IPTM3596 - Calculating gains - recalculating a wholly disproportionate gain under ITTOIA05/S507A and S512A

Following a part surrender or part assignment of a life insurance policy, sections 507A and 512A allow an interested person to apply to an officer of HMRC to recalculate a gain on a just and reasonable basis. A recalculation will be performed on this basis if the officer decides that the gain is wholly disproportionate.

The phrase ‘wholly disproportionate’ sets a high threshold. It is anticipated that there will be only very limited circumstances in which a gain will be regarded as wholly disproportionate and thus give rise to a recalculation.

The application

Interested persons can make an application to HMRC under sections 507A and 512A. An ‘interested person’ is a person who would be liable to all or part of the tax on the gain arising from the part surrender or part assignment under S507 or S511.

Where there is more than one interested person then all interested persons must make the application together. This includes all policyholders if the policy is jointly held and both the assignor and assignee where the policy has been part assigned.

Any application must include the reasons why the applicant believes that the gain is wholly disproportionate together with any documents and information to support this.

Relevant documents and information will vary according to each applicant’s circumstances but should normally include:

• the chargeable event certificate showing the gain
• a copy of the withdrawal request
• relevant correspondence in relation to the part surrender or part assignment of their policy. Ordinarily this will be between the interested person and their insurer but if the policy is in trust it could also include correspondence between the interested person and the trustees
• an explanation as to why cash was taken from the policy in the way that it was
• the date on which the policy was taken out and the amount of the initial premium
• dates and amounts of any subsequent premiums paid
• dates and amounts of any withdrawals and part surrenders before the one giving rise to the gain
• the valuation of the policy before the part surrender. Please note that because the value of the policy may change on a daily basis, we require a valuation immediately before the part surrender
• any other relevant documents or information in support of the application.

If the policy is held in trust, the required information will also include:

• the names of the persons chargeable on the gain and the capacity in which they are chargeable (for example settlor or trustee)
• confirmation whether any of the tax payable in respect of the gain has been recovered from the trust.

The above list is not exhaustive, and applicants may also be required to provide any other information or documents that the officer may reasonably require. There is no prescribed form for making the application.

Please send your application by email to [email protected] or by post to:

HM Revenue & Customs
BAI Financial Services Team 3/64
100 Parliament Street
London
SW1A 2BQ

An application must be received by HMRC within four years of the end of the tax year in which the gain arose. Applications made after this period may be considered if an officer of HMRC agrees but this will only be in exceptional circumstances.

The applicant will be given written notification of a decision not to consider a late application.

Deciding whether a gain is wholly disproportionate

As stated above, the phrase ‘wholly disproportionate’ sets a high threshold and wholly disproportionate gains are expected to arise only in very limited circumstances.

Wholly disproportionate gains tend to arise early in the life of a policy. They often arise because policyholders take cash from their policy that is far in excess of their 5% tax deferred allowance – see IPTM1510.

When deciding whether a gain is wholly disproportionate the officer will consider relevant factors such as:

• the economic gain on the rights surrendered or assigned
• the amount of the premiums surrendered in relation to the premiums paid
• the resulting tax charge in the context of all available reliefs.

Generally, wholly disproportionate gains will appear, in the context of the premiums paid, to be greatly excessive and bring into account a significant tax charge. A significant tax charge can be either excessively large or disproportionately large.

Wholly disproportionate gains will always be out of all proportion to the estimated gain on the rights surrendered or assigned (‘policy’s underlying economic gain’). However, this alone will not be sufficient to show that there is a wholly disproportionate gain. This is because wholly disproportionate gains cannot be identified by looking at one factor in isolation but require a detailed consideration of the facts and individual circumstances relevant to that gain. For example, where a gain is out of all proportion to the underlying economic gain, but does not generate a significant tax charge then, depending on other factors, it is unlikely to be considered wholly disproportionate.

It is important to note that the consideration of ‘wholly disproportionate’ is limited to considering the gain arising under S507 and S511 in relation to such factors outlined above. It does not involve a consideration of the legal principle of ‘proportionality’ more generally.

Where an officer decides that the gain is not wholly disproportionate, then the gain as calculated by S507 or S511 stands and a recalculation of that gain will not be made. An applicant will be notified in writing of such a decision. There is no right of appeal against this.

The policy’s underlying economic gain

What an officer of HMRC considers to be the underlying ‘economic gain’ will be determined in the context of the individual policy. The officer may use any reasonable method for calculating the underlying economic gain.

