It is essential that trustees, who manage the trusts, are aware who is liable for any tax charge should an underlying investment bond be surrendered. It is important to note that investment bond surrenders are taxed under the chargeable event legislation, but who is taxed depends on the type of trust and whether the settlor or settlors are alive and if not, when they died.
Onshore investment bonds suffer corporation tax within the investment fund and because of this a chargeable gain carries a 20% tax credit. Offshore bonds do not suffer any income tax within the fund (but may suffer withholding tax).
As an investment bond is a non-income producing asset there is only an income tax charge when a chargeable event results in a chargeable gain.
For the purpose of this document we have assumed that the settlor(s) and trustees are UK resident.
Bare or absolute trust
As the beneficiary or beneficiaries will have an absolute entitlement to the trust assets, they will be taxed as if they own the bond. If they are non-UK resident then there will be no UK tax liability.
However, if the trust was set up by their parents, the parental settlement anti-avoidance rules will apply. This means that any chargeable gain over £100 is assessed on the parents whilst the beneficiary is under 18 and not married.
If the chargeable gain arises under an onshore investment bond, the beneficiary or parent is treated as having paid income tax at 20% on the gain, which cannot be reclaimed if the individual is a non-taxpayer.
Discretionary and interest in possession trusts
Any chargeable gains are firstly assessed on the person who created the trust (the settlor), provided they are UK resident. Normal top-slicing rules would apply.
If the settlor has died in a previous tax year, or is not UK resident, then the chargeable gain is assessed on the trustees at the rate applicable to trusts; currently 45%. Top-slicing would not apply in this instance. If the settlor has died in a previous tax year and the trustees are non-UK resident, the chargeable gain will be assessed on any UK resident beneficiary who receives any benefits from the investment bond. Normal top-slicing rules would apply.
If the chargeable gain arises under an onshore investment bond income tax at 20% is treated as having been paid, which cannot be reclaimed.
Trusts established before 17 March 1998
Before 17 March 1998, only the settlor was liable to a tax charge for a chargeable gain. The settlor would only be liable if a chargeable event occurred whilst they were alive or in the tax year of their death.
However, if the settlor died before 17 March 1998, in subsequent tax years there would be no-one available to be assessed for a gain and therefore no tax liability would exist. Where there were two settlors only one had to die before 17 March 1998 for there to be no tax liability to exist in a subsequent tax year.
This was referred to as the ‘dead settlor rule’. This rule changed on 17 March 1998 to the regime we are familiar with today, but the rules are not retrospective. Therefore the dead settlor rule can still apply providing:
- the trust was created, the investment bond set up, and the settlor died, before 17 March 1998; and
- the investment bond has not been changed as to increase the benefits or extend the term, on or after 17 March 1998.
In the right circumstances this rule can still provide valuable tax planning advantages.
The following provides a flowchart showing who is potentially liable.
This is based on Canada Life’s understanding of applicable legislation, law and current HM Revenue & Customs practice as at March 2021. The information regarding taxation is based on our understanding of current legislation, which may be altered and depends upon the individual circumstances of the investor. We recommend that investors seek their own professional advice.