UK Government Closes Life Insurance Tax Loophole

by Jason Gorringe, Tax-News.com, London

08 March 2004

The UK government last week introduced legislation to target life insurance tax avoidance schemes which create deficiency relief for individuals in connection with their policies to set against income liable for taxation at the higher rate.

"The Government has acted quickly to stop these schemes, which depend on wholly uncommercial transactions involving life insurance policies to facilitate the avoidance of higher rate tax by very high net worth individuals," Paymaster General Dawn Primarolo noted in a statement.

The change affects the operation of section 549 of the Income and Corporation Taxes Act (‘ICTA’) 1988. The new legislation will restrict the deficiency relief available to an individual to an amount not exceeding the total of any earlier gains which formed part of that same individual's income.

The new rules will apply to all life insurance policies, life annuity contracts and capital redemption policies made on or after Wednesday, March 3. It will also apply to all existing policies and contracts which are assigned, or become used as security for a debt, or into which policyholders choose to pay further premiums, on or after that time.

Deficiency relief is allowed as a deduction against an individual's total income for the year of assessment in which the policy or contract comes to an end. It relieves tax chargeable on income at the higher rate i.e. at the difference between higher rate tax (40%) and basic, lower or dividend rate as applicable, for instance 18% on earned income and 20% on interest income.

Under the current legislation, the earlier gains do not have to have been assessable and charged to tax on the person who is later entitled to the deficiency relief or indeed to have been subject to tax at all. The avoidance schemes exploit this mismatch.

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