Loss on an overseas insurance bond

Trusts Discussion
#1

My late client died on 4th February 2020. He was the holder of this bond which was valued at that date in the region of £317,000. But the insurance company was not notified of the death until 17th March 2020, by which time the value of the underlying investments had fallen by about 20%.

The bond value was reported for IHT and tax paid on the basis of the date of death value as advised. However the settlement payment was based on the value at the date of notification, so my executor clients are some £63,000 short and have paid inheritance tax on the higher amount.

The company concerned is very reticent about providing me with the data used to calculate both the date of death figure and the settlement figure, but they have provided me with a certificate showing the chargeable gain calculated on the date of death figure, albeit that as an overseas insurer it is not a statutory certificate.

So on the face of it my clients are triply disadvantaged. They have incurred a loss; it does not appear to me to be relievable for inheritance tax under sec 178 IHTA- although I’d be very glad to know if anyone else has succeeded in claiming it in these circumstances; finally the deceased’s final income tax liability may be based on an unrealistic valuation and it’s not clear to me how I might utilise the loss against that.

Has anyone else encountered this problem before, and what were they able to do about it?

Tim Gibbons

Gibbons Solicitors Limited

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Alresford

Hampshire

SO24 9EE

Tel 01962 736926

tim@gibbons solicitors.co.uk

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#2

What matters is the market value of the bond on the date of death. This involves an assessment of the hypothetical willing buyer and seller and what is the market and who’s in it. The fact that the asset is not assignable or tradable doesn’t matter or that its value can only be realised by triggering a mechanism based in contract and involving surrendering it for redemption by the other party. The Insurance Company is not the sole arbiter of this value, though challenging their opinion is a real hurdle needing an expert of equal stature.

However it is crucial to determine what is to be valued i.e. the precise characteristics of the investment because that the spectral being who must be presumed to buy it would have to accept them, here to be bound by the contractual terms and conditions. The case law has been forged mostly in relation to shares, particularly those unlisted.

A curious feature might be that notification may be integral under the contract to crystallisation of value. That may be deferred to the date of notification/surrender and it might occur then or even later. A surrender of an insurance policy backed by an investment portfolio might leave the owner open to market risk until the insurer has completed liquidation of the underlying assets; or the insurer might have undertaken to give a fixed quote at surrender and so live with that intervening risk.

Where there is such a risk inherent in the operation of the contract terms the value on the date of death is strictly not what the redemption formula eventually yields. It is what the disembodied parties might agree as the price based on their then expectation of that yield. No doubt the length of the interval and the volatility of the relevant underlying markets will play a part. The spectral buyer would probably be prepared to pay the value on the date of death with due allowance for the downside risk during the minimum period needed to cash in the policy.

IHTM 20084, 20211, and 20212 may help

That still leaves the procedural issue of how to correct the returned value and if that is possible. The Manual is mostly concerned with HMRC’s right to reopen an agreed valuation (see 30441-5) where it is in their favour to do so and the implication is that they might not do so if there has been an overvaluation unless their conscience can be tweaked and I suspect the facts would need to be egregious and the reasons non-culpable

Jack Harper

#3

As far as I’m aware I’m afraid there seems to be little you can do (subject to challenging values as Jack discusses).

The important date is the date of death.

Chapters III and IV Pt VI IHTA 1984 which provide relief for certain losses require a sale. The diminution between the value of the bond at the date of death and date of notification is not a loss for these purposes (ie no sale occurs).

There is no loss which can be relieved for income tax purposes and a loss which arises on one policy cannot be offset against any gains arising on another policy.

Defficiency relief is irrelevant.

Malcolm Finney

#4

As someone who was previously involved in offshore bonds, I would respectfully suggest that unless it’s a very unusual bond, there’s no requirement for w willing buyer and willing seller. It is a single premium life insurance policy and assuming it to be single-life, with no surviving second (or third) life insured, the sum insured is the value at date of death plus £1 (for technical reasons) and regardless of any subsequent fall in value, the insurers must pay out the sum insured. The underlying investments will usually be daily-tradable unit trusts/UCITS and the insurer effectively buys the units back.

