INVESTMENT BONDS, TOP SLICING AND THE PERSONAL SAVINGS ALLOWANCE

Top slicing relief (TSR) for bond chargeable gains is a useful, if somewhat complex, income tax planning tool for bonds held by individuals.

The relief is in place to recognise the fact that a bond gain could have been the result of growth over many years and allows for a spreading mechanism to apply. In general terms, TSR can apply where a bond gain moves the individual into the higher or additional rate tax band. However, if there is any of the starting rate band or personal savings allowance available to set against the gain, there is also scope for TSR to apply even if an individual is already a higher rate taxpayer prior to adding the gain to their income. This can produce some surprising results, as set out in the example below.

Assume that a client has earned income of £80,000 per annum and that they have no dividend or savings income. They surrender segments of an offshore investment bond that gives rise to a chargeable event gain of £20,000. The segments surrendered had an investment term of 20 years.

The process for calculating the top slicing relief can be found in HMRC Insurance Policyholder Taxation Manual from IPTM3820 – Top slicing relief: general – HMRC internal manual – GOV.UK onwards.

Step 1: Calculate the total taxable income for the year and identify how much of the gain falls within the starting rate for savings, personal savings allowance nil rate, basic, higher or additional rate bands as appropriate.

Income:

• £12,570 Personal Allowance @ 0%                    =          £0
• £37,700 basic rate band @ 20%                          =          £7,540
• £29,730 higher rate band @ 40%                         =          £11,892

Offshore bond gain:

• £500 Personal Savings Allowance @ 0%           =          £0
• £19,500 higher rate band @ 40%                         =          £7,800

Step 2: Calculate the total tax due on the gain across all tax bands. Deduct a notional basic rate tax credit to find the total liability for the tax year.

Tax on offshore bond gain                                               =          £7,800

Notional basic rate tax credit £20,000 @ 20%             =        £4,000

Total liability: £7,800 – £4,000 = £3,800

Step 3: Calculate the annual equivalent of the gain (also known as the ‘slice’). The annual equivalent is calculated by dividing the gain by N.

£20,000 / 20 = £1,000

Step 4: Calculate the individual’s liability to tax on the annual equivalent. Deduct a notional basic rate tax credit on the annual equivalent and multiply the result by N. This gives the total relieved liability.

£500 Personal Savings Allowance @ 0%                     =          £0
£500 higher rate band @ 40%                                        =          £200

Notional basic rate credit on slice: £1,000 @ 20%     =          £200

Total relieved liability: £200 – £200                               =          £0

Step 5: Deduct the total relieved liability at step 4 from the total liability at step 2 to give the amount of top slicing relief due.

Top slicing relief: £3,800 – £0                                          =          £3,800
Tax due on Offshore Bond Gain: £7,800 – £3,800        =          £4,000

So, despite being a higher rate taxpayer for income purposes, the effective rate of tax on the bond gain is only 20%.  So, careful planning around the use of the personal savings allowance can lead to significant reductions in tax on bond gains.

If you have any questions, please feel free to contact the Technical Services team.

All information is based on our understanding and interpretation of applicable law and regulation which is subject to change. Tax treatment depends on individual client circumstances and may change in the future.