IR12 29 November 1994 TAXATION OF LIFE ASSURANCE POLICYHOLDERS The Chancellor proposes in his Budget to * remove the condition which requires most life assurance policies to be certified by the Inland Revenue before gains made by policyholders can be exempt from tax; * update the Inland Revenue's audit and information powers; * reduce the charge to tax on gains on some foreign life assurance policies and life annuity contracts; * publish draft clauses during the coming year with a view to a wider reform in 1996 of the rules for taxing gains arising to holders of life assurance policies, annuity contracts and capital redemption policies. The reduction in the charge to tax on foreign policies and contracts will apply, where claimed, to gains made on or after today and also to earlier gains where the liability to tax has not yet been finally settled. The changes to the audit and information powers will take effect on Royal Assent. The requirement for certification will be abolished with effect from 5 May 1996, on which date it is proposed that the wider reforms of policyholder taxation should take effect. The Chancellor's intention is to simplify the rules for determining liability to tax on policyholder gains and to ensure that the rules take due account of the European single market for life assurance. As such, they complement the measures announced on 31 October last affecting the tax treatment of life assurance business with overseas residents. DETAILS 1. The rules for taxing holders of life assurance policies distinguish between two types of policy. The first category comprises policies under which regular premiums of a reasonably even amount are payable, usually over a minimum period of ten years, and which secure a guaranteed capital sum payable on death. Provided such a policy is maintained for a minimum period the proceeds on surrender or maturity are exempt from income tax. 2. Other policies fall into the second category. On surrender or maturity of such a policy, or on a claim following the death of the life assured, the amount of any taxable gain is calculated. The taxable gain is usually the difference between the policy proceeds (the surrender value in the case of death) and the premiums paid, but there are special rules for calculating gains on the partial surrender of a policy. 3. For policies sold from an office in the United Kingdom, a gain arising to an individual is charged to tax only where the gain, when added to other income, gives rise to liability, or additional liability, at the higher rate of income tax. The charge to tax is at the difference between the higher and basic rates. 4. The conditions which have to be satisfied for a policy to fall within the first category are complex. A policy can only come within that category if it, or a standard form of the policy, has been certified by the Inland Revenue as complying with those conditions. This administrative requirement will be removed with effect from 5 May 1996. After this date insurers will not have to obtain a certificate from the Inland Revenue for gains on policies to qualify for exemption. 5. It is proposed that at the same time new rules for determining which policy gains should qualify for exemption will take effect. The objectives of the reform will be to simplify the rules, to modernise them to reflect developments in policy design since the current rules were framed, to eliminate anomalies in the charging provisions, and to recast the rules for calculating gains on partial surrenders so that they operate more fairly as between policyholders and the Exchequer. Draft clauses will be published next year so as to give insurers time to prepare for the changes. 6. Where a gain on a life insurance or capital redemption policy or on a life annuity contract arises, the insurer is required in most cases to notify the Inland Revenue. At present that requirement only applies to the insurer which sold the policy or contract and not to an insurer to which the business which includes the policy or contract in question has since been transferred. In this situation the new rules will ensure that the requirement to notify the Inland Revenue falls on the transferee, not the transferor. They will also give the Inland Revenue the power to prescribe the form in which the notification is given. 7. The changes will also allow the Inland Revenue to audit insurers to ensure compliance with the requirement to notify gains on such policies and contracts. 8. The changes to the audit and information powers will take effect on Royal Assent. 9. Under current rules most gains arising to holders of life assurance policies written by insurers selling into the United Kingdom from abroad are added to taxable income so that there may be a liability to lower and basic rate tax as well as at the higher rate. This differential treatment recognises that the foreign tax system to which the insurer is subject may not, unlike the United Kingdom system, tax the investment income and gains accruing for the eventual benefit of the policyholders. 10. The European Community Third Life Insurance Directive will make it easier for European life insurers to sell their products cross-border. In recognition of this, new rules are being introduced which will restrict the charge to tax on the holder of a policy written by such an insurer to the difference between the higher and basic rates of tax, in the same way as for the holder of a United Kingdom life policy, provided that: - the insurer is based in a state which is a member of the European Union or another country which is part of the European Economic Area; - in its Home State the insurer is taxed on the investment income and gains accruing for the benefit of its United Kingdom policyholders at a rate of not less than 20 per cent - the insurer has not reinsured the investment content of the policy. 11. There will be similar changes to the rules for holders of life annuity contracts and capital redemption policies where the insurer sells into the United Kingdom from abroad. 12. The changes affecting holders of policies and contracts written by other European insurers will apply to gains arising on or after today, and also to earlier gains where the tax liability on those gains has yet to be finalised. The policyholder will need to claim the benefit of the rule change but the Inland Revenue will be taking steps to identify cases where a claim may be appropriate. NOTES FOR EDITORS 1. Details of membership of the European Economic Area were given in an Inland Revenue Press Release of 9 February 1994, "European Economic Area Agreement". 2. Details of the proposals concerning the tax treatment of life assurance business with overseas residents were given in an Inland Revenue Press Release of 31 October 1994, "Overseas Life Assurance Business". Press enquiries to: 071-438-6692/6706/7327 (out of hours: 0860-359544)