Article: The UK tax treatment of offshore life policies
Author
Charles Cooper
Date
June 2023
Offshore life policies are commonly used in tax planning, but their tax treatment can be complicated and, potentially, disproportionate.
Typically a single substantial premium is paid for such a policy by the ‘policyholder’, and the policy pays out on the death of the ‘life assured’ or on an earlier surrender of the policy.
Placed into trust for the benefit of one or more individuals, an offshore life policy should fall out of the policyholder’s estate for Inheritance Tax purposes, but if the trust is drafted poorly it may be invalid so that where the policyholder dies before the life assured the value of the policy is treated as an asset in the policyholder’s estate.
While a gain accruing on the disposal of such a life policy should not be a chargeable gain for Capital Gains Tax purposes (s.210 TCGA 1992), it would be subject to the Income Tax regime applicable to life policies, known as the ‘chargeable event regime’, set out in ITTOIA 2005, Part 4.
Such ‘chargeable events’ may include (at s.484 ITTOIA 2005): (i) complete or partial surrender of the policy; (ii) assignment of rights under the policy for money or money’s worth; and (iii) payment on maturity of the policy i.e. on the death of the last ‘life assured’.
In the case of partial surrenders or assignments the deemed gain is determined by either a ‘periodic calculation’ (s.498(2) ITTOIA 2005) with a tax-free withdrawal allowance of 5% of the premium each insurance year up to the 20th year, or a ‘transaction-related calculation’ (s.510 ITTOIA 2005), whereas on a complete surrender or assignment the gain is determined by a simple calculation of the difference between the premium paid and the total benefit value (ss.491-494 ITTOIA 2005).
Who is liable to pay the tax is determined by how the policy is held immediately prior to the chargeable event in question (s.464(1) ITTOIA 2005). For example: (i) where the policy is held by a non-charitable trust, and the policyholder who created the trust is a living UK resident, the policyholder is liable (s.465(3) ITTOIA 2005) regardless of whether the trust is UK resident or not or whether the policyholder can benefit from that trust; (ii) where the policyholder has died and the policy is held by a UK resident trust, the trustees may be liable (s.467 ITTOIA 2005); or (iii) where the policyholder has died and the policy is held by a non-resident trust the ‘assets abroad code’ applies (s.468 ITTOIA 2005) with either the transferor becoming liable (under ss.720-730 ITA 2007) or the individuals in receipt of benefit (under ss.731-735C ITA 2007).
The effect of the legislation can mean that a taxpayer finds themselves liable to disproportionate chargeable event gains (for example in Lobler [2015] UKUT 152 (TC) partial surrenders of the policy resulted in an effective tax-rate of 779%) so it is important that the tax treatment of such policies is reviewed before any chargeable event occurs.
Charles Cooper | Barrister 