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Is an insurance bond capital or income to a trust

Taxation of investment bond on maturity

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A dies owning an investment bond, but the life assured is her former husband (still alive) B. It appears that B assigned the bond to A after their divorce. The bond is surrendered by A's executor and the chargeable event certificate is addressed to A, and shows A as the bond owner. I believe no income tax is due from the executor of A, as basic rate tax is deemed to have been paid. The whole estate is in held on a discretionary trust.  Do the bond proceeds pass to the Trust as income, carrying a tax credit, so that the trustees have to pay a further 25% income tax, or do the proceeds pass as capital, and are not taxable in the hands of the Trustees?

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By richard thomas
04th Mar 2021 09:29

I’m not quite sure what you mean by “pass as capital” in this connection, or what its relevance is to the tax position.

But it seems to me that, looking at the tax position, the trustees have an absolute interest in the residue of the estate (as there is no one else with any other interest) so they are entitled to receive the entire capital of the estate and so any income arising since death.

The question then is whether, when the residue is paid to the trustees by the executor, or any amount is paid on account of the entitlement to residue, the payment gives rise to “estate income” in the hands of the trustees within Chapter 6 Part 5 ITTOIA. The answer is that is does. Follow the tortuous path from section 652 to 660 to 665 to 666 to 664, taking section 670 into account, and you will see that the amount of the chargeable event gain less any estate deductions is treated as income of the trustees which has borne income tax at 20%. There will therefore be tax at 45% less 20% to pay, subject to the relief in s 669 for IHT paid (if any).

I happen to know this because I am currently administering my mother’s estate where there is also a life insurance gain arising to the estate, but I don’t have the complication of a discretionary will trust.

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By Ajtms
04th Mar 2021 09:50

Very many thanks Richard. The only thing that occured to me was that sometimes trust law is different to tax law in the way in which capital and income are treated. I will follow your advice and treat it as income in the hands of the trustee.

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By Tax Dragon
04th Mar 2021 10:22

I think it is capital for trust law purposes. (But then it's not income for tax purposes either. There is an income tax charge on a capital receipt. One of many such charges.)

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By richard thomas
04th Mar 2021 10:43

I think the better view is that the gain is treated as income for tax purposes, although Chapter 9 Part 4 ITTOIA is rather more opaque in this regard than many other provisions which explicitly deem what is, under traditional tax law rules, a capital receipt to be income, such as Chapters 6 and 8 and many of the provisions in Part 13 ITA 2007. In the case of personal reps, s 466(1) ITTOIA does actually treat it as income.

In addition, if it were not income or treated as income then there would be no obligation to notify chargeability under s 7 TMA, and no obvious way of taxing it using a s 29 assessment. This rather suggests that it is income for IT purposes, though probably not for trust purposes.

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By Tax Dragon
04th Mar 2021 11:36

You may be right about the (tax) treatment as income and I'm happy to be corrected accordingly if so. But s7 opens by talking about a person who is chargeable to income tax, while s29(1)(b) does not include a reason for the assessment being insufficient, so I'm not sure why:

richard thomas wrote:

if it were not income or treated as income then there would be no obligation to notify chargeability under s 7 TMA, and no obvious way of taxing it using a s 29 assessment.

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By richard thomas
04th Mar 2021 11:59

I tend to agree about s 7 TMA. I am currently writing a paper about the tax obligations and rights of those who are not in self-assessment, and I was thinking about the exclusions in ss 4 to 7 which are about income.

The point with s 29 is with s 29(1)(a). I and others have held that various pension tax charges cannot be the subject of a s 29(1)(a) assessment because the relevant charging provisions explicitly deem them not to be income for any purpose.

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By Tax Dragon
04th Mar 2021 12:13

The point being that 29(1)(b), though it appears to be a cover-all, can apply only if there was an assessment in the first place. I see the issue now.

I'd guess that's a point few accountants come across in practice, as most if not all their clients will be filing annual tax returns.

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Replying to Tax Dragon:
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By richard thomas
04th Mar 2021 12:36

Yes, that's quite right.

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By Tax Dragon
04th Mar 2021 10:22

But, good news, s498 includes the (45-20)% tax charge (Type 3A) so it goes into the s497 pool. (Without that specific provision, it would be 'dead' tax.)

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