If the bond is on multiple lives insured, then the above applies only on the last of those to die. If the bond is surrendered before the last life dies, then the date of death of the client (in this case) is irrelevant as the surrender is not related to that particular death. So if the value has fallen the clients either have to decide not to surrender, and to wait for the value to recover, or to accept the loss.

The final part of this is the ownership of the bond. If it was on multiple lives but owned only by the deceased the value at the date of death is the date for IHT. If the bond had multiple owners then the deceased’s share on death is as Joint Tenant and apportioned accordingly.

There can be more complex ownership and investment aspects but that is most unusual.

#5

IHTA 1984 s 167 is inapplicable to life policy valuation on death.

However, s 171 is relevant. Under s 171 any changes in the value of the death estate as a consequence of the death are taken into account. Under the typical single premium bond which is unit linked the amount payable on death is expressed as 101% of the bid value of the units at the date of death. The extra 1% referred to as the enhancement value is payable on death.

If the value at the date of notification (assumed to be later than date of death) is less than at the date of death (ie a loss arises) no IHT relief is available.

The above assumes that the bond holder was also the sole life assured in Tim’s post.

If there is more than one life assured and in Tim’s case the policy continued after the death of the bond holder on the latter’s death the value of the bond will be the market value of the bond immediately before the bond holder’s death.

Malcolm Finney

#6

The hypothetical willing seller/buyer concept is not irrelevant to the type of bond Lee Clarke describes. It represents an actual application of the principle! It seems to be an example of a policy which pays out the fixed sum assured despite being investment-backed. In such case the price the statutory notional parties are likely to arrive at is a notional price remarkably adjacent to that sum, assuming that there are no contingencies or any delay issue (HMRC do not accept that a simple delay in merely notifying the claim affects the value: IHTM 20084).

Lee mentions one difference himself: the policy being on multiple lives but due to pay out on the death of the last survivor who is still alive. In that case the willing buyer is going to have to assess the life expectancy of the remaining lives assured. As second-hand life policies have always had some kind of market the valuation methodology is well understood by HMRC and actual participants in the actual market. He also rightly draws attention to a discount where the policy is not in the deceased’s sole ownership.

Further on the correction of value point in Tim’s query, s241 of the Act applies and IHTM 30402 is HMRC’s view.

"The statute only says “If it is proved to the satisfaction of the Board that too much tax has been paid on the value transferred by a chargeable transfer…
HMRC say: “The four year limit does not apply where the charge to Inheritance Tax itself - (as distinct from the amount of tax charged) was based on an error of fact … For this purpose an alleged error in valuation is not an error of fact.”
It seems that correcting an overvalue will meet with opposition and good luck with an argument that HMRC have misinterpreted the statute (though the point arises and might bear traction if they themselves have a similar doubt).
I am presuming that the original value will have been returned on the basis of the company 's certificate and not even enquired into let alone agreed and that there was no technical mistake in using the IHT forms which might have unintentionally misled HMRC into accepting the “wrong value”.
I think Tim’s point in his own case is just that the realisation proceeds turned out to be less than the returned value and there is no specific loss on sale relief. He does not say why that was in accordance with the contract. Why was the payout less than the claim value certified? That is why I doubt the bond was in the form described by Lee. If all the bondholder was contractually entitled to was what was paid out, HMRC’s view in IHTM 20084 that (generally) the “claim value” must be judged as if notified on the day of death should not govern here because " the settlement payment was based on the value at the date of notification”. It was apparently not a mere timing issue but a crystallisation of value event. That would not be an error of fact but a technical error in the return and the company’s certificate cannot of itself govern the strict legal position.
In the “old days”, before the advent of trench warfare with no holds barred, I would have backed HMRC to gracefully accept a demonstrably tenable argument if the outcome was that tax was not charged on an amount greater than the company was contractually obliged to pay out (where that was not reduced by post-death events). Especially as accepting a company certificate at face value facilitates routine processing and lessens their administrative burden, allowing enquiries to be raised only exceptionally.

