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HMRC internal manual

Capital Gains Manual

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Life insurance policies/deferred annuities: computation of gain: disposals from 9 April 2003 interaction with Income Tax

In computing the gain or loss on a disposal of the rights conferred by a life insurance policy or deferred annuity, or an interest in those rights, the normal rules in TCGA92/S37 and TCGA92/S39 operate to exclude amounts charged to income tax as income of the person making the disposal or which are allowable in computing income - see CG14300+.

The guidance at CG69001 explains that some life insurance policies and annuities can generate an Income Tax liability under the Chargeable Event Gain rules. Chargeable Event Gains are computed under those rules on a different basis to chargeable gains for the purposes of Capital Gains Tax. The interaction between the two codes was considered in Drummond v HMRC. In that case a small Chargeable Event Gain arose on the surrender of a second hand life insurance policy. The Court of Appeal concluded that in computing the chargeable gain accruing on this disposal the Chargeable Event Gain should be excluded from the disposal consideration as it had been charged to income tax as income of Mr Drummond.

It is nonetheless possible for the differences between the two codes to result in computations made by simply applying TCGA/S37 giving rise to losses for the purposes of Capital Gains Tax greater than the losses (if any) that a taxpayer had really incurred.

For disposals on or after 9 April 2003 TCGA92/S210 restricts the amount of any loss for Capital Gains Tax purposes on the rights under a life insurance policy or deferred annuity to that which the taxpayer really incurred. TCGA92/210 (7) provides that TCGA92/S210 (8) restricts any loss on a disposal to the amount of the loss that would have arisen on the disposal if TCGA92/S37 and TCGA92/S39 were disregarded.

This restriction has no practical effect if the exemption described in CG69042 is due so that any gain on the disposal would not have been a chargeable gain as, in those circumstances, any loss is not an allowable loss anyway - see TCGA92/S16 (2) and CG15800. But if, on or after 9 April 2003, a taxpayer

  • disposes of the rights, or an interest in the rights, conferred by a life insurance policy or deferred annuity contract, and
  • the exemption is not due, and
  • a loss arises from the ‘normal’ computation

you have to re-compute the loss disregarding TCGA92/S37 and TCGA92/S39. If the result of the second computation is a loss, the amount of the loss allowable for the purposes of Capital Gains Tax is restricted to the smaller figure. If the result of the second computation is a gain (or arithmetically gives no gain or loss), there is no allowable loss. Note that any gain that results from the alternative computation is not a chargeable gain - the effect of the legislation is only to limit losses. There is an example of the comparative computation you have to make at CG69062.

If the loss of the person making the disposal is restricted by these rules, this does not have any effect at all on the Capital Gains Tax position of the person who acquired the rights or interest in the rights - TCGA92/S210 (9).

For disposals on or after 6 December 2006 you may also need to consider the Targeted Anti-Avoidance Rule (‘TAAR’) to be found at TCGA92/S16A. Where that legislation applies to a capital loss, the loss is not to be an “allowable loss” and may not be set off against chargeable gains or income, see CG15835.