Wholly Disproportionate Gains
12 March 2018
HMRC have published guidance in their manuals in respect of life assurance bonds and excess gains. As you know, life assurance bonds have a unique feature whereby individuals and trustees are able to take up to 5% tax deferred, across all of the segments, each year, out of their bonds. However, if this amount is exceeded it can lead to gains which are disproportionate to the true gain made within the bond.
The famous Lobler case resulted in a government consultation on the chargeable event regime for excess gains. However, this did not end in any rules being changed to the 5% regime but to a process being put in place that allows policyholders to make an application to have wholly disproportionate gains recalculated on a just and reasonable basis.
This saga began in in 2004 when Lobler came to England to work. He sold the family home in Holland and invested the proceeds in an offshore life insurance bond. He later borrowed substantial funds from a bank and incremented his bond. By March 2006 his bond was valued at $1,406,000.
In 2007 he withdrew $746,485 from the bond to repay his bank borrowings and in 2008 he withdrew a further $690,171 to partly pay for a recently purchased family home. These withdrawals amounted to 97.5% of the amount originally invested.
Although his original investment was ‘advised’, Lobler didn’t seek advice in respect of these partial surrenders – he didn’t think he needed to. The tax consequences were disastrous. The partial surrenders triggered income tax chargeable events. In both 2007 and 2008 the 5% tax deferred withdrawal limit was very significantly exceeded. Each year’s taxable gain was the amount received less 5% of the premium originally paid. Lobler had made no substantial profit from the investment but had managed to generate taxable income of some $1.3m with a consequent $560,000 tax liability.
When HMRC received chargeable event certificates from the life office, enquiries were opened and eventually the tax liability was established. Lobler appealed to the First-tier tax tribunal but his appeal failed; the tax liabilities had been determined correctly on the basis of the relevant legislation. Lobler then appealed to the Upper Tribunal. His lawyer had to accept that the tax analysis advanced by HMRC was correct. However, he advanced new arguments based on contract law.
The lawyer argued that Lobler had made a ‘mistake’. A ‘mistake’ operates to negate the ‘consent’ that is at the heart of all contracts . The mistake rescinds the contract; in other words the mistaken action is ignored. Lobler adopted a method of withdrawal which gave him a tax liability – despite him having made no significant investment gain. He could have met his financial requirements by fully surrendering the bond. He would then have been taxable on his ‘real’ investment gain.
This led to the HMRC consultation and eventually to legislation and HMRC manuals being updated detailing the process that policyholders can follow should a mistake be made which causes a wholly disproportionate gain.
When deciding whether a gain is wholly disproportionate, the officer of HMRC will consider relevant factors such as:
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 which can be excessively large or disproportionately large.
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.
Any application must include the reasons why the applicant believes that the gain is wholly disproportionate together with any supporting documents that demonstrate this. Relevant supporting documents will vary according to each applicant’s circumstances but should normally include:
Who can apply
HMRC make reference to ‘interested persons’ in their manuals. 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. 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.
When can individuals apply
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. There is reference in the Finance Bill which states that the legislation comes into force from the date of Royal Assent which was given on the 16 November 2017.
It seems that HMRC do not expect to have to recalculate many cases as “wholly disproportionate” sets a high limit in their eyes. Their officers will be taking into consideration many factors before making a decision. Note that 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 recalculation exercise!
Further Information can be found on HMRC’s website –