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Income Tax (Trading and Other Income) Act 2005

Commentary on Sections

Part 1: Overview

Section 1: Overview of Act

26.This section summarises the charges to tax and other matters covered in the Act. It is new.

27.The charges are grouped in the four Parts listed in subsection (1).

28.The section also provides, in subsection (2), the link to the general charge to income tax in section 1(1) of ICTA.

29.Subsection (3) explains that exemptions from the charges are located in a separate Part but there are signposts in the charging Parts to the exempt provisions most likely to apply to a particular charge.

Section 2: Overview of priority rules

30.This section provides an overview of the sections in the Act containing the rules for deciding which charge takes priority where two charges could apply. It is new. The priority rules are located at the start of each Part immediately after the opening “overview” section.

31.Subsection (3) recognises that it is necessary to look at the scope of the charging provisions as well as the priority rules. It is also a pointer to ITEPA and to case law.

Part 2: Trading income

Overview

32.This Part contains the rules relating to trading income. The Part charges:

  • the profits of a trade, profession or vocation (charged in the source legislation under Schedule D Cases I, II or V);

  • amounts treated as income on a change of accounting basis (charged in the source legislation under Schedule D Case VI); and

  • post-cessation receipts (charged in the source legislation under Schedule D Case VI).

33.The structure of the Part is to:

  • identify the income taxed as profits of a trade (Chapter 2);

  • calculate the profits of the trade (Chapters 3 to 7);

  • apply the rules for particular trades (Chapters 8 to 11);

  • apply other rules affecting the calculation of profits of the trade (Chapters 12 to 14);

  • identify basis periods (Chapter 15);

  • apply averaging (Chapter 16);

  • identify other components of trading income (Chapters 17 and 18); and

  • provide supplementary material (Chapter 19).

34.The rules in Chapters 3 to 14, dealing with profits of the trade, determine the profit of the period of account. Once the profit for tax purposes of the period of account has been calculated:

  • the basis period rules convert the profit of the period of account to the profit for the tax year; and

  • the averaging rules, if applicable, adjust the profits of tax years.

35.Two particular charges are located in Chapters 17 and 18.

36.References to “profits or gains” in the source legislation which relate only to income are rewritten in this Part omitting the reference to “gains”. This continues the tidying up of such references started in section 46(3) of and Schedule 7 to FA 1998.

Chapter 1: Introduction
Section 3: Overview of Part 2

37.This section provides an overview of the trading income Part. It is new.

38.The section includes a signpost to the exemptions in Part 6 of this Act. The exemptions that are in practice most likely to be relevant are indicated in subsection (3).

Section 4: Provisions which must be given priority over Part 2

39.This section sets out the priority rules that apply when a receipt or other credit item might otherwise fall within more than one head of charge.

40.Subsection (1) applies where there might otherwise be overlap between the charge on the profits of a trade and the charge on the profits of a UK property business. It is based on section 18 of ICTA.

41.Subsection (2) deals with potential overlap with ITEPA. It is based on section 18 of ICTA. In the source legislation Schedule D is the residual Schedule. So the charge in ITEPA on employment income, and other income formerly within Schedule E, has priority over the charge on profits of a trade (Schedule D in the source legislation). There is no potential overlap between pension and social security income in ITEPA that was formerly within Schedule D and the charge on profits of a trade.

Chapter 2: Income taxed as trade profits
Overview

42.This Chapter:

  • explains what is taxed as profits of a trade;

  • identifies different types of trade;

  • treats certain activities which do not constitute a trade as the carrying on of a trade for tax purposes; and

  • treats certain receipts which are not trading receipts on first principles as receipts of a trade for tax purposes.

Section 5: Charge to tax on trade profits

43.This section charges the profits of a trade, profession or vocation to tax. It is based on section 18(1) and (3) of ICTA.

44.Part 2 of Schedule 4 to this Act defines “trade” by reference to section 832(1) of ICTA. Section 832(1) of ICTA defines trade so as to include every “manufacture, adventure or concern in the nature of trade”. This brings within the meaning of trade an isolated transaction (or a small number of transactions) which, while in the nature of trade, is not sufficiently extensive to amount to a trade.

Section 6: Territorial scope of charge to tax

45.This section sets out the territorial limits of the charge on trade profits. It is based on section 18(1)(a)(i) and (ii) of ICTA.

46.Trades within Schedule D Case I are those “carried on in the United Kingdom or elsewhere”. That expression appears wide enough to include trades carried on wholly abroad. But Colquhoun v Brooks (1889), 2 TC 490 HL explained that the charge under Schedule D Case I covers only trades carried on at least partly in the United Kingdom. Trades carried on wholly abroad are within Schedule D Case V.

47.The distinction between Schedule D Cases I and V is important because only a person who is resident in the United Kingdom is chargeable on trade profits under both Cases. A person who is not resident in the United Kingdom is chargeable on trade profits only under Schedule D Case I. The abbreviated descriptions “UK resident” and “non-UK resident” are defined in section 878(1) of this Act.

48.Subsection (1) sets out the position for a person resident in the United Kingdom: the charge to tax covers all trade profits, wherever the trade is carried on.

49.Subsection (2) sets out the position for a person not resident in the United Kingdom: the charge to tax is restricted to profits from a trade carried on at least partly in the United Kingdom. In the case of a trade carried on partly in the United Kingdom, the charge is further restricted to the profits from the part of the trade carried on in the United Kingdom.

Section 7: Income charged

50.This section sets out the amount charged to tax. It is based on section 60(1) and (2) of ICTA (United Kingdom trades) and sections 65(3) and 68(1) of ICTA (foreign trades). See Change 1 in Annex 1.

51.Subsection (2) makes the link to basis periods. Although the charge to tax under subsection (1) is on the profits of the tax year, traders calculate commercial profit by reference to their period of account. The basis period rules identify the profits that are taxed as the profits of the tax year.

52.In most cases the basis of assessment for the profits of a foreign trade is the same as that for a trade carried on wholly or partly in the United Kingdom. So the charge is on the full amount of the profits of the tax year (subsection (1)).

53.In the case of Irish income, section 68 of ICTA has two special rules.

54.First, section 68(3)(b) of ICTA allows the inspector to direct that the income should be assessed on the basis of an average of a period. And the subsection allows the Commissioners to review the inspector’s decision. This rule is a relic of the tax system before Self Assessment. It is not rewritten.

55.Second, section 68(3) of ICTA provides that the income is computed as if it had arisen in the United Kingdom. In practice this rule puts Irish trading income on the same basis as other foreign trading income. So this second special rule for Irish income is not rewritten.

Section 8: Person liable

56.This section states who is liable for any tax charged. It is based on section 59(1) of ICTA.

57.This Act does not rewrite section 59(2) of ICTA. Section 59(2) of ICTA provides that income tax charged “in respect of any of the concerns mentioned in section 55 [of ICTA] shall be assessed and charged on the person carrying on the concern, or on the agents or other officers who have the direction or management of the concern or receive the profits thereof”.

58.Section 55 of ICTA provides that the profits arising from certain concerns such as mines and quarries shall be taxed under Schedule D Case I. Section 55 of ICTA is rewritten as section 12 of this Act.

59.The origins of section 59(1) and (2) of ICTA can be traced back to the Income Tax Act 1842. There is no longer any reason to maintain the distinction between the two subsections.

60.Section 59(2) of ICTA identifies two classes of person on whom the profits of a section 55 concern should be taxed. These are:

  • the person carrying on the concern; and

  • the agents or other officers who have the direction or management of the concern, or receive the profits.

61.Both these classes of person are likely to be covered by the section 59(1) test that they are “receiving or entitled to the profits”. But if they are not, there is no reason why a wider category of persons should be liable in respect of section 55 concerns than are liable in respect of any other trades.

62.Also, applying the “person receiving or entitled” test to the profits of a section 55 concern would not include persons who would not be chargeable through the application of section 59(2) of ICTA.

Section 9: Farming and market gardening

63.This section has two functions. First, it treats all farming or market gardening carried on in the United Kingdom as a trade. Second, it treats all farming carried on in the United Kingdom by a particular person as a single trade. It is based on section 53(1) and (2) of ICTA.

64.Subsection (1) deals with the first function. In most cases there will be no doubt that farming is a trade on first principles. Like section 10 of this Act this section can trace its origins back to the time when there was a charge to income tax under Schedule B on the occupation of land. Farming was originally charged under Schedule B. The purpose of section 53 of ICTA and its predecessor provisions was to take the charge on farming out of Schedule B and into Schedule D. With the abolition of Schedule B that function is now spent.

65.But section 53 of ICTA does make clear that even uncommercial farming is treated as a trade. This section preserves that effect.

66.Subsection (2) deals with the second function of the section. It provides that all farming carried on by a person in the United Kingdom is treated as a single trade. Farming carried on as part of another trade is not included in the single trade of farming.

67.The restriction of subsection (2) to farming in the United Kingdom is derived from the definition of “farming” in section 832(1) of ICTA.

68.Section 53(2) of ICTA uses the expression “particular person or partnership or body of persons” to make clear that the single trade rule applies also to a firm and to a body of trustees. It follows that farming carried on by a person as a member of a firm or a body of trustees is separate from any farming carried on by that person alone.

69.This section does not rewrite this rule as it applies to firms. That is dealt with in section 859 of this Act.

70.Nor does this section rewrite the reference to “body of persons” in section 53(2) of ICTA. It is generally understood that a body of persons acting as trustee, or in some other representative or fiduciary capacity, is not the same entity for tax purposes as one of those persons acting on their own behalf. So, for instance, section 15(1)1(3) of ICTA refers only to “a particular person or partnership”; there is no need to refer to a “body of persons”. Retaining a reference to a “body of persons” in this section would cast doubt on the meaning of sections where the phrase is not used.

71.The definition of “farming” and “market gardening” is in section 876 of this Act.

Section 10: Commercial occupation of land other than woodlands

72.This section deals with the commercial occupation of land for purposes other than farming or woodlands. It is based on section 53(3) and (4) of ICTA.

73.The section treats the commercial occupation of land in the United Kingdom as the carrying on of a trade. It provides certainty of treatment if land is occupied on a commercial basis in circumstances that do not amount to the carrying on of a trade on first principles.

74.The origins of section 53 of ICTA go back to the time when there was a charge to income tax under Schedule B on the occupation of land. The purpose of the Schedule B charge was to tax the profit that an occupier of the land could earn from the land itself, for example, by farming it. The tax was charged whether or not the occupier actually exploited the land.

75.The Schedule B charge was calculated by reference to the annual value of the land. This amount could be considerably less than the amount of profit an occupier could in fact derive from the land. For this reason the basis of charge was switched from Schedule B to Schedule D Case I if the land was farmed or otherwise managed on a commercial basis.

76.The last remnant of Schedule B was repealed by FA 1988. Schedule 6 to FA 1988 exempted any profits and losses from the occupation of commercial woodlands from income tax.

77.The provisions of section 53 of ICTA relating to farming are rewritten as section 9 of this Act. The provisions relating to the occupation of commercial woodlands are rewritten as section 11 of this Act.

Section 11: Commercial occupation of woodlands

78.This section provides that the commercial occupation of woodlands is not treated as a trade for any income tax purpose. It is based on section 53(4) of ICTA and paragraph 3(2) of Schedule 6 to FA 1988.

79.Subsection (3) makes clear that when this section is read together with related sections any profits and losses arising from the commercial occupation of woodlands are wholly outside the income tax system.

80.This section prevents any charge to tax as trading income and denies any claim for relief for a trade loss. Section 267(b) of this Act performs a similar function in relation to property income. Section 768 of this Act prevents there being any charge to tax under Part 5 of this Act as miscellaneous income. Section 392(1)(b) of ICTA prevents any claim for a loss against miscellaneous income because it requires that for a loss to be allowed any profit on the same transaction should be taxable.

Section 12: Profits of mines, quarries and other concerns

81.This section treats the profits and losses of certain concerns as if they were the profits and losses of a trade. It is based on section 55 of ICTA.

82.The feature most of the concerns have in common is that they exploit land for its natural resources. The section applies only if the activity carried on by the concern does not amount to a trade on first principles. If the activity is a trade on first principles the profits and losses will be taxed in accordance with section 5 of this Act.

83.Subsection (1) provides the profits and losses of the concern are calculated as if the concern were a trade. See part (A) Change 2 in Annex 1.

84.The section does not deem the concern to be carrying on a trade. This means the profits will not be liable to Class 4 national insurance contributions as they are not immediately derived from the carrying on or exercise of a trade. Nor will the taxpayer qualify for capital gains tax roll-over relief under section 152 of TCGA. That section requires the taxpayer to be carrying on a trade as defined in section 158(2) of TCGA.

85.Subsection (2) provides that the profits and losses of the concern are charged to tax as if the concern were a trade carried on in the United Kingdom. See part (B) Change 2 in Annex 1.

86.This rule applies even if the activity is carried on outside the United Kingdom. But subsection (2) makes clear that this territorial extension applies only to UK residents.

87.Subsection (3) provides that the normal loss rules apply. See part (C) Change 2 in Annex 1.

88.Subsection (4) lists the concerns to which the section applies. It updates the reference to “fishings” to “rights of fishing”.

89.Subsection (5) makes clear that section 10 of this Act has priority over section 12. This is because section 10 treats the activity as if it were a trade. This contrasts with the approach of this section, which is to the treat the profits and losses as trade profits and losses. Section 10 may be more beneficial for the taxpayer. For example, the activity would qualify as a trade for capital gains tax purposes. See section 158(2) of TCGA.

Section 13: Visiting performers

90.This section has two functions. It treats certain activities as trades and it treats those trades as carried on in the United Kingdom. It is based on sections 555 to 558 of ICTA.

91.Section 555 of ICTA requires deduction of tax from certain payments to entertainers and sportsmen. The rules about deduction of tax are not rewritten in this Act. But there is a cross-reference in the definition of “payment” in subsection (8) to the rule about deduction of tax to identify the sort of payment with which the section is concerned.

92.A visiting performer may not be in the United Kingdom long enough to become resident for tax purposes. And any relevant activities may not be part of a trade, profession or vocation carried on in the United Kingdom. So, without this section, there would be no liability to tax on the activities in the United Kingdom.

93.Subsection (1) sets out the circumstances in which the section applies. A non-resident person performs “a relevant activity” in the United Kingdom. In accordance with subsection (8), that expression means activities prescribed by regulations. The regulations are those (currently SI 1987/530) made under sections 555 to 558 of ICTA or under section 14.

94.Subsection (2) creates a United Kingdom trade that includes the “relevant activity”.

95.Subsection (4) makes clear that this section creates a trade carried on in the United Kingdom only to the extent that such a trade would not otherwise exist. If a visiting performer’s activities in the United Kingdom amount to a trade on first principles, this section does not create a trade because one already exists. But a trade is not created if the activities are part of an employment. In that case, tax is charged on the payments as employment income (see section 7 of ITEPA).

96.Subsection (5) deals with the case where payments for the relevant activity are made to a person other than the performer - typically, a company controlled by the performer. As in subsection (2), the “relevant activity” is treated as part of a United Kingdom trade. In addition, the payments are treated as made to the performer (instead of to the “other person”).

97.Subsection (7) treats the performer’s deemed trade as separate from any other trade actually carried on by the performer.

Section 14: Visiting performers: supplementary

98.This section sets out the regulation-making powers that are needed for the operation of section 13. It is based on sections 556 and 557 of ICTA.

99.Subsection (1) is a regulation-making power to deal with the consequences of including in the performer’s profits payments made to another person. It may be appropriate to allow a deduction for expenses incurred by another person (typically, but not necessarily, the person to whom the payments are made). And, if the payments are treated as receipts of the performer’s trade, they may be excluded from the calculation of the other person’s profits.

100.Section 556(5) of ICTA apparently means that the regulation-making power in section 556(3) of ICTA is itself capable of being disapplied by a regulation. This is illogical. So the reference to section 556(3) in section 556(5) of ICTA is not rewritten in this Act.

101.Subsection (2) is a regulation-making power to deal with calculation of the performer’s profits.

Section 15: Divers and diving supervisors

102.This section deals with activities which are strictly the duties of an employment but which, if certain conditions are met, are taxed as if they were the carrying on of a trade. It is based on section 314 of ICTA.

Section 16: Oil extraction and related activities

103.This section provides that certain oil-related activities are treated as a single, separate trade. It is based on section 492(1) of ICTA.

104.Section 492 is in Chapter 5 of Part 12 of ICTA. Most of that Chapter is concerned with corporation tax and is not rewritten in this Act. The section deals with oil (and gas) exploration and extraction activities in the United Kingdom and in the United Kingdom sector of the continental shelf.

105.The main consequence of treating these oil-related activities as a separate trade is that losses from other trading activities cannot be set against oil profits. That consequence is set out in section 492(2) of ICTA.

Section 17: Effect of becoming or ceasing to be a UK resident

106.This section deals with the consequence of an individual trader moving to or from the United Kingdom. It is based on section 110A of ICTA.

107.Subsection (1) sets out the circumstances in which the section applies. In accordance with section 6 of this Act a non-resident individual who carries on a trade at least partly outside the United Kingdom is charged to tax only on the profits of any part of the trade carried on in the United Kingdom. Without this section it would be possible for a taxpayer to be charged to tax on profits which accrue in part of a basis period when the taxpayer is not resident in the United Kingdom.

108.If the trade is carried on in partnership and one of the partners changes residence, the rule in this section does not apply. But there is a special rule that applies only to the partner. See sections 852(6) and 854(5) of this Act.

109.Subsection (2) sets out the consequences of a change of residence. The trade is treated as ceasing and, if appropriate, a new one is treated as starting. There is no explicit rule in section 110A of ICTA to say when the trade is treated as ceasing or starting. The only sensible inference is that it is the date of the change of residence. The section makes this clear.

110.Subsection (3) ensures that losses are still available to be carried forward.

Section 18: Effect of company starting or ceasing to be within charge to income tax

111.This section applies only to companies and deems a trade commencement or cessation to take place in particular circumstances. It is based on section 337 of ICTA.

112.Section 337 of ICTA is primarily a corporation tax rule: it applies only to companies and originates from the introduction of corporation tax. However it can be relevant to income tax.

113.That is because non-resident companies are within the charge to income tax in respect of United Kingdom trade profits (when the trade is not carried on through a permanent establishment in the United Kingdom) and UK property business income. Section 337 of ICTA applies in cases of either inward or outward company migration. Where that involves a continuing trade or UK property business there will be a change of taxing regime from income tax to corporation tax or vice versa.

114.Section 18 says what happens when a company enters or leaves the income tax regime: then its trade profits are calculated as though it had commenced or discontinued the trade. The obverse case of the company exiting or entering the corporation tax regime is proper to the rewrite of section 337 of ICTA in the corporation tax provisions.

Section 19: Tied premises

115.This section treats rent received by a trader for premises let to persons to whom the trader supplies goods sold or used on those premises as a receipt of the trade rather than a receipt of a property business. It is based on section 98 of ICTA.

116.Section 98 of ICTA is expressed in general terms. But it most commonly applies to rent received by a brewer who lets premises to tied tenants.

Section 20: Caravan sites where trade carried on

117.This section allows a person who carries on a trade associated with the operation of a caravan site to include in the receipts of that trade income from letting pitches or caravans where the letting does not itself constitute a trade. It is based on ESC B29. See Change 3 in Annex 1.

118.See section 875 and Change 148 in Annex 1 for the definition of “caravan”.

Section 21: Surplus business accommodation

119.This section allows income from letting surplus business accommodation to be treated as a trade receipt instead of as rent. It is based on the practice known as “Revenue Decision 9” set out in Inland Revenue publication Tax Bulletin of 15 February 1994. See Change 4 in Annex 1.

Section 22: Payments for wayleaves

120.This section applies if a trader receives rent from a wayleave granted in respect of land on which a trade is carried on. It is based on section 120 of ICTA.

121.Rent received in respect of a wayleave is normally taxed as property income either by Chapter 2 of Part 3 of this Act (property businesses) or by section 344 (charge to tax on rent receivable for a UK electric-line wayleave). But if the rent is received in respect of land on which a trader carries on a trade and the trader receives no other rent in respect of the same land the rent, and any associated expenses, can be included in the calculation of the trade profits. See Change 5 in Annex 1.

122.Subsection (2) applies if the rent is received in respect of a UK electric-line wayleave. A taxpayer is not required to include the rent and expenses in the calculation of the trade profits.

123.Subsection (3) applies if the rent is received in respect of any other type of wayleave. A taxpayer is not required to include the rent and expenses in the calculation of the trade profits.

124.Subsection (4) defines “rent”. Section 120 of ICTA uses the definition of “rent” in section 119(3) of ICTA (rent etc. payable in connection with mines, quarries and similar concerns). Section 119 of ICTA is rewritten as Chapter 8 of Part 3 of this Act. The definition of rent in that Chapter and in this section must be the same. See the commentary on section 336 of this Act for a fuller description of the rewrite of the word “rent” in Chapter 8 of Part 3 of this Act.

125.Subsection (5) defines “wayleave”. Section 120 of ICTA uses the word “easement” as defined in section 119(3) of ICTA to describe the nature of the right for which the rent is paid. This section uses “wayleave” as that is how most of the payments covered by this section are usually described in practice. The definition of “easement” in section 119(3) of ICTA gives that word a meaning that is much wider than its usual legal meaning. See the comments of Uthwatt J at pages 329 and 330 of Mosley v George Wimpey Ltd (1945), 27 TC 314 CA.

126.The definition of “wayleave” preserves the generality of the words in section 119(3) of ICTA and includes a reference to the Scottish equivalent, “servitude”.

127.The definition has no territorial limitation. So the section covers services other than UK electric-line wayleaves.

Section 23: Rent-a-room and foster-care relief

128.This section modifies the normal calculation rules when an individual is eligible for rent-a-room or foster-care relief under Part 7 of this Act. It is new.

129.When rent-a-room relief or foster-care relief applies the income may, depending on the total amount, be either exempt from tax or subject to a special calculation rule. This section ensures that, when appropriate, the rent-a-room and foster-care rules take priority over the usual trading profit calculation rules.

Chapter 3: Trade profits: basic rules
Section 24: Professions and vocations

130.This section makes it unnecessary to specify repeatedly that the rules in this Chapter (apart from section 30) apply to a profession or vocation as well as to a trade. It is new.

Section 25: Generally accepted accounting practice

131.This section sets out the starting point for the calculation of trade profits. It is based on section 42 of FA 1998, as amended by section 103(5) of FA 2002.

132.Subsection (1) is the general rule that requires profits to be calculated “in accordance with generally accepted accounting practice”, an expression defined in section 50 of FA 2004. In particular, such practice generally requires account to be taken of debtors and creditors and of the value of stock and work in progress. The general rule is subject to any special rule of law whether expressed in statute or explained by the courts.

133.The relevant statutory laws are mainly those that are rewritten in this Part. But there are also provisions not included in Part 2 of this Act which may affect the calculation of profits: for example, the pension contributions deductions provisions in FA 2004 and certain anti-avoidance provisions in ICTA that apply to all income types.

134.Subsection (2) makes it clear that subsection (1) does not bring with it any of the other accounting requirements, such as a formal audit.

135.Subsections (3) and (4) set out two exceptions to the general rule in subsection (1). Some barristers may use the “cash basis” of accounting (see section 160). And Lloyd’s underwriters have their own special rules (mostly in Chapter 3 of Part 2 of FA 1993).

136.The Inland Revenue does not believe that there are currently any non-resident companies liable to income tax in respect of insurance business or that there will be any in the future as the law stands at present. So this section does not reproduce the reference to companies carrying on life assurance mentioned in section 42(5) of FA 1998.

137.There are no other exceptions to the general rule. So this section does not reproduce the reference to “particular description of business” in section 42(5) of FA 1998.

Section 26: Losses calculated on same basis as profits

138.This section ensures that profits and losses are calculated on a consistent basis. It is based on section 46(2) of FA 1998.

Section 27: Receipts and expenses

139.This section is based on section 46(1) of FA 1998.

Section 28: Items treated under CAA 2001 as receipts and expenses

140.This section signposts the CAA rules. It is new.

141.In particular the CAA rules override the rules against the inclusion of capital items in sections 33 and 96 of this Act.

Section 29: Interest

142.This section sets out the basic rule that interest is of a revenue nature. It is based on section 74(1) of ICTA.

143.Section 74(1)(f) of ICTA provides that in computing the profits of a trade:

  • no deduction is allowed in respect of any capital withdrawn from or employed, or intended to be employed, as capital in the trade; but

  • the prohibition of any deduction in respect of capital should not be construed as disallowing the deduction of interest.

144.This section rewrites the second of these propositions by providing that for the purpose of calculating the profits of a trade, all interest is of a revenue nature.

145.The question of whether interest is deductible in arriving at the trade profits falls to be determined according to whether the interest meets the general criteria for the deduction of an expense of a revenue nature in calculating the profits of a trade.

Section 30: Animals kept for trade purposes

146.This section contains the basic rule for the income tax treatment of animals. It is based on paragraphs 1, 7(1) and 9(5) Schedule 5 to ICTA. The animals are treated as trading stock unless a herd basis election is made under Chapter 8 of Part 2 of this Act.

Section 31: Relationship between rules prohibiting and allowing deductions

147.This section makes clear the interaction between those provisions that allow a deduction and those provisions that prohibit a deduction. It is new. See Change 6 in Annex 1.

148.The general principle is that a rule allowing a deduction takes priority over a rule prohibiting a deduction. But this is subject to a number of exceptions.

Chapter 4: Trade profits: rules restricting deductions
Overview

149.This Chapter contains provisions prohibiting various deductions in calculating the profits of a trade or restricting the extent to which such deductions can be made.

Section 32: Professions and vocations

150.This section makes it unnecessary to specify in each section in this Chapter that the section applies to a profession or vocation as well as to a trade. The section is new.

Section 33: Capital expenditure

151.This section is based on section 74(1) of ICTA.

152.Section 74(1) of ICTA prohibits various deductions in computing a trader’s profits including:

(f)

any capital withdrawn from, or any sum employed or intended to be employed as capital in the trade, profession or vocation, …

(g)

any capital employed in improvements of premises occupied for the purposes of the trade, profession or vocation.

153.It is a long-established and generally accepted principle that capital items are ignored in calculating the profits of a trade.

154.Section 42(1) of FA 1998 requires that the profits of a trade:

  • must be computed in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in computing profits for those purposes.

155.But the question of whether a sum is income or capital is ultimately a question of law, not accountancy. For judicial authority for this proposition, see, for example the words of Brightman J on page 173 of ECC Quarries Ltd v Watkis (1975), 51 TC 153 CD(1):

…unchallenged evidence, or a finding, that a sum falls to be treated as capital or income on principles of correct accountancy practice is not decisive of the question whether in law the expenditure is of a capital or income nature.

156.A sum which is of a capital nature may however be allowed as a deduction in computing the profits of a trade because of a statutory exception to the general rule on the deduction of such items in this section. See, for example, section 89 (expenses connected with patents).

157.Section 74(1)(g) of ICTA is not rewritten as the deduction of capital employed in the improvement of premises is covered by the general prohibition on the deduction of “items of a capital nature”. In the absence of general agreement on what constitutes capital expenditure “items of a capital nature” is not defined.

Section 34: Expenses not wholly and exclusively for trade and unconnected losses

158.This section contains rules for the deduction of expenses and losses in calculating the profits of a trade. It is based on section 74(1)(a) (expenses) and (e) (losses) of ICTA.

159.Section 74(1)(a) of ICTA provides that in calculating the profits of a trade no deduction is allowed for expenditure which is not incurred “wholly and exclusively” for the purposes of that trade. This could be construed to mean that if expenditure is incurred partly for trade purposes and partly for some other purposes, no part of that expenditure can be deducted in arriving at the trade profits.

160.But section 74(1)(c) of ICTA, which prohibits any deduction in respect of the rent of premises used for residential or “domestic” purposes, provides for the apportionment of rent paid for premises used partly as residential accommodation and partly for the purposes of a trade. And in practice, a deduction is allowed for any expenditure which can be apportioned between trade and non-trade expenditure – for example, expenditure on a car used partly for trade and partly for private purposes.

161.There is judicial support for allowing a deduction where expenditure incurred for more than one purpose can reasonably be apportioned between expenditure incurred for the purpose of the trade and non-trade expenditure. See, for example, Lochgelly Iron and Coal Company Ltd v Crawford (1913), 6 TC 267 CS, in which a deduction was allowed for part of a subscription to a trade association and Copeman v Flood (1941), 24 TC 53 KB, in which the High Court remitted the case to the Commissioners to find as a fact whether the remuneration paid to certain directors who were also shareholders in the family company was wholly and exclusively expended for the purpose of the Company's trade, and if not, how much of the remuneration was so expended.

162.Conversely, the courts have held that if it is not possible to identify any part of the expenditure which is incurred wholly and exclusively for the purposes of the trade, no apportionment is possible. See, for example, Mallalieu v Drummond (1983), 57 TC 330 HL(2) in which no deduction was allowable for professional clothing worn for warmth and decency as well as being required by the taxpayer’s profession.

163.So subsection (2) of this section provides for the deduction of any part or proportion of expenses incurred partly for the purposes of the trade and partly for some other purpose which can be identified as incurred wholly and exclusively for the purposes of the trade. And because rent on dual purpose accommodation can be apportioned under subsection (2) of this section, it is not necessary to rewrite section 74(1)(c) of ICTA.

Section 35: Bad and doubtful debts

164.This section is based on the relief for bad and doubtful debts in section 74(1)(j) of ICTA. It also subsumes the relief in section 89 of ICTA for debts proved irrecoverable after a trade, profession or vocation is deemed to have ceased. See Change 7 in Annex 1.

165.See section 259 for the meaning of “statutory insolvency arrangement” in subsection (1)(c) of this section.

Section 36: Unpaid remuneration

166.This section prevents a deduction for employees’ (or an office-holder’s) pay until it is paid. It is based on section 43 of FA 1989.

167.Section 43 of FA 1989 was introduced when the assessment of employment income was put on a receipts basis. No deduction is given to the employer for employees’ pay until that pay is treated as received by the employees.

168.Subsection (1)(b) makes clear that the rule in this section is in addition to any other rules that determine whether or not a deduction is allowable.

Section 37: Unpaid remuneration: supplementary

169.This section provides definitions and further explanation of the main rule in section 36. It is based on section 43 of FA 1989.

170.Subsection (1) applies section 36 to provisions made in the accounts in respect of amounts that may become employees' remuneration. An example of such a provision would be an incentive payment that is payable only if the employee remains with the employer for a number of years.

171.Subsection (3) deals with the case in which the employer submits his or her tax return before the end of the nine month limit in section 36(2) and all or any of the remuneration is unpaid. The employer must assume the remuneration will remain unpaid. If, subsequently, the remuneration is paid within the time limit the calculation can be adjusted and the return amended. See Change 8 in Annex 1.

Employee benefit contributions
Overview

172.The next seven sections deal with the deduction allowed in respect of an employer’s contribution to an employee benefit scheme. They are based on Schedule 24 to FA 2003.

173.The sections give a comprehensive set of rules for determining when deductions can be made for payments made by an employer to a third party to hold or use to provide benefits for the employer’s employees. The rules apply in particular to contributions made to the trustees of an employee benefit trust but are not confined to such contributions. They do not apply to contributions made to certain pension schemes.

Section 38: Restriction of deductions

174.This section sets out the conditions under which a deduction may be allowed. It is based on paragraphs 1 and 8 of Schedule 24 to FA 2003.

175.Subsection (1) identifies the conditions for the section to apply. It applies only to deductions that would otherwise be allowed under normal principles. It applies both to contributions made and to provisions in respect of contributions.

176.Subsections (2)(b) and (3)(b) apply if the benefit is provided by the making of the contribution itself. This may be the case if the employer sets up a trust to meet employees' medical expenses.

177.Subsection (4) identifies a number of cases in which employer contributions are not subject to the rules in this Chapter. Significant amendments have been made to this list by section 245(5) of FA 2004. That section is part of the regime for dealing with the taxation of pension schemes. The changes take effect from 6 April 2006.

178.This Act deals with this by including the new rules in this subsection. The commencement issue is then dealt with as a transitional measure in paragraphs 13 to 15 of Schedule 2 to this Act. The old rules apply until 5 April 2006.

Section 39: Making of “employee benefit contributions”

179.This section is based on paragraphs 1 and 9 of Schedule 24 to FA 2003.

Section 40: Provision of qualifying benefits

180.This section sets out what is meant by the provision of qualifying benefits. It is based on paragraph 2 of Schedule 24 to FA 2003. One of four conditions must be met.

181.Subsection (2) identifies the general rule, condition A. Subsections (3), (4) and (5) deal with less common cases, conditions B, C and D.

182.Subsection (3) applies if the employment income and national insurance contribution charges do not arise because the benefits are provided to an employee who works outside the United Kingdom.

183.Subsection (4) applies if the employment income and national insurance contribution charges do not arise because the benefits are provided in connection with the termination of the recipient’s employment.

184.Subsection (5) applies if the benefit is provided under an employer-financed retirement benefits scheme. This condition will apply with effect from 6 April 2006. See the transitional measure in paragraph 15 of Schedule 2 to this Act. An employer-financed retirement benefits scheme is an arrangement under which the employer will pay pensions outside registered pension schemes introduced by FA 2004. The policy is to tax these benefits in the same way as other employee benefits. The definition of “employer-financed retirement benefits scheme” is given in section 44 of this Act.

Section 41: Timing and amount of certain qualifying benefits

185.This section sets out:

  • when benefits in the form of money are treated as provided; and

  • how to calculate the value of benefits provided by the transfer of an asset.

186.It is based on paragraphs 2 and 5 of Schedule 24 to FA 2003.

