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A defeat in a First Tier Tribunal case has prompted a change in HMRC approach to calculating the amount of top slicing relief available on investment bond gains. The change could see some clients entitled to more relief and HMRC say this will apply to gains from 6 April 2021 onwards.

The additional relief stems from HMRC accepting that the amount of Personal Savings Allowance (PSA) used in determining how much relief is available can be based upon the top sliced gain rather than the full gain.

What is top slicing relief?

The increase in value of an investment bond is not taxed on an annual basis but instead is deferred until there's a taxable event which results in a chargeable gain - for example, on surrender of the bond or on death of the last life assured. This is indeed one of the advantages of bonds in that the taxpayer has a degree of control on when investment profits are actually taxed.

This means investment returns accrued over many years are taxed in a single tax year. To overcome this spike in taxable income, 'top slicing' aims to put the taxpayer back into the position they would have been in had they been taxed annually over the investment period. This is achieved by calculating a figure that reduces the overall tax bill in the year of the chargeable event.

The amount of relief available is broadly the difference between the tax payable on the full gain and the tax that would have been due on the average 'top sliced' gains over the investment period. For a full explanation of how top slicing relief is calculated see our guide: Taxation of investment bonds.

What's changed?

The new guidance published last month now allows the average gain to be used to determine both the PA and PSA for the part of the calculation to determine the tax on the averaged gains.

Previously, when calculating the tax payable on the average gain for top slicing relief purposes HMRC insisted that the client's income plus their full gain should determine how much PSA was available. In contrast, the amount of personal allowance (PA) used in the top slicing calculation is s based on the average (sliced) gain.

To be clear, for that part of the top slicing relief calculation that uses the 'full gain', the entitlement to the PA and PSA will also be based on total income which includes the full gain. Top slicing relief has always proved a difficult concept to understand, but it would appear that a certain amount of logic has been restored. The outcome can only potentially benefit the taxpayer - no one will be any worse off.

Who may be entitled to additional relief?

On the face of it this new approach could benefit many clients. In practice, however, the mechanics of top slicing relief means this will not be the case.

Broadly speaking, the only clients who will benefit from this new approach will be those where both of the following are true:

• The 'full gain' plus income falls within additional rate, and
• The 'top sliced' gain plus income falls within higher rate.

For example, a client with earned income of £45,000 plus a bond gain of £150,000 held for 15 years will pay £1,500 less tax following this change of stance by HMRC. This equates to a saving of £100 for each full policy year the bond was in force. This will be a typical saving for a client in this group.

But not everyone will see a tax saving. As already mentioned, top slicing relief is based on the difference between two figures, one the notional tax on the the full gain (a) and the other the notional tax on the average gains (b).

Figure (a) is unchanged under the new approach. Figure (b) may reduce (and so increase the amount of relief) as a result of more having more PSA at either £1,000 or £500.

But the extra PSA may be negated if the notional tax calculated in figure (b) is less than the 20% notional basic rate credit (which both onshore and offshore bonds get in the TS calculation). This means where the top sliced gain falls to be taxed at basic rate figure (b) will be zero and the amount of top slicing relief is unchanged.

There's no additional relief available for anyone who has already used up their personal savings allowance with other savings income, such as interest from bank accounts or fixed interest collective investments, which exceeds their PSA.

Of course, if the client's income plus the sliced gain and income plus the full gain, both fall within the same tax band, there will no additional top slicing relief because there will be no change in the amount of PSA available.

The 'Judges' case

This change in approach is as a consequence of a First Tier Tribunal hearing in the case of Sally Judges v HMRC. This case relates to a chargeable gain which arose on death in the 2017/18 tax year. It was argued that not only should top slicing relief be calculated using a PSA based on the top sliced gain but also that allowances and reliefs may be allocated in the most advantageous way.

The use of beneficial ordering in the top slicing relief calculation is no longer possible for gains made after 11 March 2020 following a change in legislation prompted by an earlier First Tier Tribunal verdict, the 'Silver' case.

How do I claim relief?

The PSA amount within the top slicing relief calculation will be based on the average gain on all chargeable gains arising after 6 April 2021.

This means any gains made in the current tax year should automatically be calculated using the revised basis when a self-assessment tax return is submitted.

Clients have until 31 January 2024 to submit a tax return for gains arising in 2022/23 tax year. This means they still have time to submit their return using the new calculation basis.

HMRC have yet to confirm if gains from 2021/22 tax year submitted on the old basis will be automatically recalculated and refunds issued where it results in additional top slicing relief. Therefore, clients with gains relating to this tax year may wish to contact HMRC with a revised self-assessment return if they believe they may be entitled to a refund.

Any requests to have tax recalculated based on beneficial ordering will be limited to gains in the 2019/20 tax year providing the chargeable gain arose before 11 March 2020 and must be made before 6 April 2024.