Jack Harper

#7

Much of the main body of Jack’s comments are outside my own expertise, however with respect to the first paragraph, we have so far not been told anything about the bond aside from it being an “Offshore Bond” It is reasonable to assume this is a single premium unit-linked life insurance bond issued in one of the usual offshore locations such as the Isle of Man, Dublin or Luxembourg, in which case the route to realising the cash value is either

1: by way of a death claim assuming the deceased owner was the only or last remaining life assured. the insurance company will pay out the guaranteed sum insured which is the current “bid” value, determined by reference to the daily prices of the underlying collective investment funds. The value is determined easily. For technical reasons this value is uplifted by £1, to ensure that there is an element of guaranteed value, to meet the UK tax rules governing life insurance policies

  1. If there is a remaining life insured alive, by surrendering the bond, the value being the market value of the funds on the day the insurance company receives the surrender request. It’s true that the value at date of death will be needed for IHT purposes, however as these figures are published daily and can be obtained from the insurance company it’s not difficult to ascertain the value, as indeed has happened in this case.

I’m not sure how, or even why one might try to sell the bond to a third party rather than exercising the usual options above, as it will never be worth more than the figures arrived at by options 1 and 2 above. Unlike the good old days of the with profit endowment policies where there was a second hand market here’s no market for second hand unit-linked investment bonds.

#8

The deceased was the only life assured on the bond which was issued by a well-known company on the Isle of Man.

I’m following this with great interest. Thank you all for your contributions

Tim Gibbons

#9

Tim, thanks for clarifying that. In which case, the position is as per option 1 in my comments, the full sum insured (I.e., the bid value of the bond at date of death plus £1) is payable, regardless of the subsequent fall in value, If you have any problems with the insurer over this we can connect privately and I would be happy to help you resolve it,

#10

It seems to me that the position is clear and the amount to be included in the deceased’s estate is simply 101% of the bid value of the units at the date of death because in Tim’s scenario the deceased was the owner of the policy and also the sole insured life.

As Lee points out the amount payable is not reduced to the amount at the date of notification.

Malcolm Finney

#11

Sorry to be a bore but what Lee and Malcolm say, based on the assumptions they make, is only correct because 101% of the bid value equals “open market value” under s160 IHTA 1984 as interpreted by case law. Whether Lee likes it or not that case law says that open market value is what a hypothetical willing seller and hypothetical willing buyer would agree as the sale price of the actual asset regardless of whether there is extant a recognisable “market”. There is no such market for unlisted shares, the perhaps more common subject-matter of a valuation issue, but a market has to be postulated because it is the law.

I am all for pragmatism and clients are only interested in the result. HMRC’s position is to accept the basis above because it is the common or garden occurrence but the true and proper legal analysis might enable someone like Tim to challenge it in a given case. Questioners here often do not or cannot give us the full facts and I respect that. But it is hard to answer Tim’s query without knowing the exact terms of the bond and crucially why the realised proceeds were £63,000 less than the returned value and the precise basis of the latter. To challenge HMRC’s position, presumably that the returned value is of the common or garden variety, Tim will need to show them that in his case it is not “open market value” as defined in law.

There is a difference between the law and pragmatic acceptance of a methodology. Listed securities are also to be valued on the above legal basis but in practice HMRC allow (indeed suggest: IHTM 18091 et seq) that you use published figures with a few tweaks. The result may bear no resemblance to the price at which any deal could have been executed in the market at any time on the day in question because the market is open for many hours, during which the price can fluctuate, even wildly. and the law specifies no particular moment of the day for the valuation. HMRC’s practice which is truly long standing is judged to be what most taxpayers will not challenge and what they themselves are happy with. In fact I am not sure a judge has ever been asked whether it actually represents the law. Where a normal market is not open or is disrupted or the listing suspended HMRC’s normal practice may be open to challenge if the taxpayer would benefit.

