Top-slicing relief helps taxpayers who have become subject to a higher rate of tax, due to a chargeable gain being included in their income. 

Rather than treating the whole gain as taxable income in the current tax year, the relief allows the gain to be taxed as if it had occurred annually over the time invested.

Top-slicing relief is only available to individuals. It is not available to companies, trustees, or personal representatives.

The shorthand method

The simplified way of calculating top-slicing has been to divide the gain by the number of whole years the bond has been in force. The resulting ‘slice’ is then added to the individual’s other income for the tax year. If any of the slice falls within the higher rate or additional rate tax band, tax at 20% or 25% is added accordingly.  

Once the tax on the slice has been calculated, it is then multiplied again by the number of whole years the bond has been in force to obtain the tax liability. However, using this shorthand approach can often produce incorrect results.

The correct method

The personal savings allowance and starting rate for savings means that this simplified method will produce incorrect outcomes. Further changes in the top-slicing methodology introduced following the Silver judgement* can also result in errors if using a short-hand approach.

The full method involves calculating the tax liability on the whole gain and then using top slicing to calculate the amount of tax relief that can be deducted.

* Marina Silver vs The Commissioners for HMRC led to changes to the top-slicing calculation being announced on 11 March 2020

Example - Brian

Brian earns £50,270 and incurs a chargeable gain of £100,000 from an on-shore bond he has held for 10 years. As this is an on-shore bond, he is treated as already having paid basic rate tax at 20% (£20,000).

His additional tax liability, after top-slicing relief, is calculated as follows.

Step 1 – calculate tax due on income and the full gain:

* The personal allowance is reduced by £1 for every £2 of income above £100,000. As the bond gain takes total income above £125,140, the personal allowance is lost and £12,570 of earnings will become subject to higher rate tax at 40% (£5,028).
** The starting rate for savings is £5,000, reduced by non-savings income above the personal allowance. As earnings are above £17,570, this is reduced to £0.
*** The personal savings allowance is £1,000 for a basic rate tax payer, £500 for a higher rate and £0 for an additional rate taxpayer.

Step 2 – calculate total liability for the year:

* Basic rate tax is treated as already paid on an onshore bond. £100,000 @ 20% = £20,000.

Step 3 – calculate the annual equivalent (the top slice):

£100,000 gain / 10 whole years = £10,000

Step 4 - find the total relieved liability using the top slice:

* As total income is now below £100,000, the personal allowance is restored in full for the purposes of the top-slicing calculation.
** As the top-sliced gain does not fall into the additional rate of tax, a £500 personal savings allowance is available for a higher rate tax payer.

The total liability on the annual equivalent of the gain (the top slice) is £3,800. 

Basic rate tax is treated as already paid on this. £10,000 @ 20% = £2,000.

The relieved liability is therefore £3,800 - £2,000 = £1,800, which we multiply by 10 (years held) to find the total relieved liability; in this case £18,000.

Step 5 – calculate top-slicing relief due

The top slicing relief is the difference between the total liability and the total relieved liability, in this case £21,257 - £18,000 = £3,257.

This means that after top-slicing relief, Brian incurs tax of £18,000 (£21,257 – £18,000) on the bond.

As the £100,000 gain on the bond takes Brian’s total income above £125,140, his personal allowance has been reduced to £0. This means that £12,570 of his earnings of £50,270 will now be subject to higher rate tax, incurring an additional income tax charge of £5,028.

The £100,000 encashment from the bond has therefore created a total tax liability of £23,028 (£18,000 on the bond + £5,028 on his earnings).

Comment

For the 2024/25 tax year, higher rate tax starts when income exceeds £50,270. The short-hand method would suggest that as Brian’s top slice of £10,000 (£100,000 / 10) all falls within the higher rate tax band, the tax liability on the bond would be £20,000.

However, due to the personal savings allowance, the full calculation provided for a further £2,000 tax saving in top slicing relief.

The Silver judgement means that where the top-sliced gain plus income is below £100,000, the personal allowance can be restored in Step 4. However, as the total gain and income exceeded £100,000 in Step 1, the personal allowance was still lost in respect of Brian’s earnings, increasing his overall tax liability. He may therefore find it beneficial to structure his encashment in smaller chunks to ensure that total income (earnings plus chargeable gain) does not exceed £100,000 in a single tax year.

Although the shorthand method can be useful as an approximation, when calculating real-life situations, it is important to use the full methodology. Further examples of top-slicing calculations can be found in the Insurance Policyholder Taxation Manual.

Important information

Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.

The use of this document is at your own risk, and the content should not be used for the provision of professional advice.

LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.