Schedule 35 - Gains on policies of life insurance, etc: rate of tax

Finance Bill – in a Public Bill Committee at 9:15 am on 22nd May 2003.

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Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury 9:15 am, 22nd May 2003

I beg to move amendment No. 153, in

schedule 35, page 405, line 10, at end add—

'Transitional relief

6. (1) Where a person to whom a gain in respect of a policy is treated as accruing after 5th April 2004 by virtue of the provisions of this Chapter was entitled to the policy since before 1st April 2003, and provided that on or after 9th April 2003—

(a) no additional premium has been paid under the policy (other than a premium the payment of which was already required by the terms of the policy), and

(b) no sum has been paid for the acquisition of the policy or rights or interests in it,

that person may by notice to the Inland Revenue elect that the following provisions of this paragraph shall apply in relation to the amount of tax treated as deducted from the sum included in his income by virtue of section 547(5) (on its own or as applied by section 547(5AA)).

(2) Where an election is made under subparagraph (1) above the amount of tax treated as so deducted shall be ascertained by reference to the proportion of the person's period of ownership of the policy which fell after 31st March 2003, by applying the following table—

proportion of the taxpayer's period of ownership which falls after 31st March 2003 proportion of gain from which tax is treated as deducted at the lower rate proportion of gain from which tax is treated as deducted at the basic rate
not exceeding 10% 0% 100%
not exceeding 30% 25% 75%
not exceeding 50% 50% 50%
not exceeding 75% 75% 25%
over 75% 100% 0%
(3) A notice of election under subparagraph (1) above must be given in writing and may be given at any time not later than 31st January in the second year of assessment following the year in which the sum was included in his income.'.

When we exhaustively worked our way through clause 169 and schedule 33 on Tuesday, the Economic Secretary or the Paymaster General—I forget which—made the point that these complex arrangements, which have pluses and minuses, will save the insurance industry £40 million a year. The Economic Secretary has now said that it is specifically the changes that we are now discussing that will save the industry £40 million a year. Can he clarify that? I think that he did not mean two £40 millions and that it is these arrangements, not those under clause 169 and schedule 33, that have the net tax-saving effect.

The amendment is intended to provide transitional relief in respect of the increases in the effective rate of tax for taxpayers liable at more than the basic rate, when policies have been held for a significant time during which tax was paid by the insurance company at the basic rate, rather than the lower rate. Although we recognise that a truly fair system that took account of that might give rise to some complexity, there should be some form of transitional provision to cater for cases in which the gain has accrued over a significant period prior to the introduction of the changed regime for insurers. We suggest that that might be done by means of a sliding scale, as set out in the amendment, and that the relief should apply on an elective basis so that those who do not consider it worth while to invoke it need not go through the relevant complex calculations.

Photo of John Healey John Healey The Economic Secretary to the Treasury 9:30 am, 22nd May 2003

The amendment is designed to defer the full impact for higher rate taxpayers of the reduction in the rate at which tax is treated, as already paid on gains from life insurance policies. I will put the amendment in the context of the schedule, and will therefore range a little more widely.

The insurance company has paid tax as a proxy for the policyholder, as I explained in my opening remarks on clause 172. As a result of other changes in the Bill, the rate of tax payable by the company on capital gains realised on assets that it holds to meets its obligations to policyholders has been reduced from 22 per cent. to 20 per cent. I can confirm that the £40 million is a net tax saving. It is the net effect of all the life insurance measures. There is a similar reduction this year in the rate of tax payable on income from property.

The changes mean that insurance companies are now not liable at a rate higher than 20 per cent. on any of the income and gains that arise on policyholders'

funds. Other income on the funds has, since 1996, been taxed at a rate equivalent to the 20 per cent. lower rate. Higher rate taxpayers have benefited from the rate reduction since then, as they have continued to be treated as if tax had been paid at the basic rate on all their investment returns.

The amendment does not recognise the fundamental principle of the present taxing regime, which is that a gain on a life policy is income in the year in which it arises and is chargeable to tax in that year at the rates appropriate to that year. If the higher tax rates applying have fallen in the year in which the gain arises, as has generally been the case, the taxpayer will benefit. The amendment also takes no account of the fact that the reduction in the rate of tax payable on gains will benefit all policyholders to a much greater extent than the increase at which the amendment is directed. Nor does the amendment take account of the fact that no one will have to pay tax on this account before January 2006.

The changes proposed by the Government, as part of the package, merely alter the way in which the tax is distributed between the insurance company and the policyholder. They do so in a way that matches what happens and therefore reflects reality.

Since the regime for taxing life insurance was introduced in 1968, there have been up to 20 changes in the tax rates applying to basic rate taxpayers and life insurers. In all that time, under this and previous Governments, there have never been any adjustments of the kind proposed in the amendment. I encourage the hon. Gentleman to pause to reflect on why that is the case. If there had been such changes, policyholders would find them impossible to cope with. There is no good reason to delay introducing the Government's proposal beyond next April. The measure strives for simplicity. There are a few rough edges but, overall, it is a fair and sensible solution and is part of a measure that is of significant benefit to taxpayers. On that basis, I encourage the hon. Gentleman to withdraw the amendment. If he does not, I encourage my hon. Friends to reject it.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury

The complexity point was why the amendment was proposed on an optional basis. The explanatory notes suggest that the reduction of the credit to the lower rate follows from the reduction of the tax rates payable by insurance companies. I note that the reference to schedule 32 is incorrect—it should be to schedule 33.

The explanation is somewhat misleading. For many years to come, policies that mature and give rise to chargeable gains will have accrued those gains in years prior to 2003, when the underlying gains will have been subject to the basic rather than the lower rate. It is somewhat misleading to imply, as paragraph 15 of the explanatory notes, does that

''all of the profits representing the policy holders' share of income and capital gains are liable to tax at a rate equivalent to the lower rate''.

The explanatory notes recognise that the effect for a higher rate taxpayer will be to increase the rate of tax

for which he will be liable from 18 per cent. to 20 per cent. That unfairness, which will affect policies that have been held for a long time, could be dealt with along the lines of our amendment. Therefore, we believe that this is an opportunity to sort out the issue.

Question put, That the amendment be made:—

The Committee divided: Ayes 6, Noes 16.

Division number 13 Adults Abused in Childhood — Schedule 35 - Gains on policies of life insurance, etc: rate of tax

Aye: 6 MPs

No: 16 MPs

Ayes: A-Z by last name

Nos: A-Z by last name

Question accordingly negatived.

Schedule 35 agreed to.