Jack Harper

#12

It is difficult to challenge Jack’s analysis.

Valuation for IHT purposes is governed either by IHTA 1984 s 160 (ie the general “market value” valuation rule) or special provisions contained in the Act including life policies (s. 167).

In Tim’s case s 167 has no application to transfers made on death (ie s 167 only applies to lifetime transfers) and thus s 160 dictates how value is to be determined. Irrespective of real world circumstances s 160 simply postulates a theoretical world under which market value is to be determined. As Jack points out in response to Lee, the lack of a recognisable market does not preclude the principles of s 160 from applying.

S 171 provides that any amount payable (ie due) to the deceased’s estate under the insurance policy (namely, the value of the units at the date of death) is brought in to charge for IHT purposes. How does this section fit into s 160; are you saying that what is brought in to charge under s 171 may not be market value?

Where two parties are negotiating over the policy’s value, at that time the value of the underlying units would be known which at that point in time would in principle cap the market value. Depending upon the age and health of the insured at that time will indicate when the insured may die and thus in turn whether the value of the units should be discounted (eg death likely in next 7 days discount nil; death likely in 5 years time then discount applied). On the other hand the units may go up or down in future and so this factor also needs to be built into the negotiation.

It is suggested that on balance that it is almost impossible having taken into account these factors to be much wiser as to what is market value. The market value (ie what someone will pay) is thus likely to be at least the value of the units at the time of negotiation and thus the value under s160?

Malcolm Finney

#13

There are two sides to the statutory bargain. I would therefore agree (to be annoying) that the outcome with a totally bankable fixed sum payout under a bond is that the claim value is market value. While the hypothetical buyer might like a discount to make it worth his while, why should the hypothetical seller accept less? So they balance each other out. A real seller and buyer might reach a different price e.g. if the seller couldn’t wait for his cash but real people play no part here.

While HMRC dismiss (reasonably) the timing of a claim as a purely administrative formality, and it is most unlikely a claim could ever be made on the date of death, a intrinsic inbuilt delay in accessing the money could be a contractual characteristic of the asset itself. In such a case even the hypothetical personnel might agree a discounted NPV just as they might if the sale was of a debt due at a future date. Either the amount would have to be very large or the contractual deferment period very long or both. The latter might induce a real buyer to consider credit risk but the statutory sale seems to exclude creditworthiness and anything other than immediate payment unless the nature of the actual asset being sold dictates otherwise. The sale asset is always real, never hypothetical.

Jack Harper

#14

These are not “Unlisted shares”, the bond invests in quoted unit trusts, the value of which is ascertainable from the insurance company. Offshore bonds investing in unquoted assets were outlawed some years ago. The sum insured does not require a willing buyer from anywhere, and certainly not in order to calculate the value for IHT/Probate.

Secondly, it is a life insurance policy and the insurance company MUST pay out the sum insured unless they can prove some form of non-disclosure at the time of underwriting… The extensive policy conditions stipulate how the sum insured is calculated.

If every life insurance policy had to be offered to a willing buyer before the sum insured could be paid out, we would be in a right old mess!

#15

If every life insurance policy had to be offered to a willing buyer before the sum insured could be paid out, we would be in a right old mess!

No doubt. Except that is not what the law requires. I am not going to restate again what the law does require. I am also aware that an insurance policy is not an unlisted share. I regret having given the impression that I was not.The law about valuation in s160 applies to each and every asset that falls to be valued for inheritance tax purposes on death. Lee Clarke may be an expert on insurance policies, and even on the methodology of their commercial valuation, but his apparent lack of acquaintance with the law of inheritance tax is not advancing the discussion so I now desist. If other forum members have a different view of the law from myself and Malcolm Finney perhaps they would contribute.

#16

Lee- could I please have your contact details to

tim@gibbonssolicitors.co.uk

Tim