IPTM5050 - Periodical payments: tax exemption: annuity payments
Use of annuities to provide periodical payments
As described in IPTM5010, it will not always be the case that periodical payments in a personal injury case are paid by the defendant or the defendant’s insurer. A common arrangement is that under the court order or settlement agreement the defendant or defendant’s insurer purchases a life annuity or a series of life annuities for the benefit of the injured person.
The annuities used may take various forms. They may provide for payments to be made for the full duration of the life of the injured person or they may be temporary annuities that only make payments for a specified number of years. Another type of annuity that might be used is a ‘deferred annuity’ where payments only start at some date in the future.
Annuities may be tailored to meet the particular needs of the injured person, for instance a deferred annuity might be used where it is anticipated that the injured person might require an increased level of care from some date in the future.
Tax exemption for periodical payments made by way of an annuity
The legislation specifically extends the tax exemption for periodical payments in a personal injury case to annuity payments made under an annuity purchased or provided
- in accordance with a court order, agreement or Motor Insurers’ Bureau undertaking - see IPTM5020 - or a varying order - see IPTM5030
- by the person by whom the periodical payments under such an order, agreement or undertaking would otherwise fall to be made.
As with periodical payments generally, the link with the court order or agreement is crucial. If, for instance, the court order for damages provided for a lump sum to be paid to the injured person who subsequently used it to purchase an annuity, then the annuity payments would not be exempt from tax. In such circumstances, the annuity was not purchased in accordance with the court order. Secondly, it was purchased by the injured person, not the person by whom the payments would otherwise fall to be made.
Where, however, a defendant or insurer initially directly funds periodical payments of damages for personal injury specified in the court order, and then subsequently purchases an annuity for the injured person to meet the payments, the payments under the new method of funding will remain tax exempt. This will be the case even if an annuity is not specifically provided for in the order, because the Damages Act 1996 permits such a change without court approval.
Treatment of annuity payments made after the injured person’s death
The exemption from tax is personal to the injured person and so does not generally continue past his or her death. However, some annuities have a guaranteed period where payments continue to be made for a certain time after the injured person’s death, particularly if death occurs prematurely. If so, the payments made after the death are taxable in the normal way as payments from a purchased life annuity with an exempt capital element. The relevant claim would need to be made for this exemption to apply - see IPTM4300 onwards.