At stake is whether certain single-premium bonds should be classed as life assurance or as an investment. If the High Court upholds a preliminary judgment that the lump sum is an investment, capital gains tax may become payable at surrender on hundreds of thousands of policies.
The High Court ruled that a contract is not a life insurance contract unless the sum paid on death is greater than the surrender value. Allied Dunbar and General Accident this week altered the terms of single premium contracts in a bid to escape the effects of the judgment.
However, the extra tax could be applied to billions of pounds of savings on policies already in force. Axa Equity & Law has sold 64,000 single premium bonds worth pounds 1.1bn, while General Accident Life has pounds 750m invested in its portfolio bond. Allied Dunbar has pounds 1bn in its investment bond, distribution bond and guaranteed equity bond.
An Inland Revenue spokeswoman said: 'If it turns out that a whole judgment follows this preliminary one, it does have rather profound implications. We would have to have discussions with the Department of Trade and the industry before making a decision on any tax consequences.'
In his initial judgment, the Vice-Chancellor, Donald Nicholls, ruled that a policy bought by a company called Fuji Finance is not a life assurance product unless the sum paid on death is greater than when surrendered.
Michael Bryant, tax specialist at Rathbone Brothers, the fund managers, said: 'The ruling leaves a lot of people very vulnerable.
'There will be many people hoping the insurance company appeals or that the Inland Revenue will not change its position.'
Chris Brocksom, chief executive of Axa, said: 'It does appear there are many companies whose contracts do not have a substantial life assurance element. We are reassured by the initial reaction of the DTI. I do not see any reason to panic at the moment.'
Gary Tait, the investor in the case, stands to lose hundreds of thousands of pounds in tax on his initial investment of pounds 50,000.
In 1986, his Panama-registered firm, Fuji Finance, bought a life assurance policy from Tyndall Assurance on which it paid a single premium of pounds 50,000.
The policy paid up either in the event of it being surrendered or upon his death. The pounds 50,000 could be invested in any unit trust managed by Tyndall Assurance at any time without switching costs.
If the policy was surrendered Mr Tait would receive the value of the fund, minus any exit charges. Should he die, his estate would receive the same amount - the policy's life assurance element.
Mr Tait took advantage of an option in the small print in his policy. This allowed him to switch into any Tyndall funds at their prices on the previous day, allowing him to beat the markets every time.
In the space of six years he made a pounds 1m profit on his pounds 50,000 lump sum investment. Meanwhile, Tyndall was taken over by another insurer, Aetna Life, itself the subject of a takeover by a third insurer, Windsor Life.
Had Mr Tait been allowed to continue he stood to make pounds 252,000,000,000,000,000 during the policy's life, equal to Britain's gross national product for 460,000 years.
Belatedly, if unsurprisingly, Aetna Life decided to change his policy wording - and found itself facing a court challenge from Fuji Finance.Reuse content