187.Section 245(4) of FA 2004 provides (with effect from 6 April 2006) that these rules do not apply to payments under an “employer-financed retirement benefits scheme”.

188.Subsection (2) describes how to calculate the value of a qualifying benefit provided by the transfer of an asset. The amount of the benefit is the expenditure incurred on the asset by the third party including both the cost of acquiring the asset and any subsequent expenditure. If the asset was acquired by the employer and transferred to the third party the amount of the benefit is the trading deduction that would otherwise have been allowed to the employer plus any subsequent expenditure incurred by the third party.

189.Subsection (3) sets out an exception to the general rule in subsection (2). If the employment income charge is lower than the charge calculated in accordance with subsection (2) the value of the benefit is restricted to the lower amount.

Section 42: Provision or payment out of employee benefit contributions

190.This section sets out the rules for allocating the provision of qualifying benefits, or payment of qualifying expenses, by the third party against the employee benefit contributions received. It is based on paragraph 4 of Schedule 24 to FA 2003.

191.Other receipts and expenses of the third party are ignored. Qualifying benefits and qualifying expenses are treated as paid out of employee benefit contributions in priority to other expenditure and amounts received by the third party.

Section 43: Profits calculated before end of 9 month period

192.This section applies if the taxpayer makes his or her income tax return before the end of the nine month period. It is based on paragraph 6 of Schedule 24 to FA 2003.

193.A deduction is not allowed if the conditions in section 38 are not met at the time the return is made. The normal Self Assessment rules allow the return to be amended if the conditions are met before the end of the nine month period.

Section 44: Interpretation of sections 38 to 44

194.This section is based on paragraphs 3 and 9 of Schedule 24 to FA 2003 and section 245(7) of FA 2004.

195.An “employer-financed retirement benefits scheme” means:

  • a scheme for the provision of benefits consisting of or including relevant benefits to or in respect of employees or former employees of the employer

  • But neither

    • a registered pension scheme, nor

    • a section 615(3) [of ICTA] scheme,

    • is an employer-financed retirement benefits scheme.

Section 45: Business entertainment and gifts: general rule

196.This section and the following two sections deal with expenditure on business entertainment or gifts. This section is based on section 577(1),(5),(7) and (8) of ICTA.

197.Subsection (1) sets out the general rule that in calculating the profits of a trade no deduction is allowed for expenditure on providing entertainment or gifts.

198.Subsection (2) says that the general rule applies to sums paid to or on behalf of, or put at the disposal of, an employee (commonly known as an “expense allowance”) only if those sums are exclusively for meeting expenses in providing business entertainment or gifts.

199.The general rule in subsection (1) does not apply to an allowance made to an employee for meeting expenses which include – but are not restricted to – expenses incurred in the provision of business entertainment or gifts. But section 356 of ITEPA provides that no deduction from the employee’s earnings is allowed for expenses incurred in providing entertainment or gifts in connection with the trade, business, profession or vocation of his or her employer.

200.The definition of “employee” in subsection (4) of this section covers the application of this section and sections 46 and 47 to a non-resident company liable to income tax in the UK.

Section 46: Business entertainment: exceptions

201.This section is based on section 577(3),(5),(7) and (10) of ICTA.

Section 47: Business gifts: exceptions

202.This section is based on section 577(3),(5),(8),(9) and (10) of ICTA. See Change 9 in Annex 1 regarding the provision in subsection (3) for the monetary limit on the exception in respect of certain gifts to be increased by Treasury order.

Section 48: Car or motor cycle hire

203.This section restricts the amount which a trader can deduct in respect of the cost of hiring certain cars or motor cycles with a retail price (when new) of more than £12,000. The restriction is in inverse proportion to the retail price. The section is based on sections 578A and 578B of ICTA.

204.Section 578B(1) of ICTA says that for the purposes of section 578A of ICTA “car” includes a motor cycle. So this section and section 49 refer to a “car or motor cycle” throughout.

205.Section 578A(4) of ICTA provides for amounts in respect of hire charges brought into account as a receipt of the trade under section 94 of ICTA (debts deducted and subsequently released) to be reduced in the same proportion as the deduction in respect of those charges is reduced under section 578A(3) of ICTA. Subsection (4) of this section extends the same treatment to amounts in respect of hire charges taxed as a post-cessation receipt under section 103(4) of ICTA (debts released after cessation). See Change 10 in Annex 1.

206.Sections 94 and 103(4) of ICTA are rewritten in sections 97 and 249 respectively.

Section 49: Car or motor cycle hire: supplementary

207.This section is based on section 578B of ICTA.

208.Section 578B(2) of ICTA defines “qualifying hire car” for the purposes of section 578A of ICTA as a car hired under a hire-purchase agreement subject to an option to purchase which is exercisable for a nominal amount.

209.Not all hire purchase agreements require the hirer to exercise an option at the end of the hire period. Under some types of agreement, ownership of the vehicle passes automatically to the hirer at the end of the hire period. So subsection (2)(a) of this section extends the definition of “qualifying hire car or motor cycle” to include a car or motor cycle where ownership passes without the exercise of an option to purchase. See Change 11 in Annex 1.

210.Subsection (2)(c) defines “qualifying hire car or motor cycle” by reference to the definition of “qualifying hire car” in section 82 of CAA.

211.Section 82 of CAA defines a “qualifying hire car” as follows:

(1)For the purposes of this Part a car is a qualifying hire car if—

(a)it is provided wholly or mainly for hire to, or the carriage of, members of the public in the ordinary course of a trade, and

(b)the case is within subsection (2), (3) or (4).

(2)The first case is where the following conditions are met—

(a)the number of consecutive days for which the car is on hire to, or used for the carriage of, the same person will normally be less than 30, and

(b)the total number of days for which it is on hire to, or used for the carriage of, the same person in any period of 12 months will normally be less than 90.

(3)The second case is where the car is provided for hire to a person who will himself use it—

(a)wholly or mainly for hire to, or for the carriage of, members of the public in the ordinary course of a trade, and

(b)in a way that meets the conditions in subsection (2).

(4)The third case is where the car is provided wholly or mainly for the use of a person in receipt of -

(a)a disability living allowance under—

(i)the Social Security Contributions and Benefits Act 1992, or

(ii)the Social Security Contributions and Benefits (Northern Ireland) Act 1992,

because of entitlement to the mobility component,

(b)a mobility supplement under a scheme made under the Personal Injuries (Emergency Provisions) Act 1939,

(c)a mobility supplement under an Order in Council made under section 12 of the Social Security (Miscellaneous Provisions) Act 1977, or

(d)any payment appearing to the Treasury to be of a similar kind and specified by them by order.

(5)For the purposes of subsection (2) persons who are connected with each other are to be treated as the same person.

Section 50: Hiring cars (but not motor cycles) with low carbon dioxide emissions

212.This section excludes cars with low CO2 emissions and electrically propelled cars from the restriction in section 48. It is based on section 578A(2A) and (2B) of ICTA and section 60 of FA 2002.

213.Expenditure incurred on hiring a car first registered before 17 April 2002 does not qualify for relief under this section. See paragraph 17 of Schedule 2 to this Act.

214.Subsection (2) defines “car with low CO2 emissions” and “electrically propelled car” by reference to section 45D of CAA.

215.Section 45D(2) to (6) of CAA defines a car with low CO2 emissions as follows:

(2)For the purposes of this section a car with low CO2 emissions is a car which satisfies the conditions in subsections (3) and (4).

(3)The first condition is that, when the car is first registered, it is so registered on the basis of an EC certificate of conformity, or a UK approval certificate, that specifies—

(a)in the case of a car other than a bi-fuel car, a CO2 emissions figure in terms of grams per kilometre driven, or

(b)in the case of a bi-fuel car, separate CO2 emissions figures in terms of grams per kilometre driven for different fuels.

(4)The second condition is that the applicable CO2 emissions figure in the case of the car does not exceed 120 grams per kilometre driven.

(5)For the purposes of subsection (4) the applicable CO2 emissions figure in the case of a car other than a bi-fuel car is—

(a)where the EC certificate of conformity or UK approval certificate specifies only one CO2 emissions figure, that figure, and

(b)where the certificate specifies more than one CO2 emissions figure, the figure specified as the CO2 emissions (combined) figure.

(6)For the purposes of subsection (4) the applicable CO2 emissions figure in the case of a bi-fuel car is—

(a)where the EC certificate of conformity or UK approval certificate specifies more than one CO2 emissions figure in relation to each fuel, the lowest CO2 emissions (combined) figure specified, and

(b)in any other case, the lowest CO2 figure specified by the certificate.

216.Section 45D(7) of CAA provides that the amount specified in section 45D(4) may be amended by Treasury order.

217.Section 45D(9) of CAA defines an electrically propelled car as a car which is:

(a)…propelled solely by electrical power, and

(b)that power is derived from—

(i)a source external to the vehicle, or

(ii)an electrical storage battery which is not connected to any source of power when the vehicle is in motion.

Section 51: Patent royalties

218.This section is based on section 74(1)(p) of ICTA.

Section 52: Exclusion of double relief for interest

219.This section prevents a deduction for interest paid if the taxpayer claims relief under section 353 of ICTA. It is based on section 368(4) and (6) of ICTA.

220.The section will apply in the limited circumstances in which it is possible to claim relief for interest paid under section 353 of ICTA and as a deduction in calculating trade profits. This is likely only if the claim under section 353 of ICTA satisfies the qualifying conditions in section 359 of ICTA (loan to buy machinery or plant). Such relief is given in the tax year in which the interest is paid.

221.Alternatively, if the normal trade profit rules are met, the interest may qualify as a trading deduction. Such a deduction would be allowed on the normal accruals basis.

222.The section is mirrored by section 368(3) of ICTA which prevents a claim under section 353 of ICTA if the interest has been allowed as a trading deduction.

223.Subsection (5) gives the rule for deciding when relief under section 353 of ICTA has been given. It uses the definition of “finally determined” in section 43C(4) of TMA. See Change 12 in Annex 1.

Section 53: Social security contributions

224.This section prevents a deduction for most social security contributions in calculating trade profits. It is based on section 617 of ICTA.

225.The rule is that there can be no deduction for the trader’s own social security contributions. The section achieves this by prohibiting a deduction for any contributions and making an exception for contributions that an employer makes for the trade’s employees.

226.The rule in section 617 of ICTA applies generally for tax purposes. This Act splits the rule.

  • This section sets out the income tax trading income rule (applied also to property income by section 272).

  • Section 868 sets out the income tax rule for non-trading income charged to tax by this Act (including rents from “concerns” charged to tax by Chapter 8 of Part 3 of the Act).

  • A new section 360A of ITEPA is introduced by this Act (see paragraph 594 of Schedule 1 to this Act) to set out the rule for employment income.

  • Section 617 of ICTA as consequentially amended (see paragraph 262 of Schedule 1 to this Act) continues to apply for corporation tax.

Section 54: Penalties, interest and VAT surcharges

227.This section contains the rule that most tax penalties and interest are not to be deducted for tax purposes. It is based on section 90 of TMA and section 827 of ICTA.

228.The section brings together all the rules prohibiting a trading deduction for penalties, interest and surcharges imposed by statute. So it deals with interest on unpaid income tax (imposed by TMA) as well as the penalties, interest, and surcharges relating to the indirect taxes that are dealt with in section 827 of ICTA. The section is applied to property income by section 272.

229.There is a similar rule for non-trading income in section 869.

230.The table in subsection (2) sets out the specific statutory references because a general description of the penalties etc would not be precise enough. But the second column of the table is a description of the tax to indicate what is involved.

Section 55: Crime-related payments

231.This section prohibits any deduction for expenses incurred in making a payment:

  • the making of which is a criminal offence, or which would be a criminal offence if the payment was made in the United Kingdom; or

  • which is made in response to a demand, the making of which is a criminal offence.

232.The section is based on section 577A of ICTA.

233.It overrides any provision which otherwise allows a deduction to be made in calculating the profits of a trade. See section 31(1)(b) of this Act.

Chapter 5: Trade profits: rules allowing deductions
Overview

234.This Chapter contains provisions allowing various deductions in calculating the profits of a trade.

Section 56: Professions and vocations

235.This section makes it unnecessary to specify repeatedly that the rules in this Chapter (apart from sections 87 to 90) apply to a profession or vocation as well as to a trade. It is new.

Section 57: Pre-trading expenses

236.This section gives relief for expenses incurred before a trade starts. It is based on section 401(1) of ICTA.

237.Originally section 401 of ICTA gave relief by creating a loss for the tax year in which the expense was incurred. It was amended to allow the expense as a deduction on the first day of trading.

238.Subsection (1) sets the scene. Consistent with other rules in this Part, it refers to the “date” on which (instead of the “time” when) a person starts to trade.

239.Subsection (2) identifies the expenses that are allowed by the section. They are expenses that would be allowable if incurred after the start of the trade.

Section 58: Incidental costs of obtaining finance

240.This section gives relief for certain costs incurred in obtaining a loan, or an abortive loan. It is based on section 77(1),(2),(6) and (7) of ICTA.

241.Without this section, no deduction would be allowed for the incidental costs of raising a loan on capital account.

242.Subsection (2) defines “incidental costs of obtaining finance”. Expenses incurred in the course of obtaining finance other than those listed in subsection (2) are subject to the rules restricting or allowing deductions in the usual way.

Section 59: Convertible loans and loan stock etc.

243.This section excludes from relief under section 58 costs relating to certain convertible securities. It is based on based on section 77(3),(4) and (5) of ICTA

Section 60: Tenants under taxed leases: introduction

244.This section and the following five sections entitle a tenant who uses land for the purposes of a trade to a deduction in calculating the profits of the trade for expenses which he or she is treated as incurring if the land is held under a lease which gives rise to an amount brought into account under Chapter 4 of Part 3 of this Act. Chapter 4 of Part 3 of this Act is based on sections 34 to 38 of ICTA. This section is based on section 87(1),(2) and (8) of ICTA.

245.Sections 277 to 286 treat certain amounts received by landlords as receipts of a property business. Sections 291 to 294 give a tenant carrying on a property business relief in the form of a deduction for expenses which the tenant is treated as having incurred. In rewriting section 87 of ICTA, sections 60 to 65 follow the same approach as sections 291 to 294 of this Act by giving relief in the form of a deduction for expenses which the tenant is treated as having incurred.

246.Section 87(2) of ICTA treats a person who occupies for the purposes of a trade land in relation to which any amount “falls to be treated as a receipt of a Schedule A business” by virtue of section 34 or 35 of ICTA as paying rent. In accordance with the policy of treating UK and overseas property businesses in the same way as far as possible, section 60(1) of this Act extends relief under section 87(2) of ICTA to a person who occupies for the purposes of a trade land outside the United Kingdom in relation to which any amount falls to be treated as a receipt of an overseas property business by virtue of section 34 or 35 of ICTA as applied by section 65A(5) of ICTA. See Change 13 in Annex 1.

247.The amount which a tenant can deduct in respect of rent which he or she is treated as paying under section 87(2) of ICTA is qualified by:

  • the general rules as to deductions not allowable in computing the profits of a trade in section 74(1) of ICTA; and

  • rules prohibiting or restricting the deduction of specific expenditure elsewhere in ICTA.

248.In this Act, the rules restricting deductions are to be found in Chapter 4 of Part 2. Section 74(1)(a) of ICTA is rewritten in section 34 of this Act. Section 60(3) of this Act preserves the interaction of section 87(2) of ICTA and the general and specific rules restricting deductions in ICTA by providing that a deduction for an expense which a tenant is treated as incurring under section 61 of this Act is subject to the application of any provision of Chapter 4 of this Act.

Section 61: Tenants occupying land for purposes of trade treated as incurring expenses

249.This section treats a tenant under a lease in respect of which an amount is brought into account by the landlord under sections 277 to 282 (a “taxed lease”) as incurring an expense for each day on which the property held under the lease is occupied for the purposes of his or her trade. It is based on section 87(2),(3) and (9) of ICTA.

250.Sections 277 to 282 rewrite sections 34 and 35 of ICTA. Sections 34 and 35 of ICTA treat premiums and certain other amounts in respect of leases as rent. In sections 277 to 282, a person who receives a premium, or an amount treated as a premium in section 34 or 35 of ICTA, is instead treated as entering into a transaction mentioned in section 264 (if the land to which the lease relates is in the United Kingdom) or in section 265 (if the land is outside the United Kingdom). This gives rise to a UK or overseas property business (as defined in sections 264 and 265) if the recipient is not already carrying on such a business.

251.Sections 277 to 282 then require the recipient to bring an amount in respect of the premium or other amount payable under the lease into account as a receipt in calculating the profits of his or her property business.

252.Section 87(2) of ICTA treats a tenant who occupies land for the purposes of a trade as paying rent. This corresponds to the treatment in sections 34 and 35 of ICTA of a landlord who receives a premium, or an amount treated as a premium, as rent.

253.Subsection (1) instead treats the tenant as incurring an expense in respect of the land subject to the taxed lease. This corresponds to the treatment of the premium or other amount in respect of the land as a receipt in calculating the profits of the landlord’s property business in sections 277 to 282 of this Act.

254.Section 87 of ICTA says that the tenant is treated as paying rent for the purposes of making deductions in calculating the profits of a trade. But the tenant is only entitled to a deduction if at least some of the property is used for the purposes of the trade. So subsection (3) defines a qualifying day as a day on which the tenant occupies all or a part of the land subject to the taxed lease for the purposes of carrying on a trade.

255.The formula in subsection (4) calculates the expense for each qualifying day by spreading the amount of the taxed receipt evenly over the receipt period of that receipt. Defining “A” in that formula as “the unreduced amount of the taxed receipt” makes clear that the amount of the expense which the tenant is treated as incurring for each qualifying day is calculated by reference to the amount of the taxed receipt before any reductions or deductions.

256.Subsection (5) modifies that formula for a qualifying day on which the tenant occupies only part of the land subject to the taxed lease for the purposes of a trade.

257.Section 87(3) of ICTA requires a “just apportionment” to be made where part only of the land subject to the lease is used for the purposes of the trade. Subsection (5) instead requires the fraction of the land which is occupied by the tenant for the purposes of the trade to be calculated “on a just and reasonable basis”. See Change 14 in Annex 1.

Section 62: Limit on deductions if tenant entitled to mineral extraction allowance

258.This section prevents a double deduction where a tenant is entitled under section 403 of CAA to an allowance in respect of qualifying expenditure on acquiring a mineral asset. It is based on section 87(7) of ICTA.

259.Section 87(7) of ICTA refers to an allowance for “any chargeable period”. Section 832 of ICTA defines chargeable period (other than in the case of an accounting period of a company) as a year of assessment. So this section refers instead to an allowance for “a tax year”.

Section 63: Tenants dealing with land as property employed for purposes of trade

260.This section applies to a tenant who, while not occupying a property, uses the property for the purposes of a trade – for example a trader who lets premises held under a taxed lease to a tenant who sells only goods supplied by that trader. It is based on section 87(4) and (6) of ICTA.

261.Subsection (2) treats the tenant as if he or she occupied the property for the purposes of relief under section 61 of this Act.

262.Subsection (3) is based on section 87(6) of ICTA which says that a tenant shall not be treated as paying rent under section 87(4) of ICTA for any chargeable period for which rent has, or will be, treated as paid under section 37(4) of ICTA. It prevents a tenant obtaining relief under section 61 to the extent that relief for the same day has been allowed in calculating the profits of a property business under section 292. Section 292 rewrites section 37(4) of ICTA.

Section 64: Restrictions on section 61 expenses: lease premium receipts

263.This section is based on section 87(5) of ICTA. It restricts the expenses a tenant is treated as incurring under section 61 where a tenant under a taxed lease:

  • grants a sublease in respect of a property which section 63 treats the tenant as occupying for the purposes of the trade; and

  • receives in respect of the sublease, an amount which is brought into account as a receipt under Chapter 4 of Part 3 of this Act (a “lease premium receipt”).

264.Section 87(5) of ICTA applies where there is a reduction in a receipt of a Schedule A business by virtue of section 34 or 35 of ICTA. This section also applies where there is a reduction in a receipt of an overseas property business by virtue of section 34 or 35 of ICTA as applied by section 65A(5) of ICTA. See Change 13 in Annex 1.

265.Section 61 treats a tenant who occupies land under a taxed lease for the purposes of a trade as incurring an expense for each qualifying day in the receipt period of the taxed receipt relating to the taxed lease. The expense is calculated by reference to the amount of the taxed receipt.

266.If there is a reduction under section 288 in the amount which the tenant brings into account as a receipt under Chapter 4 of Part 3 of this Act in respect of the sublease, section 64 makes a corresponding reduction in the amount of the expense which section 61 treats the tenant as incurring for a qualifying day in the receipt period of the lease premium receipt.

267.It is not clear how the rule in section 37(5) of ICTA (as applied to section 87(4) of ICTA by section 87(5)) of ICTA is intended to apply where there is more than one “amount chargeable” by reference to which relief can be claimed for the same qualifying day.

268.Subsections (3) and (4) treat the tenant as incurring an expense for a qualifying day of the amount by which the “daily amount” of the taxed receipt exceeds:

  • the “daily reduction” of the lease premium receipt; or

  • if the qualifying day falls within the receipt period of more than one lease premium receipt, the total of the daily reductions of those lease premium receipts.

269.This corresponds to the treatment in section 293 of this Act of an expense under section 292 for a qualifying day which falls within the receipt period of more than one lease premium receipt. See Change 15 in Annex 1.

270.The “daily amount” of a taxed receipt and the “daily reduction” of a lease premium receipt are calculated according to the formulas in subsection (6):

  • the formula for calculating the daily amount of the taxed receipt is the same formula used in section 61(4) to calculate the amount of the expense which the tenant is treated as incurring for each qualifying day in the receipt period of the taxed receipt; and

  • the formula for the daily reduction of the lease premium receipt allocates equal amounts of the reduction by reference to the taxed receipt under section 288 to each day in the receipt period of the lease premium receipt.

Section 65: Restrictions on section 61 expenses: lease of part of premises

271.This section is based on section 87(5) of ICTA. It adapts section 61:

  • where section 64 applies; and

  • the sublease granted by the tenant does not extend to the whole of the premises subject to the taxed lease.

272.Subsection (4) deals with the case where the conditions for relief in sections 64 and 65 are met on the same qualifying day in respect of more than one lease. This corresponds to the treatment in section 294(4) of this Act of expenses under sections 292 and 293 where more than one taxed receipt falls to be reduced by reference to the same taxed receipt. See Change 15 in Annex 1.

273.Subsection (5) adapts the formulas in sections 61(4) and 64(6) by multiplying the unreduced amount of the taxed receipt in those formulas (“A”) by the fraction of the premises to which the sublease relates.

274.Section 87(3) of ICTA requires a “just apportionment” to be made where part only of the land to which section 87(2) of ICTA applies is occupied for the purposes of a trade. This section instead requires the fraction in subsection (5) to be calculated “on a just and reasonable basis”. See Change 14 in Annex 1.

Section 66: Corporation tax receipts treated as taxed receipts

275.This section and the following section ensure that a tenant is entitled to relief for an expense under section 61 by reference to an amount treated as a result of section 34 or 35 of ICTA as a receipt of a Schedule A business, or an overseas property business, of a landlord liable to corporation tax in the same way as if the landlord was liable to income tax on an equivalent amount as a receipt of his or her property business under sections 277 to 282 of this Act. This section is new.

276.Section 296 of this Act adapts certain terms used to give a tenant who is carrying on a property business relief under sections 287 to 290 by reference to an amount taken into account for income tax purposes under sections 277 to 282 so as to give relief instead by reference to an amount treated as a receipt under section 34 or 35 of ICTA for the purpose of corporation tax:

  • subsection (1) of section 296 introduces the label “corporation tax receipt” for an amount treated as a receipt of a Schedule A business under section 34 or 35 of ICTA on the interest of a landlord liable to corporation tax for an accounting period ending after 5 April 2005, or which would be treated as such a receipt other than for relief under section 37(2) of ICTA;

  • subsection (2) of section 296 provides that, for the purposes of Chapter 4 of Part 3 of this Act, a corporation tax receipt is treated as a taxed receipt and the lease in respect of which it arose is treated as a taxed lease. “Taxed lease” and “taxed receipt” are defined in section 287(4);

  • subsection (3) of section 296 adapts the term “receipt period” (as defined in section 288(6)) to apply to a corporation tax receipt; and

  • subsection (4) of section 296 adapts the term “unreduced amount” (as defined in section 290(2) and (5)) to apply to a corporation tax receipt.

277.In applying section 296 for the purposes of sections 60 to 67, this section performs the same function as section 296 in relation to a tenant who occupies or otherwise employs property subject to a taxed lease for the purposes of his or her trade.

Section 67: Restrictions on section 61 expenses: corporation tax receipts

278.This section is new. It ensures that any relief given for corporation tax purposes under section 37(2) or (3) of ICTA for an accounting period ending after 5 April 2005 by reference to:

  • a receipt brought into account under Chapter 4 of Part 3 of this Act where the landlord is liable to income tax; or

  • a receipt brought into account under section 34 or 35 of ICTA where the landlord is liable to corporation tax,

is taken into account in applying section 61 in the same way as any relief under section 288.

279.Subsections (1), (2) and (3) refer to a reduction under section 37(2) or (3) of ICTA by reference to “the amount chargeable on the superior interest”.

280.Section 37(1) of ICTA defines “the amount chargeable on the superior interest” as an amount treated as a receipt of a Schedule A business under section 34 or 35 of ICTA, or which would be so treated other than for relief under section 37(2) or (3) of ICTA, The “superior interest” is the interest in the property held by the immediate landlord.

281.Paragraph 20 of Schedule 1 to this Act amends section 37(1) of ICTA by extending the definition of “the amount chargeable on the superior interest” to include any amount treated as a receipt of a property business under sections 277 to 282 of this Act, or which would be treated as such a receipt other than for relief under the additional calculation rule in section 288.

282.So in this section “the amount chargeable on the superior interest” is an amount:

  • treated as a receipt under section 34 or 35 of ICTA for any tax year; or

  • treated as a receipt under Chapter 4 of Part 3 of this Act for an accounting period ending after 5 April 2005 as a result of the amendments to section 37(1) of ICTA made under paragraph 20 of Schedule 1 to this Act.

Section 68: Replacement and alteration of trade tools

283.This section allows a deduction for the cost of replacing or altering trade tools if the only reason a deduction would not be allowed is that the expenditure is of a capital nature. It is based on that part of section 74(1)(d) of ICTA that relates to deductions in respect of the replacement (“supply”) or alteration of implements, utensils and other articles employed for the purposes of the trade.

284.Expenditure on repairing trade premises or tools is revenue under the normal rules. And following the Special Commissioners decision in Jenners Princes Street Edinburgh Ltd v CIR (1998), SpC000166(3), it is generally accepted that the reference in section 74(1)(d) of ICTA to expenditure “beyond the sum actually expended” does not prohibit the deduction of a provision for repairs if the cost of the repairs would be allowable. So that part of section 74(1)(d) of ICTA which deals with repairs is not rewritten.

Section 69: Payments for restrictive undertakings

285.This section allows a trader to deduct certain amounts paid to employees for restrictive undertakings. Such amounts might not otherwise be deductible to the extent that they are capital in nature or fall foul of the “wholly and exclusively” rule. The section is based on section 73(2) of FA 1988.

286.Section 73(2) of FA 1988 applies only to amounts brought into charge on the employee as earnings under section 225 of ITEPA. The former cross-refers to the latter where the definition of the amounts concerned is set out.

287.Subsection (1) provides for the deduction. In so doing it focuses on the key element for the rule to apply: the fact of payment.

288.Subsection (2) provides a timing rule. The deduction allowed by section 73 of FA 1998 is taken in the period of account in which the payment is made and no deduction is allowed in any other period. Similar words are used in section 77(6) and section 88(2) so the timing rules for deductions in Chapter 5 of Part 2 of this Act are explicit and consistent.

Section 70: Employees seconded to charities and educational establishments

289.This section allows a trader to deduct the cost of an employee seconded to a charity or educational establishment in calculating the trade profits. It is based on section 86(1),(2) and (3) of ICTA.

290.Section 86 of ICTA allows a trader who seconds an employee to a charity or educational establishment to deduct the cost of employing the seconded person to the extent that those costs would have been deductible if the employee continued to be employed for the purposes of the employer’s trade. This section allows the employer to deduct all costs attributable to the seconded employee during the period of the secondment, regardless of whether those costs would have been allowed if the employee had not been seconded. See Change 16 in Annex 1.

291.Subsection (3) defines “educational establishment” by reference to various bodies listed in section 71 and to any other educational body approved by “the Secretary of State or, in Northern Ireland, the Department of Education”. For the purposes of section 86 of ICTA and of this section, “the Secretary of State” is the Secretary of State for the Department for Education and Skills.

Section 71: Educational establishments

292.This section defines “educational establishments” for the purposes of section 70. It is based on section 86(3),(4),(5) and (6) of ICTA.

293.Section 86(4)(c) of ICTA refers to an independent school registered under section 465 of the Education Act 1996. Section 465 of the Education Act 1996 was repealed by the Education Act 2002. So subsection (1)(c) refers instead to an independent school registered under section 161 of the 2002 Act.

Section 72: Payroll deduction schemes: contributions to agents’ expenses

294.This section an allows an employer a deduction for expenses incurred in operating the payroll deduction scheme. It is based on section 86A of ICTA.

295.The main rules for payroll deduction schemes are found in Part 12 of ITEPA. Under such a scheme, an employer deducts charitable donations from employees’ salaries and pays them to an agent, who distributes them to the employees’ chosen charities.

296.The agent’s administrative costs may be deducted from the donations. But many employers voluntarily pay the costs themselves so that the employees’ full donations can go to the chosen charities.

297.Normally, payments made voluntarily to meet someone else’s expenses are not made wholly and exclusively for the purposes of a trade and therefore would not be deductible. Employers might get relief for donations to charitable agencies under the Gift Aid scheme. But there are restrictions on the operation of that section and relief would not be available if the agent was not itself a charity.

298.This section gives relief for the expenses as a trading deduction.

299.Subsection (3) defines “approved scheme” and “approved agent” by reference to the definitions in section 714 of ITEPA.

300.Section 714(2) of ITEPA defines “approved scheme” as:

a scheme which is approved (or is of a kind approved) by the Inland Revenue and under which—

(a)the payer is required to pay sums withheld to a body which is an approved agent at the time of the withholding, and

(b)the approved agent is required—

(i)to pay sums withheld to the specified charity or charities, or

(ii)in a case where the agent is itself a specified charity, to retain any sum due to itself …

301.Section 714(3) of ITEPA defines “approved agent”:

For the purposes of this section a body is an “approved agent” if it is approved by the Inland Revenue for the purpose of paying donations to one or more charities.

Section 73: Counselling and other outplacement services

302.This section provides a deduction for certain expenses of counselling provided for employees. It is based on sections 589A and 589B of ICTA, section 108 of FA 1993 and Schedule 6 to ITEPA.

303.Subsection (3) cross-refers to ITEPA for the conditions that need to be met for the deduction to be allowed (section 310 of ITEPA exempts the employee from tax in respect of counselling received).

Section 74: Retraining courses

304.This section gives a deduction for certain expenses of retraining provided for employees. It is based on section 588 of ICTA and Schedule 6 to ITEPA.

305.Subsection (2) cross-refers to ITEPA for the conditions that need to be met for the deduction to be allowed (section 311 of ITEPA exempts the employee from tax in respect of qualifying retraining courses).

306.The section does not rewrite section 588(3)(b) of ICTA. That provision makes a deduction in calculating the employer’s trade profits conditional on the employee’s exemption under section 311 of ITEPA in respect of the expenditure in question. This condition is not consistent with the similar provision rewritten in section 73 and does not serve any material purpose. See Change 17 in Annex 1.

Section 75: Retraining courses: recovery of tax

307.This section allows the recovery of tax when a deduction under section 74 subsequently proves to have been wrongly allowed. It is based on section 588 of ICTA and Schedule 6 to ITEPA.

308.Subsection (2), like section 74(2) cross-refers to the relevant provisions in ITEPA to refer to the conditions that have not been met.

309.Subsections (4) and (5) refer to the Inland Revenue rather than, as in the source legislation, to the inspector. See Change 149 in Annex 1.

Sections 76 to 80: Redundancy payments etc
Overview

310.These five sections are based on the trading income rules relating to redundancy payments in sections 90, 579 and 580 of ICTA. The rules that deal with the employee’s liability are in section 309 of ITEPA.

311.The trading income rules were introduced to reverse the decisions in CIR v Anglo Brewing Co Ltd (1925), 12 TC 803 and Godden v A Wilson’s Stores (Holdings) Ltd (1962), 40 TC 161. In those cases the courts held that certain payments to employees on the closing down of a trade were not deductible in arriving at trading profits. In neither case was the payment made in accordance with a pre-existing obligation.

312.In 1999 the Inland Revenue announced (Tax Bulletin 39G, February 1999) that it will be guided by the decision in Commissioner of Inland Revenue v Cosmotron Manufacturing Co Ltd (1997), 70 TC 292(4).

313.In that Hong Kong case the Privy Council decided that redundancy payments made under a pre-existing obligation were deductible. Although that decision is merely persuasive in the United Kingdom, the Inland Revenue no longer argue that payments made under a pre-existing obligation (including a statutory obligation) are covered by the Anglo Brewing and Wilson’s Stores decisions. The announcement in Tax Bulletin means that it may not be necessary to give the employer a statutory right to a deduction in calculating trading profits. But these sections put the matter beyond doubt.

Section 76: Redundancy payments and approved contractual payments

314.This section sets out the circumstances in which the following three sections apply and explains the terms used in the main provisions. It is based on section 579(2) of ICTA.

315.The sections retain the label “redundancy payment” and the expression “additional payment” from the source legislation. This section also introduces the label “approved contractual payment” to describe the payments that may replace redundancy payments in some cases.

