Kim Jarvis: Chargeable events and deficiency relief

Canada Life’s Kim Jarvis looks at chargeable events and deficiency relief in this technical article for Retirement Planner

In the current climate, some individuals may need to withdraw money from their investment bonds.

However, with market volatility, this may mean that when the individual surrenders the investment bond instead of creating a chargeable gain a loss may occur.

It is important to note that while there is no relief under the chargeable event regime for an investment loss under a bond, a special relief called ‘deficiency relief’ may, however, be available to individuals, but only when the bond comes to an end. Deficiency relief is not available to trustees, personal representatives or companies.

It is given as a higher rate income tax reduction. Therefore, if the individual is not liable for higher or additional rate tax in the tax year of the chargeable event, there will be no tax reduction and deficiency relief will be of no benefit.

The purpose of the relief is to ensure that any chargeable gain assessed on earlier partial surrenders on the same bond does not exceed the overall gain on that bond. If, when a bond comes to an end (death, full surrender or maturity), the calculation of gain results in a negative figure and the individual is a higher or additional rate taxpayer, deficiency relief can reduce the overall higher rate income tax liability. It cannot be used to reduce the tax liability at the additional rate.

Deficiency relief

Deficiency relief is calculated as follows. Firstly; does the calculation of the gain result in a negative figure?  If the answer is yes the amount of allowable deficiency relief is the lower of the negative gain at the termination of the bond and the total of previous gains on earlier part surrenders.

Let’s look at an example.

  • Rufus took out a bond on 1 January 2012 for £100,000
  • On 1 February 2014, he took a partial surrender of £50,000
  • An “excess” chargeable gain of £35,000 (£50,000 – (3 x 5% x £100,000)), occurred on the 31 December 2014
  • On 1 May 2020, he fully surrenders the policy for £70,000 when he is a higher rate taxpayer

When calculating the chargeable gain on the full surrender of the bond does a negative figure occur? The formula for calculating a chargeable gain, on full surrender, is TB – (TD+PG), where:

  • TB is the surrender proceeds plus any previous partial surrenders
    • £70,000 + £50,000 = £120,000
  • TD is the total amount invested into the bond
    • £100,000
  • PG it the total amount of gains treated as arising on calculation events occurring before the surrender or maturity. This is the total amount of previous chargeable excesses created by partial withdrawals in excess of the 5% allowance
    • £35,000
  • £120,000 – (£100,000 +£35,000) = -£15,000

As a negative figure has resulted, deficiency relief is available but it is limited to the lower of the negative figure on surrender (£15,000) or the total of previous gains on earlier partial surrenders (£35,000). So, the amount of deficiency relief that Rufus can claim is limited to £15,000.

Secondly, the relief is given by extending the basic rate band by the amount of the loss. This means that in the 2020/21 tax year up to a further £15,000 of Rufus’s taxable income is chargeable at the basic rate instead of the higher rate.

Remember that only income liable for higher rate tax is relieved, so for example if Rufus had taxable income of £45,000 only £7,500 can be relieved (£45,000-£37,500 (basic rate tax band 2020/21)), and the remainder is lost. This means that £7,500 of Rufus’s income will be taxed at 20%, not 40% as would otherwise have been the case.

Alternatively, if Rufus had taxable income of £55,000 a further £15,000 would be taxed at 20% with £2,500 being taxed at 40%.

When considering deficiency relief you need to be aware that the amount of relief is restricted to the total chargeable gains that have been assessed on the individual who is claiming the relief. So, in the example above, if the previous gain had been made by another policyholder before it was assigned to Rufus, no relief would be available to him when he surrendered the bond.

Deficiency relief can be a valuable relief, but remember that as with all reliefs there are conditions that need to be satisfied in order for it to be claimed:

  • The individual must at least be a higher rate taxpayer
  • It is not available on “excess” events, only on full termination of the bond
  • Previous “excess” events must have occurred on the bond

With the current market turmoil clients have been naturally concerned about their finances in the short term with some needing to access their investment bonds.

But as there is no relief when an individual fully surrenders a bond resulting in a negative figure, having made no previous withdrawals, it is essential, in the current climate, that professional advice is sought.

Kim Jarvis is technical manager at Canada Life