Tax Tuesday today highlights a potentially useful item for any taxpayers who might have realised a gain on an investment bond in the last two years. This relates to a helpful change in the way top-slicing relief is now calculated (and the fact that that change is effectively backdated two years – see below).
Because gains arising on encashment of investment bonds might typically have accrued over many years, the tax that arises in the year of encashment is subject to what is known as “top-slicing relief”.
This relief tries to ensure that the tax payable on the gain, which arises in one cumulative amount in the year of encashment, is restricted to the tax which would have accrued if the average annual amounts of that gain had been taxed as an addition to the taxpayer’s income (potentially within lower rates of tax than the large cumulative gain would suffer by arising in one go). So, the relief works by applying the relevant tax rate to the average annual gain amount and then multiplying the result by the number of full years for which the investment has been held. As noted above, this can serve to ensure that a taxpayer does not suffer higher tax rates than they “should”, simply because the gain is so large that it would otherwise break through one or more tax rate thresholds in the year of encashment.
The flaw in the calculations
For a long time, however, the top-slicing relief calculations suffered from a flaw in that the calculation was undertaken after the gain amount had already been taken into account in determining whether the taxpayer’s personal allowance was reduced (NB taxable income arising in a year in excess of £100,000 sees a tapering out of the personal allowance). Putting that another way, even though the average annual amount of gain might have meant that the taxable income for the taxpayer was notionally inside £100,000 for top-slicing relief purposes, the personal allowance might already have been reduced, irrespective, if taxable income, including the full cumulative gain, exceeded £100,000 for the year. This was found to be inconsistent (and inappropriate) in a tribunal case called Silver.
As a consequence of that case the law was formally changed for gains arising after 11 March 2020.
The additional good news and the potential opportunity for refunds
The revised law is good news, of course, but the additional element of good news, which gives rise to this blog-post, derives from the following:
As a consequence, no doubt, of the relevant circumstances of Silver, HMRC have indicated, within their Inspectors’ Manuals, that, while the law is changed formally with effect from March 2020, they will, nevertheless, allow the new calculations to be applied for tax years from 2018/19 forward. This means that gains in 2018/19 and 2019/20 can benefit. Taxpayers should check to see whether they might have suffered a loss of personal allowance in either of these years as a result of gains on investment bonds, and might therefore now have a case to claim a refund of overpaid tax.
If you have any questions about top-slicing relief and the revised rule, please do not hesitate to get in touch with your relationship principal, or with Chris Barrington, Tax Partner.