Annex 1: Minor changes in the law made by the Act: Change 120: Exempt income: purchased life annuity payments: determining the age of the person during whose life a purchased life annuity is payable: sections 720(4) and 721(4)
This change alters in certain circumstances the age to be taken for the person during whose life a purchased life annuity is payable for the purposes of calculating the amount of the annuity that is exempt.
Section 656(1) of ICTA provides for a part of an annuity payment made under a purchased life annuity to be treated as capital (the “capital element”). The effect is that, so far as it consists of the capital element, the annuity payment is exempt from income tax.
The way in which that exempt part is calculated varies according to the type of annuity involved, but the legislation is very jumbled and does not distinguish the different types very clearly.
By definition (see section 657(1) of ICTA) the term of a purchased life annuity is always dependent on the duration of a human life. The amount of the annuity payment might also be dependent on the duration of a human life. And the term or the amount (or both) might also be dependent on some other contingency (a “non-life contingency”).
There are two basic approaches to the calculation of how much of any annuity payment is exempt. Which approach applies is, in general, determined by whether or not the amount of the annuity payment depends on some non-life contingency. Where the amount does depend on a non-life contingency, a constant sum is exempt (assuming the period covered by each payment is the same) - see section 656(2) of ICTA. This is determined by reference to the purchase price of the annuity and its expected term. Under section 656(2)(a)(ii) of ICTA the term is determined as at the date when the first annuity payment begins to accrue “by reference to prescribed tables of mortality”.
But where the amount of the payment does not depend on a non-life contingency a constant proportion of each payment is exempt. (See section 656(3)(a) to (c) of ICTA.) Under section 656(4)(c) of ICTA the proportion used is the proportion that the total amount or value of the consideration for the grant of the annuity bears to the actuarial value of the annuity. That is determined as at the date on which the first payment begins to accrue “by reference to the prescribed tables of mortality”.
Section 656(7) of ICTA provides that in using the prescribed tables of mortality to determine the expected term of an annuity or the actuarial value of the annuity payments:
“the age, as at the date when the first of the annuity payments begins to accrue, of a person during whose life the annuity is payable shall be taken to be the number of years of his age at his last birthday preceding that date.”
So the age of the person during whose life the annuity is payable is determined by reference to his or her last birthday before the date of the calculation. Accordingly, where the calculation is to be made on the individual’s actual birthday, it is still his or her age on his or her previous birthday that is taken even though he or she is, in any ordinary sense, a full year older.
Actuarial practice recognises the annuitant’s age in years and fractions of years. For simplicity of calculation the purchased life annuity legislation only recognises full years, but it is not consistent with actuarial practice that it should attribute to an individual an age that he or she attained a year and a day previously. Inland Revenue practice follows actuarial practice in this respect, and so bases the calculation on the age attained on the date of the calculation if that date is the individual’s birthday. Under both approaches for calculating how much of any annuity payment is exempt, the constant sum approach and the constant proportion approach, this practice produces a higher figure for the exempt element than the legislation. Sections 720(4)(b) and 721(4)(c) of this Act rewrite this practice.
This change is in taxpayers’ favour in principle. But it is expected to have no practical effect as it is in line with current practice.