Module 9 – How to calculate tax on the gain with top slicing relief
Tax on the gainIn module 9 we'll look at how the tax is calculated on the gain. There is a five-step process for working out the tax on a gain.
1 – Add the gain to the individual's other income for the tax year when the chargeable event arises.
2 – Work out the appropriate tax rates (income tax)
3 – Tax the gain on all the rates applicable
4 – If it's an onshore bond, take off the deemed lower rate tax (20%)
5 – Check if the gain takes the individual policyholder into higher tax rate. If the policyholder wasn't already in that higher tax bracket, apply top slicing.
If the individual is a non-higher rate taxpayer and the gain from a bond causes their total income to fall into the higher rate tax band then special averaging rules apply. This calculation allows the tax liability for the gain to be averaged out. Higher rate tax is only applied to the top part of the gain, which remains after this allowance. This is called top slicing.
The relief is specifically designed for individuals who are non-higher rate taxpayers. The relief can’t help individuals who are already taxed at the higher rate before the chargeable event gain is added to their income.
Top slicing determines what fraction of the gain, known as the ‘slice’, is liable for higher rate tax.
Partial withdrawals across all segments
Onshore
Gain on the chargeable event / Complete years since last chargeable event on partial withdrawal or part assignment to the current one = slice
Offshore
Gain on the chargeable event / Total number of complete years bond has been in force = slice
Surrender of individual segments
Onshore
Gain on the chargeable event / Total number of complete years bond has been in force = slice
Offshore
Gain on the chargeable event / Total number of complete years bond has been in force = slice
Calculating the slice
The chargeable events (for full surrender) are shown below, including how the slice is calculated.
Full withdrawals:
Onshore
Gain on the chargeable event / Total number of complete years bond has been in force = slice
Offshore
Gain on the chargeable event / Total number of complete years bond has been in force = slice
Let’s look at an example of how to calculate the slice. Mrs Martin takes out an onshore bond in 1990 for £100,000. The policy runs for 20 years until 2010 when she surrenders it for £500,000. Her other income for that year is £15,000. The formula is:
The ‘slice’ = Gain on that particular chargeable event = 500,000 – 100,000 = £20,000
Total number of years the bond has been in force 20
Applying the tax to the ‘slice’
Now that we’ve identified the size of the slice, we need to apply the appropriate tax to it. Here’s a step-by-step guide showing the process for calculating tax. Mrs Martin takes out an onshore bond in 1990 for £100,000. The policy runs for 20 years until 2010 when it has a surrender value of £500,000. She has applied top slicing to the gain and the slice is £20,000 (an example of the calculation is below in bold).
1 Now we have the slice, we can tax it £20,000
2 Establish amount of other income for that tax year £15,000
3 Add the slice to the other income £35,000
4 Deduct the current higher rate tax band £32,400 (estimated)
5 Tax result at 20% (higher tax rate at 40% minus deemed lower rate tax at 20%) (£35,000 - £32,400) = £2,600 @ 20% = £520
6 Multiply the tax figure by the number of years the bond has been in force (£520 x 20 years) = £10,400
7 The result is the amount of higher rate tax due £10,400
8 If it’s an onshore bond then this is the total tax due £10,400
9 If it’s an offshore bond, higher rate tax on the slice is still… £10,400
10 In this case, the lower rate tax is due (20%) on the whole gain £400,000 x 20% = £80,000
11 The result is the total tax due for the offshore bond £80,000 + £10,400 = £90,400
As you can see from the illustration, the original gain was £400,000. However, the higher rate tax after top slicing relief for this individual is dramatically reduced to £10,400.
As we’ve seen on the previous screen, Mrs Martin has a gain of £400,000 on her onshore bond. The slice of this gain, liable for top slicing is £20,000. After top slicing relief is applied, the total tax due is reduced to £10,400.
Had top slicing not been available Mrs Martin’s higher rate liability on the gain would have been as follows:
Other income = £15,000
Unsliced gain = £400,000
= £415,000 less £32,400 = £382,600 @ 20% = £76,520
As a result of top slicing relief therefore, Mrs Martin has reduced her higher rate tax by £66,120 (£76,520 - £10,400).
Had Mrs Martin’s bond been offshore the higher rate tax would have been exactly the same but she would also have to pay lower rate tax on the full gain of £80,000 (£400,000 x 20%).
Remember, the following four steps are how to calculate the tax on a gain:
1 – Add the gain to the other income for the tax year when the chargeable event arises.
2 – Work out the appropriate income tax rates.
3 – Subtract the deemed lower rate tax (20%) if an individual or a trustee owns the onshore bond.
4 – If the individual incurs higher rate tax as a direct result of the gain, then apply top slicing.
In this module you’ve learned how tax is applied to a gain.
You’ve also seen how and when top-slicing relief is applied.