The Inland Revenue has closed the deficiency relief tax avoidance loophole, which had allowed higher rate taxpayers to offset the losses of life insurance policies against any higher rate income tax.
Life office officials say use of deficiency relief – under section 549 of the Income and Corporate Taxes Act 1988 – is a practice recognised to be against the spirit of the original Revenue proposals and few firms encouraged its use, because deficiency relief had never been intended to allow higher-rate taxpayers to offset the income of a life insurance product against their earned interest.
Deficiency relief allows a deduction against an individual’s total income for the year in which the policy matures or ends, and allows the relief to be set at the difference between higher rate tax and basic, lower or dividend rate – so earned income could be paid at 18% tax rather than 40% and interest income could be paid at 20%.
That has now changed and any policy which is assigned or is used as security for a debt, within a life insurance policy – such as a bond - a life annuity contract or capital redemption policy and continues to pay premiums is subject to the Revenue change.
Anne Young, senior technical manager at Scottish Widows, points out a basic rate tax payer could create the loss by investing £10,000 in a bond and make a partial withdrawal or surrender of £8,000 for example, at some point.
Once the withdrawal is made, the policyholder could then ‘sell’ the investment onto their spouse - who is a higher-rate tax payer - in order to generate an artificial loss rather than a gain.
Even if there is a gain on the product of £1,000, for example, says Young, the fact that a withdrawal was made will trigger a chargeable event. As a result of the money already taken, what should seem like a fund worth £11,000 or a £1,000 gain, the fund instead holds just £3,000, and appears as a loss offering tax relief because deficiency relief is set on amounts under £7,500.IFAonline
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