Tax shock over Widows windfall

By WILLIAM KAY
Updated: 19:00 EST, 4 September 1999

Thousands of Scottish Widows policyholders could face a shock tax bill for windfall payments after the proposed £7 billion takeover by Lloyds TSB Group.

Experts believe the tax bill could be as high as £300 million which would reduce the windfall payments received by higher-rate taxpayers by between 25% and 40%. This could wipe at least £2,400 off the average £6,000 payout.

It may also spark a long and costly High Court battle between Lloyds TSB and the Inland Revenue.

Fears have been fuelled by the Revenue's recent change in approach to windfalls when it decided to make the payout to members of the Automobile Association liable for tax.

The Edinburgh-based Widows management, led by chief executive Mike Ross, is still locked in negotiations with the Revenue nearly three months after the deal with Lloyds TSB was first announced.

So far the Revenue has denied reports that windfalls to Widows policyholders will be subject to capital gains tax. But the real threat to policyholders, kept secret by both sides until now, is of unexpected income tax bills.

A spokeswoman for Widows said: 'We are still no further forward. We are awaiting a response from the Revenue.

'We are in discussions. That is all I can say at this stage.'

Visitors to the Scottish Widows Internet site are informed that an 'explanatory circular' is expected to be sent out 'in the autumn of this year'. As part of the takeover, Lloyds intends next year to distribute £5.7 billion in cash among 1.6 million qualifying Scottish Widows members.

The 700,000 who hold life insurance policies, pensions, annuities, endowments or investment bonds will receive fixed payments of £500.

The 900,000 members who have policies linked to the mutual's with-profits fund will receive extra payments depending on how much and for how long they have invested with the company.

The average payment will be £6,000, with wide variations.

When insurer Norwich Union went public three years ago, it legitimately avoided tax by adding the windfall to policy bonuses instead of paying cash.

But the position changed this year when Centrica bid £1.1 billion for the AA, offering £240 for every member. That payment has been regarded by the Revenue as a dividend and standard-rate taxpayers will receive their windfalls tax-free. But higher-rate taxpayers will pay £60 in tax.

If that formula were applied to the Widows windfalls, policyholders would pay an estimated £144 million on the basis of the average figures quoted, assuming that high taxpayers account for about one in 10 of the 1.6 million in line for the payments.

However, in practice, it is likely that those taxpayers have policies well above the average value, triggering a Revenue cull in the region of £300 million. The eventual bill could be much steeper.

A Revenue spokeswoman said: 'Each demutualisation case is treated on its merits. We look at what has been drawn up and decide whether the windfall is a dividend or shares.

'There is no simple way of putting it, because there are so many different things to be taken into consideration.'

On Friday, Lloyds TSB referred all calls to Scottish Widows.

Another mutual insurer being floated is Canada Life, but that does not present the same tax problem as it is offering its members shares rather than cash.

This means that no tax is payable, apart from income tax on dividends, until the shares are sold. Even then, small sales are protected by the capital gains tax allowance, currently £7,100 a year.

Building society stock market floats are exempt from such tax raids by the provisions of the 1986 Finance Act. All previous demutualisations are safe from further tax threat, as their details were announced only after agreement with the Revenue.