Section 77: Payments in respect of employment wholly in employer’s trade

316.This section sets out the main rule governing redundancy payments made by an employer. It is based on section 579(2) of ICTA.

317.If a payment is otherwise allowable (possibly as a result of the Cosmotron decision – see the overview for this group of sections), this section does not interfere with the accountancy treatment of the payment. In that case, the normal accruals basis applies.

318.Subsection (5) is based on section 113(2) of ICTA. The timing rule in section 579(2)(b) of ICTA refers to the “discontinuance” of a trade. That word has to be interpreted in the light of section 113 of ICTA: the trade is not treated as discontinued unless there is a complete change in the persons carrying it on.

319.The deduction allowed by section 579 of ICTA is for “a redundancy payment ... made”. It is clear that a deduction is allowed only if a payment has been made. It follows that the deduction is to be taken in the period of account in which the payment is made and that no deduction is allowed in any other period.

320.Subsection (6) has a timing rule expressed in similar words to those used in sections 69 and 88 of this Act. So the timing rules for deductions in Chapter 5 of Part 2 are explicit and consistent. This special timing rule applies if the payment is allowable only as a result of this section.

Section 78: Payments in respect of employment in more than one capacity

321.This section deals with the case where the employee is employed in more than one capacity. It is based on section 579(5) of ICTA. The section covers the case where there is a private element in the employment and makes clear what part of the payment is allowed as a deduction in calculating trade profits.

322.Section 579(5) of ICTA does not specify the basis on which to apportion the payment. This section adopts the “just and reasonable” apportionment that is used consistently in this Act. See Change 14 in Annex 1.

Section 79: Additional payments

323.This section deals with any voluntary payments that an employer makes in addition to the statutory (or approved) payments dealt with in section 77 of this Act. It is based on section 90 of ICTA.

324.Unlike the payments in section 77, these additional payments are allowable only if the sole reason for their disallowance is the cessation of the trade.

325.The section applies to payments in connection with the cessation of part of a trade in the same way as it applies to payments in connection with the cessation of a whole trade. See Change 18 in Annex 1.

326.Subsection (2) is based on section 113(2) of ICTA. Section 90(3) of ICTA refers to the “discontinuance” of a trade. That word has to be interpreted in the light of section 113 of ICTA: the trade is not treated as discontinued unless there is a complete change in the persons carrying it on.

327.A redundancy payment is not disallowable solely on account of a partial change of persons carrying on a trade. But this subsection puts it beyond doubt that a partial change of persons carrying on a trade does not count as a cessation.

Section 80: Payments made by the Government

328.This section sets out what happens if it is not the employer who makes the redundancy payment to the employee. It is based on section 579(6) of ICTA.

329.In some cases the Government makes the payment and is reimbursed by the employer. This section ensures that the employer is allowed a trading deduction.

330.Subsection (1)(b) reflects the effect of the devolution settlements. See Change 19 in Annex 1.

Section 81: Personal security expenses

331.This section allows the deduction of certain expenditure, by individuals trading alone or in partnership, on their personal security. It is based on sections 112 and 113 of FA 1989.

332.Expenditure within this section normally falls foul of the “wholly and exclusively” rule in section 34 (based on section 74(1)(a) of ICTA). That is because it is incurred for an essentially non-business purpose.

333.The source legislation expressly overrides, where appropriate, both sections 74(1)(a) and (1)(b) of ICTA. Section 74(1)(b) of ICTA is not rewritten because it is not necessary (see the commentary on that provision in the explanatory notes on paragraph 45 of Schedule 1 to this Act). So the condition in subsection (1)(e) refers only to the rule in section 34.

334.The source legislation allows a deduction only for expenditure of a revenue nature. Section 81 can accordingly apply only to expenses of a revenue nature because section 33 is not overridden. There are parallel rules in section 33 of CAA which deal with similar expenditure of a capital nature.

335.Section 81 gives a narrowly targeted deduction which applies in particular and unusual circumstances. So it contains an extensive set of conditions which must be met for the deduction to succeed.

336.Subsection (1)(b) states the main condition: if there is no special threat there is no need to improve security and the rule cannot apply.

337.Subsection (1)(e) makes it clear that it is only the wholly and exclusively prohibitive rule that is overridden.

Section 82: Contributions to local enterprise organisations or urban regeneration companies

338.This is the first of five sections that allow deductions for contributions to local enterprise agencies, training and enterprise councils (TECs), local enterprise companies in Scotland, business links and urban regeneration companies. The sections are based on sections 79, 79A and 79B of ICTA.

339.Contributions to these bodies are generally donations and are likely to be made for benevolent reasons, rather than wholly and exclusively for the purposes of the trade (see section 34 of this Act).

340.Subsection (3) is an anti-avoidance rule. It prevents a trader using the section to obtain a deduction for private expenditure, such as funding the training of a family member, by passing funds through one of these bodies. The source legislation disallows any deduction if there is a benefit to the trader. This section merely restricts the deduction by the value of the benefit. See Change 20 in Annex 1.

341.Subsection (5) sets out what happens if the trader receives a benefit in connection with the contribution. The rules in ICTA charge the benefit to tax for a “chargeable period”, which, for income tax purposes, means a tax year. It is simpler to charge the benefit for a period of account. This is consistent with the similar charge on benefits in connection with gifts of trading stock (see section 108 of this Act). See Change 21 in Annex 1.

342.The charge on the benefit applies if the benefit is received by a person “connected with” the trader. That expression is explained in section 878(5) of this Act.

343.Subsection (6)(b) deals with the case where the recipient’s trade has ceased before the benefit is received. It treats the benefit explicitly as a post-cessation receipt. See Change 22 in Annex 1.

344.Subsection (7) makes clear the extent of the disallowance under subsection (3) or charge under subsection (6).

345.The subsection limits the “disqualifying benefit” in accordance with the Inland Revenue practice. See Change 20 in Annex 1.

Section 83: Meaning of “local enterprise organisation”

346.This section lists some of the organisations that qualify for deductions to be allowed under section 82. It combines the definitions in sections 79(4) and 79A(5) of ICTA.

347.Subsection (2) deals with local enterprise agencies. These agencies may take a number of forms and do not have an approval procedure for any other purpose. So the tax legislation specifies that they must be approved for this purpose.

348.The subsection introduces the expression “relevant national authority”. The expression is used also in sections 84 and 85 of this Act.

349.The subsection reflects the effect of the devolution settlements. See Change 19 in Annex 1. The National Assembly for Wales (Transfer of Functions) Order 1999 (SI 1999/672) devolves the functions of the Secretary of State under section 79 of ICTA to the National Assembly for Wales. So the “relevant national authority” may be the Assembly. But the Order does not refer to section 79A of ICTA. So the equivalent functions in subsections (3) and (5) of this section are still exercised only by the Secretary of State.

350.Subsections (3) to (5) deal with other bodies to which section 82 of this Act applies. These other bodies have to be set up in a particular way for other reasons and the tax legislation merely follows the existing procedures.

Section 84: Approval of local enterprise agencies

351.This section and section 85 set out the detailed rules that apply for the approval of local enterprise agencies and the withdrawal of such approval. They are based on section 79(4) to (7) of ICTA.

352.The section sets out the basic procedure for approving a local enterprise agency. The references to “relevant national authority” are explained in section 83(2) of this Act.

Section 85: Supplementary provisions with respect to approvals

353.This section and section 84 set out the detailed rules that apply for the approval of local enterprise agencies and the withdrawal of such approval. They are based on section 79(4) to (7) of ICTA.

354.The references to “relevant national authority” in this section are explained in section 83(2) of this Act.

Section 86: Meaning of “urban regeneration company”

355.This section sets out the detailed rules that apply for the designation of urban regeneration companies. It is based on section 79B(5) to (8) of ICTA.

Section 87: Expenses of research and development

356.This section gives relief for the cost of research and development undertaken by or on behalf of a trader. It is based on section 82A of ICTA.

Section 88: Payments to research associations, universities etc

357.This section gives relief for payments by a trader to various bodies engaged in scientific research. It is based on section 82B of ICTA.

358.Section 82B(1) of ICTA allows a deduction for “the sum paid”. So subsection (2) allows a deduction for the period in which the payment is made.

359.Section 82B of ICTA provides that “the Board” shall refer any question as to whether, or to what extent, activities constitute scientific research for the purposes of section 82B to the Secretary of State. Section 832(1) of ICTA defines “the Board” as the Commissioners of Inland Revenue.

360.Subsection (6) instead says that any question as to what constitutes scientific research must be referred to the Secretary of State by “the Inland Revenue”. “The Inland Revenue” is defined in section 878(1) of this Act as “any officer of the Board of Inland Revenue”. See Change 149 in Annex 1.

361.For the purposes of section 82B of ICTA and of this section, “the Secretary of State” is the Secretary of State for the Department of Trade and Industry.

Section 89: Expenses connected with patents

362.This section allows a deduction for expenses connected with patents. It is based on section 83 of ICTA.

363.Subsection (1) sets out the expenses that are allowable. The deduction is on the basis of expenses incurred. This relaxes any requirement in the source legislation that fees have to be paid before a deduction can be made. See Change 23 in Annex 1.

364.Subsection (2) establishes that the rule in this section is an exception to the general rule in section 56.

Section 90: Expenses connected with designs or trade marks

365.This section allows a deduction for expenses connected with designs or trade marks. It is based on section 83 of ICTA.

366.Subsection (1) sets out the expenses that are allowable. The deduction is on the basis of expenses incurred. This relaxes any requirement in the source legislation that fees have to be paid before a deduction can be made. See Change 23 in Annex 1.

367.Subsection (2) establishes that the rule in this section is an exception to the general rule in section 56 of this Act.

Section 91: Payments to Export Credits Guarantee Department

368.This section allows a trader to deduct the cost of certain payments to the Export Credits Guarantee Department (“ECGD”). It is based on section 88 of ICTA.

369.Section 88 of ICTA refers to payments made under arrangements made by the Secretary of State in pursuance of section 11 of the Export Guarantees and Overseas Investment Act 1978. This section refers instead to arrangements made under section 2 of the Export and Investment Guarantees Act 1991 which replaced the 1978 Act.

370.Section 13(1) of the Export and Investment Guarantees Act 1991 delegates the functions of the Secretary of State under section 2 of the 1991 Act to the ECGD. So the reference to the Secretary of State in section 88 of ICTA is not rewritten in this section.

371.Section 88 of ICTA allows a trader to deduct “sums paid” to the ECGD. This section instead allows a deduction for any “sum payable” by the trader. See Change 24 in Annex 1.

Section 92: Expenses connected with foreign trades

372.This is the first of three sections that set out the special rules for expenses of a foreign trade. The sections are based on sections 80 and 81 of ICTA.

373.The expenses to be allowed are those of a business trip: the condition in sections 80(3) and 81(4) of ICTA is that the trader’s absence from the United Kingdom should be wholly and exclusively for the purpose of a foreign trade (or for the purpose of a foreign trade and another trade).

374.The section sets out a single condition related to the purpose of the trader’s absence from the United Kingdom. That condition applies for all the expenses set out in subsection (3).

375.In the case of family expenses, section 80(5) of ICTA requires the absence to be for the purpose of one or more foreign trades. The section relaxes this requirement. It allows the absence to be either for the purposes of the foreign trade or for the purposes of that trade and one or more other trades. The “other trades” may include one that is not carried on wholly outside the United Kingdom. So the treatment of family expenses is brought into line with the treatment of other expenses. See Change 25 in Annex 1.

376.In the case of travelling expenses, section 81(3) of ICTA seems to impose a further condition requiring the performance of “functions” at the place of departure. This section does not include that further condition. See Change 25 in Annex 1.

377.Subsection (1)(d) makes it clear that the section applies if it is only the “wholly and exclusively” rule that would otherwise disallow the expenses. The normal trading rule (based on the courts’ explanation of the rule in section 34 of this Act) is that the cost of home to work travel is not allowable for tax purposes. Other trading rules (such as the prohibition for capital expenditure in section 33) continue to apply.

378.Subsection (2) includes the rule that the special relief is not available if the income from the trade is assessable by reference to amounts received in the United Kingdom (the “remittance basis”). Section 80 of ICTA refers to section 65(4) of ICTA. This section refers directly to the remittance basis, which is explained in section 878(2) of this Act.

379.The section applies the special rules to the calculation of the profits of Irish trades (always assessed on the arising basis) even if the taxpayer’s other foreign income is assessed on the remittance basis. See Change 26 in Annex 1.

380.Subsection (3) sets out the expenses that qualify for relief under this section.

381.Subsection (4) defines the term “foreign trade”. It replaces the reference in section 80 of ICTA to a trade carried on wholly abroad and the reference in section 81 of ICTA to a trade “in the case of which section 80 applies”.

Section 93: Allocation of expenses

382.This section sets out the rules for allocating the expenses of the trades if the trader carries on more than one foreign trade. It is based on sections 80 and 81 of ICTA.

383.Those sections provide that the apportionment should be “reasonable”. Other apportionments in this Act are made on a “just and reasonable” basis. This section uses “just and reasonable”. See Change 14 in Annex 1.

Section 94: Family expenses

384.This section sets out the family expenses that qualify for an allowance. It is based on section 80(6) and (9) of ICTA. The 60 day condition in section 80(5) of ICTA is in section 92(3)(c) of this Act.

385.Section 1 of the Family Law Reform Act 1987 (broadly) treats illegitimate children in the same way as legitimate children. Section 831(4) of ICTA disapplies that section. So section 80(9) of ICTA needs specially to bring illegitimate children within the scope of the relief in that section. Section 831(4) of ICTA does not apply to this Act. So the Family Law Reform Act ensures that illegitimate children are within this section.

Chapter 6: Trade Profits: Receipts
Overview

386.This Chapter contains provisions on how various receipts are to be treated in calculating the profits of a trade.

Section 95: Profession and vocations

387.This section makes it unnecessary to specify repeatedly that the rules in this Chapter (apart from section 105) apply to a profession or vocation as well as to a trade. The section is new.

Section 96: Capital receipts

388.This section corresponds to section 33 of this Act (capital expenditure) for capital receipts. It is new.

389.Subsection (1) sets out the general rule that items of a capital nature are not to be treated as receipts of a trade.

390.It is a long established principle that capital receipts are ignored in calculating the profits of a trade for income tax purposes. The principle that income tax applies only to receipts of a revenue nature is set out by Lord MacNaghten in Attorney General v London County Council (1900), 4 TC 265 HL:

Income Tax, if I may be pardoned for saying so, is a tax on income. It is not meant to be a tax on anything else.

391.Decisions in subsequent cases on whether a receipt is in the nature of income or capital have taken as their starting point Lord MacNaghten's principle that only receipts of a revenue nature fall to be included in the computation of the profits of a trade. See, for example, the comments of Lord Dundas and Lord Ormidale in Glenboig Union Fireclay Co, Ltd v CIR (1922), 12 TC 427 HL on whether a sum received as compensation for not working certain seams:

…"the sum under consideration was surely of the nature of capital not revenue….the compensation was paid for the loss of a capital asset…the sum can surely not be described as profits arising from the Appellant's trade or business. (Lord Dundas)

…the sum received as compensation…falls to be dealt with as capital….it seems to me to be impossible to predicate of the £15,000 that they were profits arising or accruing from the trade or business of the company. (Lord Ormidale)

392.And, after recalling Lord MacNaghten's dictum in the London County Council case, Lord Moncreiff commented in Trustees of Earl Haig v CIR (1939), 22 TC 725 CS as follows:

I accordingly proceed on the assumption, (which moreover appears to me to be a sound assumption) that all profits from trade, being the profits dealt with in Case I, are profits which have an “income” and not a “capital” quality.

393.More recently, the principle that capital receipts are not subject to income tax was restated by Lord Templeman in Beauchamp v F W Woolworth (1989), 61 TC 542 HL(5):

[Section 1 ICTA 1988] … directs … that income tax shall be charged in respect of profits described in Schedule D set out in [section 18 ICTA 1988]. That section directs … that tax shall be charged in respect of the annual profits arising or accruing to any person … from any trade. … The expression ‘annual profits’ confirms that income tax is to be charged on profits of an income nature as opposed to capital profits …

394.The question of whether a receipt is of a capital or a revenue nature falls to be determined by reference to the nature of the trade. This principle was set out by Lord MacMillan in Van den Berghs Ltd v Clark (1935), 19 TC 390 HL after reviewing the early authorities on distinguishing between income and capital receipts:

…the nature of a receipt may vary according to the nature of the trade. The price of the sale of a factory is ordinarily a capital receipt, but it may be an income receipt in the case of a person whose business it is to buy or sell factories.

395.Subsection (2) disapplies the general rule in subsection (1) where there is statutory provision for a capital sum to be taken into account as a receipt in calculating the profits of a trade. See, for example, section 106 of this Act (sums recovered under insurance policies etc.).

Section 97: Debts incurred and later released

396.If an amount owed by a trader is released, this section treats the amount released as a trading receipt. The section is based on section 94 of ICTA.

397.Subsection (1)(c) sets out the exception that applies if the debt is released as part of a “statutory insolvency arrangement” (defined in section 259 of this Act). This rule reflects the change to section 94 of ICTA made by section 144 of FA 1994.

398.If the trader is no longer carrying on the trade when the debt is released, the amount released is charged to tax as a post-cessation receipt (see section 249 of this Act).

Section 98: Acquisition of trade: receipts from transferor’s trade

399.This section sets out what happens if a successor to a trade receives a sum that arose from the trade when it was carried on by the predecessor. It is based on section 106(2) of ICTA.

400.If a sum arises from a trade that has ceased, the usual rule is that the sum is a post-cessation receipt (see Chapter 18 of Part 2 of this Act). But, if the right to receive the sum is transferred with the trade to a person who takes over the trade, this section applies instead.

401.Subsection (2) treats the sum as a receipt of the successor’s trade. It is not charged on the predecessor. The source legislation applies “for all purposes”. This section applies for income tax purposes. Section 106(2) of ICTA (as amended by paragraph 85 of Schedule 1 to this Act) applies for corporation tax purposes. Section 37(1) of TCGA ensures that any sums received as a result of the transfer are not charged to capital gains tax.

402.Subsection (3) makes it clear that the sum is not treated as a post-cessation receipt.

403.Different rules apply if the right to receive sums is transferred to a person who does not take over the trade (see section 251 of this Act).

Section 99: Reverse premiums

404.This is the first of a group of five sections based on section 54 of and Schedule 6 to FA 1999. This legislation was introduced following the decision of the Privy Council in Commissioner of Inland Revenue v Wattie [1998], STC 1160. An inducement (a “reverse premium”) paid to a tenant to take a lease of land is taxed as income in the hands of the tenant.

405.Subsection (2) introduces the term “the recipient”, which is used throughout this group of sections.

406.Subsection (3) identifies the transaction which gives rise to a reverse premium.

407.Subsection (4) refers to an interest in land being “granted”. This distinguishes such a transaction from one in which an interest is assigned. The general rule is that a charge to tax on a reverse premium arises on the grant of an interest in land but not on its assignment. But assignment can give rise to a charge if the assignor is connected with the grantor.

408.The meaning of “reverse premium” in this section is applied for the purpose of section 311 by subsection (6) of that section.

409.Paragraph 28 of Schedule 2 rewrites the transitional provision in section 54(2) of FA 1999. These sections do not apply to pre-1999 reverse premiums.

Section 100: Excluded cases

410.This section brings together the various exclusions from the charge on reverse premiums. It is based on paragraphs 5, 6 and 7 of Schedule 6 to FA 1999.

Section 101: Tax treatment of reverse premiums

411.This section treats a reverse premium as is a revenue receipt, rather than a capital item. It is based on paragraph 2 of Schedule 6 to FA 1999.

412.Subsection (2) is the rule for a trader. The reverse premium is treated as a receipt of the trade.

413.Subsection (3) is the rule for a non-trader. The reverse premium is treated as a receipt of a property business in accordance with section 311 of this Act.

414.If the transaction giving rise to the reverse premium is at arm’s length there is no statutory timing rule; the normal accountancy treatment applies. If the transaction is not at arm’s length, there is a timing rule in section 102.

Section 102: Arrangements not at arm’s length

415.If a property transaction is not at arm’s length there is a special timing rule. This section provides that the whole of the reverse premium is taxed when the property transaction is entered into. It is based on paragraph 3 of Schedule 6 to FA 1999.

416.Subsection (1) refers to “connected persons”. That expression is defined for the purpose of this section in section 103.

417.Subsection (5) deals with the case where the recipient enters into a property transaction for the purpose of a trade but the trade has not yet started. In that case, the reverse premium is brought into account when the trade starts.

Section 103: Connected persons and property arrangements

418.This section contains the definition of “connected persons” that applies for the group of sections on reverse premiums. It includes a cross-reference to section 878(5) of this Act, which relies on the definition of “connected persons” in section 839 of ICTA. The section is based on paragraph 8 of Schedule 6 to FA 1999.

Section 104: Distribution of assets of mutual concerns

419.This section deals with the consequences for a trader of receiving a distribution from a mutual concern that is a corporate body. It is based on section 491 of ICTA.

420.Subsection (1) sets out the circumstances in which a distribution may give rise to a tax charge. It refers to a distribution out of assets that “represent profits” of the concern. This is not quite the same as “assets of a body corporate, other than assets representing capital”, as identified in section 491(1) of ICTA. The difference is that the section excludes assets that represent capital gains of the concern. See Change 27 in Annex 1.

421.Subsection (2) is the general rule: the distribution is treated as a receipt of the trade.

422.Subsection (3) deals with the case where the distribution is received after the trade has ceased. The section treats the distribution explicitly as a post-cessation receipt. See Change 22 in Annex 1.

423.In the trading income Part the rules apply to the person carrying on a trade rather than to the trade itself. So section 113 of ICTA is not needed to treat a trade as ceasing when there is a change in the person carrying it on. That section is repealed (see paragraph 94 of Schedule 1 to this Act). Subsection (3) of this section reproduces the combined effect of section 491(3)(b) and (4) of ICTA.

424.Subsection (4) explains when money or money’s worth “represents assets” in subsection (1). “Money’s worth” includes consideration for the right to receive a distribution but excludes anything otherwise chargeable to tax.

425.Subsection (5) is a special rule that applies if the right to receive a distribution is transferred other than at arm’s length. Market value is substituted for the actual amount received.

426.The section omits the references to mutual insurance and industrial and provident societies in section 491(9) and (11) of ICTA. Those examples were intended to help readers but there is no comprehensive definition of “mutual business”. The subsections were intended to deal with particular doubts which were common when the provision was enacted in 1964. Those doubts do not exist today.

Section 105: Industrial development grants

427.This section deals with the treatment of certain grants under the Industrial Development Act 1982 or the corresponding provision in Northern Ireland. It is based on section 93 of ICTA.

428.This section does not rewrite the references in section 93(2) of ICTA to the Industry Act 1972, the Industries Development Act (Northern Ireland) 1966 and the Industries Development Act (Northern Ireland) 1971. These enactments were repealed or replaced in 1982 and there are no outstanding instalments under the old enactments.

429.Section 93(3) of ICTA disapplies section 93(1) of ICTA in the case of grants towards the payment of all or part of a corporation tax liability made under Article 7 of the Industrial Development (Northern Ireland) Order 1982. Persons liable to income tax do not, in general, receive grants for the payment of corporation tax. But such a grant could, in principle, be made under Article 7 of the 1982 Order to a partnership with an associated company.

430.Grants in respect of corporation tax liabilities can not be made under any of the enactments listed in subsection (1) of this section other than Article 7 of the Industrial Development (Northern Ireland) Order 1982. So subsection (2) of this section excludes all grants in respect of corporation tax liabilities.

Section 106: Sums recovered under insurance policies etc.

431.This section is based on section 74(1)(l) of ICTA.

432.Section 74(1)(l) of ICTA prohibits the deduction in computing a trader’s profits of “any sum recoverable under an insurance or contract of indemnity”. This is regardless of whether the sum is revenue or capital in nature.

433.Where a sum is recovered under an insurance policy or contract of indemnity in a year other than the year in which the event in respect of which it is received occurs, section 74(1)(l) of ICTA requires any deduction made in respect of that event to be adjusted to reflect the recovery.

434.This section provides instead that a capital sum recovered by a trader under an insurance policy or a contract of indemnity is brought into account as a receipt in calculating the profits of the trade to the extent that the loss or expense has been deducted in calculating those profits. This means the timing of the receipt will follow the accountancy treatment. See Change 28 in Annex 1.

435.No special provision is needed for sums of a revenue nature.

Chapter 7: Trade profits: gifts to charities etc.
Section 107: Professions and vocations

436.This section makes it unnecessary to specify repeatedly that the rules in this Chapter apply to a profession or vocation as well as a trade. It is new.

Section 108: Gifts of trading stock to charities etc.

437.This section sets out the main rule for gifts of trading stock. It is based on sections 83A and 84 of ICTA, which give relief for gifts to charities and educational establishments respectively.

438.When a trader disposes of trading stock other than in the course of a trade the general rule is that the market value of the stock is taken into account in calculating the profits of the trade. That general rule is not explicit in the source legislation but it is explained in Sharkey v Wernher (1955), 36 TC 275 HL. This section sets out the exception to the general rule and applies if the trader disposes of trading stock by way of gift to a charity etc.

439.There is a test for gifts to educational establishments in section 84(2) of ICTA concerning the use to which the gift is put in the business of the educational establishment. There is no equivalent test in the rules for the relief for gifts to charities, in section 83A of ICTA. This section does not reproduce the condition in section 84(2) of ICTA. See Change 29 in Annex 1.

440.The ICTA reliefs originally applied not only to gifts of trading stock but also to gifts of machinery and plant. That element of the reliefs is now in section 63 of CAA.

441.Subsection (1) combines the ICTA reliefs for gifts to charities and gifts to educational establishments. It includes the extension of the relief to registered clubs in Part 3 of Schedule 18 to FA 2002. The relief covers gifts “for the purposes of” charities etc. See Change 30 in Annex 1.

442.Subsection (2) sets out the relief available under the section. It does not require a claim by the trader. In this respect, the section is different from section 84(3) of ICTA (but not from section 83A). See Change 31 in Annex 1.

443.Subsection (4) lists the bodies (other than charities, registered clubs and educational establishments) to which a trader may make gifts that qualify for relief.

Section 109: Receipt by donor or connected person of benefit attributable to certain gifts

444.This section sets out what happens if a trader receives a benefit in connection with a gift of trading stock or plant and machinery. It is based on sections 83A and 84 of ICTA.

445.Subsection (1) applies the section if a benefit is received by the trader or a connected person. Section 82 of this Act (contributions to local enterprise organisations or urban regeneration companies) uses the same approach. The benefit must be in connection with a gift for which relief has been given under section 108 or under the corresponding capital allowances rule.

446.If the donor is still carrying on the trade when the benefit is received the value of the benefit is treated as a trading receipt. The ICTA rules impose a charge (under Schedule D Case I or II, but not explicitly as a trade receipt) for a chargeable period, which for an income tax payer is the tax year.

447.But the profits of a trade are calculated by reference to periods of account. (The basis period rules then determine the profits of the tax year.) Subsection (2) charges the benefit by reference to the period of account in which it is received. See Change 21 in Annex 1.

448.If the donor has ceased to carry on the trade when the benefit is received the value of the benefit is treated as a post-cessation receipt. This treatment replaces the general charge under Schedule D Case VI. See Change 22 in Annex 1.

Section 110: Meaning of “designated educational establishment”

449.This section defines “designated educational establishment” for the purpose of section 108. It is based on section 84(5) to (8) of ICTA.

450.The National Assembly for Wales (Transfer of Functions) Order 1999 (SI 1999/672) devolves the functions of the Secretary of State under section 84 of ICTA to the National Assembly for Wales. So this section refers to the Assembly.

451.The section reflects the effect of the devolution settlements. See Change 19 in Annex 1. The section also uses the new name of the Northern Ireland department.

Chapter 8: Trade profits: Herd basis rules
Overview

452.This Chapter gives the rules for what is commonly known as the “herd basis”. It is based on Schedule 5 to ICTA. The object of the herd basis is to treat a herd of animals in a similar fashion to a capital asset. Without the election the individual animals in the herd would be treated as separate items of trading stock. With the election:

  • there is no tax allowance for the initial cost of, or any subsequent increase in the size of, the herd;

  • the net cost of replacing animals in the herd is allowable;

  • any profit or loss on the sale of a single animal or a small number of animals from the herd without replacement is included in the profits of the trade; and

  • if the whole, or a substantial part of the herd, is sold and not replaced the resulting profit or loss is not included in the profits of the trade.

453.An election can be made only in respect of animals kept for their produce.

Section 111: Election for application of herd basis rules

454.This section allows a taxpayer to elect for the “herd basis rules” to apply and introduces some basic concepts. It is based on paragraphs 1(2), 1(3), 2(1), 3(1) and 9(1) of Schedule 5 to ICTA.

455.Subsection (1) allows a taxpayer to make a “herd basis election” if he or she keeps, or has kept, a “production herd”. “Production herd” is defined in section 112(1)(c). The effect of a “herd basis election” is that the “herd basis rules” apply. These rules are set out in sections 114 to 123. The time limits for making the election are set out in sections 124 to 126. Section 878(3) and (4) of this Act sets out general rules for making claims and elections.

456.Subsection (4) makes clear that the Chapter has no application to a herd kept in circumstances that do not amount to the carrying on of a trade.

Section 112: Meaning of “animal”, “herd”, “production herd” etc.

457.This section provides various definitions used in the Chapter. It is based on paragraphs 8 and 9 of Schedule 5 to ICTA.

458.This section would be the natural home for the rule in paragraphs 7 and 9(5) of Schedule 5 to ICTA that prevents the herd basis rules applying to working animals. Paragraphs 7 and 9(5) of Schedule 5 to ICTA exclude certain animals from being part of a production herd. These are animals kept for the work they do in connection with the trade or those kept for public exhibition, or racing or other competitive purposes. In practice this rule is unnecessary since animals in a production herd must be kept wholly or mainly for the sake of their produce. So the exclusions are not rewritten.

459.Subsection (1)(a) rewrites the definition of animal in paragraph 9 of Schedule 5 to ICTA. Most of the definitions in paragraph 9 of Schedule 5 to ICTA refer to “animals and other living creatures”. The main reason for the reference to “other living creatures” is to make clear that the Schedule applies to birds.

460.Subsection (1)(c) rewrites the definition of “production herd” in paragraph 8(5) of Schedule 5 to ICTA. Herd basis elections are made by reference to classes of production herd. See section 124. Section 113(2) identifies when different production herds are treated as being of the same class.

461.Subsection (3) gives the general rule that immature animals are not treated as part of the herd for tax purposes even if they are, in practice, kept in the herd; for example, calves kept with cows.

462.Subsection (4) sets out the exception to the general rule in subsection (3). It will usually apply only to certain flocks of sheep, commonly known as “hefted flocks”, kept under particular natural conditions on mountain, hill or heath land.

463.Subsection (6) makes clear that an immature animal can be treated as added to the herd when it becomes mature. There is a definition of maturity for female animals in section 113(5).

Section 113: Other interpretative provisions

464.This section provides further definitions. It is based on paragraphs 3, 8 and 9 of Schedule 5 to ICTA.

465.Subsection (2)(a) applies if production herds of animals of different species are kept for the same product; for example, a herd of cows and a herd of goats both kept for milk production. Each herd satisfies the definition of production herd. Subsection (2)(a) prevents them being treated as of the same class.

466.Subsection (2)(b) prevents animals of the same species being treated as of the same class if they are kept for different products; for example, one herd of cows kept for milk production and another herd of cows kept for its calves.

467.Subsection (6) clarifies what is meant by “a substantial part of the herd”. This is a question of fact depending on the circumstances. But 20% of the herd will always be regarded as substantial. See Change 32 in Annex 1. The following sections refer to “a substantial part of the herd”.

  • Section 118(1) (sale of animals from the herd);

  • Section 119(1) (sale of whole or substantial part of herd);

  • Section 120(4) and (5) (acquisition of new herd begun within 5 years of sale);

  • Section 122(1) (replacement of part sold within 5 years of sale); and

  • Section 126(1) (slaughter under disease control order).

Section 114: Initial cost of herd and value of herd

468.This section sets out the treatment of the initial cost, and value, of the herd. It is based on paragraph 3(2) of Schedule 5 to ICTA.

469.No deduction is allowed for the initial cost of the herd. Neither is the value of the herd taken into account in calculating the profits of the trade.

Section 115: Addition of animals to herd

470.This section sets out the treatment of additions to the herd. It is based on paragraph 3(2) and (3) of Schedule 5 to ICTA.

471.Subsection (1) makes clear that there is a difference between additions, to which this section applies, and replacements dealt with in section 116.

472.Subsection (2) prevents a deduction for the cost of the additional animal. It is a similar rule to section 114(1) and is also based on paragraph 3(2) of Schedule 5 to ICTA.

473.Subsections (3) and (4) deal with the case in which the additional animal was part of the trading stock immediately before it became part of the herd. Subsection (3) requires the farmer to add an amount called “the balancing amount” to his or her trade receipts. The balancing amount is defined in subsection (4) and is intended to recover the costs that will already have been allowed as a trading expense.

Section 116: Replacement of animals in herd

474.This section sets out the treatment if an animal in the herd is replaced. It is based on paragraph 3(4) and (5) of Schedule 5 to ICTA.

475.Subsection (1) introduces the terms “old animal” to describe an animal leaving the herd and “new animal” to describe the animal that replaces it. The circumstances in which an animal is treated as sold and the meaning of “sale proceeds” are extended by the definitions in section 113(3) and (4).

