When an individual surrenders part of a life policy, a chargeable gain is triggered equal to the surrender proceeds less 5% of the premium for each year that the policy has been held. This method of calculation can produce a tax bill out of all proportion to the economic gain, especially early in the life of a policy.
So, for example, in Joost Lobler ( UKUT 0152 (TCC)), partial surrender of about 97.5% of each of 100 policies which Mr Lobler had held for between two and three years yielded proceeds of about $1.4 million, which generated a tax charge of $560,000. The economic gain on the partial surrenders, by contrast, was about $65,000. The First-tier Tribunal called this ‘an outrageously unfair result’, a view that might be shared by anyone who has fallen foul of the same arcane tax rules as Mr Lobler.
On appeal, the Upper Tribunal applied a discretionary remedy normally available only to the High Court known as ‘rectification’. Mr Lobler had made a mistake: he could have opted for a full surrender, a partial surrender across all policies and funds, or full surrender of individual policies, but he chose instead a partial surrender across all policies from specific funds. Acting without advice, he had made the wrong decision, for if he had opted for a full surrender of individual policies, he would have incurred a tax charge more in keeping with the economic gain. The Tribunal decided that his mistake was serious enough to warrant rescission and rectification.
Lobler was a lead case behind which a number of appeals were stayed, and in the months following the Upper Tribunal’s decision, the same remedy was applied where the facts were sufficiently similar to those in Lobler. Most of the appellants had been unrepresented or badly advised; many were elderly persons who had invested their life savings in the policies.
Just and reasonable recalculation
HMRC then consulted on a possible change in the law, intended to prevent any recurrence of Lobler. The most sensible option put forward was to apply the normal part-disposal calculation but, in the event, the Government did not pursue that. Instead, F(No.2)A 2017 section 9 added two new provisions to the existing code on chargeable event gains: ITTOIA 2005, sections 507A and 512A, which provide that a policyholder can apply to have a gain under section 507 or 512 (part-surrenders or part-assignments) recalculated on a ‘just and reasonable basis’ if it appears ‘wholly disproportionate’. An application must be made within four tax years, or longer if ‘exceptional circumstances’ apply and HMRC agrees to extend the time limit. There is no right of appeal if HMRC decides a gain does not fit the description of ‘wholly disproportionate’ and refuses the application.
HMRC guidance at Insurance Policyholder Taxation Manual IPTM 3596 states that ‘there are only very limited circumstances in which a gain will be regarded as wholly disproportionate and thus give rise to a recalculation’. It explains that a gain will be ‘wholly disproportionate’ if it appears ‘greatly excessive’ compared to the premiums paid and if it gives rise to a ‘significant’ (ie ‘excessively large’ or ‘disproportionately large’) tax charge. It will also appear ‘out of all proportion’ to the underlying economic gain. A just and reasonable recalculation will normally have regard to the underlying economic gain at the time of part-surrender or part-assignment (the example in the guidance uses the normal CGT part-disposal formula to determine this).
It is vital that practitioners are aware of the 2017 changes and the option for policyholders to ask for a just and reasonable recalculation of a wholly disproportionate gain.
HMRC cannot be relied upon to draw policyholders’ attention to the relief (see Thakoral Tailor  FTT 0845 (TC) where the judge had to do her own research and point out the change in the law to the presenting officer!) and an unsophisticated taxpayer who falls into the part-surrender trap through ignorance of the potentially devastating tax consequences is hardly likely to spot an abstruse provision in a finance act that allows for the gain to be recalculated. Therefore the onus is very much on the tax adviser in the – hopefully – rare cases where the problem will arise.
Robin Williamson MBE CTA (Fellow) is an author and commentator on tax, welfare and public policy, and a part-time senior policy adviser at the Office of Tax Simplification. He was technical director of the CIOT’s Low Incomes Tax Reform Group from 2003 to 2018.