Time Apportionment Relief and Top Slicing

If you've been reading about holding offshore bonds and lessening tax liability, then you may have heard of the terms Time Apportionment Relief and Top Slicing, but what are these and how can they be used to lessen your tax bill when you come to realize your gains?

Well, believe it or not, the UK revenue do actually play fair when it comes to taxing you on the gains you've made on your assets.
So lets assume you've held a portfolio bond, which you earned Deemed Gains credits on while you were offshore, but have now realized a profit which takes your slightly beyond your accrued credit.

In this example, an investor takes out a bond and invests £100,000. After three years, he endorses this to a UK friendly product to stop Deemed Gains being applied and at the end of the sixth year, he decides to surrender, or encash the bond.
During this time, the bond has made a 62.08% gain and is now worth £162,080; a gain of £62,080.

During the years that the investor spent offshore, the investor accrued Deemed Gains credits to the value of 52.08%, so £52,080 is deemed to have already been taxed, leaving only £10,000 to be inspected by the revenue.
But here is where customs actually do play fairly, they realise that this untaxed gain was made over 6 years, but the investor was only in the UK for 3 years as they can only tax the gains made while the investor was UK resident, they apply Time Apportionment Relief - 3 years in the UK divided by 6 years for the total gain means that only 50% is considered, so now the sum is halved to just £5,000 to be taxed.

That's not bad is it?

The revenue actually calculate this on a daily basis, so the calculation would have looked more like 1095 / 2190. If the investor had been offshore for 3 years and 1 week it would have been 1095 (2 years) - 7 (days) time spent in the UK, so 1088 / 2190, = 49.7%.

But what can we do about this £5,000 to be taxed? Well, the gains generated from a bond are treated as income, rather than as capital gains, so now we can apply Top Slicing to potentially further reduce the tax.

Top Slicing is where the income received, in this case £5,000 is split over the years that the client was UK resident - in the case 3 years, £1,666.67 a year. This is then applied to the client's normal income and taxed at the normal rate of income tax - either 0%, 20%, 40% or 50%, depending on the client's tax band for their normal income.
If the gain is small and doesn't push the client's income for that year up into a higher tax band for income then Top Slicing isn't neccessary, but what if you normally earn close to the limit for your band and then see a large gain such as £50,000 or £100,000 push you into the 40% or 50% tax band? Top slicing may, if over enough years reduce the total (annual) gain down and retain your current tax position for income.

So let's assume that our investor earns £34,400.
A £5,000 gain would take that income to £39,400, meaning that £2,000 over the tax band threshold would be taxed at 40% and the remaining £3,000 at 20%.

£3,000 x 20% = £600
£2,000 x 40% = £800
Tax Bill = £1,400

But because of Top Slicing, we can assign this £5,000 over three years, so the investors income was actually just £36,066.67 in each year, meaning he stays in the 20% tax band. So the new result looks like this:

£1,666.67 x 20% = £333.33
Multiply this by the 3 years the gains were made
Total Tax Bill = £1,000

The investor has now saved himself a further £400.

So through a combination of Deemed Gains, Time Apportionment Relief and Top Slicing, we have a final tax bill of £1,000, or a net profit of £61,080 (equivalent tax rate of 1.6%).

Holding these assets directly would have resulted in capital gains taxation.
Capital gains tax is also tested against income, but only in the year of encashment and is taxed at different rates to normal income tax.

The following example is the same investor, with the same annual income level, encashing his directly-held assets.

Annual tax-free personal allowance of £10,100 for Capital Gains Tax.
Gains: £62,080 - £10,100 = £51,980 to be treated for taxation purposes
Annual Income - £34,400 meaning £3,000 is available to use at the lower rate of capital gains tax.
£3,000 x 18% = £540
£48,980 x 28% = £13,714.40
Total Tax Bill = £14,254.40 (22.96%)

So through careful tax planning for the future our investor has saved himself £13,254.40 in tax.

You may even be able to save yourself more tax by assigning your bond or parts of it, if taking a partial surrender, to a lower-rate tax payer, such as a spouse or relative before encashment.

For more information on planning your assets for your future tax liabilities, contact a financial advisor.