Annex 1: Minor changes in the law made by the Act: Change 119: Exempt income: purchased life annuity payments: carry forward of excess exempt capital element in purchased life annuity payment: section 719 and paragraph 144 of Schedule 2
This change gives statutory effect to ESC A46.
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. 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.
An example of an annuity where the amount depends on a non-life contingency is an index-linked annuity where the amount of the annuity fluctuates with movements in the Retail Prices Index. Initially the return under this type of annuity is low and the gross annuity may fall short of the amount of the constant exempt sum. With inflation the amount of the annuity payments is likely to rise and in due course to overtake the amount of the exempt sum.
ESC A46 deals with the situation where the amount of the annuity payment is less than the amount computed as exempt under the constant sum method in section 656(2) of ICTA. It allows any excess of the exempt amount over the gross annuity to be carried forward and increase the exempt part of the next payment. Section 719(5) of this Act gives statutory effect to the concession and Part 9 of Schedule 2 to this Act enables such excesses that were not absorbed by annuity payments made before tax year 2004-05 because they were too small, to be carried forward by increasing the exempt amount of the first payment made after 5 April 2005.
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.