Liabilities: investigating liabilities: chargeable gains that give rise to an income tax liability when a life insurance policy matures
Under ITTOIA 2005/Chapter 9 an individual who is the beneficial owner of rights under a life policy may have the gain arising from the payment of benefits as a result of their death treated as taxable income. The gain is viewed as arising immediately before death and treated as income received before the death. The charge to income tax is made under the chargeable event legislation and takes priority over any charge to Capital Gains Tax.
Where the policy is a UK life policy, an income tax charge will normally only arise where the deceased was a higher rate taxpayer, or where the gain takes the deceased into the higher rate tax band. Where the personal representatives state that a deduction for tax liabilities relates to a UK life insurance policy of which the deceased was the beneficial owner you should ask them for a copy of the ‘chargeable event certificate’ and you should check that the deceased was a higher rate taxpayer. If not, you should deny the deduction. If the deduction is for higher rate tax, you should establish the additional (higher rate) income tax charged as a result of the death. You should allow the deduction claimed limited to the amount of the additional higher rate tax actually charged. This is because the deceased is treated as having already paid income tax at basic rate - ITTOIA 2005/S530.
Where a policy is an offshore life policy it is possible for basic-rate taxpayers as well as higher-rate taxpayers to be liable for the charge to income tax. If the personal representatives claim a deduction for tax liabilities relating to an offshore life policy of which the deceased was the beneficial owner you should allow the whole deduction, including the basic-rate tax. This is because the offshore fund is not treated as though basic-rate tax has already been paid.
It is important to distinguish between deductions relating to the beneficial owner of a life policy and deductions relating to the Settlor. On the death of the Settlor of a life policy, income tax may be charged under ITTOIA 2005/S465 in the same way as on the death of a beneficial owner. In these circumstances, however, this is not an allowable deduction for Inheritance Tax purposes as ITTOIA 2005/S538 provides for the Income Tax paid to be recovered from the Trustees. (IHTA84/S162(1) disallows liabilities for which there is a right of reimbursement.) You should refer the file to Technical if:
- the personal representatives are claiming a deduction for an income tax liability relating to a policy that does not form part of the deceased’s estate for Inheritance Tax purposes,
- the position is not clear for any reason, or
- the personal representatives do not accept the position.