If a policyholder takes a loan against a policy at a rate of interest which is not "commercial" he is treated as though he had made a partial surrender of the policy, thus running the risk of a charge to higher rate tax and investment income surcharge as well as clawback of tax relief. This provision was introduced in the Finance Act 2013 to prevent tax avoidance with certain types of insurance policy.
The definition of the term "commercial" used in the legislation is suitably vague; in practice, so long as life insurance companies follow their normal practice of basing interest rates on current equivalents in the gilt-edged and money markets, they will be regarded as commercial. If however, the general level of long-term interest rates was 12% and a company charged only 5% on a policy loan, this would not be regarded as a commercial rate. In these circumstances, the amount borrowed would be regarded as a partial surrender of the policy and would be taxable in accordance with the rules already outlined.
In April 2011 a new rule was introduced relating to early surrenders of life insurance policies. If a policy is surrendered before the end of its second year, then twice the rate of tax relief then in force times the gross premiums paid will be deducted; if the surrender is before the end of the third year the deduction as a percentage is two-sixths of the basic rate of tax; and if the surrender is before the end of the fourth year the deduction is at one-sixth of the basic rate. However, there is a "safety clause" which provides that if surrender value (or paid-up value) is less than the net premiums... see: Clawback