When the then chancellor Alistair Darling announced in 2009 that there'd be an income limit of £100,000 on the availability of the personal allowance neither he, nor tax professionals, appreciated the unintended consequences.
The result was to introduce yet another element of complexity into the UK tax system.
When an individual is taxable in respect of a gain on a life assurance or capital redemption bond, that gain is taxed as income, and is treated as forming the highest part of the individual’s income.
That gain could push an individual’s income into a higher tax band.
If it brought the individual’s income above £100,000, there would be a loss of personal allowance.
Top slicing relief was introduced to give relief to those subject to a higher rate of tax due to a gain on a life or capital redemption policy being included in their income.
This seems logical and fair. A gain could accrue over many years but be taxed in a single year, for example on full surrender of a policy.
Even when the chargeable event gain doesn't push a taxpayer into a higher tax rate, some top slicing relief might still be available.
This is due to the effects of the personal savings allowance, the nil rate tax band and the starting rate for savings.
Calculating the 'slice'
Top slicing relief is only available to individuals - trustees, companies and personal representatives aren't entitled to it.
Deemed gains on personal portfolio bonds also don't qualify for top slicing relief.
The relief involves calculating the annual equivalent of the gain - commonly called a ‘slice’.
In the case of a full surrender of a UK bond, the slice is the gain divided by the number of full years for which the policy was in force.
Where there is an ‘excess’ event (that is, the cumulative 5 per cent allowance being breached) on a UK bond, the slice is the gain divided by the number of full years since the last chargeable event, or the start of the policy if it's the first chargeable event.
The calculation can be more complex following changes introduced by the Finance Act 2013, which extended ‘time apportionment relief’ to holders of UK bonds.
This relief reduces the taxable element of a gain to reflect the bond owner’s period of residence outside of the UK.
The Silver case, and what happened next
So what happens when a gain added to the individual’s other income exceeds £100,000 (impacting the availability of personal allowance), but the slice when added to the individual’s other income doesn't break the £100,000 barrier?
It was widely believed the personal allowance couldn't be used in calculating the tax on the slice.
But this belief proved to be ill-founded following the Silver v HMRC case (2019), heard in the First Tier Tax Tribunal.
The judge held that the calculation of the tax on the slice was a hypothetical one, worked out on the basis that the individual’s gain was the slice rather than the full gain.
The judge ruled that the personal allowance could therefore be deducted in computing the tax on the slice. After considering the judgement, HMRC decided not to appeal.
In the Finance Act 2020, legislation was introduced to put the position beyond doubt.
Where an individual has adjusted net income over £100,000 and their personal allowance is reduced, then for gains on or after 11 March 2020 the personal allowance is reinstated for the purposes of calculating top slicing relief only.
The personal allowance must be set against other income in preference to the gain.
What should advisers be doing?
In a recent update, HMRC set out its position, saying:
“The new legislation to top slicing relief cases will apply from tax year 2018/19.
● “Customers who have reported gains in 2018/19 will have the correct level of relief calculated through an auto-recovery exercise, where the claim is within the nine-month window from date of receipt and where liability decreased
● “Customers reporting gains in their 2019/20 self-assessments will have the correct level of relief calculated manually for them and will need to make a paper return
● “For returns relating to 2020/21 onwards, the top slicing relief calculation will be performed automatically through the self-assessment system.”
HMRC adds: “No taxpayer should receive less relief than was previously calculated by HMRC. If a taxpayer has a reduced personal allowance due to a gain being included in their income for the year, they may be entitled to more relief.”
So what about self-assessments which include top slicing relief calculations based on the old (and now found to be incorrect) interpretation of the rules?
A claim for repayment of income tax that's been overpaid can be made within four years of the end of the relevant tax year.
In terms of whether gains for 2016/17 and 2017/18 could be recalculated in order to get a tax refund, it seems HMRC would oppose such a claim.
The relevant HMRC manual states:
“Overpayment relief is not due if the claim relates to a mistake in a self-assessment return or other tax calculation and the tax liability was calculated in accordance with the practice generally prevailing at that time.”
On the question of whether this covers situations in which the prevailing practice was found to be wrong, that is open to debate.
Advisers and clients might want to take tax advice from an accountant or lawyer as to the prospects of a successful claim for overpayment relief.
In any event, it's worth reviewing all gains since 2016/17 where the client’s income, including chargeable event gains, exceeded £100,000.