The amendment to the legislation was driven by the decision in the recent First‑Tier Tribunal case of Marina Silver v The Commission for HMRC (2019) UKFTT 0263 (TC), and transforms how top-slicing relief impacts on an individual’s personal allowance.
Where an individual’s adjusted net income exceeds the limit of £100,000, their personal allowance is reduced by £1 for each £2 above this limit. So, for tax year 2020/21, if an individual’s adjusted net income exceeds £125,000, they will lose their £12,500 personal allowance in its entirety.
It has long been HMRC’s view that, when working out whether an individual will lose all or part of their personal allowance, that the full chargeable gain from the encashment of a life insurance bond is used, and not just the top-sliced gain. So, for example, where the policyholder held the bond for 10 years and had a gain of £100,000, it is this figure that’s used in calculating adjusted net income and not the much-reduced top-sliced gain of £10,000.
The outcome in the Marina Silver case was that HMRC’s stance was found to be wrong and it should be the top-sliced gain which is used in calculating the policyholders’ adjusted net income.
The facts of the case were that in the tax year 2015/16 Mrs Silver encashed a life insurance bond she’d held for over 21 years and created a chargeable gain of £110,721. She also had other income of £31,101.
HMRC took its normal stance that, as Mrs Silver’s adjusted net income was £141,822, she lost all her personal allowance, which in 2015/16 was £10,600.
Mrs Silver argued it should be the top-slice figure of £5,272 (£110,721 ÷ 21 years) that be used, as this gave her an adjusted net income of £36,373 (£31,101 + £5,272), so preserving her full personal allowance.
The judge agreed with Mrs Silver and noted that Parliament’s intent with top-slicing relief was to allow a person who has accrued a gain over a period of years to have relief when such a gain becomes taxable in a single year.
The relief was intended to make the tax liability roughly what it would have been had the gains been taxed in the year it had accrued. So, when carrying out the tax calculation, it made sense that the taxpayer should also use the top-sliced figure.
HMRC’s interpretation would result in someone who was a basic rate taxpayer in the year of encashment, and who would not have had any higher rate tax to pay on the withdrawals from the bond had it been taxable year by year, having to pay higher rate tax on the bulk of gain. Top-slicing relief would therefore have been denied to those it was intended to help.
The changes to the legislation will permit the personal allowance to be reinstated within the taxpayer’s top-slicing relief calculation, where it has been reduced by including the full chargeable gain in their income for the year.
This, in the simplest of terms, means that in a situation where an individual can benefit from top-slicing relief, it is the top-slice that is added to their other income to determine whether or not it impacts on the personal allowance.
The legislation will also be amended to confirm that, when carrying out the top-slicing tax calculation, allowances and reliefs must be set as far as possible against other income in preference to the gain.
These changes are effective for chargeable events occurring on or after 11 March 2020. HMRC has appealed the outcome of the Silver case, so until that outcome is known, earlier chargeable events will unfortunately be dealt with under HMRC’s previous interpretation of the rules.
Neil MacGillivray is head of technical support at James Hay