies to suit their particular tax position.

c. Partial surrender of policies

Withdrawals by partial surrender of policies will not result in policy gains under the tax rules provided the amounts withdrawn do not exceed the partial surrender withdrawal allowance. Each policy in your client’s contract has its own separate allowance. For each premium under the policy concerned the allowance is 5% of the premium for the policy year in which it is paid and a further 5% allowance accrues at the start of each subsequent policy year for the next 19 years.

If investors exceed the 5% allowance, the whole of the excess will be treated as a policy gain, which will be deemed to arise on the last day of the policy year in which the excess occurs. The tax rules for calculating partial surrender gains ignore actual investment performance.

d. Full surrender of individual policies

The policy gain calculation on full surrender of a policy takes into account investment performance and any previous sums treated as partial surrender gains under the policy concerned.

The gain is the amount by which the proceeds from the policy, including any previous partial surrender proceeds, exceed the premium(s) and any previous partial surrender gains. If there is no excess then there is no gain and no charge to tax on full surrender of the policy.

e. Full encashment of the contract

On full encashment, the gain arising under the contract as a whole will be the sum of the full surrender gains under each of the policies then comprising the contract.

Basic rate income tax

No liability to this tax arises.

Higher rate income tax (HRT)

a. If your client’s other taxable income is liable to HRT

In this situation effectively the whole of your client’s policy gains will be liable to marginal rate tax (40% - 20%). Currently there is just one higher rate (40%) on all taxable policy gains over £37,400. Thus if their other taxable income exceeds £37,400 their net policy gains under their Skandia contract policies will bear income tax at 20%.

The slice relief provisions outlined in b. are not relevant to this situation.

b. If your client’s other taxable income is only liable to basic rate income tax

In this situation, the slice relief provisions may reduce or avoid higher rate income tax at 20% in respect of policy gains arising in the tax year.

Each gain arising in the tax year, net of any time apportionment relief in the case of an offshore policy, is divided into a ‘slice’ by reference to the appropriate slice relief period for the policy concerned. The resulting slices are then added together into an aggregate slice. For instance if your client has gains under two policies, each with a slice relief period of five years, and the gain under each policy is £2,000 (total gains of £4,000), the slice for each gain will be £400 (ie £2,000 divided by 5) and the aggregate slice for calculating any higher rate income tax will be £800.

For a gain under an onshore policy the slice relief period is the number of complete policy years, from the date the policy commenced to the date of the chargeable event when the gain arises. However, in the case of partial surrender chargeable events, if the current event follows one or more previous events the slice relief period for the current event is restricted to the number of complete policy years since the most recent previous event.

The aggregate slice for all the policy gains in the tax year is added to your client’s other taxable income. Marginal rate income tax only arises if the total exceeds the higher rate income tax threshold. In that situation higher rate income tax on the excess over the threshold is calculated and converted into a tax rate by reference to the aggregate slice. That tax rate is then applied to all the policy gains.

Example

Taxable income is £36,900. Using the slice relief example above, the aggregate slice is £800. Therefore £300 is in excess of the Basic Rate Threshold. £300/£800 x 20% is 7.5% effective tax rate. This tax rate is then applied to £4,000 policy gains.

50% rate

An extra 10% will be levied on the element of slice falling above the £150,000 threshold. Principally all the gain above £37,400 to £149,999 will suffer 40% then the additional part of the slice above £150,000 will suffer a further 10%.