Top slicing relief revisited – the Budget changes explained

Last updated 2 April 2020

The Spring Budget confirmed a change to the HMRC approach to taxing bond gains arising after 11 March 2020. The change may affect those whose total income, including the full bond gains, exceeds £100,000. Those with total income of £100,000 or less will not be affected.

Those affected will benefit from an increase in the amount of top slicing relief that can be claimed reducing the overall amount of tax due.

Who will it affect?

Basically, it will affect those whose total income plus the averaged gain is less than £100,000, but the full gain when added to income is above this amount.

It will not mean they get their full PA back when calculating their income liability but they will now see more top slicing relief available as the averaged gain is used to determine the PA used for this purpose.

Taxation of bond gains - the basic principles

A key feature of investment bonds is that profits are not taxed annually, but will be taxed when encashments are made and a chargeable event arises.

Taxing the whole gain in the year of the chargeable event may, however, be seen as unfair as total income will ’spike’ with tax being paid at higher rates than if the gains had actually been taxed yearly.

To rectify this, top slicing provides relief from tax at higher rates. This is done by taking the difference between two calculations. The first one calculates tax on the bond based on the full gain (the ’total liability’). The second one is based on the average gain (the ‘relieved liability’). The difference between these two figures is ’top slicing relief’, and can be deducted from the main tax computation.

The change

HMRC have changed their stance on how much personal allowance (PA) is used in these calculations. PA is reduced by £1 for every £2 of total income (called adjusted net income, and includes bond gains) over the income limit of £100,000, until it is lost altogether. For the current tax year this would be once total income exceeds £125,000.

With regards to the top slicing relief calculations, before 11 March 2020 the HMRC held the view that the PA available in both parts of the calculation should be based on total income, including the full bond gain, not the averaged gain. This view was challenged in the 'Silver case', where the taxpayer argued that when calculating the 'relieved liability' using the average gain, the average gain should be added to other income instead of the full gain to determine the PA to be used in that part.

The upshot is that the legislation will be amended to confirm that the average gain (and not the full gain) will indeed be added to other income to determine the PA used in the relieved liability part of the calculation for all gains made from 11 March 2020.

This could mean an increased amount of relief available and reduction in the ultimate tax bill as a higher amount of personal allowance is available.

Example:
Jade has a salary of £40,000. She also has an offshore bond with a gain of £100,000 made over 10 years.

Her full tax liability (excluding any relief for top slicing) is £48,300. Her total income (including the full bond gain) means she has no personal allowance.

Salary:	£37,500 @ 20% basic rate	= £7,500
Salary:	£2,500 @ 40% higher rate	= £1,000
Gain:	£500 @ 0% PSA	= £0
Gain:	£99,500 @ 40% HRT	= £39,800
Total liability		= £48,300

From this amount top slicing relief of £19,800 can be deducted and is calculated as follows:

Total liability - Tax on full gain
Total income is £140,000, therefore no personal allowance is available, but £500 of the personal savings allowance (PSA) will be available.

Salary:	£37,500 @ 20% basic rate	= £7,500
Salary:	£2,500 @ 40% higher rate	= £1,000
Gain:	£500 @ 0% PSA	= £0
Gain:	£99,500 @ 40% HRT	= £39,800
Tax treated as paid:	(£100k @ 20%)	= £20,000
Total liability on bond		= £19,800

Relieved liability - Tax on averaged gains
Total income with the average gain of £10,000 is now £50,000, so the full personal allowance can be used. The PSA is still £500.

Salary:	£12,500 @ 0% PA	= £0
Salary:	£27,500 @ 20% BRT	= £5,500
Gain:	£500 @ 0% PSA	= £0
Gain:	£9,500 @ 20%	= £1,900
Tax treated as paid:	(£10k @ 20%)	= £2,000
Relieved liability on bond		= £0

The amount of top slicing relief available is therefore £19,800 (£19,800 - 0).

Had the relieved liability been calculated on the HMRC’s previous understanding, there would have been no personal allowance available in the ‘relieved liability’ part of the top slice calculation. The relieved liability would then have been:

Salary:	£37,500 @ 20% basic rate	= £7,500
Salary:	£2,500 @ 40% higher rate	= £1,000
Gain:	£500 @ 0% PSA	= £0
Gain:	£9,500 @ 40%	= £3,800
Tax treated as paid:		= £2,000
Relieved liability on bond [(3,800 - 2,000) x 10 years]		= £18,000

Top slicing relief would have therefore been £19,800 - £18,000 = £1,800 (instead of £19,800, £18,000 less than under the new rules).

Gains made before 11 March 2020

There is still some uncertainty over how these will be treated. HMRC practice has been to include the full bond gain in the calculation of total income when determining the PA to be used for top slicing where the gain was made before 11 March 2020. The PA will therefore be the same for both the total liability and relieved liability parts (and for the above example, giving a £18,000 higher tax bill).

HMRC have now withdrawn their appeal in the ‘Silver’ case. The case which was due to be heard in the Upper Tier Tribunal on 2 April 2020 could have a bearing on the calculation of top slicing relief for gains made before 11 March 2020 including where tax has already been paid.

Unfortunately, decisions in the First Tier Tribunal do not set a legal precedence. Further guidance from HMRC is awaited as to what the withdrawal of their appeal means for those individuals affected i.e. those with gains before 11 March 2020 where the full gain when added to other income exceeded £100,000 but the averaged gain plus their income was below the threshold.

Order of income

The Budget also took the opportunity to confirm another point relating to the calculations. The legislation has always considered bond gains to be taxed on top of all other income for top slicing purposes.

However, a taxpayer is able to use their personal allowance to their best advantage. For example, if an individual has a salary of £10,000 and therefore unused personal allowance of £2,500, they can use this against any other source of income they choose if this would result in less tax.

But this is not the case for top slicing relief calculations, and the new legislation confirms that any unused personal allowance must be used with other income before bond gains. This could mean that unused personal allowance has to be set against income that might otherwise pay tax at 0% such as dividends up to £2000.

Summary

In many cases the amount of top slicing relief will not change following the Budget. Where both the full gain and averaged gain when added to income don’t exceed £100,000, the amount of top slicing relief will remain unaltered from 11 March 2020. Equally there is no change if the averaged gain will result in the loss of the personal allowance. Only where total income plus the averaged gain is less than £100,000 but the full gain when added to income is above this amount will there be additional relief available.

Those clients who have gains which arose before 11 March 2020 should keep a close eye on future HMRC guidance in this area before submitting returns or attempting to reclaim potential overpaid tax from earlier tax years.