476.Subsection (2) sets out the basic rule that any sale proceeds of the old animal are included in the farmer's trade receipts. This rule is subject to a number of exceptions:

  • if the animal is slaughtered under a disease control order and the new animal is of a worse quality (see section 117);

  • if the farmer acquires, or begins to acquire, a new herd within five years of the old herd being sold (see section 120); and

  • if a substantial part of the herd is sold and the farmer acquires or begins to acquire replacement animals within five years (see section 122).

477.Subsection (4) deals with the deduction due for the replacement animal. The basic principle in paragraph 3(4)(b) of Schedule 5 to ICTA is that the cost of the second animal is deducted as a trading expense. But paragraph 3(4)(b) of Schedule 5 to ICTA provides for an exception - “in so far as that cost consists of such costs as are allowable apart from the provisions of this Schedule as deductions in computing profits of farming under Case I of Schedule D”.

478.It is not clear from ICTA what these costs are. In fact the exception is aimed at the case where the replacement animal comes from trading stock. Here the costs of breeding or acquiring it and, if relevant, rearing it to maturity have already been allowed. The farmer is not allowed a double deduction for costs that have already been allowed.

479.This section does not reproduce that part of paragraph 3(4)(b) of Schedule 5 to ICTA which refers to the cost of the new animal being subject to paragraph 3(6) of Schedule 5 to ICTA. This reference appears to be an error made in the 1988 consolidation of ICTA. It is generally accepted that it is the rule in paragraph 3(4)(a), and not paragraph 3(4)(b), of Schedule 5 to ICTA which should be qualified by paragraph 3(6) of Schedule 5 to ICTA.

Section 117: Amount of receipt if old animal slaughtered under disease control order

480.This section limits the amount of the receipt taxed under section 116 if the old animal is slaughtered under a disease control order. It is based on paragraph 3(6) of Schedule 5 to ICTA.

481.Paragraph 3(6) of Schedule 5 to ICTA restricts the amount of the receipt to “the amount allowable as a deduction”. It is not immediately clear what this amount is. This section makes clear that it is the amount allowable as a deduction in respect of the new animal. This is called “the equivalent amount for the new animal”.

482.Subsections (4) and (5) define “the equivalent amount for the new animal”. Subsection (4) deals with the case in which the replacement animal comes from the farmer’s trading stock. Subsection (5) deals with all other cases.

Section 118: Sale of animals from herd

483.This section sets out the rules that apply if an animal is sold from the herd and not replaced. It is based on paragraph 3(10) of Schedule 5 to ICTA.

484.Subsection (1) identifies the scope of the section. References to the sale of an animal include references to its death or destruction. See section 113(3). An explanation of what is meant by “substantial part of the herd” is given in section 113(6).

485.Subsections (2) and (3) explain that profits are included as trade receipts and losses are allowed as trade deductions.

486.Subsection (4) sets out how to calculate the profit or loss. The definition of “deductible amount for the animal” is in subsection (5).

Section 119: Sale of whole or substantial part of herd

487.This is the first of three sections that set out the rules relating to the sale of all or a substantial part the herd within 12 months. It is based on paragraph 3(8) of Schedule 5 to ICTA.

488.The section merges the rules in paragraph 3(7) to (9) of Schedule 5 to ICTA. See Change 33 in Annex 1. An explanation of what is meant by “substantial part of the herd” is given in section 113(6).

489.Subsection (2) sets out the general rule. If the herd, or a substantial part of the herd, is sold within a year no profit is taxed as a trade receipt and no loss is allowed as a trade deduction. This overrides the rule in section 118(2) and (3) (sale of animals from herd).

Section 120: Acquisition of new herd begun within 5 years of sale

490.This section sets out the rules that apply if, following the sale of the herd (either all at once or within 12 months), the farmer begins to acquire a new herd within five years. It is based on paragraph 3 of Schedule 5 to ICTA.

491.Subsection (2) sets out the general rule. The section treats what is really an acquisition as a replacement by applying section 116 (replacement of animals in herd) unless the sale was for reasons outside the farmer's control.

492.Subsection (3) identifies the time when the sale proceeds of the animal in the old herd are brought into account as a trade receipt.

493.Subsection (4) applies if the number of animals in the new herd is smaller than the number of animals in the old herd but the difference is not substantial. See Change 33 in Annex 1.

494.Subsection (5) applies if the number of animals in the new herd is smaller than the number of animals in the old herd and the difference is substantial. The effect is that the difference between the number of animals in the old herd and the new herd is treated as the disposal of part of a herd. Section 119 will apply if there are no further replacements. Section 122 will apply if there are further replacements within five years.

495.Subsection (6) applies if the number of animals in the new herd is larger than the number of animals in the old herd. The effect is that the difference between the number of animals in the old herd and the new herd is treated as an addition to the herd and section 115 applies.

496.Subsection (7) clarifies what is meant by a “substantial part of the herd”. See Change 32 in Annex 1.

Section 121: Section 120: sale outside farmer's control

497.This section limits the amount taxed as a trade receipt under section 120 if the sale is for reasons outside the farmer's control and the replacement animal is of a worse quality. It is based on paragraph 3(9)(a) of Schedule 5 to ICTA.

498.The section is similar to section 117 although it is not limited, as that section is, to disposals under a disease control order. The source legislation for both sections refers to the amount of the trading receipt being restricted to “the amount allowable as a deduction”. It is not immediately clear what this amount is.

499.Subsection (2) makes clear that it is the amount allowable as a deduction in respect of the new animal. The section calls this “the equivalent amount for the new animal”.

500.Subsections (3) and (4) define “the equivalent amount for the new animal”. Subsection (3) deals with the case in which the replacement animal comes from the farmer’s trading stock. Subsection (4) deals with all other cases.

Section 122: Replacement of part sold begun within 5 years of sale

501.This section sets out the rules that apply if, following the sale of a substantial part of a herd (either all at once or within a year), the farmer begins to replace it within five years. It is based on paragraph 3(8) and (9) of Schedule 5 to ICTA.

502.Subsection (1) sets out the conditions for the section to apply. An explanation of what is meant by “substantial part of the herd” is given in section 113(6).

503.Subsection (2) applies section 116 (replacement of animals in herd). The sale proceeds of the old animal are brought into account as a trade receipt. This is subject to the exception given in section 123 if the sale was for a reason outside the farmer's control.

504.Subsection (3) provides the sale proceeds are not recognised until the new animal is acquired.

505.Subsection (4) deals with the case where not all the animals sold are replaced. No profit or loss arising from the sale is brought into account as a trade receipt.

Section 123: Section 122: sale outside farmer's control

506.This section limits the amount taxed as a trade receipt under section 122 if the sale is for reasons outside the farmer's control and the new animal is of a worse quality. It is based on paragraph 3(9)(a) of Schedule 5 to ICTA.

507.The section is similar to section 117 although it is not limited, as that section is, to disposals under a disease control order. The source legislation for both sections refers to the amount of the trading receipt being restricted to “the amount allowable as a deduction”. It is not immediately clear what this amount is.

508.Subsection (2) makes clear that it is the amount allowable as a deduction in respect of the new animal. The section calls this “the equivalent amount for the new animal”.

509.Subsections (3) and (4) define “the equivalent amount for the new animal”. Subsection (3) deals with the case in which the replacement animal comes from the farmer’s trading stock. Subsection (4) deals with all other cases.

Section 124: Herd basis elections

510.This section sets out the rules for the making of herd basis elections. It is based on paragraph 2 of Schedule 5 to ICTA.

511.The section does not specify that the election is to be made to “the inspector”. Section 878(4) draws attention to the rules in TMA, which apply for the purposes of this Act. Those rules require elections to be made to “an officer of the Board”.

512.Subsection (2) sets out the time limit for making the election. It merges the rules for partnerships and all other taxpayers with one exception. See Change 34. The exception is the extension to the time limit given to taxpayers other than partnerships by paragraph 2(5) of Schedule 5 to ICTA. This extension is preserved in subsection (2)(b).

513.Subsection (3) defines “the first relevant period of account”. See Change 34 in Annex 1.

514.Subsection (4) expands on subsection (1), which provides that an election must specify the class of production herd to which it relates. This means separate elections must be made for each class of production herd and that an election may not relate to more than one class of production herd. Separate elections may be made for different classes.

515.Subsection (6) identifies the production herds to which the election applies.

516.Subsection (7) identifies the periods of account to which the election applies. See Change 35 in Annex 1. Section 129 allows earlier years to be re-opened to give effect to an election.

517.Subsection (8) deals with the case in which the farmer is a firm and there is a change in the partners in the firm. Paragraph 2 of Schedule 5 to ICTA refers to “the farmer making the election”. If the farming trade is carried on in partnership, the “farmer” means the firm. If there is a change in the members of a firm, the question arises whether there is a new “farmer”. Subsection (8) makes clear that there is.

Section 125: Five year gap in which no production herd kept

518.This section deals with the case where there is a period of at least five years when the farmer does not keep a production herd of the particular class for which he or she has made a herd basis election. It is based on paragraph 4 of Schedule 5 to ICTA.

519.Subsection (2) explains the consequences for the herd basis rules if the farmer starts to keep another production herd of the same class after the end of the five year period. See Change 36 in Annex 1.

Section 126: Slaughter under disease control order

520.This section sets out the rules for making an election outside the normal time limits following slaughter under a disease control order. It is based on paragraph 6 of Schedule 5 to ICTA.

521.Subsection (1) sets out the conditions for the section to apply. An explanation of what is meant by “substantial part of the herd” is given in section 113(6).

522.Subsection (2) allows the farmer to make a herd basis election in respect of the class of production herd involved in the slaughter and identifies the relevant time limits.

523.In line with the approach adopted in the rewrite of the ordinary time limits in section 124 this section merges the rules for partnerships and all other taxpayers and applies the longer time limits given to partnerships. See Change 37 in Annex 1.

524.Subsection (3) identifies the periods of account to which the election applies.

Section 127: Preventing abuse of the herd basis rules

525.This section provides anti-avoidance rules that may apply if a farmer transfers the whole or part of a production herd in a transaction that is not an open market sale. It is based on paragraph 5 of Schedule 5 to ICTA.

526.Subsection (1) sets out the conditions for the section to apply. If the transfer is not an open market sale the section will apply if either the “control condition” or the “herd basis benefit condition” are met.

527.Subsection (2) defines the relationship that must exist between the parties to the transfer for the “control condition” to apply.

528.Subsection (4) sets out the conditions for the “herd basis benefit condition” to apply.

529.Subsection (6) gives the counter-action that applies if either the “control condition” or the “herd basis benefit condition” are met. The animals are treated as sold at their open market value. Section 175(3) in Chapter 12 of Part 2 of this Act (trade profits: valuation of stock and work in progress) makes clear that this section takes priority over the provisions of that Chapter.

Section 128: Information if election made

530.This section gives the Inland Revenue power to obtain information about the animals kept for the purposes of the trade. It is based on paragraph 10 of Schedule 5 to ICTA.

531.Only the person carrying on the trade can be required to deliver a return. The reference to “inspector” has been changed to “Inland Revenue”. See Change 149 in Annex 1.

Section 129: Further assessment etc. if herd basis rules apply

532.This section enables effect to be given to a herd basis election made after an assessment has become final, either by amendment or by repayment of tax. It is based on paragraph 11 of Schedule 5 to ICTA.

Chapter 9: Trade profits: films and sound recordings
Overview

533.This Chapter rewrites the special rules for expenditure on the production and acquisition of films, tapes and discs in sections 40A to 43 of F(No 2)A 1992, section 48 of F(No 2)A 1997 and sections 99 to 101 of FA 2002 as they apply to persons trading in the exploitation of films, tapes and discs. Rules for non-trade businesses involving films or sound recordings are in sections 609 to 613 of this Act.

Section 130: Expenditure to which this Chapter applies

534.This section is based on sections 40A to 43 of F(No 2)A 1992.

535.Section 40A(1) of F(No 2)A 1992 refers to a “master version” of a film. Section 40A(5) defines a “master version” of a film as “a master negative, master tape or master audio disc” of the film. Section 43(1) of F(No 2)A 1992 defines “master negative”, “master disc” and “master tape” in relation to a film.

536.Subsections (1) to (4) of this section refer instead to “the original master version of a film or sound recording”. See Change 38 in Annex 1.

537.Subsection (5) excludes interest and the incidental costs of obtaining finance from the definition of expenditure incurred in the production or acquisition of films and sound recordings. See Change 39 in Annex 1.

538.Section 135 and sections 137 to 140 of this Act provide for a deduction in calculating the profits of the trade of the amount of preliminary, production or acquisition expenditure on the original master version of a film or sound recording allocated to a relevant period. In each case, the deduction is subject to the application of “any prohibitive rule”. Section 130(7) defines “any prohibitive rule” for the purposes of such deductions.

Section 131: Meaning of “film” and related expressions

539.This section is based on section 43 of F(No 2)A 1992 and paragraph 1 of Schedule 1 to the Films Act 1985.

540.Subsection (1) reproduces the definition of “film” in paragraph 1(1) of Schedule 1 to the Films Act 1985. This is based on the requirement in section 43(2) of F(No 2)A 1992 that references to a film in sections 41 and 42 of F(No 2)A 1992 are to be construed in accordance with paragraph 1 of Schedule 1 to the Films Act 1985.

541.Subsection (3) provides that a series of films in respect of which the Secretary of State has given a direction under paragraph 1(4) of Schedule 1 to the Films Act 1985 is treated as a single film for the purposes of this Chapter. For the purposes of Schedule 1 to the Films Act 1985 and of this section, “the Secretary of State” is the Secretary of State for the Department for Culture, Media and Sport.

542.Paragraph 1(4) of Schedule 1 to the Films Act 1985 provides as follows:

(4)The Secretary of State may direct that a number of films shall be treated as a single film for the purposes of this Schedule if—

(a)they form a series with not more than twenty-six parts;

(b)the combined playing time is not more than twenty-six hours; and

(c)in the opinion of the Secretary of State the series constitutes a self-contained work or is a series of documentaries with a common theme.

Section 132: Meaning of “original master version” and “certified master version”

543.This section is based on sections 40A(5) and 43(1) of F(No 2)A 1992.

544.Section 40A(5) of F(No 2)A 1992 defines a “master version” of a film as “a master negative, master tape or master audio disc” of the film. Section 43(1) of F(No 2)A 1992 defines “master negative”, “master disc” and “master tape” in relation to a film.

545.Subsection (1) defines “original master version” in relation to both a film and a sound recording. See Change 38 in Annex 1.

546.Subsection (3) introduces the label “certified master version” for a film certified by the Secretary of State for Culture, Media and Sport as a qualifying film, tape or disc under paragraph 3 of Schedule 1 to the Films Act 1985. For the purposes of Schedule 1 to the Films Act 1985 and of this section, “the Secretary of State” is the Secretary of State for the Department for Culture, Media and Sport.

547.The criteria for certification under paragraph 3 of Schedule 1 to the Films Act 1985 are set out in paragraph 4 of that Schedule. Paragraph 4 of Schedule 1 to the Films Act 1985 requires the maker of the film to be ordinarily resident in a member State of the European Union and includes further requirements regarding the percentage of total expenditure on the production of the film to be incurred in the United Kingdom and on the fraction of the labour costs of the film to be paid to citizens of, or persons ordinarily resident in, a member State of the European Union.

548.The special rules for the treatment of certified master versions in sections 40D, 41 and 42 of F(No 2)A 1992, section 48 of F(No 2)A 1997 and sections 99 to 101 of FA 2002 are rewritten in sections 136 to 144 of this Act.

Section 133: Meaning of “relevant period”

549.This section is based on sections 40B, 40D and 43 of F(No 2)A 1992.

Section 134: Expenditure treated as revenue in nature

550.This section is based on section 40A of F(No 2)A 1992.

551.Expenditure on the production or acquisition of a film is in the nature of capital expenditure on the provision of a fixed asset and is eligible for capital allowances under the normal rules in CAA. This section provides for expenditure and receipts in respect of a film or sound recording to be treated instead as revenue for income tax purposes.

552.Section 143 allows the person carrying on the trade to elect for this section and sections 135 to 140 of this Act (which contain rules for allocating expenditure treated as revenue to relevant periods) not to apply.

Section 135: Films and sound recordings: production or acquisition expenditure

553.This section sets out the basic rules for allocation of expenditure to a relevant period. It is based on sections 40B and 40C of F(No 2)A 1992.

554.Section 40B of F(No 2)A 1992 refers to expenditure on the production or acquisition of a master version of a film. Subsection (1) refers instead to the original master versions of “films or sound recordings”. See Change 38 in Annex 1.

555.Subsection (2) provides that a deduction for production or acquisition expenditure allocated to the relevant period is subject to the application of “any prohibitive rule”. “Any prohibitive rule” is defined in section 130(7) of this Act as any provision of the Income Tax Acts which prohibits, or restricts the extent of, a deduction in calculating the profits of a trade.

556.Subsection (4) provides for production and acquisition expenditure to be allocated to a relevant period in such a way that it will be written off over the period during which the value of the film or sound recording is expected to be realised. This is generally known as the “income matching” method of allocation.

557.Subsection (5) allows the amount allocated under subsection (4) to be increased to an amount equal to the value realised in the relevant period. This is generally known as the “cost recovery” method.

558.This section dispenses with the requirement in section 40B(5) of F(No 2)A 1992 for a claim to be made if the “cost recovery” method is to apply. See Change 40 in Annex 1.

559.Subsection (7) provides that if any expenditure in respect of the original master version of a film or sound recording is allocated to the relevant period under the special rules for certified master versions in sections 137 to 140 of this Act (or under the corresponding rules in F(No 2)A 1992) no expenditure in respect of the same master version can be allocated under this section. This gives the person carrying on the trade a choice in any relevant period between allocating expenditure under the basic rules in this section or under the special rules for certified films in sections 137 to 140. See Change 41 in Annex 1.

Section 136: Application of provisions about certified master versions

560.This section is based on sections 41 and 42 of F(No 2)A 1992.

Section 137: Certified master versions: preliminary expenditure

561.This section allows preliminary expenditure on a qualifying film “genuinely intended for theatrical release” to be written off in the relevant period in which it is incurred. It is based on section 41 of F(No 2)A 1992 and section 99(1) of FA 2002.

562.Preliminary expenditure is not defined. It consists of expenditure incurred in deciding whether to make the film (generally known in the industry as “development” or “pre-production” expenditure). “Genuinely intended for theatrical release” is defined in section 144 of this Act and refers to films intended for commercial release in cinemas.

563.This section dispenses with the requirement in section 41(1) of F(No 2)A 1992 for a claim to be made for preliminary expenditure to be allocated to a relevant period. See Change 40 in Annex 1.

564.Subsection (3) provides that a deduction for preliminary expenditure allocated to the relevant period is subject to the application of “any prohibitive rule”. “Any prohibitive rule” is defined in section 130(7) of this Act as any provision of the Income Tax Acts which prohibits, or restricts the extent of, a deduction in calculating the profits of a trade.

565.Subsection (7) prevents preliminary expenditure being relieved both under this section and under the basic rules in section 135 in the same relevant period. See Change 41 in Annex 1.

Section 138: Certified master versions: production or acquisition expenditure

566.This section allows production or acquisition expenditure on a qualifying film intended for commercial release in cinemas to be written off over three years. It is based on section 42 of F(No 2)A 1992, section 48(4) and (5) of F(No 2)A 1997 and section 99(1) of FA 2002.

567.Subsection (2) provides that a deduction for production or acquisition expenditure allocated to the relevant period is subject to the application of “any prohibitive rule”. “Any prohibitive rule” is defined in section 130(7) of this Act as any provision of the Income Tax Acts which prohibits, or restricts the extent of, a deduction in calculating the profits of a trade.

568.Subsections (3) to (5) allow up to one-third of production or acquisition expenditure not already allocated under sections 137, 139 or 140 of this Act (or under the corresponding rules in F(No 2)A 1992) to be allocated to a relevant period under this section.

569.This section dispenses with the requirement in section 42(1) of F(No 2)A 1992 for a claim to be made for production or acquisition expenditure to be allocated to a relevant period. See Change 40 in Annex 1.

570.Subsection (7) provides that expenditure may not be allocated to a relevant period under this section if expenditure in respect of the same film has been allocated to that period under the basic rules in section 135 of this Act.

Section 139: Certified master versions: production expenditure on limited-budget films

571.This section allows production expenditure incurred before 2 July 2005 on a qualifying film with total production expenditure of £15 million or less and intended for commercial release in cinemas to be written off in full in the period in which it is incurred. It is based on section 42 of F(No 2)A 1992, section 48 of F(No 2)A 1997 and section 99(1) of FA 2002.

572.Subsection (2) provides that a deduction for production expenditure allocated to the relevant period is subject to the application of “any prohibitive rule”. “Any prohibitive rule” is defined in section 130(7) of this Act as any provision of the Income Tax Acts which prohibits, or restricts the extent of, a deduction in calculating the profits of a trade.

Section 140: Certified master versions: acquisition expenditure on limited-budget films

573.This section allows expenditure incurred before 2 July 2005 on the first acquisition of a qualifying film with total production expenditure of £15 million or less and intended for commercial release in cinemas to be written off in full in the period in which it is incurred. It is based on section 42 of F(No 2)A 1992, section 48 of F(No 2)A 1997 and sections 99(1) and 101 of FA 2002.

574.Subsection (3) provides that a deduction for acquisition expenditure allocated to the relevant period is subject to the application of “any prohibitive rule”. “Any prohibitive rule” is defined in section 130(7) of this Act as any provision of the Income Tax Acts which prohibits, or restricts the extent of, a deduction in calculating the profits of a trade.

Section 141: Meaning of “total production expenditure”

575.This section defines “total production expenditure” for the rules on limited budget films in sections 139 and 140. It is based on section 48(6),(6A) and (7) of F(No 2)A 1997.

576.Subsection (4) substitutes an “arm’s length” amount for any expenditure incurred as a result of a transaction between connected persons in arriving at the total production expenditure. “Connected person” is defined in section 839 of ICTA (see section 878(5) of this Act).

Section 142: When expenditure is incurred

577.This section is based on section 48(9) of F(No 2)A 1997 and section 5 of CAA.

Section 143: Election for sections 134 to 140 not to apply

578.This section allows for the person carrying on the trade to elect for sections 134 to 140 not to apply to expenditure on a certified film intended for commercial release in cinemas. It is based on section 40D of F(No 2)A 1992.

579.The effect of such an election is that expenditure on the film will be treated not as revenue expenditure but as capital expenditure. Capital allowances may then be available under the normal rules in CAA.

580.This section dispenses with the requirement in section 40D(3) of F(No 2)A 1992 for an election to be made “in such form as the Board of Inland Revenue may determine”. This is because under section 42(2), (10) and (11) of TMA an election must be made either in a return under sections 8, 8A and 12AA of TMA (the form of which is determined by the Board) or “in such form as the Board may determine” in accordance with paragraph 2(3) of Schedule 1A to TMA .

Section 144: Meaning of “genuinely intended for theatrical release”

581.This section is based on section 99(2) of FA 2002.

582.Section 99(3) and (4) of FA 2002 contain transitional rules for qualifying films which do not meet the “genuinely intended for theatrical release” test but for which application for certification was received before 17 April 2002 or which were commissioned on or before 17 April 2002. See paragraph 35 of Schedule 2 to this Act.

Chapter 10: Trade profits: certain telecommunication rights
Overview

583.This Chapter applies to certain telecommunication licences and capacity on telecommunication cable systems known as indefeasible rights to use (IRUs). It is based on Schedule 23 to FA 2000.

584.The Chapter provides that the income tax treatment follows the treatment in the accounts provided the accounts are prepared in accordance with generally accepted accounting practice. This allows a taxpayer who acquires qualifying rights a deduction for expenditure that would otherwise be capital for tax purposes.

585.It applies to IRUs acquired on or after 21 March 2000. See the transitional rule in paragraph 39 of Schedule 2 to this Act.

Section 145: Professions and vocations

586.This section makes it unnecessary to specify repeatedly that the rules in this Chapter apply to a profession or vocation as well as a trade. It is new.

Section 146: Meaning of “relevant telecommunication right”

587.This section defines “relevant telecommunication right”. It is based on paragraph 1 of Schedule 23 to FA 2000.

588.To date, the only licences to which paragraph (a) applies were granted in response to the government auction of third generation mobile telephone licences in April 2000.

Section 147: Expenditure and receipts treated as revenue in nature

589.This section sets out the general rule that the tax treatment follows the treatment in the accounts. It also identifies a number of circumstances that will be treated as the acquisition or disposal of a relevant telecommunications right. It is based on paragraph 2 of Schedule 23 to FA 2000.

590.Subsection (1) sets out the conditions for the section to apply. An amount in respect of the acquisition cost or disposal proceeds of the rights must be included in the calculation of profit or loss in accounts prepared in accordance with generally accepted accounting practice. In the case of acquisition costs this will usually be an amount of amortisation.

591.This section does not rewrite paragraph 4 of Schedule 23 to FA 2000 because it is likely to be of theoretical application only in the income tax field. Paragraph 4 of Schedule 23 to FA 2000 deals with the case in which the taxpayer is a member of a group of companies that prepares consolidated group accounts. It provides that in relation to paragraphs 2 and 3 of Schedule 23 to FA 2000 the accounting treatment in the taxpayer's accounts must be no more cautious than that adopted in the group accounts.

592.It is unlikely that a company liable to income tax would acquire a right to which the Schedule applies. Even if it did paragraph 4 of Schedule 23 to FA 2000 would be relevant only if it was a member of a group of companies which prepared consolidated accounts on a less cautious basis.

Section 148: Credits or debits arising from revaluation

593.This section sets out the rules that apply if the rights are revalued in the taxpayer’s accounts. It is based on paragraph 3 of Schedule 23 to FA 2000.

594.The main purpose of this section is to prevent the taxpayer obtaining a cost-free increase in the amount on which amortisation will be allowed. If the value of the rights as shown in the accounts is increased in accordance with generally accepted accounting practice the amount on which amortisation is allowed is also increased. But the taxpayer has not borne any costs in respect of this increase. The effect of this section is to tax the amount of the revaluation.

595.The section applies even if the revaluation is not reflected in the profit and loss account. For example, generally accepted accounting practice may deal with the revaluation wholly as a balance sheet item.

596.The section does not apply to revaluations that are not made in accordance with generally accepted accounting practice. Amounts in respect of these revaluations would not meet the test in section 147(1).

Chapter 11: Trade Profits: Other specific trades
Overview

597.This Chapter contains special rules for the taxation of particular trades.

Section 149:Taxation of amounts taken to reserves

598.This section contains a special rule for the treatment of securities held by dealers on which the profits and losses are calculated by reference to the “fair value” of the securities rather than on a realisation basis. It is based on section 472A of ICTA.

599.Section 472A of ICTA applies to securities held by a person carrying on a banking or insurance business, or a business of dealing in securities, profits from the sale of which would “form part of the trading profits of that business”.

600.The Inland Revenue does not believe that there are currently any individuals or non-resident companies liable to income tax in respect of a banking business. Similarly, the Inland Revenue does not believe that there are, or will be in the future as the law stands at present, any individuals (other than Lloyd’s underwriters) or non-resident companies liable to income tax in respect of an insurance business.

601.So this section does not refer specifically to banking and insurance businesses. But such businesses (except for Lloyd’s underwriters who come instead within the special rules in sections 171 and 176 of and Schedule 20 to FA 1993) are covered by the reference to a trade in which a profit on the sale of securities would be brought into account in calculating the profits.

602.Financial assets can be dealt with in a number of ways for accounting purposes.

603.Where a dealer in securities uses United Kingdom generally accepted accountancy practice (“UK GAAP”), profits and losses calculated by reference to the fair value of securities treated as trading assets are taken to profit and loss account. “Fair value” is an accounting term, the meaning of which is broadly equivalent to market value.

604.UK GAAP is defined in section 50(4) of FA 2004:

In the Tax Acts “UK generally accepted accounting practice”—

(a)means generally accepted accounting practice with respect to accounts of UK companies (other than IAS accounts) that are intended to give a true and fair view, and

(b)has the same meaning in relation to—

(i)individuals,

(ii)entities other than companies, and

(iii)companies that are not UK companies,

as it has in relation to UK companies.

605.Section 50(4)(a) of FA 2004 refers to accounts “other than IAS Accounts”. “IAS Accounts” is defined in section 50(1) of FA 2004 as “accounts prepared in accordance with international accounting standards”.

606.“International accounting standards” is defined in section 50(2) of FA 2004 as:

…international accounting standards, within the meaning of Regulation (EC) No. 1606/2002 of the European Parliament and the Council of 19 July 2002 on the application of international accounting standards, adopted from time to time by the European Commission in accordance with that Regulation.

607.Where a dealer in securities prepares accounts in accordance with international accounting standards, the securities would usually fall to be accounted for as at fair value, in accordance with paragraph 9 of International Accounting Standard 39, (“IAS 39”) and any profits and losses calculated by reference to the fair value of securities taken to the profit and loss account. But a trader may instead account for certain securities as “available for sale” if they do not meet the conditions for being treated as at fair value through profit or loss. In such a case profits and losses calculated by reference to the fair value of securities are taken initially to a statement of changes in equity.

608.It is expected that from 2005 UK GAAP in this area will follow IAS 39. In UK terms the profits and losses on “available for sale” assets will be taken to the statement of total recognised gains and losses.

609.Section 42 of FA 1998 provides that the computation of profits or losses from a trade must be based on accounts drawn up in accordance with GAAP, subject to any adjustment authorised by law. Implicit in this rule is that the profits must appear in the profit and loss account. There is no tax law (apart from section 472A of ICTA) which allows profits on equity securities taken to any form of reserve to be treated as if they were taken to profit and loss account.

610.Subsection (2) provides that if changes in the fair value of the securities are taken either to the statement of recognised gains and losses (UK GAAP) or to the statement of changes in equity (IAS accounts), the profits or losses on those securities are taken into account in calculating the profits of the trade.

611.Subsection (3) disapplies subsection (2) where the profit or loss has been brought into account in an earlier accounting period. This prevents the same amount being taken into account twice.

612.Subsection (3)(b) provides that subsection (2) does not apply to “an amount recognised for accounting purposes by way of correction of a fundamental error”. This refers to the requirement in International Accounting Standard 8 (Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies) that the correction of a fundamental error should be treated as a prior period adjustment. “For accounting purposes” is defined in section 832(1) of ICTA as “for the purposes of accounts drawn up in accordance with generally accepted accounting practice”. See Schedule 4 to this Act.

613.The definition of “securities” in subsection (4) is based on section 472A(4) of ICTA. Section 472A(4)(a) defines “securities” to include rights, interests or options treated as shares for the purposes of sections 126 to 136 of TCGA by virtue of sections 135(5) or 136(5) of TCGA. Sections 135(5) and 136(5) of TCGA define “shares” in the case of a company with no share capital as “any interests in the company possessed by members of the company.” So subsection (4)(c) of this section defines “securities” to include such interests.

Section 150: Conversion etc. of securities held as circulating capital

614.This section provides for relief on the conversion or exchange of securities held as part of the circulating capital of a trade of dealing in securities. The relief corresponds to the relief on the conversion or exchange of securities held as capital assets in sections 126 to 136 of TCGA. This section is based on sections 473 and 730C of ICTA.

615.Section 473(1) of ICTA applies to securities to which a person carrying on a banking or insurance business, or a business of dealing in securities, is beneficially entitled - the profits from the sale of which would “form part of the trading profits of that business”. This section does not stipulate that the person must be beneficially entitled to the securities in question. See Change 42 in Annex 1.

616.The Inland Revenue does not believe that there are currently any individuals or non-resident companies liable to income tax in respect of a banking business. Similarly, the Inland Revenue does not believe that there are, or will be in the future as the law stands at present, any individuals (other than Lloyd’s underwriters) or non-resident companies liable to income tax in respect of an insurance business.

617.So this section does not refer specifically to banking and insurance businesses. But such businesses (except for Lloyd’s underwriters who come instead within the special rules in sections 171 and 176 and Schedule 20 to FA 1993) are covered by the reference to a trade in which a profit on the sale of securities would be brought into account in calculating the profits.

618.Subsection (3) excludes securities brought into account at “fair value” in calculating the profits for the period in which the relevant transaction takes place. These are instead dealt with in section 149 of this Act.

619.Subsection (7) adapts the anti-avoidance rule in section 137(1) of TCGA to income tax in determining whether subsection (2)(a) of this section applies to treat a transaction as resulting in the original holding being equated with a new holding under sections 126 to 136 of TCGA. Section 137(1) of TCGA provides that sections 135 and 136 of TCGA do not apply to an exchange of shares unless the exchange is “effected for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability to capital gains tax or corporation tax”.

620.The definition of “securities” in subsection (8) is based on section 473(6) of ICTA:

  • section 473(6) of ICTA defines “securities” to include rights, interests or options treated as shares for the purposes of sections 126 to 136 of TCGA by virtue of sections 135(5) or 136(5) of TCGA. Sections 135(5) and 136(5) of TCGA define “shares” in the case of a company with no share capital as “any interests in the company possessed by members of the company.” So subsection (8)(d) defines “securities” to include such interests;

  • section 473(6) of ICTA defines “securities” by reference to the definition of “security” in section 132 of TCGA. Section 138A(3) of TCGA assumes that in certain circumstances earn-out rights are a security within section 132 of TCGA. So subsection (8)(f) includes such earn-out rights in the definition of “securities”.

Section 151: Exchanges of gilts for gilts strips

621.This section sets out the trading income rules for the exchange of gilts for gilt strips. It is based on section 730C of ICTA. The rules for the consolidation of gilts are in section 152. The rules about regulations in connection with valuations are in section 154.

622.Section 151 ensures that a profit or loss on the exchange of a gilt for gilt strips is recognised for tax purposes even if it is not shown in the accounts of the trade. This is the opposite of the rule in section 150 that a conversion of a security is, in effect, ignored. Section 150(2) provides that the special rules for gilt strips override the general rule for securities.

