Top slicing relief for bonds taxation: the facts

HMRC adopt a five step procedure as follows:

Step 1: Calculate the total taxable income for the year and identify how much of the gain falls within the starting rate for savings, personal savings allowance nil rate, basic, higher or additional rate bands as appropriate. Any gift aid payments must be disregarded both in this computation and in the remaining steps below.

Step 2: Calculate the total tax due on the gain across all tax bands. Deduct basic rate tax treated as paid* to find the individual's liability for the tax year. 

Step 3: Calculate the annual equivalent of the gain. The annual equivalent is calculated by dividing the gain by N (see earlier).

Step 4: Calculate the individual’s liability to tax on the annual equivalent. For gains arising on or after 11 March 2020, the personal allowance is recalculated where appropriate. The amount of the savings starting rate and personal savings 'allowance' used in the top slicing relief calculation are set by virtue of the taxpayer’s adjusted net income for the tax year. They are not adjusted to calculate the notional tax due on the ‘sliced gain’. Deduct basic rate tax treated as paid* on the annual equivalent and multiply the result by N. This gives the individual's relieved liability 

Step 5: Deduct the individual's relieved liability at step 4 from the individual's liability at step 2 to give the amount of top slicing relief due.

*Note: Basic rate tax is also deducted for offshore bonds for the purposes of the top slicing calculation.

There is a worked example for both onshore and offshore bonds later in this article. 

Top slicing relief is not just available to mitigate a higher rate liability arising on a chargeable event gain but is also available to mitigate an additional rate liability. In 2022/23, individuals with adjusted net income in excess of £150,000 are subject to additional rate tax of 45% on the excess (39.35% dividend additional rate).

There is a worked example where part of the gain falls into additional rate later in this article. 

In this case, the total gains are added together. The 'annual equivalent' is calculated separately for each gain, and then these annual equivalents are added together. 

Top slicing relief is available to mitigate a higher rate or additional rate income tax liability arising as a result of a chargeable event gain being added to the taxpayer's total income. It does not: 

• Reduce income for the purposes of child or working tax credits (instead the full amount of the gain is included).

• Reduce income below £100,000 to preserve full entitlement to the personal allowance.

• Apply to personal representatives, corporate's or trustees. However, for the avoidance of doubt where a gain arises on a trust held policy and the creator is chargeable then that person would be eligible for top slicing relief. In contrast, where the creator is deceased or non resident and the trustees are non resident then a UK beneficiary receiving a benefit from the trust is taxable on that amount - if so, top slicing relief is not available.

• Apply to annual gains that arise on 'personal portfolio bond events.' 

HMRC Helpsheets 320 and 321 help investors fill in the relevant boxes in their tax return for gains on UK life insurance policies and foreign life insurance policies respectively. The Helpsheets are available from HMRC 

• HMRC Helpsheets 320
  
  
• HMRC Helpsheets 321

Gains on UK policies are inserted into the 'Additional information' pages of the tax return. The full amount of the gain should be returned together with the number of complete years. This information is available from the chargeable event certificate issued by the insurer. If the individual is due any top slicing relief it will then be automatically calculated using the information provided.

Gains on foreign policies are inserted into the 'Foreign' pages of the tax return. A chargeable event certificate might not be available showing the gain if the policy was taken out before 6 April 2000, and for later policies the reporting requirements are not as onerous as those for UK policies. Nevertheless it remains the responsibility of the investor to report gains under self assessment principles.

HMRC - Insurance Policyholder Taxation Manual
HMRC - Self assessment guidance 

Anne has a taxable salary in tax year 2022-2023 of £36,100 (after personal allowances) and a chargeable event gain of £24,000 on the surrender of an investment bond that she had held for just over eight years. The basic rate band for 2022-23 is £37,700.

Her tax liability for 2022-23 before top-slicing relief is

Calculation of Relief

Step one

Anne's taxable income (including the chargeable event gain) is £60,100. The gain falls within the different tax bands as follows:

PSA - £500 @ 0%

Basic Rate Band - £1,100 @ 20%

Higher Rate Band - £22,400 @ 40% 

Step two 

The total tax due on the bond gain across all tax bands is £9,180

The tax treated as paid on the gain is £24,000 @ 20% = £4,800

The individual’s liability for the tax year is therefore £9,180 - £4,800 = £4,380

Step three 

The 'annual equivalent' of the gain £24,000 / 8 = £3,000. 

Step four 

The 'annual equivalent' + taxable income = £3,000 + £36,100 = £39,100.

The total tax on the slice is (£500 @ 0%) + (£1,100 @ 20%) + (£1,400 @ 40%) = £780

The tax treated as paid on the slice is £3,000 @ 20% = £600

The individual’s tax relieved liability is (£780 - £600) multiplied by “N”. In this “N” case is 8 years so the tax relieved liability is £1,440 

Step five 

Top slicing relief = £4,380 – £1,440 = £2,940 

Summary

Anne's liability after top-slicing relief is £16,400 - £2,940 = £13,460

The basic rate credit is £24,000 @ 20% = £4,800.

The overall liability is reduced to £13,460 - £4,800 = £8,660 

If we took the last example of Anne, but instead the bond had been offshore, the above five steps would be identical.

Anne's liability after top slicing relief would be £16,400 - £2,940 = £13,460

There is no reduction in her liability since no basic rate credit is due for an offshore bond. 

