How is Top Slicing Relief calculated for 2018/19?

Top Slicing Relief hypothetically spreads a chargeable event gain (CEG), such as a gain on a life policy, over the years of the policy, such that the tax is payable as if the CEG had been received in equal amounts in every year. It’s not an exact calculation as it doesn’t match the income to the actual tax years, but it gives a good approximation.

The law (ITTOIA 2005 s 535) requires the taxpayer to perform two calculations:

1. tax due when the whole CEG is taxed in one year;
2. tax due on the annual equivalent (gain divided by the number of years the policy was held (n)). The result is multiplied by n.

Top Slicing Relief is the difference between the two resulting figures.

The tax in the second calculation should be calculated using the hypothetical (based on one year’s worth of the CEG) personal and savings allowances, rates and tax bands for the year in which the CEG was received, multiplied by the number of years of the policy. HMRC’s calculation does not take into account all the allowances that would apply in the hypothetical second calculation above. For an individual whose adjusted net income exceeds £100,000, the amount of the personal allowance available to them in that tax year is reduced in accordance with ITA07/PT3/CH2/S35(2). The top slicing calculation must use allowances based on the income of the tax year of the gain rather than by reference to the annual equivalent of the gain. Where the personal allowance has been reduced, it is this reduced figure that forms part of the calculation for relieved liability.

The top-slicing relief is the result: calculation 1 minus calculation 2.

Example:

In 2018/19 Tom has taxable employment income of £32,000, net of the personal allowance. He has a chargeable event gain of £50,000 on the full surrender of a life insurance policy which he has held for 5 years. As this is a UK policy, basic rate tax will be treated as having been paid on the amount of the gain, in this case £10,000.

For 2018/19, higher-rate tax applies when taxable income exceeds £34,500.

As Tom is a higher rate taxpayer this year, his personal savings allowance is £500.

The starting rate for savings will not be due as Tom’s total non-savings income above the personal allowance exceeds £5,000.

Step 1: Calculate the total taxable income for the year and identify how much of the gain falls within the starting rate for savings, personal savings allowance nil rate, basic, higher or additional rate bands as appropriate.

Step 2: Calculate the total tax due on the gain across all tax bands. Deduct basic rate tax treated as paid to find the individual’s liability for the tax year.

Total tax chargeable on the gain                 £19,400

Less Basic Rate tax treated as paid           (£10,000)

Total liability for the year                              £9,400

Step 3: Calculate the annual equivalent of the gain. The annual equivalent is calculated by dividing the gain by the number of years the policy has been held (N).

In this case the annual equivalent is £50,000/5 = £10,000.

Step 4: Calculate the individual’s liability to tax on the annual equivalent. The amount of the savings starting rate and personal savings allowance used in the top slicing relief calculation are set by virtue of the taxpayer’s adjusted net income for the tax year. They are not adjusted to calculate the notional tax due on the ‘sliced gain’. Deduct basic rate tax treated as paid on the annual equivalent and multiply the result by N. This gives the individual’s relieved liability.

500 x 0%                             =0

2,000 x 20%                       =400

7,500 x 40%                       = 3,000

Liability to tax    = 3,400

The basic rate treated as paid on the annual equivalent is £10,000 x 20% = £2000

The relieved liability is therefore £3,400 -  £2,000 multiplied by N (5) to find the total relieved liability, in this case £7,000.

Step 5: Deduct the individual’s relieved liability at step 4 from the individual’s liability at step 2 to give the amount of top slicing relief due.

Top slicing relief is the difference between the total liability and relieved liability, in this case £9,400 - £7,000 = £2,400.