Section 152: Consolidation of gilt strips

623.This section sets out the trading income rules for the consolidation of gilt strips. It is based on section 730C of ICTA.

624.This section ensures that a profit or loss on the consolidation of gilt strips is recognised for tax purposes even if it is not shown in the accounts of the trade. This is the opposite of the rule in section 150 that a conversion of a security is, in effect, ignored. Section 150(2) provides that the special rules for gilt strips overrides the general rule for securities.

Section 153: Meaning of “gilt-edged security” and “strip”

625.This section provides the definition of “gilt-edged security” for the purposes of this Act and the definition of “strip” for the purposes of sections 151 and 152. It is based on section 730C of ICTA and section 47 of FA 1942.

Section 154: Regulations for determining market value of securities or strips

626.This section contains the power for making regulations in connection with the valuation of gilts and gilt strips. It is based on section 730C(6) and (7) of ICTA.

Section 155: Levies and repayments under FISMA 2000

627.This section provides for the inclusion, in a calculation of trading profits, of certain payments arising from the Financial Services and Markets Act 2000 (“FISMA”). It is based on section 76A of ICTA.

628.Section 76A of ICTA applies to all persons who are “authorised persons” for the purposes of FISMA.

629.Subsection (1)(b) reflects section 76A(1) of ICTA and makes it clear that investment companies are not within the provision.

630.Subsection (2) provides for a deduction. Most FISMA levies would be allowable expenses under the basic trade profit calculation rules. The purpose of this provision is to deal with the exceptional case where deduction of a levy would otherwise be prevented by a prohibitive rule.

631.The expenses allowable and the receipts chargeable are determined by reference to FISMA. Subsections (4) and (5) provide the link with FISMA.

Section 156: Purchase or sale of woodlands

632.This section applies to a person carrying on a trade of dealing in land who buys and sells land on which trees are growing. It is based on section 99(1) of ICTA.

633.Subsection (2) provides that the cost of the trees or any saleable underwood is disregarded in calculating the profits of the trade. The section applies only to the disposal of the land as part of a trade of dealing in land. It has no application to the trader's use of the land before it is sold.

634.The cost of the land will include the value of the trees and underwood growing on it. Any profit on the sale of the trees and underwood is tax-free because of the exemption for the occupation of commercial woodlands. See section 11 of this Act. Subsection (2) prevents the dealer in land obtaining a trade deduction for that part of the cost of the land that is attributable to the cost of the trees.

635.Subsection (3) applies if the dealer sells the land with any of the trees and underwood still growing on it. The part of the sale price that relates to the trees and underwood is not treated as part of the sale proceeds.

636.The section applies only to woodlands purchased under a contract entered into on or after 1 May 1963. See paragraph 42 of Schedule 2 to this Act.

Section 157: Relief in respect of mineral royalties

637.This section gives relief if trade receipts include mineral royalties. It is based on section 122 of ICTA.

638.Most mineral royalties will be taxed under Chapter 8 of Part 3 of this Act. That Chapter rewrites the charge under Schedule D Case VI if rents are received from a concern listed in section 55 of ICTA. That list includes mines and quarries. The charge under Schedule D Case VI results from the operation of section 119 of ICTA. That section alters the normal priority rule between Schedules A and D. It applies to rents that would normally be taxed under Schedule A and provides that the rents are to be taxed under Schedule D. It does not say under what Case of Schedule D the charge is to be imposed.

639.In nearly all cases the rents will be taxed under Schedule D Case VI as they are not received in respect of a trade. But it is possible that the receipt of the rent will be incidental to a trade. In that case section 261 of this Act provides that the rent will be taxed under Part 2 of this Act. This is only likely to happen if the rent is received by a property developer in respect of land held as trading stock.

640.If the rent is a mineral royalty as defined in section 122(5) of ICTA the trader is entitled to the relief given by section 122(1) of ICTA. The mineral royalties are halved. The relief is rewritten in this section because dealers in land are the traders who are most likely to benefit from the relief. But the relief is not confined to dealers in land.

Section 158: Lease premiums etc.: reduction of receipts

641.This section prevents a person carrying on trade of dealing in land being taxed on all or part of a lease premium, or of certain other amounts received in respect of a lease, both as a receipt of the trade under Part 2 of this Act and as a receipt of a property business under Part 3 of this Act. It is based on section 99(2) and (3) of ICTA.

642.Subsections (2) and (3) provide for a receipt taken into account in calculating the profits of a trade of dealing in land to be reduced by the amount of that receipt taken into account under sections 277 to 285 of this Act.

643.Subsections (4) and (5) provide for a corresponding adjustment to be made in calculating the profits of the trade if tax paid as a result of section 284 or 285 is repaid under section 301 or 302 of this Act.

Section 159: Ministers of religion

644.This section sets out special rules for self-employed ministers of religion. It is based on section 332(3) of ICTA. The rest of that section was rewritten as sections 290 and 351 of ITEPA.

645.Subsection (1) provides that the section applies in calculating the profits of the profession or vocation of a minister of religion. This brings the wording of the rule into line with the other rules for permitting deductions. See Change 43 in Annex 1.

646.Section 332 of ICTA was originally intended to give a comprehensive set of rules for the expenses of ministers of religion. In practice, the Inland Revenue apply the usual trading rules if they are more generous. Anything within section 332(3)(a) of ICTA would not be disallowed by section 74(1)(a) of ICTA. But there may be items not within section 332(3)(a) of ICTA which are allowed in practice as being within the usual rules.

647.A self-employed minister can in practice make deductions for revenue expenses that are wholly and exclusively for the purposes of the profession or vocation. For such a minister the rule in paragraph (a) of section 332(3) of ICTA, which provides for a deduction where expenses are incurred wholly, exclusively and necessarily in the performance of the duties, imposes a harsher test.

648.So section 332(3)(a) of ICTA is not rewritten, leaving the more generous rule in section 34 of this Act to apply. See Change 44 in Annex 1.

649.Subsection (2)(b) introduces a “just and reasonable apportionment” which does not have a special appeal mechanism. See Change 45 in Annex 1.

650.Subsection (3) uses the term “incurs” in preference to “borne”. See Change 43 in Annex 1.

651.Subsection (4) sets out how to calculate the deduction under subsection (3). If the expenses of maintenance, repair, insurance or management incurred wholly and exclusively for the purposes of the profession or vocation exceed one quarter of the expenses within subsection (3) no further deduction is due but the deduction is not restricted to one quarter. If the expenses of maintenance etc do not exceed one quarter, a further deduction is due. So the total deduction for expenses within subsection (3) varies according to the extent to which they are expenses incurred wholly and exclusively for the purposes of the profession or vocation.

Section 160: Alternative basis of calculation in early years of practice

652.This section preserves the “cash basis” for some barristers. It is based on section 43 of FA 1998. It sets out the single exception to the general rule in section 25 of this Act that profits must be calculated in accordance with generally accepted accounting practice. It applies to barristers in the early years of practice. They are allowed to draw up accounts on a cash basis or a “fees billed” basis.

653.The section uses the phrase “independent practice” in line with the current Codes of Conduct of the English Bar and the Bar of Northern Ireland. The same expression correctly identifies practising advocates in Scotland.

Section 161: Mineral exploration and access

654.This section deals with intangible drilling costs of production wells in the oil and gas industry. It is based on section 91C of ICTA. Intangible costs are those which do not result in the acquisition or creation of machinery or plant. An example would be the cost of hiring a drilling rig. Production wells are wells that are drilled after the presence of oil in an area has been established and which are used to extract the oil.

655.Before the enactment of section 91C of ICTA in 1997, a deduction was allowed for the intangible drilling costs of the second and subsequent production wells in any area. This reflected a Special Commissioners’ decision in 1920 that this expenditure is of a revenue nature. Section 91C of ICTA disallows a deduction for such costs. It does this by denying a deduction for expenditure which, if it had been carried out while exploring for oil, would not have been allowed as a deduction.

656.Subsection (1) sets out the circumstances in which the section applies. It identifies the expenditure as being on “mineral exploration and access”, an expression defined in subsection (3).

657.Subsection (2) is the main rule. It ensures that any expenditure on drilling a production well that is deductible on normal principles can continue to be deducted. But no deduction is allowed for intangible drilling costs which were previously deductible only as a result of the earlier Special Commissioners’ decision. These costs are capital expenditure and qualify for mineral extraction capital allowances (see Part 5 of CAA).

Section 162: Payments by persons liable to pool betting duty

658.This section gives a special deduction to traders who pay pool betting duty. It is based on those parts of section 126 of FA 1990 and section 121 of FA 1991 which relate to the calculation of the profits of traders.

659.The majority of pool betting duty is paid by large companies operating football pools. But an individual or firm may carry on a trade as a pools promoter.

660.In 1990, following the Hillsborough disaster, pool betting duty was reduced on condition that the money saved be paid to the Football Trust 1990 to implement Lord Justice Taylor’s recommendations on safety and comfort at football grounds. In 1991 the duty was reduced again, this time on condition that the money be paid to the Foundation for Sport and the Arts, a charitable trust which supports athletic sports and games and promotes the arts. The reductions were initially for a limited period, but have so far been maintained.

661.Subsection (1) sets out the circumstances in which the section applies. It introduces the expression “qualifying payment”.

662.Subsection (2) defines a “qualifying payment” to which the section applies. It does not specify that payments in consequence of the 1990 reduction in pool betting duty must be paid for football safety and comfort, and that payments in consequence of the 1991 reduction must be paid to the Foundation for Sport and the Arts. Instead the section applies to a payment for either purpose in consequence of any reduction in pool betting duty. See Change 46 in Annex 1.

663.The section retains a general description of the payments, without identifying the bodies which were the targets of the original legislation. It is clear that payments made as a consequence of a reduction in pool betting duty to either body would qualify for relief under the section.

664.The source legislation is restricted to the 1990 and 1991 reductions in pool betting duty. This section applies to payments made in consequence of any reduction in the duty. See Change 47 in Annex 1.

665.Subsection (3) is the rule that allows the payments as a trading deduction. Without this rule the payments might be disallowed because they are annual payments or because they are not made wholly and exclusively for the purposes of the payer’s trade.

Section 163: Deduction for deemed employment payment

666.This section sets out the trading income rules that were originally part of the “IR35” scheme for the taxation of workers supplied by an intermediary. It is based on paragraph 17 of Schedule 12 to FA 2000. The worker is treated as receiving a “deemed employment payment” and is taxed accordingly (see Chapter 8 of Part 2 of ITEPA). This section ensures that an equivalent amount (and no more) is allowed as a trading deduction in calculating the profits of the intermediary.

667.Subsection (1) sets the scene, using expressions that are defined in subsection (5) by cross-reference to the employment income rules in ITEPA.

668.Subsection (2) identifies the amounts that are allowed as trading deductions.

669.Subsection (3) is a timing rule. Generally, the deemed employment payment is treated as made at the end of the tax year (see section 50(3) of ITEPA). In some circumstances the payment is treated as made earlier (see section 57 of ITEPA). In either case, the trading deduction is given for the period in which the payment is treated as made.

670.Subsection (4) is the rule that prevents any double deduction. It caters for the possibility that the payments may qualify as trading deductions on first principles and for the possibility that the payments may also qualify as trading deductions in a period of account different from that specified in subsection (3).

Section 164: Special rules for partnerships

671.This section sets out two additional rules that apply if a deduction under section 163 is to be given in calculating the trading profits of a firm. It is based on paragraph 18 of Schedule 12 to FA 2000.

672.Section 847 of this Act explains that “firm” is used in this Act to refer to persons carrying on a trade in partnership. It includes a limited liability partnership (see section 863).

673.Subsection (1) introduces the circumstances in which the section applies.

674.Subsection (2) is the rule that a deduction under section 163 of this Act cannot be used to create a loss in a firm. It is based on paragraph 18(2) of Schedule 12 to FA 2000.

675.Subsection (3) is the rule that limits the trading deduction to the amount that would have been deductible if the worker had been an employee of the intermediary, plus a margin to cover the expenses of the firm.

676.In accordance with paragraph 244 of Schedule 6 to ITEPA, “deemed Schedule E payment” in paragraph 18 of Schedule 12 to FA 2000 is replaced by “deemed employment payment”. Similarly, in the same paragraph, “Schedule E” is replaced by “the employment income Parts of the Income Tax (Earnings and Pensions) Act 2003”.

677.But the specific statutory references, such as those to “paragraph 7” (of Schedule 12 to FA 2000), are covered by the general rule in paragraph 5 of Schedule 7 to ITEPA. That general rule is that any reference to a repealed provision is to be read as a reference to the rewritten provision.

678.Paragraph 7 of Schedule 12 to FA 2000 has been repealed and rewritten as section 54(1) of ITEPA. So the reference to that paragraph in paragraph 18 of Schedule 12 is to be read as a reference to section 54(1) of ITEPA. This section updates the references to paragraph 7.

Section 165: Deduction for site preparation expenditure

679.This section sets out the rules for expenditure on preparing a site so that it can be used for waste disposal. It is the first of four sections that deal with waste disposal. They are based on sections 91A, 91B and 91BA of ICTA.

680.This section covers expenditure which is not deductible because it is capital and which is not eligible for capital allowances; in other words, expenditure that would otherwise go unrelieved for income tax purposes.

681.Subsection (1) introduces the concept of waste materials being deposited on a “waste disposal site”, an expression defined in section 167. It makes it clear that a deduction is allowed only for a period of account in which waste is deposited on the site.

682.The reference to a “predecessor” was inserted into ICTA by FA 2000 to ensure that the relief continues even if the trade is no longer carried on by the person who originally incurred the site preparation expenditure. The term is defined in subsection (3).

683.Subsection (2) is the link to section 166, which calculates the amount of expenditure that is allowed as deduction.

684.A deduction under section 91B of ICTA is allowed only if the trader makes a claim (in such form as the Board may direct) and submits such plans and other documents (if any) as the Board may require. This section drops the requirement for a claim. See Change 48 in Annex.

685.Paragraph 44 of Schedule 2 to this Act rewrites the transitional provision in section 91BA(1) of ICTA. Expenditure cannot be “inherited” if the site changed hands before March 2000.

Section 166: Allocation of site preparation expenditure

686.This section spreads site preparation expenditure over the useful life of the site. It is based on section 91B of ICTA.

687.Subsection (1) calculates the allowable expenditure for a period of account by means of a formula.

688.Subsection (2) explains how to arrive at the “residual expenditure”, part of which is allowed as a trading deduction by subsection (1).

689.It is necessary to exclude amounts for which capital allowances have been given. In the case of expenditure incurred before 1989, it is also necessary to exclude part of the “unrelieved old expenditure”, an expression defined in subsection (4).

690.Most waste disposal sites have a life of only four or five years. But some, notably in the nuclear waste industry, have preparation expenditure dating from before 6 April 1989. So this section preserves the rules for the pre-1989 expenditure.

691.Subsection (3) uses a formula to arrive at the amount of the unrelieved old expenditure that is to be excluded from the calculation in subsection (1).

Section 167: Site preparation expenditure: supplementary

692.This section contains the definitions of the expressions used in the waste disposal sections. Although the definitions are expressed to apply “for the purposes of sections 165 and 166”, the definition of “waste disposal licence” is also used to define a “site restoration payment” in section 168(5).

693.The section also sets out the rules for pre-trading expenditure. The section is based on sections 91B and 91BA of ICTA.

694.Subsection (1)(c) reflects the effect of the devolution settlements. See Change 19 in Annex 1.

Section 168: Site restoration payments

695.This section deals with payments for the restoration of a site after it has been used for waste disposal. It is based on section 91A of ICTA.

Section 169: Cemeteries and crematoria: introduction

696.This section, and the following three sections, contain special rules for persons carrying on a trade of operating a cemetery or crematorium. They are based on section 91 of ICTA.

697.Without special provisions, no allowance would be due for the cost of land sold for interments, memorial gardens attached to crematoria or the surrounding land and buildings because expenditure on such land and buildings is in the nature of capital. The provisions in sections 169 to 172 recognise that most land and buildings in a cemetery or memorial garden are of little value when the cemetery or memorial garden is full.

698.This section introduces the provisions in section 170 to 172 and defines some of the terms used in those sections. It is based on section 91(1),(2),(5),(7) and (8) of ICTA.

699.Section 91(7)(a) of ICTA adapts the rules for cemeteries in section 91 of ICTA to crematoria and treats “land which is devoted wholly to memorial garden plots” as a cemetery, or as land in a cemetery. Subsection (1) of this section instead includes the carrying on of a crematorium, and the maintenance of “memorial gardens plots” in the trades to which sections 169 to 172 apply.

700.Subsection (4) is based on the definition of “relevant capital expenditure” in section 91(2) of ICTA.

701.Section 91(5) of ICTA provides that a change of ownership is ignored in calculating the relief due to the person then carrying on the trade. So subsection (4) of this section includes expenditure incurred by “a predecessor” of the person carrying on the trade (“the trader”) in the definition of ancillary capital expenditure.

Section 170: Deduction for capital expenditure

702.This section provides for a deduction for certain capital expenditure incurred by the trader or a predecessor. It is based on section 91(1), (4) to (7) and (9) of ICTA.

703.Section 91 of ICTA refers to “land” in a cemetery or crematorium. Subsection (1) of this section refers instead to “an interest in” such land. This accommodates better the possibility that operators of cemeteries and crematoria might sometimes hold land in leasehold rather than in freehold form.

704.Subsection (3)(a) is based on section 91(6) of ICTA which prohibits deductions in respect of the same expenditure under both section 91(1)(a) and section 91(1)(b) of ICTA.

Section 171: Allocation of ancillary capital expenditure

705.This section contains special rules for allocating ancillary capital expenditure to a period of account. It is based on section 91(1) and (3) to (8) of ICTA.

706.See section 169(4) of this Act for the definition of “ancillary capital expenditure”.

707.Subsection (1) calculates the ancillary capital expenditure attributable to a relevant period. It does this by allocating part of the total of all ancillary capital expenditure incurred before the end of the relevant period (the “residual expenditure”) to that period in the same proportion that the number of grave-spaces or memorial garden plots sold in the period (“PSR”) bears to the total of the number of spaces or plots sold in the period and the number of spaces or plots potentially available for sale at the end of that period (“PSR” + “PAR”).

708.Section 91(3) of ICTA excludes from “relevant capital expenditure” expenditure on buildings or structures destroyed “before the beginning of the first period to which [section 91(1)] applies” and a proportion of other expenditure “incurred before that time”.

709.Section 91(4) of ICTA excludes from the residue of any expenditure at the end of a period (“residual expenditure”) insurance money or other compensation received “after the beginning of the first period to which [section 91(1)] applies” in respect of buildings or structures sold or destroyed before the end of the relevant period.

710.Section 91 of ICTA is ultimately derived from section 22 of FA 1954 and the first period to which section 91 of ICTA applies is 1954-55. So subsection (2) of this section defines “residual expenditure” so as to exclude:

  • ancillary capital expenditure on buildings destroyed before “the beginning of the first sale period”; and

  • the sale proceeds of, or any compensation received in respect of, the sale or destruction of any asset representing ancillary capital expenditure sold or destroyed “after the beginning of the first sale period”.

711.The “first sale period” is defined in subsection (4) as the period in which land in the cemetery or memorial garden was first sold for the purposes of the trade or the basis period for 1954-55, if later.

712.Similarly, subsection (3) calculates “the excluded amount of any remaining old expenditure” to be deducted from residual expenditure under subsection (2)(b) by reference to the number of grave-spaces and plots sold before the beginning of the basis period for 1954-55 and the number potentially available for sale immediately before the beginning of that period.

Section 172: Exclusion of expenditure met by subsidies

713.This section is based on section 91(9) of ICTA which applies the provisions of section 532 of CAA for the purposes of section 91 of ICTA.

714.Subsection (1) is based on the general rule in section 532 of CAA. Subsections (3) to (5) are based on the exceptions to general rule in sections 534 to 536 of CAA.

715.Subsection (3) refers to a grant made under Northern Ireland legislation and declared by the Treasury to correspond to a grant under Part 2 of the Industrial Development Act 1982.

716.The term “Northern Ireland legislation” is defined by Schedule 1 to, and section 24(5) of, the Interpretation Act 1978. Paragraph 3 of Schedule 13 to the Northern Ireland Act 1998 provides an amendment which would cover Acts of the Northern Ireland Assembly.

717.The Capital Allowances (Corresponding Northern Ireland Grants) Order 2001 (SI 2001/810) lists various grants made in Northern Ireland declared by the Treasury to correspond to a grant under Part 2 of the Industrial Development Act 1982 in so far as they are made towards capital expenditure. The Industrial Development Act 1982 was repealed with effect from 22 July 2004. But a deduction under section 170 of this Act continues to be allowed for expenditure met by a grant corresponding to a grant under Part 2 of the 1982 Act incurred by the trader, or by a predecessor.

Chapter 12: Trade profits: valuation of stock and work in progress
Overview

718.This Chapter sets out the rules for valuing stock and work in progress when a person ceases to carry on a trade, profession or vocation. The rules for trading stock are in sections 173 to 181. The rules for work in progress are in sections 182 to 185.

Section 173: Valuation of trading stock on cessation

719.This section sets out two general propositions based on section 100(1) and (1ZA) of ICTA. First, a valuation has to be made. Second, that valuation has to be made in accordance with the rules set out.

720.Subsection (1) restricts the operation of the section (and the other valuation rules) to the calculation of the profits of a trade when a person ceases to carry it on. It includes a signpost to the detailed valuation rules in sections 175 to 178.

721.Subsection (2) makes it clear that any transfer-pricing adjustment takes precedence over the rules for trading stock in this Chapter.

722.Subsection (3) is the rule for trades carried on in partnership. The general rule in ICTA is that a change in the person carrying on a trade is treated as the cessation of the trade. But, in the case of a trade carried on in partnership, section 113(2) of ICTA provides that there is a cessation only if there is a complete change in the persons (the partners) carrying on the trade.

723.Subsection (4) ensures that the special rules for the valuation of stock in this Chapter do not apply when the trader dies.

Section 174: Meaning of “trading stock”

724.This section defines trading stock. The definition applies:

  • in this Chapter;

  • in sections 135 and 136 (films and sound recordings);

  • in section 236 (adjustment income); and

  • in section 252 (post-cessation receipts).

725.The section is based on sections 100(2) and 101(3) of ICTA.

726.Section 101(3) of ICTA is invoked by section 100(2) and is concerned with valuation of incomplete services at the time of “discontinuance”. So the definition in this section refers to incomplete services at the “time of the cessation”.

Section 175: Basis of valuation of trading stock

727.This section introduces the five sections that follow. It is based on section 100 of ICTA. The five sections (including section 179 which defines “connected persons”) deal with valuation of stock that is transferred to another trader. Subsection (4) of this section deals with valuation in any other case.

Section 176: Sale basis of valuation: sale to unconnected person

728.This section sets out the rule for the common case where the trading stock is transferred to an unconnected trader. It is based on section 100(1A)(a) of ICTA. It leads directly to the use of the sale price of the stock as the basis of valuation. If the transfer is other than by sale, section 181 explains how the expressions used in this section are to be interpreted.

Section 177: Sale basis of valuation: sale to connected person

729.This section sets out the rule for the case where the stock is transferred to a connected person. It is based on section 100(1A)(b) of ICTA.

730.The section preserves the concept of an arm’s length price. This will usually be the same as the open market value (see section 175(4)) but sometimes there will be a difference.

731.For example, in an inheritance tax case, IRC v Spencer-Nairn [1991], STC 60, the Court of Session considered the meaning of an arm’s length price and distinguished it from open market value. This was on the basis that the seller in that case had imperfect information. A sale at arm’s length by that seller would not assume that the seller had better information; a sale in the open market would assume perfect information on both sides of the bargain.

732.Furthermore, in the case of an actual sale to a connected trader, there is no need to assume there is a sale. It is enough to treat the sale as made at arm’s length. This leaves open the possibility that the stock is worth something different from open market value to a person who intends to use the stock in the trade.

Section 178: Sale basis of valuation: election by connected persons

733.This section allows the seller and purchaser of stock that would otherwise be valued at arm’s length under section 177 to elect to use instead the price paid for the stock. The section is based on section 100(1C), (1D) and (3) of ICTA.

734.The election cannot be made unless the arm’s length value of the stock is greater than its “acquisition value” in the hands of the seller.

735.The “acquisition value” of the stock for the trader who ceases to trade is effectively book value, but the definition in subsection (5) is more complicated than this. In the case where the net realisable value of stock has fallen below cost in the period leading up to cessation, a new period is deemed to start just before the deemed sale. That allows the new, lower, net realisable value to be used. It may be possible to manipulate net realisable value by selling the stock at an undervalue after the accounting date. So paragraph (a) of the definition assumes that the sale is at an arm’s length value.

736.The election substitutes the price paid for the arm’s length value of the stock. But the price paid must be higher than the acquisition value. Otherwise, the election substitutes the acquisition value for the arm’s length value.

737.The time limit for the election in section 100(1C) is two years from the end of the tax year in which the trade ceases. This is inconsistent with most other time limits for income tax payers. The time limit in subsection (4) of this section is the normal time limit for claims and elections in this Act. See Change 49 in Annex 1.

738.This section does not specify that the election is to be made to “the inspector”. Section 878(4) of this Act draws attention to the rules in TMA, which apply for the purposes of this Act. Those rules require elections to be made to “an officer of the Board”.

Section 179: Connected persons

739.This section provides a definition of connected persons for the stock valuation sections. It is based on section 100(1F) of ICTA.

740.This section is one of the exceptions to the general rule in section 847 that a firm is not to be regarded for tax purposes as a separate entity. If a firm is connected with the seller or purchaser of its stock, section 177 (rather than section 176) applies but the firm may make an election under section 178.

741.The definition includes references to bodies corporate because the tax liability of a person charged to income tax may be affected by a transaction involving a company.

Section 180: Cost to buyer of stock valued on sale basis of valuation

742.This section sets out the rule for the buyer of the stock. It is based on section 100(1E) of ICTA. In a “sale basis” case, any value given to the trading stock of the taxpayer whose trade has ceased is also used to calculate the profits of the buyer of the stock.

743.Section 100(1A) to (1C) of ICTA continue to apply for corporation tax. So the reference to those subsections is retained to cater for the case where the stock is acquired from a person liable to corporation tax. In the reverse case, where the stock is transferred from a person liable to income tax to a person liable to corporation tax, the valuation is made in accordance with this Chapter. The consequential amendments to section 100 of ICTA produce the right result for corporation tax (see paragraph 79 of Schedule 1 to this Act).

Section 181: Meaning of “sale” and related expressions

744.The stock valuation sections refer to a sale of stock. This section explains how the sections are to be interpreted if the stock is transferred other than by way of sale. It is based on section 100 of ICTA.

Section 182:Valuation of work in progress on cessation

745.This is the first of four sections that deal with the valuation of work in progress on cessation. The sections are based on section 101 of ICTA.

746.Subsection (1) introduces the different bases of valuation in sections 184 and 185. Unlike the corresponding section 173, relating to the valuation of trading stock, this section does not require that work in progress is valued at cessation. But a valuation is usually ensured by the requirement to calculate profits in accordance with generally accepted accounting practice (see section 25 of this Act). The only exception to this rule concerns barristers and advocates (see section 160 of this Act).

747.Subsection (2) is the rule for professions carried on in partnership. The general rule in ICTA is that a change in the persons carrying on a profession is treated as the cessation of the profession. But, in the case of a profession carried on in partnership, section 113(2) of ICTA provides that there is a cessation only if there is a complete change of partners.

748.Subsection (3) ensures that the special rules for the valuation of work in progress in this Chapter do not apply when the person carrying on the profession or vocation dies.

Section 183: Meaning of “work in progress”

749.This section provides the definition of work in progress. It is based on section 101(3) of ICTA. This definition has a reference to the time at which the valuation is made. This is appropriate because the definition is used only in this Chapter and in section 252 of this Act. In both cases, the statute is concerned with the cessation of a profession or vocation.

Section 184: Basis of valuation of work in progress

750.This section sets out the main rules for the valuation of work in progress. It is based on section 100(1) of ICTA.

751.Subsection (1) applies if the work in progress is transferred to a person carrying on a profession or vocation. In that case, it is valued at the sale price.

752.There are no alternatives to the sale price. So there is no need for a rule (such as that in section 180 for stock) about the tax cost to the purchaser of the work in progress. The cost is always the price paid.

753.Subsection (2) applies if the work in progress is not transferred to a person carrying on a profession or vocation. In that case, it is valued at an arm’s length price. As explained in the commentary on section 177, this Chapter retains the distinction between this basis of valuation and open market value.

Section 185: Election for valuation at cost

754.This section allows an election for work in progress to be valued at cost. It is based on section 101(2) and (2A) of ICTA. If the election is made the profit element in closing work in progress is not assessed until payment is received. If the election is made, the later payment is treated as a post-cessation receipt.

755.This section does not specify that the election is to be made to “the inspector”. Section 878(4) of this Act draws attention to the rules in TMA, which apply for the purposes of this Act. Those rules require elections to be made to “an officer of the Board”.

Section 186: Determination of questions by Commissioners

756.This section assigns proceedings to Commissioners. It is based on section 102(1) of ICTA. The valuation of trading stock and work in progress on cessation will affect the tax liabilities both of the trader who ceases and of the trader (if any) who takes over the stock (or work in progress). This section gives the rule about which body of Commissioners should resolve any dispute about that valuation.

Chapter 13: Deductions from profits: unremittable amounts
Overview

757.This Chapter gives statutory effect to ESC B38. See part (A) Change 50 in Annex 1. The extra-statutory concession provides relief for trade debts that cannot be remitted to the United Kingdom. It is similar in scope to section 584 of ICTA, which is rewritten as Chapter 4 in Part 8 of this Act.

758.Section 584 of ICTA provides relief for unremittable income arising outside the United Kingdom, including unremittable trade profits. But relief under section 584 of ICTA does not extend to trade debts owed to, or paid to, the trader outside the United Kingdom if the profits of the trade arise in the United Kingdom. This Chapter provides relief for such debts and payments.

759.ESC B38 requires the relief to be claimed. Under this Chapter the relief is allowed as a deduction without the need for a formal claim. See part (B) Change 50 in Annex 1.

760.The deduction is not mandatory if the qualifying conditions are met. A taxpayer can choose whether or not to include the deduction in his or her tax return. If a deduction is taken the recovery provisions in section 191 follow automatically.

Section 187: Professions and vocations

761.This section makes it unnecessary to specify repeatedly that the rules in this Chapter apply to a profession or vocation as well as a trade. It is new.

Section 188: Application of Chapter

762.This section defines the basic concepts. It is based on ESC B38.

763.The relief applies both to amounts owed to the trader and to amounts that have been paid to the trader. Relief is allowed if some, or all, of those amounts cannot be remitted to the United Kingdom because of foreign exchange restrictions. The different definitions of “unremittable” in subsections (2) and (3) reflect the differences between an amount that has been paid and an amount owed.

764.The relief is available to any trader, including a financial trader.

765.Subsection (4) provides a definition of “foreign exchange restrictions”. Local foreign exchange restrictions are not defined in the extra-statutory concession but are clearly a key concept in the operation of the concession. This subsection introduces a definition based on section 584(1)(a) of ICTA, which is rewritten as section 841(3) of this Act. By basing the definition on section 584 of ICTA this Act brings the two reliefs into line.

766.Section 584(1)(a) of ICTA is almost identical to section 585(1)(b) of ICTA. Section 584(1)(a) of ICTA is rewritten as section 841(3) and section 585(1)(b) of ICTA as section 835(3) of this Act. This section and sections 841(3) and 835(3) clarify the scope of sections 584(1)(a) and 585(1)(b) of ICTA in two ways.

767.First, both sections 584(1)(a) and 585(1)(b) of ICTA refer to “the impossibility of obtaining foreign currency in that territory”. It could be argued that this condition is not met if it is possible to obtain foreign currency in the overseas territory regardless of whether that currency may be transferred to the United Kingdom. The sections in this Act makes clear that it must not be possible to obtain foreign currency that could be transferred to the United Kingdom.

768.Second, the sections in this Act make clear that the reference to foreign currency in sections 584(1)(a) and 585(1)(b) of ICTA does not include currency of the overseas country or territory. In relation to sterling the currency of the overseas country or territory clearly is foreign but in this context “foreign” means foreign to the local territory.

769.Sections 584 and 585 of ICTA include a requirement that the inability to transfer the funds is not due to any lack of reasonable endeavours on the part of the taxpayer. That condition has not been repeated in this Act. See Change 135 in Annex 1.

Section 189: Relief for unremittable amounts

770.This section sets out how the relief is given. It is based on ESC B38.

771.The section has more detail than the extra-statutory concession about the mechanics of the relief. This is necessary to give the certainty required for Self Assessment. Relief can be given only against the profits of the trade that include the unremittable amount. It cannot be used to create or increase a loss. But any excess relief is not lost. It is carried forward and set against future profits of the trade.

772.Subsection (1) sets out the basic condition that relief is given as a deduction in calculating trade profits.

773.Subsection (2) deals with the case in which the trader has profits but the relief would create a loss. The excess of the unremittable amounts is carried forward to the next period of account in which the trader has sufficient profits to absorb the excess.

774.Subsection (3) deals with the case in which the trader has losses and the relief would increase those losses. The total of the unremittable amounts is carried forward to the next period of account in which the trader has sufficient profits to absorb the excess.

775.Subsection (4) allows a deduction for any amounts brought forward in the next period of account in which the trader has made profits.

776.Subsection (5) prevents the relief creating a loss but, as explained in the commentary on subsections (2) and (3) any excess is not lost but carried forward.