Example

A policyholder invested £100,000 in a policy on 10 August 2020 and withdrew £60,000 on 19 July 2022. The best estimate of the policy’s surrender value immediately before the part surrender was £110,000. The underlying economic gain arising on the part surrendered could be calculated as:

Value of part surrender £60,000

Less

Premium related to that part surrendered (£54,545)

[Premium x Value of part surrender/Value of whole policy]

[£100,000 x £60,000 / £110,000]

Underlying economic gain on part surrendered £5,455

Gains arising from tax arrangements

Under S507A(10) and S512A(10), no recalculation will be made under S507A or S512A if the gain arises as a result of one or more transactions which form part of arrangements, the main purpose, or one of the main purposes, of which is to obtain a tax advantage for any person. Under S507A(11) and S512A(11) ‘arrangements’ include any agreement, understanding, scheme, transaction or series of transactions (whether or not legally enforceable), and ‘tax advantage’ has the meaning given by CTA10/S1139.

Where a decision is made not to recalculate a gain because it falls under S507A(10) or S512A(10) the applicant will be notified of the decision in writing.

Recalculating the gain

A wholly disproportionate gain is recalculated by an officer of HMRC on a ‘just and reasonable’ basis. What is a just and reasonable basis will normally be

determined by the underlying economic gain of the policy at the time of the part surrender or part assignment. The overarching aim however is to achieve a method of calculation that is clear, simple and fair. A recalculation under S507A or S512A will not result in a larger gain than under S507 or S511.

Following a recalculation of the gain the applicant will be advised, in writing, of the result of the recalculated gain. There is no right of appeal in respect of the basis of recalculation.

When a gain is recalculated effect will be given to that recalculation by the amendment of a tax return or, where that is not possible, by HMRC repaying any tax overpaid. If an individual has recovered any tax from trustees where the policy is held on a non-charitable trust then any amount repayable following a recalculation under S507A or S512A must be repaid as soon as possible to the trustees.

Effect of a recalculation

It is the responsibility of the policyholder(s) to report the revised chargeable gain on their tax return following the guidance on GOV.UK.

Where a recalculation is made HMRC will only notify the policyholder(s) of it. HMRC will not notify insurers and insurers will not be able to amend or reissue chargeable event certificates. This means that chargeable event certificates will not show the correct chargeable gain after a recalculated part surrender or assignment.

It is therefore imperative that policyholders maintain sufficient records to accurately calculate gains arising when the policy is terminated as their insurers will be unable to calculate these gains on their behalf once the first recalculation has been made.

This is because a recalculation under S507A and S512A will replace the gain calculated by reference to S507 and S511 for the relevant tax year only. Where further part surrenders or part assignments are made the gains arising will not be affected by the earlier recalculation.

However, any recalculated gain will affect the gain on full surrender, maturity etc. as well as the amount of any deficiency arising. As the recalculations are for tax purposes only insurers will not incorporate them into their calculations on termination of the policy.

Example

Ms Jane Smith invested £100,000 in a life insurance policy on 1 January 2018. She withdrew £70,000 on 1 August 2018 that resulted in a gain under S507 of £65,000 arising on 31 December 2018. Following an application under S507A, this gain was recalculated as £3,000.

On 24 April 2019 she withdraws £6,000 resulting in a gain of £1,000 arising on 31 December 2019.

On 25 October 2021 she fully surrenders the policy for a payment of £30,000.

Her insurer does not issue a chargeable event certificate as from their perspective there is no gain on full surrender, according to their records:

-	Insurer’s Record	Actual
Total cash received from policy	£106,000	£106,000
Less - Premiums	£100,000	£100,000
Net	£6,000	£6,000
Previous Gains	£65,000	£3,000
-	£1,000	£1,000
Gain chargeable to income tax	Nil	£2,000

Ms Smith will therefore need to ensure that her tax return shows the correct gain of £2,000.

Reviews and complaints

There is no statutory right of appeal against a decision under S507A or S512A. However, if a policyholder is unhappy with the decision made or service given they can ask us to review their case. If the policyholder is not satisfied with the outcome of our review, they can make a complaint. If the policyholder is still unhappy after their complaint has been reviewed, they can ask for a different adviser to take a fresh look at it. Subsequently they can ask the Adjudicator to look into the complaint and finally they can ask a Member of Parliament to refer the complaint to the Parliamentary and Health Service Ombudsman.