Chargeable event gains in a trust

Chargeable event gains in a trust

My client died a few years ago with a UK capital redemption bond held in a UK discretionary trust that has a chargeable event gain certificate that was triggered after my client’s death. Who pays the tax on this gain? 

It would seem that the trustees are chargeable to income tax on the chargeable event gain.

In most cases when a chargeable event gain arises to a UK resident individual, the gain is taxed on that individual as the beneficial owner of the policy under Condition A of s465 ITTOIA 2005. If the policy is insured on the life of the policyholder, the death of the assured normally extinguishes the policy rights and the gain is taxed on the deceased as part of their final, personal income.

The tax treatment is different when we are looking at policies held in trust. Where the rights are held on trust, the trust gain is taxed on a UK resident settlor under Condition B of s465 ITTOIA 2005 where gains arise in the settlor’s lifetime including at any time in the tax year of death. As the settlor here died a few years ago, it would seem that Condition B also does not apply.

HMRC’s guidance on the above is at IPTM3240.

A policy can be insured on an individual’s life or several individuals’ lives or, as here, under a capital redemption policy where there is no life assured.

As the trustees appear to be UK resident, they are liable for income tax on the chargeable event gain under s467 ITTOIA 2005. Note the exception for policies taken out before 17th March 1998 as mentioned in IPTM3240.

As the trustees are a body of persons, rather than an individual, they will not be entitled to top slicing relief under s535 ITTOIA 2005 and will be chargeable to income tax at the trust rates of tax of s479 ITA 2007. If this is a UK policy, the trustees will be entitled to a notional basic rate tax credit under s530 ITTOIA 2005.

If the trustees have not already done so, they will need to register under the Trust Registration Service enabling them to file a self-assessment tax return to disclose the gain and pay income tax accordingly.

It is also important to note that even though the trustees will pay income tax on this chargeable event gain this remains capital under trust law and so is not available income for distribution to beneficiaries – see TSEM3210.

Any distribution to the trust beneficiaries of the policy proceeds would be a capital distribution and so an exit charge for IHT purposes under s65 IHTA 1984. Therefore, a form IHT100 may be required to be submitted as may payment of an IHT liability.

It would seem the remaining trustees may have decided to encash the policy without considering the tax repercussions. It is often more tax efficient to appoint the policy to the beneficiaries (still an exit charge for IHT) which would allow the individual beneficiaries to personally encash the policy resulting in personal income tax charges with access to their (usually lower) rates of income tax and access to top slicing relief.

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