Section 190: Restrictions on relief

777.This section describes the various circumstances in which relief is not allowed. It is based on ESC B38.

778.Subsection (1) denies a deduction if the funds are applied outside the United Kingdom.

779.Subsection (2) denies a deduction if a deduction has been allowed under section 35 of this Act on the grounds that the debt has become bad or doubtful.

780.Subsection (3) denies a deduction if the trader has received an insurance recovery in respect of the debt. This differs from the approach in the extra-statutory concession. Paragraph 4 of the concession denies relief if any part of the debt is insured. This Act denies, or recovers, relief only if an insurance recovery is received. See part (C) Change 50 in Annex 1.

781.Subsection (4) denies a deduction if the trader can make a claim under section 842 that the income is unremittable. This restriction will apply only if the profits of the trade that include the unremittable amounts arise outside the United Kingdom, for example, because the profits arise in an overseas branch.

Section 191: Withdrawal of relief

782.This section sets out the circumstances in which relief is withdrawn and the machinery by which it is withdrawn. It is based on ESC B38.

783.Subsection (2) lists the events that trigger a withdrawal of the relief. Paragraphs (a) and (d) deal with the straightforward cases in which the amount, or part of it, ceases to be unremittable or is exchanged for an amount that can be remitted. Paragraphs (b), (c), (e) and (f) deal with the events listed in section 190 that would have prevented relief being given if they had occurred before the deduction was allowed.

784.Paragraph (f) deals with the case of insurance recoveries. It differs from the approach in the extra-statutory concession, which denies any relief if the debt is insured. This Chapter denies or recovers relief only if an insurance recovery is received (see the commentary on section 190). This follows the approach in section 843 when a payment is received from the Exports Credit Guarantee Department. See part (C) Change 50 in Annex 1.

785.Subsection (3) sets out the way the relief is recovered. The amount identified in subsection (2) is treated as a trade receipt for the period of account in which the event occurs. It is possible more than one event will apply to the same amount. Subsection (3)(b) ensures the relief is withdrawn only once.

786.Subsection (4) applies if the amount of the insurance recovery is less than the amount that is unremittable. In that case the amount of the recovery is limited to the amount of the insurance recovery.

Chapter 14: Disposal and acquisition of know-how
Overview

787.This Chapter sets out the rules for calculating trade profits if a trader receives a payment for know-how. Payments to non-traders are dealt with by the rules in sections 583 to 586.

788.The Chapter refers to the “disposal” of know-how. As Walton J pointed out in John and E Sturges Ltd v Hessel (1975), 51 TC 183 ChD(6) (on page 206):

the mere imparting of “know-how” cannot be equated with the disposal of a capital asset. Just like the schoolmaster’s knowledge, it remains the property of the person imparting it as well after as before another is told.

789.This Act retains “disposal” because “disclosure” gives rise to difficulties in identifying the person to whom the disclosure is made (who may not be the person who buys the know-how).

Section 192: Meaning of “know-how” etc.

790.This section sets out the meaning of know-how and explains other concepts used in the Chapter. It is based on sections 531(8) and 533(7) of ICTA and section 572 of CAA.

791.The definition of “mineral deposits” in subsection (2) is restored to what it was before the enactment of CAA. See Change 51 in Annex 1.

792.Subsections (5) and (6) extend the meaning of “sale” to include an exchange. This rule is based on section 572 of CAA, which applies to section 531 of ICTA in accordance with section 532 of ICTA.

Section 193: Disposal of know-how if trade continues to be carried on

793.This section sets out a general rule for the treatment of payments received for the disposal of know-how. It is based on section 531 of ICTA.

794.Subsection (1) includes a signpost to the main exceptions to the general rule:

  • if the know-how is disposed of as part of the disposal of a trade; and

  • if the seller and buyer are under common control.

795.Subsection (2) is the general rule that consideration for the disposal of know-how is treated as a trade receipt.

796.Subsections (3) to (6) deal with the case where know-how is disposed of with other assets. The rules are based on section 572 of CAA, which applies to section 531 of ICTA in accordance with section 532 of ICTA.

Section 194: Disposal of know-how as part of disposal of all or part of a trade

797.This section sets out the main exception to the general rule in section 193. It is based on section 531(2) and (3) of ICTA.

798.Subsection (1) establishes that the section applies if the know-how is disposed of as part of the disposal of a trade.

799.Subsection (2) provides that a payment for know-how as part of the disposal of a trade is generally treated as a capital receipt for goodwill. This rule applies only if the person making the disposal is liable to income tax. If that person is liable to corporation tax the rule in section 531 of ICTA continues to apply.

800.Subsection (3) deals with the person acquiring the know-how. Again, the payment for the know-how is generally treated as a capital payment for goodwill and the rule applies only if the person acquiring the know-how is liable to income tax.

801.The capital treatment in section 531(2) of ICTA also applies for capital gains tax purposes. That part of the rule is inserted as a new section 261A into TCGA (see paragraph 444 of Schedule 1 to this Act).

802.Subsection (4) is an exception to the capital treatment in subsections (2) and (3). It applies if the trade was carried on wholly abroad by the person disposing of the know-how.

803.Subsection (5) allows the parties to the transaction to elect for the payment not to be treated as one for goodwill. The effect of an election for the purchaser is that the payment may qualify for capital allowances under Part 7 of CAA. Or, exceptionally, the purchaser may be able to treat the payment as a trading expense. As such an election may affect both parties to the transaction the election has to be made by both.

804.The question whether the election is made under this section or under section 531(3) of ICTA is decided by reference to the position of the person disposing of the know-how. If that person is liable to income tax this section applies; if the person is liable to corporation tax, ICTA applies.

805.This section does not specify that the election is to be made to “the inspector”. Section 878(4) of this Act draws attention to the rules in TMA, which apply for the purposes of this Act. Those rules require elections to be made to “an officer of the Board”.

806.Subsection (6) gives the time limit for the election. Most elections in this Act have to be made on or before the “first anniversary of the normal self-assessment filing date”. But in this case one of the persons making the election may be chargeable to corporation tax. So the time limit for an election is based on the date of the disposal.

807.Subsection (7) deals with a disposal by an income tax payer to a corporation tax payer. An election under section 531(3) of ICTA is treated as an election under this section. The corresponding rule for a disposal by a corporation tax payer to an income tax payer is in section 531(3A) of ICTA (inserted by paragraph 207 of Schedule 1 to this Act).

Section 195: Seller controlled by buyer etc.

808.This section ensures that if the seller and buyer are under common control:

  • the general rule in section 192 does not apply; and

  • the parties to the transaction may not elect for the payment for know-how to be treated as a capital payment for goodwill.

809.The section is based on section 531(7) of ICTA.

810.For the purposes of this section, “control” is defined (through section 878(6)) by reference to section 840 of ICTA. The ICTA definition of “control” is identical in effect to that in section 574 of CAA. But as the relevance of “control” in this Act goes wider than this Chapter, the ICTA definition is used here.

811.This section is one of the exceptions to the general rule in section 847 of this Act that a firm is not to be regarded for tax purposes as a separate entity. If a firm is connected with the seller or purchaser of its know-how the payment for know-how is treated as one for goodwill.

Chapter 15: Basis periods
Overview

812.Profits for a tax year are taxed by reference to the amount of profit earned in the basis period for that tax year.

813.This Chapter gives the rules that identify the basis period for a particular tax year.

814.For established, on-going trades with a constant accounting date – the majority of cases –the rules operate very simply: the basis period for a tax year is the 12 month period ending on the accounting date in that year.

815.But special rules are needed when a trade begins or ends. And further rules have to deal with less common events such as a change of accounting date or if accounts are regularly prepared to a particular day (rather than a particular date) in the year.

816.The rules in this Chapter are ordered so that the rules dealing with the more unusual cases are located at the end of the Chapter: the simplest cases are fully dealt with by the first six sections.

Section 196: Professions and vocations

817.This section makes it clear to whom the basis period rules apply. It is new.

Section 197: Meaning of “accounting date”

818.The basis period rules operate by reference to the accounting date falling in the tax year. This section defines the key term “accounting date”. It is based on sections 60(5) and 62(2) of ICTA.

819.Subsection (1) gives the main rule. Sub-paragraph (b) deals with the case where two periods of account end in the same tax year and so there are two accounting dates.

820.Subsection (2) deals with two particular cases outside the main rule.

821.Subsection (2)(a) refers to section 211. That provision applies if the accounts are made up to a particular day in the year rather than a particular date. See the commentary on section 211 and Change 56 in Annex 1.

822.Subsection (2)(b) refers to section 214. That provision extends the definition of “accounting date” to include the date in the tax year to which accounts are treated as being prepared under the change of accounting date rules. That can arise when the period of account ending with the new date starts in, say, year six and ends in year eight: then an accounting date - the new date - is treated as falling in year seven.

Section 198: General rule

823.This section gives the general rule which will apply year on year to most taxpayers unless it is displaced by a special rule. It is based on section 60(3) of ICTA.

824.Subsection (2) lists the provisions that displace the general rule.

Section 199: First tax year

825.This section gives the rule that applies to the first year of trading. It is based on section 61(1) of ICTA.

826.Subsection (2) addresses the case where the trade both starts and ends in the same tax year and signposts the reader to the “final tax year” rule in section 202.

Section 200: Second tax year

827.This section gives the rules that apply to the second year of trading. It is based on sections 60(3)(a) and (b), 61(2) and 63 of ICTA.

828.It makes explicit what is merely implicit in the source legislation. It covers several possible cases and a separate subsection addresses each.

829.Subsection (4) applies only when there is no accounting date in the second year and the accounting dates in the first and third years are the same. When there is no accounting date in the second year and the accounting dates in the first and third years are not the same there is a change of accounting date and section 214(3) applies to give a notional accounting date for the second year. Under section 197 that is treated as an accounting date for the purpose of the Chapter 15 rules and section 200(2) or (3) then determines the basis period for the second year depending on when the notional accounting date falls.

Section 201: Tax year in which there is no accounting date

830.This section deals with the case where there is no accounting date in a tax year. It is based on section 60(3)(b) of ICTA.

831.This section does not apply if there is no accounting date in a tax year because there is a change of accounting date effected by a period of account which entirely spans the year in question. In that case section 214 applies and treats an accounting date as falling in the spanned year.

Section 202: Final tax year

832.This section gives the basis period for the final year of trading. It is based on sections 61(1) and 63 of ICTA.

833.Subsection (1) deals with the more usual case and subsection (2) the less usual case.

Section 203: Apportionment etc. of profits to basis periods

834.If the period of account does not coincide with the basis period, profits must be apportioned. This section gives the rules for the apportionment. It is based on section 72(1) and (2) of ICTA and the non-statutory practice described in paragraph 71025 of the Business Income Manual.

835.Subsection (4) legislates that non-statutory practice. It allows apportionment in ways other than the apportionment by reference to days permitted by section 72(2) of ICTA. See Change 52 in Annex 1. The wording of subsection (4) makes it clear that the option to choose an alternative basis of apportionment is exercisable only by the taxpayer, not the Inland Revenue.

Section 204: Meaning of “overlap period” and “overlap profit”

836.The basis period rules are designed to ensure that, over the lifetime of a trade, the total profits assessed exactly equal the total profits earned. This section defines the key concepts of “overlap period” and “overlap profit” that are central to achieving that. It is based on section 63A(5) of ICTA.

Section 205: Deduction for overlap profit in final tax year

837.This section provides the authority for deducting overlap profit in what is probably the more common of the two cases where it may be deducted: in calculating the profits of the final year of trading. (The other, on certain changes of accounting date, is dealt with in section 220.) It is based on section 63A(3) of ICTA.

838.This adjustment is a key part of the rules which ensure that, over the lifetime of a trade, the total profits assessed exactly equal the total profits earned.

Section 206: Restriction on bringing losses into account twice

839.This section states a short but important rule which prevents an “overlap loss” from being used more than once in aggregation. It is based on section 63A(4) of ICTA.

Section 207: Treatment of business start-up payments received in an overlap period

840.This section provides a special rule for business start-up payments. It is based on section 127 of ICTA.

841.The charge in ICTA is under Schedule D Case VI. But logically the income is trade profits.

842.The policy is that business start-up payments should be taxed only once. This section achieves that result directly, instead of by taking the income out of the calculation of trade profits. See Change 53 in Annex 1. There is a transitional rule in paragraph 49 of Schedule 2 to this Act to ensure that the new treatment applies only to payments received after 5 April 2005.

843.Paragraph 108 of Schedule 1 to this Act repeals section 127 of ICTA. Subsection (3) of that section treats business start-up payments as earned income and as relevant earnings. This Act preserves that treatment because the payments are brought into account as receipts of the trade.

844.Subsection (3) sets out in full what the “corresponding payments” are in Northern Ireland and reflects the effect of the devolution settlements. See Change 19 in Annex 1.

Section 208: When the late accounting date rules apply

845.This is the first of three sections whose purpose is to simplify the normal operation of the basis period rules in particular circumstances. They avoid the creation of very short overlaps (less than six days) between basis periods - and therefore small amounts of overlap profit. They are based on the non-statutory practice described in paragraph 71170 of the Business Income Manual.

846.That practice benefits taxpayers who, at the start of trading, prepare accounts to 31 March - a popular accounting date. They allow the accounts for the opening years to be treated as though they were prepared to 5 April.

847.And because it would be illogical to exclude cases where the chosen accounting date would result in overlaps even shorter than those arising from an accounting date of 31 March, accounts prepared to 1 to 4 April are also included. See Change 55 in Annex 1.

848.Despite the simple purpose of this provision it gives rise to some complex issues. As well as covering those cases involving accounts prepared to dates between 30 March and 5 April, it needs also to deal with cases where:

  • trading begins late in the tax year (that is, after 31 March); or

  • the first account is for a period longer than 12 months.

849.And it has to ensure that:

  • the application of the rule remains optional (some taxpayers may, depending on their own particular circumstances, wish their opening profits to be dealt with under the normal rules); and

  • no profits are assessed twice or slip out of account.

850.For these reasons the rules are set out in three sections. The first section (section 208) sets the scene and the two following sections (sections 209 and 210) state the rules depending on whether or not there is an actual accounting date in the tax year.

851.Section 208 sets the scene by stating the purpose of the rules and when they can apply.

852.Subsection (2) applies the relevant rules. Most taxpayers with a late accounting date will probably wish to take advantage of these rules. So the rules apply automatically unless the taxpayer “elects out”. See Change 54 in Annex 1.

853.Subsection (3)(b) refers to the intention of the taxpayer. This addresses practical difficulties that arise when the accounting date is only an intended accounting date at the time the return is made.

854.Subsection (4) states the time limit for an opt out election. It has been made as straightforward as possible by adopting the procedures and time limits of the Self Assessment cycle.

Section 209: Rule if there is an accounting date

855.This is the second of the three sections whose purpose is to simplify the normal operation of the basis period rules in particular circumstances. It deals with the case where there is an actual accounting date in the tax year.

Section 210: Rules if there is no accounting date

856.This is the third of the three sections whose purpose is to simplify the normal operation of the basis period rules in particular circumstances. It deals with the more complex case where there is no accounting date in the tax year.

857.That case is more complex because in those circumstances it is necessary:

  • to bring a notional accounting date into the tax year, corresponding to the intended accounting date; and

  • if the trade begins very near the end of the tax year, to charge the profits of the first tax year as part of the profits of the following tax year.

Section 211: Treating middle date as accounting date

858.This is the first of three sections that, together, prevent the complex change of accounting date rules (in sections 214 to 220) from applying in particular circumstances. They are based on the non-statutory practice described in paragraph 71175 of the Business Income Manual.

859.Some taxpayers prefer to prepare their accounts regularly to a particular day in the tax year (for example, the last Friday in September) rather than to a particular date. The chosen day can then fall on a range of (normally) seven dates. Because the chosen day will not, from year to year, fall on the same date this would trigger the change of accounting date rules every year.

860.These sections legislate the practice that enables those taxpayers to choose the middle date of the actual dates to which accounts may be prepared as the accounting date. They prevent the change of accounting date rules applying. See Change 56 in Annex 1.

861.In these sections the date which is to be taken as the accounting date is referred to as the “middle date” rather than the “mean date” (the term used in paragraph 71175 of the Business Income Manual). “Middle date” better reflects common usage and the fact that the actual accounting date does not normally vary by more than four days from that middle date. The only exception is when the day to which accounts are prepared is at or near the end of February and the day can fall on 29 February. Then the spread of dates on which the chosen day can fall is extended from seven to eight. But the “middle date” is still the fourth of those dates.

862.These sections express a rule based on a simple idea. But there are surprisingly complex implications. It is, for example, necessary:

  • to express concisely, yet clearly, the “four day” condition while allowing for the fact that accounts may be prepared to a particular day (such as the last Sunday in the year) or to a day in a particular week (such as the last day of a school term);

  • to preserve the optional nature of the practice;

  • to ensure that taxpayers can, if they wish, move in or out of the practice authorised by the sections without the same profits being assessed twice or dropping out of charge; and

  • to ensure that no profits are assessed twice or drop out of charge when the trade ends.

863.Because of this complexity the rule is set out in three sections.

864.Section 211 is the first of the three sections and sets the scene by stating the purpose of the rule and the election requirements.

865.The bracketed words in subsection (1)(b) address the case of a chosen day that can fall on 29 February.

866.Subsection (4) make elections as straightforward as possible by adopting the procedures and time limits of the Self Assessment cycle. Unlike the opt out election for the late accounting date rules (see the commentary on section 208) the election for the middle date rules is “opt in”. This is because it is less clear that taxpayers will want automatically to choose the middle date treatment than it is that they will want to choose the late accounting date treatment.

Section 212: Consequence of treating middle date as accounting date

867.This is the second of the three sections that, together, prevent the complex change of accounting date rules from applying in particular circumstances. It states the effect of electing for the middle date treatment.

868.The section can apply whether or not the previous year was treated in the same way: if it was not, subsection (2) applies, and if it was, subsection (3) applies. See Change 56 in Annex 1.

Section 213: Circumstances in which middle date not treated as accounting date

869.This is the third of the three sections that, together, prevent the complex change of accounting date rules from applying in particular circumstances. It ensures that when the middle date treatment ceases to apply no profits are assessed twice and no profits drop out of charge.

870.The section does this by imposing continuity in profit counting between the two relevant basis periods. This is necessary because when a middle date is used to mark the end of the basis period for the earlier year, the actual date to which its profits are calculated may otherwise result in a gap preceding, or an overlap with, the actual date on which the basis period for the following year begins. This section ensures continuity between the two when the basis period for the second year is given by any of the provisions listed in subsection (2).

Section 214: When a change of accounting date occurs

871.This is the first in a group of seven sections dealing with changes of accounting date. This is the most complex aspect of the basis period rules. By separating these “change” sections from the main sections the taxpayer who does not change accounting date is sheltered from most of that complexity.

872.Section 214 determines the basis period for the year in which a change of accounting date takes place. It is based on section 62(1)(a), (2) and (5) of ICTA.

873.Subsection (1) covers two cases. Normally the year in which the change takes place is the first year in which accounts are prepared to the new date. But sometimes the period of account ending on the new accounting date will straddle an entire tax year (because that period of account is longer than 12 months). In these circumstances the straddled year is the year in which the change is treated as having taken place.

874.Subsection (2) is necessary to “switch off” the middle date treatment and to allow the provisions of section 213 to operate if appropriate (see the commentary on section 213).

875.Subsection (3) attributes an accounting date to a year which is straddled by the period of account ending with the new accounting date. That is necessary to determine the correct basis period for the straddled year. For example, if the period of account effecting the change of accounting date runs for 15 months from 1 April 2006 to 30 June 2007 an accounting date is treated as falling on 30 June 2006 in the tax year 2006-07 although, in fact, there is no accounting date in that year.

Section 215: Change of accounting date in third tax year

876.This section is the first of two sections that deal with a change of accounting date in particular years and for which special rules are required. It is based on sections 62(1) and (2)(b) and 63 of ICTA.

877.The approach in the change of accounting date sections follows that adopted in the earlier sections: that the general rule in section 198 applies unless a specific rule applies. A specific rule will apply when the basis period must be different from that which would be given by the general rule or when additional conditions apply.

878.In a continuing trade, specific rules will always apply to years in which a change of accounting date occurs after the third year (see section 216). This is because conditions have to be met for changes of accounting date in those years to be effective for tax purposes (see the commentary on section 216 and section 217). But for changes in the second and third years there are no conditions and the general rule will often apply. Section 215 deals with the case where the general rule does not apply in the third year.

Section 216: Change of accounting date in later tax year

879.This section applies to changes of accounting date occurring at any time after the third year, other than in the final year. It is based on sections 62(1), (2) and (3) and 63 of ICTA.

880.Changes of accounting date are normally effective for tax purposes and the basis period then aligns with accounts prepared to the new accounting date. But exceptionally, changes of accounting date will not be effective for tax purposes and then the basis period becomes out of step with the period of account.

881.Subsections (2) and (3) give the main change of accounting date rule. When a change is effective for tax purposes the basis period simply aligns with the new accounting date in the year of change.

882.Both subsections refer to section 217 that sets out the conditions that a change must meet to be effective for tax purposes.

883.When subsection (3) applies, the basis period for the year of change will be longer than 12 months.

884.Subsection (4) preserves the old basis period, notwithstanding the change of accounting date, when, exceptionally the conditions in section 217 are not met. This means that apportionment of the profits of the periods of account to the basis period is required.

Section 217: Conditions for basis period to end with new accounting date

885.This section sets out the conditions which must be satisfied for a change of accounting date to be effective for tax purposes. It is based on section 62A(1), (2), (3), (4), and (5) of ICTA.

886.Subsection (1)(c) imposes a test which may be satisfied by meeting either of two conditions. The first, condition A in subsection (4), is a “no recent change” condition and is of the same “mechanical” type as those in subsections (1)(a) and (1)(b).

887.The second, in subsection (6), is, in part, a condition of purpose. Unlike the others, it introduces a test which is qualitative in nature. But it becomes relevant only if condition A in subsection (4) is not met. It is therefore likely to apply in relatively few cases. For those reasons and to achieve a simpler rule for the more common cases, the associated Inland Revenue notice and taxpayer appeal rules are stated in a separate section (section 218).

Section 218: Commercial reasons for change of accounting date

888.This section deals with three aspects of the “commercial reason” condition in section 217(6)(a):

  • the automatic assumption of commerciality;

  • timely notice by the Inland Revenue to the contrary; and

  • appeals to the Commissioners if the Inland Revenue’s view is disputed.

It is based on section 62A(5), (6), (7), (8), and (9) of ICTA.

889.Subsection (1) makes the effect of section 62A(5)(b) of ICTA clear: that a change is treated as having been made for a commercial reason in the absence of a timely challenge by the Inland Revenue.

890.Subsection (6) prevents a wish to obtain a tax advantage from being a commercial reason for the change of accounting date rules.

Section 219: The year after an ineffective change of accounting date

891.This section sets out the rules that apply in the tax year following a year in which a change of accounting date takes place that does not result in a change of basis period. It is based on section 62(3) and (4) of ICTA.

892.When a change of accounting date takes place that does not result in a change of basis period, section 216(4) applies and the basis period for the year of change remains the 12 month period ending with the old accounting date. As a result, basis period and period of account fall out of alignment. Such cases may be relatively uncommon. But, where they do arise, specific rules are needed to ensure the proper working of the basis period rules in subsequent years. In those years, the taxpayer can revert to the old accounting date, maintain the new one, or change to a different date altogether.

893.Subsection (2) deals with the case where, in the year after the ineffective change, the new date is maintained. It allows the rules to operate as though the change takes place for the first time in that later year (rather than in the actual year of change). This allows the taxpayer to make a fresh attempt to change the basis period without, for example, falling foul of the “any recent change” rule in section 217(4).

894.Subsection (3) deals with the case where, in the later year, the taxpayer reverts to the old accounting date. This second change is not counted as a change for the purpose of the relevant rules.

Section 220: Deduction for overlap profit on change of accounting date

895.This section allows the deduction of overlap profit in a year in which there is a change of accounting date leading to a change of basis period and that basis period is longer than 12 months. It is based on section 63A(1) and (2) of ICTA and paragraphs 71140, 71155, and 71170 of the Inland Revenue Business Income Manual.

896.This adjustment for overlap profit is one of the two rules which help to ensure that, over the lifetime of a trade, the total profits assessed exactly equal the total profits earned. (The other, which authorises a deduction of overlap profit in the tax year in which the trade ceases, is in section 205). And it ensures that, in the year of change, no more than 12 months’ profits are assessed.

897.Calculating the deduction can be quite complex, particularly, for example, if there have been other changes of accounting date and deductions for overlap profit in previous years. Subsection (3) uses a step-by-step method statement to aid calculation.

898.This section includes three aspects which have previously been dealt with on a non-statutory basis.

899.Subsection (4) deals with the first (described in paragraph 71140 of the Business Income Manual). Where profits must be apportioned, it allows the use of any reasonable basis of calculation instead of the measure by days referred to elsewhere in the section, provided its use is reasonable and consistent. See Change 52 in Annex 1. The wording of subsection (4) makes it clear that the option to choose an alternative basis of apportionment is exercisable only by the taxpayer, not the Inland Revenue.

900.Subsection (5) deals with the second. It permits a change of accounting date to 31 March (or to 1, 2, 3, or 4 April) to be treated as though it were a change to 5 April (described in paragraph 71170 of the Business Income Manual). This avoids the need to make small restrictions to the deduction for overlap profit and will always work to the taxpayer's advantage. See Change 55 in Annex 1.

901.Finally, subsection (6) provides the option (described in paragraph 71155 of the Business Income Manual) to disregard 29 February in calculating a deduction for overlap profit if the change of accounting date is to a date falling on 31 March to 5 April inclusive. This always works to the taxpayer's advantage. See Change 57 in Annex 1.

Chapter 16: Averaging profits of farmers and creative artists
Overview

902.A person carrying on farming or market gardening or a creative artist may make an averaging claim. The claim is for the profits of two tax years to be adjusted. This is possible only if the profits of the two years differ to a material extent.

Section 221: Claim for averaging of fluctuating profits

903.This section sets out who may make an averaging claim. It is based on section 96 of ICTA (farmers) and Schedule 4A to ICTA (creative artists). In the case of creative artists a claim may be made in respect of the profits of a trade carried on wholly outside the United Kingdom. See Change 58 in Annex 1.

904.In the case of a person assessed on the remittance basis, the assessment is on the amount of “sums received” rather than the profits. So a claim may not be made in respect of income assessed on the remittance basis.

905.Subsection (2) extends the meaning of farming to include market gardening and factory farming. See Change 59 in Annex 1.

906.Subsection (4) makes it clear that “profits from a trade” means the amount before the deduction of losses. If a loss is sustained in the trade for the relevant tax year subsection (5) ensures that it does not create a negative profit for the purposes of averaging; it results in a profit of nil.

907.The reference in section 96(7)(c) of ICTA to any deduction for stock relief under Schedule 9 to FA 1981 is spent. Schedule 9 was repealed by ICTA. So this Chapter omits the reference.

Section 222: Circumstances in which claim may be made

908.This section sets out the circumstances in which an averaging claim may be made. It is based on section 96 of and Schedule 4A to ICTA.

909.Subsection (2) makes explicit the fact that a claim may be made in relation to a tax year which was the later year on a previous averaging claim. This rule is merely implicit in the opening words of section 96(1) of ICTA.

910.Subsection (4) is based on the rules in section 96(4)(b) of and paragraph 4(2) of Schedule 4A to ICTA. The rule in section 96 of ICTA provides that no claim is to be made in respect of any tax year “in which the trade is (or by virtue of section 113(1) [of ICTA] is treated as) set up and commenced or permanently discontinued”. The rule in this section follows the wording in Schedule 4A to ICTA.

911.There is some doubt whether “the trade” referred to in ICTA can mean a partner’s “deemed trade” (see section 111(4) of ICTA). It is generally accepted that individual partners cannot make an averaging claim in relation to the year in which they start or permanently cease to carry on a qualifying trade in partnership. This subsection makes clear that the rule applies to a partner’s deemed trade. See Change 60 in Annex 1.

Section 223: Adjustment of profits

912.This section sets out the way in which the profits of each of the two tax years for which a claim is made are adjusted. It is based on section 96 of and Schedule 4A to ICTA. It also includes a signpost to Schedule 1B to TMA.

913.There are two methods for adjusting the profits.

914.Subsection (3) sets out the first method. The profits of the two years are added together and then averaged.

915.Subsection (4) sets out the second method. The subsection uses a method statement to show how a more complex calculation is made. The aim is to achieve a straight line taper from a full adjustment when the profits differ by 30% to no adjustment when they differ by 25%.

Section 224: Effect of adjustment

916.This section explains the effect of adjusting profits after a claim is made. It is based on section 96 of and Schedule 4A to ICTA.

917.Subsection (4) deals with the relationship between an averaging claim and claims for relief under any other provision of the Income Tax Acts.

918.Section 96(9)(a) of ICTA provides that the time limit for the making of these other claims is the last day of the period during which the averaging claim is capable of being revoked. This section describes the time limit as being the last date on which the averaging claim could have been made. The actual time limit remains unchanged.

Section 225: Effect of later adjustment of profits

919.This section explains the effect of adjusting profits after a claim is made. It is based on section 96(5) of and paragraph 10 of Schedule 4A to ICTA.

920.Subsection (4) sets out the rule for a further averaging claim. This section removes any doubt that the normal 22 month time limit applies. See Change 61 in Annex 1.

Chapter 17: Adjustment income
Overview

921.This Chapter sets out the rules for dealing with two sorts of changes in the way profits of a trade are calculated.

922.The first sort of change is in the way the accounts are drawn up. The general rule is that profits must be calculated on the basis of accounts drawn up in accordance with generally accepted accounting practice (see section 50 of FA 2004 and section 25 of this Act). There is an exception to this general rule for some barristers and advocates (see section 160 of this Act), who may calculate their profits on a cash basis.

923.If there is a change from the cash basis to the earnings basis, some receipts and expenses may fall out of account. This sort of change was dealt with originally in the rules that became section 104(4) to (7) of ICTA. Those rules were replaced by the rules in section 44 of and Schedule 6 to FA 1998. The 1998 rules were replaced by section 64 of and Schedule 22 to FA 2002.

924.The second sort of change is in the way tax adjustments are made. These are the adjustments “required or authorised by law in calculating profits for tax purposes” (section 25). This sort of change was dealt with for the first time by the 2002 legislation.

925.Section 860 of this Act applies the rules to trades carried on in partnership.

Section 226: Professions and vocations

926.This section makes it unnecessary to specify repeatedly that the rules in this Chapter apply to a profession or vocation as well as a trade. It is new.

Section 227: Application of Chapter

927.This section sets out the circumstances in which an adjustment may arise. It is based on section 64 of FA 2002.

928.Section 64 of FA 2002 refers to a change of the basis on which profits are calculated. This might mean any change of basis. But paragraph 3(2) of Schedule 22 to FA 2002 makes clear that it does not include a change which occurs on a change of ownership of a trade.

929.The trading income rules in this Part are generally “person-based”. So this section applies when a person changes the basis. That person must be the same before and after the change of basis. So this section reproduces the effect of paragraph 3(2) of Schedule 22 to FA 2002.

930.An adjustment has to be made if:

  • the “old basis” accorded with the law or practice at the time; and

  • the “new basis” accords with the current law and practice.

931.The difference in wording is to cater for a case in which a decision of the Courts makes it clear that a previously accepted view of the law was wrong. In that case, the old basis accorded with the practice but not the law. The 1998 rules did not cater for this. But the 2002 rules (and the rules in this Chapter) do.

932.Section 64(1)(a) of FA 2002 refers to “a change of basis in computing the profits for the purposes of Case I or II of Schedule D”. So the change of basis rules are “rules applicable to Cases I and II of Schedule D” (section 65(3) of ICTA) and apply to foreign trade profits assessed under Schedule D Case V.

933.This conclusion is reinforced by the fact that, if the adjustment is negative, any relief under paragraph 5 of Schedule 22 to FA 2002 is given by way of “a deduction in computing profits”.

934.The section refers to “a trade”. So the rules apply to trades carried on wholly outside the United Kingdom as they apply to trades carried on at least partly in the United Kingdom.

935.There is a transitional rule in paragraph 59 of Schedule 2 to this Act. An adjustment arising from a change of accounting basis before 6 April 1999 is not charged to tax if the recipient was born before 6 April 1917.

Section 228: Adjustment income and adjustment expense

936.This section sets out the treatment of the adjustment. It is based on paragraphs 4 and 5 of Schedule 22 to FA 2002.

937.If the adjustment is positive it is called adjustment income. Adjustment income is charged as trading income under section 229. Section 64 of and Schedule 22 to FA 2002 create a charge under Schedule D Case VI if there is a positive adjustment on a change of basis. This Act deals with the income where it logically belongs. In this case, the income is trading income.

938.In the case of foreign trades, a positive adjustment on a change of basis is charged to tax under Schedule D Case VI in the source legislation even though the profits of the trade are chargeable under Case V. This Chapter treats trades carried on wholly abroad in the same way as trades carried on wholly or partly within the United Kingdom (unless the income is assessable on the remittance basis).

939.The charge in the source legislation under Schedule D Case VI has consequences for loss relief and the charge to Class 4 national insurance contributions. This Chapter preserves the position for loss relief in section 232(3). This Act preserves the position for Class 4 national insurance contributions because the consequential amendments to the social security legislation ensure that those contributions are charged only on profits chargeable under Chapter 2 of Part 2 of this Act.

940.If the adjustment is negative it is called an adjustment expense. An adjustment expense is dealt with in sections 233 and 234.

Section 229: Income charged

941.This section sets out the amount charged to tax. It is based on section 69 of ICTA. Adjustment income is charged to tax separately from the profits of a trade (see section 5).