Bridgit has a taxable salary in tax year 2022-2023 of £32,700 and a chargeable event gain of £160,000 on the surrender of an onshore bond on 1 June 2021 that she had held for just over eight years.

Her total income is greater than £100,000 so the basic personal allowance is reduced to zero, but reinstated at Step 4.

Her tax liability for 2022-23 before top-slicing relief is: 

Calculation of Relief 

Step one

Bridgit's taxable income (including the chargeable event gain) is £192,700. The gain falls within the different tax bands as follows:

Basic Rate Band - £5,000 @ 20%

Higher Rate Band - £112,300 @ 40%

Additional Rate Band - £42,700 @ 45% 

Step two

The total tax due on the bond gain across all tax bands is £65,135

The tax treated as paid on the gain is £160,000 x 20% = £32,000

The individual’s liability for the tax year is therefore £65,135 - £32,000 = £33,135 

Step three

The 'annual equivalent' of the gain £160,000 / 8 = £20,000 

Step four

In this step, we add Bridgit’s salary of £32,700 to the £20,000 slice to give us a notional adjusted income of £52,700. As this figure is below £100,000 the full personal allowance will be reinstated, in this step only. As detailed later in the article, her personal allowance must be set against her salary in preference to the gain.

With regard to the salary, £12,570 is taxed at 0% within the personal allowance. The balance of £20,130 is taxed at 20%. The bond slice of £20,000 will then be taxed as follows.

The total tax on the slice is  (£17,570 @ 20%) + (£2,430 @ 40%) = £4,486

The tax treated as paid on the slice is £20,000 @ 20% = £4,000

The individual’s relieved liability is (£4,486 - £4,000) multiplied by “N”. In this “N” case is 8 years so the tax relieved liability is £3,888. 

Step five

Top slicing relief = £33,135 – £3,888  = £29,247 

Firstly, bear in mind that the FA 2020 top slicing measures only apply with effect from 11 March 2020 and may not be applied retrospectively.

When calculating top slicing relief, the starting rate for savings and the personal savings ‘allowance’ must be considered. Unlike the personal allowance situation (see below), HMRC consider that from 11 March 2020, there is no recalculation in step 4 when calculating the notional tax due on the slice.

In contrast, where an individual has adjusted net income over £100,000 and their personal allowance is reduced then the position for gains arising on or after 11 March 2020 is that the reduced personal allowance is recalculated for the purposes of Step 4 of the top slicing relief calculation only.

Budget 2020 also confirmed that within the calculation of top slicing relief, reliefs and allowances available must now (i.e. from 11 March 2020) be set-off, as far as possible, against other income in preference to the gain. This means that the rules comprised in S25(2) of ITA 2007 do not apply – these rules require reliefs and allowances to be set against income in a way that results in the greatest reduction in an individual’s income tax liability.

Example

Fraser has salary of £25,140 and on 1 July 2022 he surrenders a bond held for 10 years with a gain of £100,000. 

• His adjusted net income of £125,140 reduces his personal allowance to nil.

• His starting rate for saving is nil (because the first £5,000 of taxable income is earned income).

• His personal savings allowance is £500 (because he is a higher rate taxpayer).

• For the purposes of Step 4 of the top slicing relief calculation his personal allowance is recalculated to £12,570 (because his £25,140 salary plus bond slice of £10,000 falls well below £100,000).

• His personal savings allowance is not recalculated within Step 4 of his top slicing relief calculation. Instead it remains at £500.

• His non entitlement to the starting rate for savings is also not recalculated within Step 4.

• His recalculated personal allowance must be set as far as possible against other income (i.e. his salary) in preference to his bond gain 

The Top Slicing Relief changes were announced as taking effect from the date of the Budget (11 March 2020). This led to questions concerning those with chargeable event gains prior to that date.

On 20 July 2020, HMRC confirmed to the Chartered Institute of Taxation (CIOT)  that the mode of calculation as set out in the March 2020 Budget (and which is now included in the Finance Act) will be applied, ‘by concession’, to any gains in both 2018/19 and 2019/20 tax years. This was subsequently confirmed in Agent Update 79. Originally, Agent Update 78, indicated that HMRC would only be applying the new provisions to 2019/20 gains.

HMRC started an automatic process to identify any taxpayers who filed in 2018/19 and should have benefited from more of their personal allowance in their Top-Slicing Relief computation. HMRC have said that amendments made will only be favourable to taxpayers although the CIOT understands it is possible this new treatment is not always in the taxpayer’s favour.

Any taxpayer in the same position in 2019/20 need to file a paper return, for HMRC to process manually. From 2020/21, HMRC’s Self-Assessment calculator should produce the right result and returns should not need to be filed manually. 

2017/18

Chargeable event gains which arose in 2017/18 are in time for overpayment relief claims only up to 5 April 2022.

In this tax case relating to the 2017/18 tax year, the First-tier Tribunal confirmed that the legislation introduced in 2020 removing beneficial ordering was not clarification of existing legislation and did not have retrospective effect. The decision was released on 18 February 2022 and is within the 56-day appeal period for HMRC to challenge. 

Tim Good (of Absolute Accounting Software Ltd) who represented the taxpayer in the above case commented that the Judge agreed that when applying beneficial ordering, the legislation requires that the income tax liability rather than income tax payable is to be minimised (i.e. before rather than after deducting any notional bond tax credit). This may occasionally result in higher overall tax payable than calculated by the current HMRC self-assessment calculator in respect of gains arising on or after 11 March 2020.