Section 230: Person liable

942.This section states who is liable for any tax charged. In FA 2002 the charge is under Schedule D Case VI. So section 59(1) of ICTA applies.

Section 231: Calculation of the adjustment

943.This section contains the main rules for calculating the adjustment. It is based on paragraph 2 of Schedule 22 to FA 2002. The section presents the rules as a method statement.

944.The 2002 legislation introduced three new rules.

945.The first new rule concerns a change in the basis of valuing stock. The rule is in item 3(b) of step 1 of the method statement. For instance, in Period 1 the accounts show closing stock of £1200. That is reduced for tax purposes, in accordance with the practice then prevailing, to £1000. In Period 2 the opening stock in the accounts is £1200. So there is no adjustment within item 3(a). But if a new practice allows the opening stock value to stand for tax purposes there is an adjustment within item 3(b). There is a corresponding rule in item 3 of step 2.

946.The second new rule concerns a change in the way that depreciation is recognised. This rule is in item 4 of step 1. The expression “for accounting purposes” is defined in section 832(1) of ICTA – see Schedule 4 to this Act.

947.The third new rule restricts the circumstances that can give rise to a deduction in step 2 to those that are purely a matter of timing. For instance, in Period 1 the accepted view was that an item of expenditure was capital and it was “added back” in the tax computation. After a Court decision, that view changes and, if the expenditure had been incurred in Period 2, no tax adjustment would have been required. Without item 2(b) of step 2, item 2(a) would give a deduction.

Section 232: Treatment of adjustment income

948.This section sets out two special rules for the treatment of adjustment income. It is based on paragraph 4(2) of Schedule 22 to FA 2002.

949.Subsection (1) establishes when the adjustment income arises, so that it is charged to tax for the appropriate year under section 229.

950.Subsection (3) treats the income as trade profits for the purpose of loss relief. So, for example, any losses of the same trade brought forward can be set against the income.

951.Subsection (4) preserves the treatment of adjustment income as earned income.

952.It also makes clear that adjustment income is relevant UK earnings for the purpose of making pension contributions.

953.FA 2004 made significant changes to the taxation of pension schemes. The changes take effect from 6 April 2006. This Act deals with this by including the new rules in section 232. The commencement issue is then dealt with as a transitional measure in paragraph 57 of Schedule 2 of this Act. The old rules apply until 5 April 2006.

Section 233: Treatment of adjustment expense

954.This section treats an adjustment deduction as a trading expense. It is based on paragraph 5 of Schedule 22 to FA 2002.

Section 234: No adjustment for certain expenses previously brought into account

955.This section deals with the case where the old basis of calculation allowed a tax deduction but the new basis requires the deduction to be spread over several periods. It is based on paragraph 6 of Schedule 22 to FA 2002.

956.In the absence of this section there would be a positive adjustment within item 2 of step 1 of the calculation of the adjustment in section 231. That would produce the right result overall but the rule would take effect too early. Instead, no adjustment is calculated but no deduction is allowed in future for expenses that have already been taken into account.

Section 235: Cases where adjustment not required until assets realised or written off

957.This section is a timing rule for an adjustment which results from any of the three new rules in section 231. It is based on paragraph 7 of Schedule 22 to FA 2002.

958.These new rules are the ones mentioned in the commentary on section 231. The general timing rule is that any adjustment is made at the end of the first period of account on the new basis (see section 232(1) and section 233(1)). But any adjustment income for stock, work in progress or depreciation is charged when the asset is realised or written off.

Section 236: Change from realisation basis to mark to market

959.This section is concerned with a change from the realisation basis to “mark to market” accounting. It is based on paragraph 8 of Schedule 22 to FA 2002.

960.“Mark to market” is a basis of accounting used by traders in financial assets. Instead of carrying the assets in the books at cost, financial traders draw up accounts to show the assets at a fair value at the accounting date. But for tax purposes the realisation basis may have been used.

961.In the first period in which mark to market is adopted for tax purposes, the opening stock may be valued at a higher (market) value than the closing stock of the previous period. Or a financial asset may have been carried in the accounts at cost but appear as a deduction in a later period at fair value. In either case, there is an adjustment within section 231.

962.As in section 235, the charge on adjustment income is postponed until the asset is realised.

Section 237: Election for spreading if section 236 applies

963.This section provides for an election to be made if there is a charge (following a change to mark to market) under section 236. It is based on paragraph 9 of Schedule 22 to FA 2002.

964.The election is to spread the adjustment charge over six periods of account beginning with the first one in which the new basis is adopted. As the charge is postponed under section 236 until the asset is realised, this first period is not necessarily the one in which the charge would be made without the election.

965.“Period of account” is defined in section 832(1) of ICTA.

966.Subsection (2) sets out the usual Self Assessment time limit for an election.

Section 238: Spreading on ending of exemption for barristers and advocates

967.This section sets out a special rule for spreading adjustment income in the case of barristers and advocates. It is based on paragraph 11 of Schedule 22 to FA 2002.

968.The income is spread over ten years, subject to a maximum charge in any one year.

969.In paragraph 4 of Schedule 6 to FA 1998 there was another rule for spreading adjustment income. Spreading was available to a person who changed accounting basis to comply with section 42 of FA 1998 (generally accepted accounting practice). Such a change would have taken effect by 5 April 2000.

970.In accordance with paragraph 17 of Schedule 22 to FA 2002 the repeal of Schedule 6 to FA 1998 takes effect only in relation to a change of basis on or after 1 August 2001. So the transitional rule in paragraph 4(2)(a) of Schedule 6 to FA 1998 may continue to affect current liabilities if they include part of a pre-2001 adjustment.

971.The rules in paragraph 13(3) and (4) of Schedule 22 to FA 2002 apply only if an election is made under paragraph 11 by a partner. As barristers and advocates do not carry on their professions in partnership, these rules are not needed.

Section 239: Election to accelerate charge under section 238

972.This section sets out the election that is available if adjustment income is spread under section 238. A taxpayer may choose to have any part of the outstanding adjustment income taxed earlier than would otherwise be the case. The section is based on paragraph 12 of Schedule 22 to FA 2002.

973.Subsection (2) sets out the usual Self Assessment time limit for an election.

974.The effect of an election is set out in paragraph 12(4) of Schedule 22 to FA 2002. It is not clear what the “additional amount” referred to in the sub-paragraph is. In some cases more than the total adjustment income could be charged to tax within the period of ten years over which it is spread. Subsection (4) of this section sets out the effect of an election. See Change 62 in Annex 1.

Section 240: Liability of personal representatives if person liable dies

975.This section makes it clear that a taxpayer’s personal representatives take over from the taxpayer both the liability to tax on adjustment income and the right to make any election. It is based on paragraph 14 of Schedule 22 to FA 2002.

Chapter 18: Post-cessation receipts
Overview

976.This Chapter charges receipts which are derived from a trade but are not received until after the trade has ceased and have not been brought into the calculation of profits.

Section 241: Professions and vocations

977.This section makes it unnecessary to specify repeatedly that the rules in this Chapter apply to a profession or vocation as well as a trade. It is new.

Section 242: Charge to tax on post-cessation receipts

978.This section charges post-cessation receipts to tax. It is based on sections 103 and 104 of ICTA. Post-cessation receipts are charged separately from the profits of a trade (see section 5 of this Act).

Section 243: Extent of charge to tax

979.This section sets out the charge to tax. It is based on sections 103 and 104 of ICTA, which create a charge under Schedule D Case VI on post-cessation receipts. This Act deals with the income where it logically belongs. In this case the income is trading income.

980.The charge in the source legislation under Schedule D Case VI has consequences for loss relief and the charge to Class 4 national insurance contributions. This Chapter preserves the position for loss relief in section 254. This Act preserves the position for Class 4 national insurance contributions because the consequential amendments to the social security legislation ensure that those contributions are charged only on profits chargeable under Chapter 2 of Part 2 of this Act.

981.Subsection (3) deals with a trader who has become non-resident after the trade has ceased. A trade carried on at least partly in the United Kingdom (see section 6) may include income that arises abroad. When the trader was resident in the United Kingdom all the profits of the trade would have been within the charge under Part 2 of this Act. This subsection removes the charge on a non-resident if the receipt arises abroad.

982.There is a transitional rule in paragraph 61 of Schedule 2 to this Act. A post-cessation receipt arising from a cessation before 6 April 2000 is not charged to tax if the recipient was born before 6 April 1917.

Section 244: Income charged

983.This section sets out the amount charged to tax. It is based on section 69 of ICTA, which applies because the charge in ICTA is under Schedule D Case VI.

Section 245: Person liable

984.This section states who is liable for any tax charged. It is based on section 59(1) of ICTA, which applies because the charge in ICTA is under Schedule D Case VI.

Section 246: Basic meaning of “post-cessation receipt”

985.This section sets out the basic meaning of “post-cessation receipt”. It is based on sections 103 and 104 of ICTA.

986.Subsection (1) is the general rule that a post-cessation is a sum received after a person has ceased to carry on trade.

987.Subsection (2) deals with the case of a non-resident company liable to income tax. If a company ceases to be liable to corporation tax it is treated as ceasing to carry on the corporation tax trade. A post-cessation from that trade may be charged to income tax.

988.Subsections (3) and (4) explain how the idea of a person ceasing to carry on a trade is applied if the trade is carried on in partnership. If a partner leaves a firm and receives a sum, that sum may be a post-cessation receipt. In ICTA this is because the end of the partner’s “deemed trade or profession” is treated as a permanent discontinuance of a trade for the purposes of the post-cessation receipts rules.

Section 247: Other rules about what counts as post-cessation receipts

989.This section is new. It contains signposts to:

  • the nine sections in this Act that treat other sums as post-cessation receipts; and

  • the two sections in this Act that exclude certain sums from the charge on post-cessation receipts.

Section 248: Debts paid after cessation

990.This section sets out what happens when a trader is allowed a deduction for a bad or doubtful debt owed to the trade but then recovers the debt after the trade has ceased. It is based on sections 103(5) and 109A of ICTA.

991.In the straightforward case where a deduction for the debt has been given during the course of the trade section 103(5) of ICTA makes it clear that the recovery has not been “taken into account” in calculating the trade profits. The result is that the recovery is within the charge in section 103 of ICTA.

992.In the less common case where the entitlement to relief has arisen under section 109A of ICTA after the cessation, the recovery is dealt with in section 109A of ICTA itself.

993.This section deals with both these cases.

994.Subsections (1) and (2) deal with the straightforward case and treat the recovery of the debt as a post-cessation receipt. The references to corporation tax and section 74(1)(j) of ICTA cater for the possibility that a deduction for a bad debt is allowed to a company liable to corporation tax but the debt is paid to a person liable to income tax.

995.Subsections (3) and (4) deal with the less common case and treat the recovery of the debt as a post-cessation receipt.

Section 249: Debts released after cessation

996.This section sets out the rules that apply when a debt owed by the trader is released after the trade has ceased. It is based on section 103(4) of ICTA.

997.Subsection (1) sets out the four conditions to be met if the section is to apply. It is the equivalent of section 97 of this Act which applies in the case of a continuing trade. The references to corporation tax caters for the possibility that a deduction for an expense is allowed to a company liable to corporation tax but a person liable to income tax takes over the related trade debt and is released from it.

998.Subsection (3) deals with the case of a non-resident company liable to income tax. If the company becomes liable to corporation tax it is treated as ceasing to carry on the income tax trade.

Section 250: Receipts relating to post-cessation expenditure

999.This section sets out what happens if relief has been claimed for post-cessation expenditure and there is a recovery. It is based on section 109A(3) of ICTA.

1000.Subsection (2) sets out the sorts of expenditure for which relief may have been claimed and which sums are treated as post-cessation receipts.

Section 251: Transfer of rights if transferee does not carry on trade

1001.This section deals with the position of the transferor if the right to a post-cessation receipt is transferred for value to a non-trading transferee. It is based on section 106 of ICTA.

1002.The transferor is charged to tax on the amount received for the transfer if the transfer is at arm’s length. Otherwise the transferor is charged to tax on the arm’s length value of the transfer. There is no later charge to tax on the transferee when the post-cessation receipt is received.

1003.Section 98 of this Act sets out the position if the transfer is to a trading transferee.

Section 252: Transfer of trading stock or work in progress

1004.This section excludes from the charge on post-cessation receipts sums arising from the transfer of stock and work in progress. It is based on sections 103(3)(c), 104(6) and 110(6) of ICTA.

1005.Subsection (1) makes explicit the general rule that there is no tax charge on a post-cessation receipt arising from trading stock or work in progress.

1006.The policy is that stock and work in progress should be valued at cessation in accordance with the rules in Chapter 12 of this Part. Once that has been done there is no need to charge tax on any sums arising from the disposal or realisation of stock and work in progress.

1007.In the case of stock, section 173 of this Act requires a valuation on cessation in all cases. It follows that its value is taken into account in calculating the profits before the cessation. But the valuation rules apply to work in progress only “if … the work in progress is valued” (section 182 of this Act). Such a valuation is made only by businesses whose accounts are drawn up on the earnings basis.

1008.When the charge on post-cessation receipts was extended to non-earnings basis cases in 1968 the exclusion for work in progress often did not apply because in many of those cases closing work in progress was not valued. The policy was to tax post-cessation receipts arising from work in progress (under section 104 of ICTA). Nowadays non-earnings basis cases are much rarer.

1009.A valuation of work in progress is not required for barristers and advocates within section 160 of this Act. So, in these non-earnings basis cases, receipts from work in progress after the cessation are charged to tax.

1010.Subsection (2) is a signpost to the rule that allows a taxpayer to value work in progress at cost and to have the profit element of a sum received later for work in progress taxed as a post-cessation receipt.

Section 253: Lump sums paid to personal representatives for copyright etc.

1011.This section exempts certain lump sums from the charge on post-cessation receipts. It is based on section 103(3)(b) and (bb) of ICTA.

1012.A professional author or designer may receive lump sums from the sale of rights in artistic works in the course of the carrying on a profession. Such sums are brought into account in calculating the profits of the profession. But this section makes it clear that, in the case of sales after the death of the author or designer, the sums are not charged to tax.

1013.The section ensures that a lump sum received for the assignment of design right is not treated as a post-cessation receipt. See Change 63 in Annex 1.

1014.The definition of “assignment” in section 879 of this Act applies so that the word means “assignation” in Scotland.

Section 254: Allowable deductions

1015.This section is the first of two that set out the rules for allowing deductions from sums charged as post-cessation receipts. It is based on section 105 of ICTA.

1016.Subsection (3) ensures that a deduction is not allowed for any expenses for which relief has already been allowed under section 109A of ICTA (relief for post-cessation expenditure). The reference to section 90(4) of FA 1995 (not part of the Tax Acts because it relates to capital gains tax) is retained because relief may be given under that section following a claim under section 109A of ICTA.

Section 255: Further rules about allowable deductions

1017.This section is the second of two that set out the rules for allowing deductions from sums charged as post-cessation receipts. It is based on section 105 of ICTA.

1018.Subsection (2) ensures that any loss unused at the date of cessation is set off against post-cessation receipts in the same order as it would have been set off against profits under section 385 of ICTA, that is, against an earlier year before a later year.

1019.Subsection (4) ensures that no expense or loss can be set against amounts treated as post-cessation receipts by section 248 (debts paid after cessation) or section 250 (receipts relating to post-cessation expenditure).

1020.The references to capital allowances in section 105(1)(b) and (3) of ICTA are no longer needed because any capital allowance is allowed as a trading expense.

Section 256: Treatment of post-cessation receipts

1021.This section treats most post-cessation receipts as earned income and relevant UK earnings. It is based on section 107 of ICTA. See Change 64 in Annex 1.

1022.FA 2004 made significant changes to the taxation of pension schemes. The changes take effect from 6 April 2006.

1023.This Act deals with this by including the new rules in section 256 of this Act. The commencement issue is then dealt with as a transitional measure in paragraph 60 of Schedule 2 to this Act. The old rules apply until 5 April 2006.

Section 257: Election to carry back

1024.It may be beneficial for a taxpayer to have a post-cessation receipt assessed for the year of cessation instead of the year of receipt. This section, based on section 108 of ICTA, allows the taxpayer to elect for that treatment.

Chapter 19: Miscellaneous and supplementary
Section 258: Changes in trustees and personal representatives

1025.This section sets out what happens if there is a change in the trustees or personal representatives who are carrying on a trade. It is based on section 113(7) of ICTA.

1026.There is a similar rule for property income in section 361 of this Act.

Section 259: Meaning of “statutory insolvency arrangement”

1027.This section defines “statutory insolvency arrangement”. It is based on section 74(2) of ICTA.

1028.Section 74(2)(a) of ICTA refers to a voluntary arrangement under the Insolvency Act 1986 (dealing with individual voluntary arrangements in England and Wales) and the Insolvency (Northern Ireland) Order 1989. This section refers also to the Bankruptcy (Scotland) Act 1985. See Change 65 in Annex 1.

Part 3: Property income

Overview

1029.This Part charges “property income”. That is, income from land.

1030.This Part taxes income that is taxed under different Schedules and Cases in the source legislation. So it covers, for example, income from land in the United Kingdom and abroad as well as post-cessation receipts and certain charges arising from changes in the basis on which a taxpayer calculates property business profits.

1031.This reflects the rewrite approach of grouping charges which are logically part of the same “family”. In Part 3 the unifying factor is that all the charges are on amounts that are, ultimately, attributable to exploiting an interest in land.

1032.But although the charges that are, in the source legislation, distinct, are here grouped in one Part, they do not lose their identity for all purposes. Loss relief for example (not dealt with in this Act) requires them to be kept apart. For this reason the charge on “property income” has specific components (see the commentary on section 260).

1033.References to “profits or gains” in the source legislation which relate only to income are rewritten in this Part omitting the reference to “gains”. This continues the tidying up of such references started in section 46(3) of and Schedule 7 to FA 1998.

Chapter 1: Introduction
Section 260: Overview of Part 3

1034.This section is introductory. It is new.

1035.Subsection (1) sets out the components of “property income”.

1036.Subsection (1)(a) refers to the main component. That is income from land that is taxed in the source legislation under Schedule A if it is land in the United Kingdom and under Schedule D Case V if it is foreign land. Central to the charge is the concept of the “property business”. That is discussed in more detail in the commentary on sections 264 and 265.

1037.Subsection (1)(e) refers to post-cessation receipts of a UK property business. In the source legislation they are charged under Schedule D Case VI. This Act deals with the income where it logically belongs. In this case, the income is property income.

Section 261: Provisions which must be given priority over Part 3

1038.This section provides the rules to determine which Part takes priority in the event of any overlap of the charge on the profits of a trade and the charge on the profits of an overseas property business or the charge under Chapters 8 and 9 of this Part.

1039.It is based on section 18 of ICTA and section 65A(1) of ICTA as regards overlap between an overseas property business and a foreign trade. It gives statutory effect to the Crown Option as regards overlap between an overseas property business and a UK trade. See Change 66 in Annex 1.

1040.It is based on the definitions of Schedule D Cases I and VI in section 18 of ICTA as regards overlap between a trade and the profits of a UK concern or the profits of a UK electric line wayleave. Case VI charges income that is not charged under any other case. So it is correct to give trading income (Case I in the source legislation) priority.

Section 262: Priority between Chapters within Part 3

1041.This section gives an order of priority between Chapter 3 and Chapters 8 and 9 of this Part of this Act and between Chapters 8 and 9. It is based on sections 119(1) and 120(1) of ICTA.

1042.Subsection (3) deals with income that falls within both Chapter 8 and Chapter 9 of this Part of this Act. See Change 5 in Annex 1.

Chapter 2: Property businesses
Section 263: Introduction

1043.This section introduces the Chapter and provides a “road map” to the key provisions. It is new.

1044.Chapter 2 sets out the key concepts underlying the main component of income within this Part of this Act by defining “property business” and “generating income from land”.

Section 264: UK property business

1045.This section defines “UK property business” and introduces the concept of “generating income from land”. It is based on section 15(1) of ICTA.

1046.It makes it clear that all the income from a person’s UK land interests is treated as falling within a single UK property business.

1047.The term “property business” is not entirely straightforward. The term used in the source legislation – “Schedule A business” – was introduced as part of the 1995 reform of Schedule A. That concept was helpful in providing a vessel to contain all the income from land previously charged under Schedule A and to which the rules for calculating trade profits could be applied. But the concept of a Schedule A business – and a UK property business - is rather more complex than that of a trade. That is reflected in this and the other sections that, together, define the range of income that is assessed as income of a property business.

1048.First, the income has to be defined by reference to land law. There are only limited possibilities for simplifying terms which have to link directly with the concepts and language of current land law.

1049.Second, the concept of the “property business” is, to a certain extent, an artificial one. Unlike the term “trade” it may not always correspond to an activity organised in a way that the proprietor would necessarily describe as a business. As such, the term has to cover:

  • “real” businesses where the lettings are organised in a professional way;

  • lettings which are not so organised; and

  • casual and one-off transactions which may have very little of the qualities normally associated with a business.

Then all of these lettings of different types must be treated as part of the same, single business.

1050.Although the Chapter builds on the concept of the “business”, the approach to defining a “UK property business” differs from the approach in the source legislation. This Act uses the term “UK property business” rather than “Schedule A business”. Although the terms “UK property business” and “Schedule A business” are defined differently they have the same tax effect.

1051.Paragraph 1(1) of Schedule A (see section 15(1) of ICTA) provides for tax to be charged on “the annual profits arising from a business carried on for the exploitation, as a source of rents or other receipts, of any estate, interest or rights in or over land in the United Kingdom”. Under paragraph 1(2) of Schedule A, “to the extent that any transaction is entered into for [that purpose], it is taken to be entered into in the course of such a business”. Paragraph 1(3) of Schedule A treats all businesses and transactions carried on or entered into by a particular person, so far as they are carried on or entered into for that purpose, as together forming a single business for the purposes of Schedule A.

1052.Section 832(1) of ICTA provides:

“Schedule A business” means any business the profits or gains of which are chargeable to income tax under Schedule A, including the business in the course of which any transaction is by virtue of paragraph 1(2) of that Schedule to be treated as entered into.

1053.Each of the individual businesses carried on (or, by virtue of paragraph 1(2) of Schedule A, notionally carried on) for the purpose mentioned in Schedule A is thus a “Schedule A business”. Under paragraph 1(1) and (3) of Schedule A, the charge to tax is on the profits of the single notional business consisting of all the Schedule A businesses carried on by a single person. It is that notional business that is defined as the person’s “UK property business” in section 264.

1054.Section 859 explains how the “one business per person” rule applies in the case of a business carried on (or a transaction entered into) in partnership.

Section 265: Overseas property business

1055.This section defines “overseas property business”. It is based on section 65A of ICTA.

1056.The definition is identical to that of “UK property business” except that the land from which the income arises is outside the United Kingdom. That is the only difference between a UK and an overseas property business: income from land outside the United Kingdom can arise only in an overseas property business; income from land in the United Kingdom can arise only in a UK property business.

1057.For the purpose of deciding whether there is an overseas property business, overseas land law is interpreted in accordance with section 363.

1058.The priority rules in the trading income Part of this Act (section 4) make it clear that a charge under Part 3 of this Act as United Kingdom property income has priority over a charge under Part 2 as trading income. This reflects the rule in Schedule D Case I (section 18(3) of ICTA). The sort of receipt to which this rule might apply is rent received by a property developer from the temporary letting of land awaiting development. The rent is taxed as property income, even if it could properly be regarded as a trade receipt.

1059.In the case of a foreign trade and foreign property, the rule in section 65A(1)(b) of ICTA is the reverse of that in section 18(3) of ICTA. An overseas property business does not include “income to which section 65(3) of ICTA applies (income immediately derived from carrying on a trade …)”. So the priority rule in section 261 preserves this position.

Section 266: Meaning of “generating income from land”

1060.This section defines “generating income from land”. It is based on sections 15(1), 24 and 65A of ICTA.

1061.The section defines what may be described as the essence of the property business. That is, exploiting rights of land ownership for profit. But it is not intended to identify everything that must be taken into account in calculating the profits of such a business. The concept of the property business is wider than that. “Property business” includes, for example, amounts specifically charged under other provisions such as certain insurance recoveries (see section 106 applied by section 272(2)).

1062.Subsection (1) states the basic definition of “generating income from land”.

1063.Subsection (2) extends the meaning of “rent” and is based on section 24(6)(b) of ICTA. It applies to payments by tenants, whether made to the landlord or to someone else, in respect of maintenance or repair of the leased premises that the tenant is not required by the lease to carry out. Including this extension in the main section (in the source legislation it is relegated to a “construction” section) keeps all the relevant definitions together.

1064.Subsection (3) explains “other receipts” in subsection (1). This list is not exhaustive but amounts that are not listed here would have to be of a similar nature to those that are listed to come within the definition.

1065.Subsection (4) extends the charge to particular types of receipt. The source legislation cross-refers to a definition of “caravan” in the Caravan Sites and Control of Development Act 1960. There is an Act-wide, uniform definition of “caravan”: see the commentary on section 875 and Change 148 in Annex 1.

1066.There is also a new Act-wide, uniform definition of “houseboat” which introduces changes in the law: see the commentary on section 878(1) and Change 150 in Annex 1.

Section 267: Activities not for generating income from land

1067.This section excludes certain “land-related” income from property income and cross-refers to the trading income provisions under which that income is charged. It is based on sections 15(1) and 65A of ICTA.

Chapter 3: Profits of property businesses: basic rules
Section 268: Charge to tax on profits of a property business

1068.This section charges the profits of a property business to tax. It is based on sections 15 and 18 of ICTA.

Section 269: Territorial scope of charge to tax

1069.This section sets out the limitations on the charge to tax on a UK property business and an overseas property business. It is based on sections 18 and 65A of ICTA.

1070.Subsection (1) establishes that the profits of a UK property business are charged to tax whatever the residence status of the taxpayer.

1071.Subsection (2) establishes that the profits of an overseas property business are charged to tax only if the taxpayer is a UK resident.

1072.Income from an overseas property business is assessable under Schedule D Case V. So the charge to tax is subject to the territorial restriction in Schedule D. A non-resident person is taxable only on income from “property” in the United Kingdom (see paragraph (a)(iii) of Schedule D in section 18(1) of ICTA). So a non-resident is not charged to tax on the income from overseas property.

1073.Subsection (3) is the special rule for Irish income. It is based on section 68 of ICTA. Even if a person is entitled to the remittance basis for other foreign income Irish income is assessable on the basis of the income arising. But it is not clear how the rules in sections 65(4) and 68 of ICTA interact. This section makes it clear that the rules for an overseas property business are used in calculating the income from Irish property. See Change 67 in Annex 1.

1074.Subsection (4) is a signpost to the special rule in Chapter 11 of Part 2 of this Act for the non-Irish foreign income of a person who is assessable on the remittance basis. The overseas property business rules in section 65A of ICTA are disapplied in the case of a remittance basis person by section 65(4) of ICTA.

Section 270: Income charged

1075.This section states the amount charged to tax. It is based on sections 21 and 65 of ICTA.

1076.The section refers simply to “profits” rather than “annual profits” used in the source legislation. Omitting “annual” is consistent with the approach adopted for trading and savings and investment income - the word adds nothing to the meaning of “profits”.

Section 271: Person liable

1077.This section states who is liable for any tax charged. It is based on sections 21 and 59 of ICTA.

Section 272: Profits of a property business: application of trading income rules

1078.This is the main rule for calculating the profits of a property business. It is based on sections 21A and 65A of ICTA.

1079.The same basic rules apply to the calculation of both UK and overseas property businesses.

1080.From 1995, the profits of a Schedule A business charged to income tax are calculated by treating the business as similar to a trade and applying the calculation rules of Schedule D Case I.

1081.In the source legislation this is achieved by section 21A of ICTA. But, at the margins, the application of certain of the Case I rules to Schedule A is not altogether clear.

1082.First, the relationship of section 21A(2) of ICTA to section 21A(1) of ICTA is uncertain. Section 21A(2) of ICTA refers to provisions that apply “in accordance” with section 21A(1). It is open to debate whether section 21A(2) of ICTA merely contains examples of the Schedule D Case I provisions that apply in accordance with the general rule in section 21A(1) of ICTA or whether it contains an exhaustive list of those provisions. The former appears the better view and the one best reflecting the underlying policy.

1083.Second, some Schedule D Case I provisions that are applied to Schedule A are inherently incapable of applying to income from land. The “herd basis” provisions in section 97 of and Schedule 5 to ICTA (rewritten in Chapter 8 of Part 2 of this Act) are an example. They are among the provisions of Chapter V of Part 4 of ICTA that are applied to Schedule A specifically (subject to stated exceptions) by section 21A(2) of ICTA. But they are not among the exceptions referred to in section 21A(4) of ICTA.

1084.On the other hand, some Schedule D Case I provisions outside Chapter V of Part 4 of ICTA that seem potentially more relevant, such as the car hire provisions in sections 578A and 578B of ICTA, are not applied specifically.

1085.Section 272 clarifies these matters by listing all the sections in Part 2 of this Act that are relevant to property business profits.

1086.Some of the sections in Part 2 of this Act that are applied to a property business contain rewrite changes. Those changes are carried through to property income. Details of those changes are recorded in the Annex 1 notes on the particular sections in Part 2 of this Act.

1087.Subsection (1) states the general principle that the profits of a property business are calculated in the same way as the profits of a trade. This reflects the fact that there are provisions not included in Part 2 of this Act which may affect the calculation of profits. For example, the pension contributions deductions provisions in FA 2004 and certain anti-avoidance provisions in ICTA that apply to all income types.

1088.Subsection (2) lists all the sections in Part 2 of this Act that are relevant to property business income. It reflects the principle that section 21A(1) of ICTA applies all Schedule D Case I calculation provisions to Schedule A unless they are expressly disapplied elsewhere. Provisions that are expressly disapplied in the source legislation are excluded from the list.

1089.Also excluded are provisions which are attracted to Schedule A in the source legislation either expressly by section 21A(2) of ICTA or under the general principle expressed in section 21A(1) of ICTA, but which are incapable of applying once carried over to the context of the property business. Exclusion is achieved simply by omitting them from the list of provisions that do apply.

1090.The majority of the provisions in Part 2 of this Act that can apply to a property business are applied by subsection (2). But in some cases later sections set out the provisions specifically (Chapter 7 (adjustment income) and Chapter 10 (post-cessation receipts)).

1091.The following sections that are applied by subsection (2) merit specific mention. These are:

  • sections 48 to 50: expenses of car hire;

  • sections 188 to 191: deduction for unremittable amounts.

1092.Including these accurately reflects the effect of section 21A(1) of ICTA.

1093.Although the list in subsection (2) excludes sections in Part 2 of this Act that are inherently incapable of applying to a property business it does not exclude those that are merely unlikely to apply. This recognises the possibility of certain provisions applying in unusual circumstances. Examples are section 87 and section 88 (scientific research). Although their relevance to a property business is unlikely, it is not inconceivable and they are needed to cater for the possibility of a landlord funding an activity that would qualify as “scientific research”. An example might be research on the decontamination of brown land with a view to building an investment property on it.

1094.Subsection (3) ensures that the trading income provisions cross-referred to in subsection (2) work properly in the context of the property business.

Section 273: Amounts not brought into account as part of a property business

1095.This section excludes from the profits of a property business certain income from land that, exceptionally, may be taxed as profits of a trade. It is based on sections 15 and 65A of ICTA.

1096.Subsection (1) signposts to the relevant provisions.

  • See Change 3 in Annex 1 in respect of caravans.

  • See Change 4 in Annex 1 in respect of surplus business accommodation.

  • See Change 5 in Annex 1 in respect of payments for wayleaves.

Section 274: Relationship between rules restricting and permitting deductions

1097.This section determines the interaction between those provisions that allow a deduction and those provisions that prohibit a deduction. It is new. See Change 6 in Annex 1.

1098.This section does a similar job in the property income Part to that which section 31 does in the trading income Part. The general principle is that a rule allowing a deduction takes priority over a rule prohibiting a deduction. But that is subject to the exceptions the section mentions.

1099.Subsection (4) makes it clear that the effect of this priority rule extends to the large number of trading income rules that apply to property income indirectly through section 272.

Section 275: Apportionment of profits to tax year

1100.This section deals with cases where the period of account does not coincide with a tax year. It is based on sections 21A, 72 and 65A of ICTA.

1101.This section is necessary because the charge under section 270 is on the property business profits arising in the tax year.

1102.In the source legislation section 72 of ICTA is one of the provisions applied to Schedule A specifically by section 21A(2) of ICTA. Section 72 of ICTA is rewritten for trade profits in section 203. But simple cross-reference to that trading income section would not work very well for property income because that section is drafted in terms of basis periods and basis periods are not relevant to property income. So section 275 is a specific property income version.

1103.Subsection (4) adopts the approach of section 203(4) in permitting an alternative basis of apportionment if its use is reasonable and consistent. See Change 52 in Annex 1. The wording of subsection (4) makes it clear that the option to choose an alternative basis of apportionment is exercisable only by the taxpayer, not the Inland Revenue.

Chapter 4: Profits of property businesses: lease premiums etc.
Overview

1104.This Chapter contains rules for the taxation of premiums, and certain other amounts paid in respect of leases, which would otherwise generally be amounts of a capital nature. It is based on sections 34 to 38 of ICTA.

1105.The effect of section 34 of ICTA is that premiums for leases with an effective duration of 50 years or less, and certain other amounts treated as premiums, are treated wholly or partly as income in the hands of the recipient. Premiums in respect of leases with a duration of one year or less are treated wholly as income. For premiums in respect of leases with a duration of between one and 50 years, the amount treated as income is calculated on a sliding scale according to the duration of the lease. Similar provision is made for amounts treated as premiums under section 34(4) and (5) of ICTA. See sections 277 to 281.

1106.Section 35 of ICTA applies when a lease for 50 years or less is granted for a premium less than market value and is then reassigned at a profit. The assignor is treated as receiving as income an amount calculated on a sliding scale according to the duration of the lease. See sections 282 and 283.

1107.Section 36(1) and (2) of ICTA apply when an estate or interest in land is sold with a condition that it may be required to be sold back to the vendor. The vendor is treated under section 36(4A) of ICTA as receiving as income an amount calculated on a sliding scale according to the earliest date on which the interest could fall to be reconveyed. Section 36(3) makes similar provision where the terms of the sale provide for the grant of a lease to the vendor. See sections 284 to 286.

1108.Section 37 of ICTA contains rules under which:

  • there may, in certain circumstances, be a reduction in the amount of another receipt under section 34 or 35 of ICTA – see sections 287 to 290; and/or

  • the tenant under the lease may be entitled to a deduction in calculating the profits of his or her property business – see sections 291 to 294.

1109.A tenant who uses land subject to a lease in respect of which there is a receipt under section 34 or 35 of ICTA in connection with a trade, profession or vocation may be entitled under section 87 of ICTA to a deduction in computing the profits of that trade, profession or vocation. Section 87 of ICTA is rewritten in sections 60 to 65 of this Act.

1110.Section 38 of ICTA contains rules for determining the duration of a lease for the purposes of sections 34 to 36 of ICTA. See sections 303 to 305.

Section 276: Introduction

1111.This section is new.

1112.Subsection (3) refers to “any lease” in the case of sums payable instead of rent or for the variation or waiver of the term of a lease. See commentary on sections 279 and 281 and Change 68 in Annex 1.

1113.Subsection (6) defines a “short-term” lease as “a lease whose effective duration is 50 years or less”. The “effective duration” of a lease is its duration for the purpose of the lease premium rules. This may not be the same as the contractual duration. See commentary on sections 303 and 304.

Section 277: Lease premiums

1114.This section contains the basic rule for the amount treated as a receipt if a premium is paid on the grant of a short-term lease. It is based on sections 34(1), (6) and (7A) and 37(2) of ICTA.

1115.Section 34(1) of ICTA treats a landlord who receives a premium as receiving an amount by way of rent. Section 34(6) of ICTA treats a person other than a landlord who receives a premium as receiving income as a result of entering into a transaction within paragraph 1(2) of Schedule A in section 15(1) of ICTA.

1116.This section instead treats both landlords and non-landlords as entering into a transaction mentioned in section 264 of this Act (if the land to which the lease relates is in the United Kingdom) or section 265 of this Act (if the land to which the lease relates is outside the United Kingdom).

1117.Section 264 in Chapter 2 of Part 3 of this Act provides that a person’s UK property business consists of:

(a)every business which the person carries on for generating income from land in the United Kingdom, and

(b)every transaction which the person enters into for that purpose otherwise that in the course of such a business.

1118.Section 269(1) of this Act provides that the profits of a UK property business are charged to tax under Chapter 3 of Part 3 of this Act whether the business is carried on by a UK resident or a non- UK resident.

1119.Section 265 in Chapter 2 of Part 3 of this Act provides that a person’s overseas property business consists of:

(a)every business which the person carries on for generating income from land outside the United Kingdom, and

(b)every transaction which the person enters into for that purpose otherwise that in the course of such a business.

1120.Section 269(2) and (3) provides that the profits of an overseas property business are charged to tax under Chapter 3 of Part 3 of this Act only if the business is carried on by a UK resident but in the case of a UK resident to whom the remittance basis applies, only in respect of land in the Republic of Ireland.

1121.The effect of sections 264 and section 265 is that the transaction which subsection (2) of this section treats the person as entering will be included in the person's UK or overseas property business, or will constitute the person's UK or overseas property business if that person is not already carrying on such a business.

1122.The approach adopted in subsections (2) to (4) of section 277 is also followed in rewriting the rules on:

  • sums payable instead of rent in section 279;

  • sums payable for the surrender of a lease in section 280;

  • sums payable for the variation or waiver of the term of a lease in section 281;

  • assignments for profit of lease granted at undervalue in section 282;

  • sales with right to reconveyance in section 284; and

  • sale and leaseback transactions in section 285.

1123.Section 34(1) of ICTA treats rent treated as received by a landlord as received when the lease is granted. Section 34(7A) of ICTA provides that an amount treated as received as rent must be taken into account for the chargeable period in which it is treated as received. There is no corresponding rule for non-landlords in section 34(6).

1124.Subsection (3) requires the person to whom the premium is due (both landlord and non-landlord) to bring an amount into account in calculating the profits of the property business for the tax year in which the lease is granted. See Change 69 in Annex 1.

Section 278: Amount treated as lease premium where work required

1125.This section is based on section 34(2) and (3) of ICTA.

Section 279: Sums payable instead of rent

1126.This section deals with cases where a payment is made instead of rent for some or all of the duration of a lease. It is based on sections 34(1), (4), (6) and (7A) and 37(2) of ICTA.

1127.Section 34(1) of ICTA applies if the duration of the lease is not more than 50 years. But section 34(4)(a) of ICTA provides that any period other than that in relation to which the sum is payable in lieu of rent must be ignored in arriving at the duration of the lease. So for the purposes of section 34(4) of ICTA the duration of a lease cannot be longer than the period in respect of which the sum is payable instead of rent. Subsection (1) makes clear that –irrespective of the length of the lease – the payment of a sum instead of rent for a period of not more than 50 years is within the scope of this section. See Change 68 in Annex 1.

1128.Subsections (2) to (4) of this section are drafted on the same basis as subsections (2) to (4) of section 277.

1129.Subsection (2) treats a person to whom a sum is due instead of rent as entering into a transaction mentioned in section 264 (if the land to which the lease relates is in the United Kingdom) or section 265 (if the land to which the lease relates is outside the United Kingdom). The effect of sections 264 and 265 is that the transaction will be included in, or will constitute, the person's UK or overseas property business.

1130.Section 34(1) of ICTA treats income in the hands of a landlord as received when the lease is granted. There is no corresponding rule for non-landlords in section 34(6) of ICTA. This section instead requires the person carrying on the property business (whether or not that person is the landlord) to bring an amount into account in calculating the profits of that business for the tax year in which the sum instead of rent is payable. See Change 69 in Annex 1.

1131.The formula in section 34(1) of ICTA calculates the amount treated as received by way of rent by reference to the duration of the lease. Section 34(4)(a) of ICTA says that in computing the profits of the business any period other than that in respect of which the sum is paid instead of rent must be ignored. So in calculating the amount to be treated as rent in respect of a sum within section 34(4) of ICTA, the duration of the lease for the purposes of the formula in section 34(1) of ICTA must be adjusted in accordance with section 34(4)(a) of ICTA.

1132.Subsection (6) combines the requirements at sections 34(1) and (4)(a) of ICTA so that the period used in the formula in subsection (5) is the shorter of the period for which the payment is made and the period from the beginning of that period to the end of the effective duration of the lease.

Section 280: Sums payable for surrender of lease

1133.This section deals with cases where a sum is payable for the surrender of a lease. It is based on sections 34(1), (4), (6) and (7A) and 37(2) of ICTA.

1134.Subsections (2) to (4) of this section are drafted on the same basis as subsections (2) to (4) of section 277.

1135.Subsection (2) treats a person to whom a sum is due as consideration for the surrender of the lease as entering into a transaction mentioned in section 264 (if the land to which the lease relates is in the United Kingdom) or section 265 (if the land to which the lease relates is outside the United Kingdom). The effect of sections 264 and 265 is that the transaction will be included in, or will constitute, the person's UK or overseas property business.

1136.Section 34(1) of ICTA treats income in the hands of a landlord as received when the lease is granted. There is no corresponding rule for non-landlords in section 34(6) of ICTA. This section instead requires the person carrying on the property business (whether or not that person is the landlord) to bring an amount into account in calculating the profits of that business for the tax year in which the sum for the surrender of the lease is payable. See Change 69 in Annex 1.

Section 281: Sums payable for variation or waiver of term of lease

1137.This section deals with the case where a payment is made for the variation or waiver of any of the terms of a lease. It is based on section 34(1), (5), (6), (7) and (7A) of ICTA.

1138.Section 34(1) of ICTA applies if the duration of the lease is not more than 50 years. Section 34(5)(a) of ICTA provides that any period before or after the period for which the variation or waiver has effect must be ignored in arriving at the duration of the lease. So for the purposes of section 34(4) of ICTA, the duration of a lease cannot be longer than the period for which the variation or waiver has effect. Subsection (1) makes clear that – irrespective of the length of the lease – the payment of a sum as consideration for the variation or waiver of the terms of a lease for a period of not more than 50 years is within the scope of this section. See Change 68 in Annex 1.

1139.Section 34(6) of ICTA says that sums due to a person other than a landlord under:

  • section 34(1) of ICTA (premiums);

  • section 34(4) of ICTA (sums payable instead of rent or for the surrender of a lease); and

  • section 34(5) of ICTA (sums payable for the variation or waiver of the terms of a lease),

are charged on that person.

1140.Section 34(7) of ICTA disapplies section 34(6) of ICTA if the payment is due to a person not connected with the landlord. But section 34(7) of ICTA does not explicitly set aside the requirement in section 34(5) of ICTA to treat sums payable for the variation or waiver of the terms of a lease as the payment of a premium to the landlord if that payment is made to a person unconnected with the landlord. So it is not clear whether section 34(6) of ICTA catches a person unconnected with the landlord who receives a consideration in connection with the variation or waiver of the terms of a lease (eg a person living above a shop who receives a payment in consideration of the landlord waiving a term in the shop lease which restricts the hours during which the shop may open).

1141.Subsection (1) deals with this by providing that this section applies only if the sum is due to the landlord or a connected person. “Connected person” is defined in section 839 of ICTA (see section 878(5) of this Act). See Change 70 in Annex 1.

1142.Subsections (2) to (4) of this section are drafted on the same basis as subsections (2) to (4) of section 277.

1143.Subsection (2) treats a person to whom a sum is due as consideration for the variation or waiver of the terms of a lease as entering into a transaction mentioned in section 264 (if the land to which the lease relates is in the United Kingdom) or section 265 (if the land to which the lease relates is outside the United Kingdom). The effect of sections 264 and 265 is that the transaction will be included in, or will constitute, the person's UK or overseas property business.

1144.Section 34(1) of ICTA treats income in the hands of a landlord as received when the lease is granted. There is no corresponding rule for non-landlords in section 34(6) of ICTA. This section instead requires a person carrying on the property business (whether or not that person is the landlord) to bring an amount into account in calculating the profits of that business for the tax year in which the sum is payable. See Change 69 in Annex 1.

1145.Section 37(2) of ICTA provides for the reduction of amounts treated as rent under section 34 or 35 of ICTA which arise in respect of the “grant or disposition” of a lease. It is arguable that section 37(2) of ICTA does not apply to an amount treated as income under section 34(5) of ICTA in respect of a sum payable for the variation or waiver of the terms of a lease because the amount does not arise in respect of the grant or disposition of a lease.

1146.Section 287(1) extends relief under section 288 to receipts in respect of sums payable for variation or waiver. This is reflected in subsection (5) of this section. See Change 71 in Annex 1.

1147.The formula in section 34(1) of ICTA calculates the amount treated as received by way of rent by reference to the duration of the lease. Section 34(5)(a) of ICTA says that in computing the profits of the business any period other than that in relation to which the variation or waiver has effect must be ignored. So in calculating the amount to be treated as rent in respect of a sum within section 34(5) of ICTA, the duration of the lease for the purposes of the formula in section 34(1) of ICTA must be adjusted in accordance with section 34(5)(a) of ICTA.

1148.Subsection (6) combines the requirements in section 34(1) and (5)(a) of ICTA so that the period used in the calculation is the shorter of the period for which the variation or waiver has effect and the period from the beginning of that period to the end of the effective duration of the lease.

Section 282: Assignments for profit of lease granted at undervalue

1149.This section treats a person who assigns, at a profit, a lease granted to him or her at less than its true value as receiving an amount calculated by reference to the smaller of the discount at which the lease was granted and the profit on the assignment. It is based on sections 35(1), (2) and (2A) and 37(2) of ICTA.

1150.Subsections (2) to (4) of this section are drafted on the same basis as subsections (2) to (4) of section 277.

1151.Subsection (2) treats a person who assigns the lease at undervalue as entering into a transaction mentioned in section 264 (if the land to which the lease relates is in the United Kingdom) or section 265 (if the land to which the lease relates is outside the United Kingdom). The effect of sections 264 and 265 is that the transaction will be included in, or will constitute, the person's UK or overseas property business.

1152.Section 35(2A) of ICTA treats income deemed to have been received under section 35 of ICTA as received when the consideration for the assignment of the lease becomes payable. This section instead brings an amount into account as a receipt in calculating the profits of the property business for the tax year in which the consideration for the assignment is payable. See Change 69 in Annex 1.

1153.The formula in subsection (4) for calculating the deemed receipt if there is an assignment at a profit is based on section 35(2) of ICTA (which refers back to the formula in section 34(1) of ICTA).

Section 283: Provisions supplementary to section 282

1154.This section is based on section 35(1) and (2) of ICTA.

Section 284: Sales with right to reconveyance

1155.This section brings a deemed receipt into account if property is sold on terms which provide for the property to be reconveyed to the seller, or to a connected person, at less than the sale price. It is based on section 36(1) and (4A) of ICTA.

1156.“Connected person” is defined in section 839 of ICTA (see section 878(5) of this Act).

1157.Section 36(1) of ICTA does not specify any limit on the time between sale and reconveyance. But because section 36(1) of ICTA reduces the amount of the deemed income by 1/50th for each complete year between sale and reconveyance, no charge arises if the property is reconveyed more than 51 years after the sale. So this section applies only if the period between sale and reconveyance is not more than 50 years. See Change 72 in Annex 1.

1158.Subsections (2) to (4) of this section are drafted on the same basis as subsections (2) to (4) of section 277.

1159.Subsection (2) treats the person who sells the land as entering into a transaction mentioned in section 264 (if the land to which the lease relates is in the United Kingdom) or section 265 (if the land to which the lease relates is outside the United Kingdom). The effect of sections 264 and 265 is that the transaction will be included in, or will constitute, the person's UK or overseas property business.

1160.Section 36(4A) of ICTA treats income deemed to have been received under section 36 of ICTA as received when the property is sold. This section instead brings an amount into account as a receipt in calculating the profits of the property business for the tax year in which the property is sold. See Change 69 in Annex 1.

1161.The formula in subsection (4) is based on section 36(1) of ICTA. Section 36(1) of ICTA deems the person by whom the property is sold to receive an amount equal to the excess, if any, of the sale price over the price at which the property is to be reconveyed or, if the earliest date on which the property can be reconveyed is two or more years after the sale, the excess reduced by 1/50th for each complete year between the sale and that date.

1162.If a property is reconveyed within two years of sale, the amount given by the formula in subsection (4) is equal to the excess of the sale price over the price at which the property is reconveyed. So it is not necessary to prescribe different rules for properties reconveyed before and after the two year period.

Section 285: Sale and leaseback transactions

1163.This section brings a deemed receipt into account if property is sold on terms which provide for the grant of a lease to the seller, or to a connected person, at less than the sum of any premium for the lease and the value on the date of sale of the right to lease back the property. It is based on section 36(1), (3), (4) and (4A) of ICTA.

1164.“Connected person” is defined in section 839 of ICTA (see section 878(5) of this Act).

1165.Section 36(1) of ICTA does not specify any limit on the time between sale and leaseback. But because section 36(1) of ICTA reduces the amount of the deemed income by 1/50th for each complete year between sale and leaseback, no charge arises if the property is leased back more than 51 years after the sale. So this section applies only if the period between sale and leaseback is not more than 50 years. See Change 72 in Annex 1.

1166.Subsections (3) to (5) of this section are drafted on the same basis as subsections (2) to (4) of section 277.

1167.Subsection (3) treats the person who sells the land as entering into a transaction mentioned in section 264 (if the land to which the lease relates is in the United Kingdom) or section 265 (if the land to which the lease relates is outside the United Kingdom). The effect of sections 264 and 265 is that the transaction will be included in, or will constitute, the person's UK or overseas property business.

1168.Section 36(4A) of ICTA treats income deemed to have been received under section 36 of ICTA as received when the property is sold. This section instead brings an amount into account as a receipt in calculating the profits of the property business for the tax year in which property is sold. See Change 69 in Annex 1.

1169.The formula in subsection (5) is based on section 36(1) and (3) of ICTA. Section 36(1) of ICTA, as adapted by section 36(3) of ICTA, deems the person by whom the property is sold to receive an amount equal to the excess, if any, of the sale price over the sum of any premium for the lease and the value on the date of sale of the right to lease back the property or, if the earliest date on which the property can be leased back is two or more years after the sale, the excess reduced by 1/50th for each complete year between the sale and that date.

1170.If a property is leased back within two years of sale, the amount given by the formula in subsection (5) is equal to the excess of the sale price over the sum of any premium for the lease and the value on the date of sale of the right to lease back the property. So it is not necessary to prescribe different rules for calculating the amount of the receipt for properties leased back before and after the two year period.

Section 286: Provisions supplementary to sections 284 and 285

1171.This section is based on section 36(2)(a), (3) and (4B) of ICTA.

Section 287: Circumstances in which additional calculation rule applies

1172.This section and the next eight sections (all based on section 37 of ICTA) contain special rules giving a tenant relief by reference to the amount of a premium or other sum brought into account as a receipt in calculating the profits of a property business of his or her landlord under section 277 or sections 279 to 282:

  • sections 287 to 290 provide for the amount of a premium or other sum brought into account as a receipt in the hands of a tenant who is also a landlord to be reduced if the tenant’s own landlord has received a premium or other amount within section 277 or sections 279 to 282 in respect of the same property;

  • sections 291 to 294 allow a tenant under a lease in respect of which the landlord has received a premium or other amount within section 277 or sections 279 to 282 a deduction in calculating the profits of any property business carried on by the tenant; and

  • section 295 caps the total relief which can be given by reference to a premium or other sum brought into account in calculating the profits of a property business under section 277 or sections 279 to 282 to the amount of that receipt.

1173.Section 287 is based on section 37(1), (2), (3) and (9) of ICTA.

1174.Section 37(2) of ICTA provides for the reduction of amounts treated as rent under section 34 or 35 of ICTA which arise in respect of the “grant or disposition” of a lease. But section 37(2) does not provide for the reduction of an amount in respect of a sum paid under section 34(5) for the variation or waiver of the terms of a lease because a variation or waiver is not in respect of the grant or disposition of a lease. This section extends relief to payments for variation or waiver. See Change 71 in Annex 1.

1175.The definitions of “taxed lease” and “taxed receipt” in subsection (4) are based on the definitions of “head lease” and “amount chargeable on the superior interest” in section 37(1) of ICTA.

1176.Section 37(9) of ICTA contains the following prohibition against excess relief:

An amount or part of an amount shall not be deducted under this section more than once from any sum, or from more than one sum, and shall not in any case be so deducted if it has been otherwise allowed as a deduction in computing the income of any person for tax purposes.

1177.But section 37 of ICTA does not give rules for calculating deductions if there is more than one premium under section 34 of ICTA, or more than one amount treated as a premium under section 35 of ICTA, and gives taxpayers no guidance as to how deductions under section 37 of ICTA are to be calculated in order not to breach the limit in section 37(9) of ICTA.

1178.Subsection (5) stipulates that for section 288 to apply there must be at least one taxed receipt with an “unused amount”. See Change 73 in Annex 1.

1179.Amounts within section 278 (amount treated as lease premium where work required) are not specified separately in this section, or in section 288, because section 278(2) treats such amounts as premiums within section 277.

Section 288: The additional calculation rule

1180.This section provides for the amount of a receipt calculated under section 277 or sections 279 to 282 of this Act to be reduced if there is an earlier taxed receipt in relation to the same property. It is based on section 37(2), (3), (7) and (9) of ICTA.

1181.The amount to be reduced is referred to in this section, and in section 289, as “the receipt under calculation”.

1182.Section 37(2) of ICTA provides for the reduction of amounts treated as rent under section 34 or 35 of ICTA which arise in respect of the “grant or disposition” of a lease. But section 37(2) of ICTA does not provide for the reduction of an amount in respect of a sum paid under section 34(5) of ICTA for the variation or waiver of the terms of a lease because a variation or waiver is not in respect of the grant or disposition of a lease.

1183.Section 287 extends relief to payments for variation or waiver. This is reflected in the reference to section 281 in subsection (2) of this section. See Change 71 in Annex 1.

1184.This section introduces the label “basic relieving amount” for the amount by which the receipt under calculation is to be reduced.

1185.Subsection (3) requires the basic relieving amount to be restricted under section 289(5) so that it does not exceed the amount of the receipt under calculation. This means that if the basic relieving amount exceeds the amount of the later taxed receipt, the excess is not available to offset against other receipts. See Change 73 in Annex 1.

1186.If there is more than one taxed receipt by reference to which the receipt under calculation may be reduced, it is for the person entitled to the relief to decide the order in which relief is to be taken by reference to those receipts. And where a basic relieving amount has been calculated by reference to more than one taxed receipt, subsection (3) provides for the total of the basic relieving amounts to be restricted under section 289(5) .

1187.The use of the “unreduced amount” of the taxed receipt (defined in section 290(2) of this Act) in the formula in subsection (4) makes clear that the basic relieving amount by reference to a taxed receipt is to be calculated according to the amount of that receipt before any reductions or deductions.

1188.The definition of “receipt period” in relation to a receipt under section 277 and sections 279 to 282 in subsection (6) is based on the definition of “the period in respect of which an amount arose” in section 37(7)(b) of ICTA.

Section 289: The additional calculation rule: special cases

1189.This section modifies the rule in section 288 for cases within sections 277 to 281 if a sub-lease is granted in respect of part only of the premises subject to the taxed lease. It is based on section 37(2), (3) and (9) of ICTA.

1190.Section 37(2) of ICTA provides for the reduction of amounts treated as rent under section 34 or 35 of ICTA which arise in respect of the “grant or disposition” of a lease. But section 37(2) of ICTA does not provide for the reduction of an amount in respect of a sum paid under section 34(5) of ICTA for the variation or waiver of the terms of a lease because a variation or waiver is not in respect of the grant or disposition of a lease.

1191.Section 287 extends relief to amounts brought into account in respect of sums payable for the variation or waiver of the terms of a lease. This is reflected in the reference in subsection (2) of this section to the receipt under calculation “under any of sections 277 to 281”. See Change 71 in Annex 1.

1192.But this section does not apply to receipts under section 282 (assignments for profit of lease granted at undervalue) because it is not possible for a lease to be assigned other than in respect of the whole of the premises subject to the lease.

1193.Section 37(3) of ICTA requires a “just apportionment” of the amount chargeable on the superior interest to be made if the whole of the premises are not subject to the lease. This section instead requires the basic relieving amount by reference to a taxed receipt to be calculated by reference to the fraction of the premises which is subject to the lease calculated on a “just and reasonable basis”. See Change 14 in Annex 1.

1194.Subsection (4) restricts the reduction calculated under section 288(4) or subsection (2) of this section to the “unused amount” of the taxed receipt by reference to which it is calculated. This is based on the general prohibition against excess relief in section 37(9) of ICTA. See Change 73 in Annex 1.

Section 290: Meaning of “unused amount” and “unreduced amount”

1195.This section is based on section 37(1), (8) and (9) of ICTA.

1196.The “unused amount” of a taxed receipt is defined in subsections (1) and (5). See Change 73 in Annex 1.

Section 291: Deductions for expenses under section 292

1197.This section and the next three sections give a tenant relief in calculating the profits of his or her property business by reference to the amount of the premium or other sum brought into account by the landlord (the “taxed receipt”) in respect of the same property. This section is based on section 37(4) and (9) of ICTA.

1198.Section 37(4) of ICTA treats a tenant under a lease in respect of which a chargeable amount arose under section 34 or 35 of ICTA as paying rent for the purpose of computing the profits of a Schedule A business.

1199.A deduction for rent which a tenant is treated as paying under section 37(4) of ICTA is allowed only in respect of premises used in the Schedule A business. So subsection (2) provides that a deduction for an expense which a tenant is treated as incurring under section 292 is allowed for each “qualifying day” on which all or part of the premises subject to the taxed lease is either occupied for the purposes of the tenant’s property business or is sublet.

1200.A “qualifying day” is defined in section 292(3) as a day which falls within the receipt period of the taxed receipt.

1201.The amount which the tenant can deduct in respect of the rent which he or she is treated as paying under section 37(4) of ICTA is qualified by:

  • the general rules as to deductions not allowable in computing the profits of a trade in section 74(1) of ICTA; and

  • rules prohibiting or restricting the deduction of expenditure elsewhere in ICTA.

1202.In this Act, the rules restricting deductions are in Part 2 of Chapter 4. Section 74(1)(a) of ICTA is rewritten in section 34. Subsection (3) of this section preserves the interaction of section 37(4) of ICTA and the general and specific rules restricting deductions in ICTA by providing that a deduction for an expense which a tenant is treated as incurring under section 292 is subject to the application of any provisions of Chapter 4 of Part 2 of this Act.

1203.Subsection (4) provides that the deduction allowed in respect of an expense under section 292 may be restricted to prevent the cap in section 295 on the total relief which can be given by reference to a taxed receipt being exceeded. See Change 73 in Annex 1.

Section 292: Tenants under taxed leases treated as incurring expenses

1204.This section sets out the method of calculating the expense for which a deduction may be allowed under section 291. It is based on section 37(4) of ICTA.

1205.Section 37(4) of ICTA treats a tenant as paying rent for the purposes of making deductions in respect of the expenses of his or her Schedule A business. In this section, the tenant is treated instead as incurring an expense for each qualifying day in the receipt period of the taxed receipt. This corresponds to the treatment of premiums and other sums payable in respect of leases in section 277 and sections 279 to 282 of this Act, and of amounts treated as receipts in sections 284 and 285 of this Act, as amounts to be brought into account in calculating the profits of a property business rather than as rent.

1206.The formula in subsection (4) calculates the expense for each qualifying day by spreading the amount of the taxed receipt evenly over the receipt period of that receipt. Defining “A” in that formula as “the unreduced amount of the taxed receipt” makes clear that the amount of the expense which the tenant is treated as incurring for each qualifying day is calculated by reference to the amount of the taxed receipt before any reductions or deductions.

Section 293: Restrictions on section 292 expenses: the additional calculation rule

1207.This section supplements section 292 where a tenant is entitled under section 288 to a reduction in a receipt within section 277 or sections 279 to 282. It is based on section 37(5) of ICTA.

1208.If an amount treated under section 34 or 35 of ICTA as income of a Schedule A business has been reduced under section 37(2) of ICTA, a tenant is entitled under section 37(5) of ICTA to a deduction in respect of deemed rent under section 37(4) of ICTA only if the appropriate fraction of the amount chargeable on the superior interest exceeds the later chargeable amount. The deduction is then allowed in the same proportion as the excess bears to the appropriate fraction of the amount chargeable on the superior interest.

1209.This section provides instead for a tenant to be treated as incurring an expense for a qualifying day under section 292 only to the extent that the “daily amount of the taxed receipt” exceeds the “daily reduction of the lease premium receipt”.

1210.The daily amount of the taxed receipt and the daily reduction of the lease premium receipt are calculated according to the formulas in subsection (6):

  • the formula for calculating the daily amount of the taxed receipt is the same formula used in section 292(4) to calculate the amount of the expense which the tenant is treated as incurring for each qualifying day; and

  • the formula for calculating the daily reduction of the lease premium receipt spreads the reduction calculated under section 288 evenly over the receipt period of the lease premium receipt.

See Change 15 in Annex 1.

1211.It is not clear how the rule in section 37(5) of ICTA governing the interaction of section 37(2) and (4) of ICTA is intended to apply if there is more than one later chargeable amount falling to be reduced under section 37(2) of ICTA by reference to an amount chargeable on the superior interest or a later chargeable amount falls to be reduced under section 37(2) of ICTA by reference to more than one amount chargeable on the superior interest.

1212.Subsection (5) provides that where there is more than one lease premium receipt by reference to which the tenant may be treated as incurring an expense for the same qualifying day, the tenant is treated as incurring an expense for that day only to the extent that the daily amount of the taxed receipt exceeds the total of the daily reductions of each of the lease premium receipts. See Change 15 in Annex 1.

Section 294: Restrictions on section 292 expenses: lease of part of premises

1213.This section adapts sections 292 and 293 for cases where the tenant’s lease does not extend to the whole of the property in respect of which the landlord received a premium. It is based on section 37(6) of ICTA.

1214.Section 287(1) extends relief under 288 to sums payable for variation or waiver brought into account under section 281. This is reflected in subsection (1)(c) of this section. See Change 71 in Annex 1.

1215.Section 37(6) of ICTA says that where section 37(3) of ICTA applies (ie if the tenant’s lease extends to part only of the premises subject to the landlord’s lease) section 37(4) and (5) of ICTA are to be applied separately to that part of the premises subject to the tenant’s lease and to the rest of the premises. But it is not clear how the rule in section 37(6) of ICTA is intended to apply if the premises subject to the landlord’s lease are subject to more than one sublease in respect of different parts of those premises.

1216.Subsection (3) applies sections 292 and 293 separately to that part of the premises which is subject to the tenant’s lease and to the remainder of the premises. And subsection (4) deals with the case where there is more than one sublease which does not extend to the whole of the landlord’s premises. See Change 15 in Annex 1.

1217.Subsection (5) adapts sections 292 and 293 where the lease does not extend to the whole of the premises by multiplying the unreduced amount of the taxed receipt (“A”) by the fraction of the premises to which the sublease relates in the formulas for calculating:

  • the expense for a qualifying day in section 292(4); and

  • the daily amount of the taxed receipt in section 293(6).

1218.Section 37(6) of ICTA requires the amount chargeable on the superior interest to be “proportionately adjusted” where the tenant’s lease does not extend to the whole of the premises. This section instead requires the fraction in subsection (5) to be calculated “on a just and reasonable basis”. See Change 14 in Annex 1.

Section 295: Limit on reductions and deductions

1219.This section is based on the general prohibition against excess relief in section 37(9) of ICTA. It restricts total relief allowed by reference to a taxed receipt by way of:

  • reductions under the additional calculation rule in section 288 in the amount brought into account by a tenant who is also a landlord; and

  • deductions in calculating the profits of a tenant’s property business under section 292,

to the amount of the taxed receipt after any deductions calculated by reference to that receipt for expenses incurred under section 61 of this Act in calculating the profits of a tenant who uses the property subject to the lease for the purposes of his or her trade. See Change 73 in Annex 1.

Section 296: Corporation tax receipts treated as taxed receipts

1220.This section and the next two sections ensure that a tenant is entitled to relief under sections 287 to 295 by reference to an amount treated under section 34 or 35 of ICTA as a receipt of a Schedule A business, or an overseas property business, of a landlord liable to corporation tax in the same way as if the landlord was liable to income tax on an equivalent amount as a receipt of his or her property business under sections 277 to 282.

1221.This section adapts certain concepts used in sections 287 to 290 to give relief by reference to an amount taken into account for income tax purposes under sections 277 to 282 to give relief by reference to amounts treated as receipts under section 34 or 35 of ICTA for the purposes of corporation tax. The section is new.

1222.Section 37(1) of ICTA refers to an amount treated as a receipt of a Schedule A business under section 34 or 35 of ICTA, or which would be so treated other than for relief under section 37(2) or (3) of ICTA, as “the amount chargeable on the superior interest”. The “superior interest” is the interest in the property held by the tenant's immediate landlord.

1223.Paragraph 20 of Schedule 1 to this Act amends section 37(1) of ICTA by extending the definition of “the amount chargeable on the superior interest” to include any amount treated as a receipt of a property business under sections 277 to 282 of this Act, or which would be treated as such a receipt other than for relief under the additional calculation rule in section 288 of this Act.

Section 297: Taking account of reductions in corporation tax receipts

1224.This section is new. It ensures that any relief given for corporation tax purposes under section 37(2) or (3) of ICTA for an accounting period ending after 5 April 2005 to a tenant who is also a landlord by reference to:

  • a receipt brought into account under this Chapter where the tenant's landlord is liable to income tax; or

  • a receipt brought into account under section 34 or 35 of ICTA where the tenant's landlord is liable to corporation tax,

is taken into account in the same way as any relief under sections 287 to 290 of this Act.

1225.Subsections (1) and (2) refer to a reduction under section 37(2) or (3) of ICTA in “the amount chargeable on the superior interest”. The amount chargeable on the superior interest here refers to an amount:

  • treated as a receipt under section 34 or 35 of ICTA for any tax year; or

  • treated as a receipt under this Chapter for an accounting period ending after 5 April 2005 as a result of the amendments to section 37(1) of ICTA made under paragraph 20 of Schedule 1 to this Act.

Section 298: Taking account of deductions for rent as a result of section 37(4) or 87(2) of ICTA

1226.This section is new. It ensures that any deduction for corporation tax purposes for rent which a tenant is deemed to pay under section 37(4) or 87(2) of ICTA for an accounting period ending after 5 April 2005 by reference to:

  • a receipt brought into account by the landlord under this Chapter where the landlord is liable to income tax; or

  • a receipt brought into account by the landlord under section 34 or 35 of ICTA where the landlord is liable to corporation tax,

is taken into account in the same way as any deduction for an expense incurred under sections 61 or 292 of this Act.

1227.Subsections (3) and (4) refer to amounts treated as rent under section 37(4) of ICTA by reference to “the amount chargeable on the superior interest”. The amount chargeable on the superior interest here refers to an amount:

  • treated as a receipt under section 34 or 35 of ICTA for any tax year; or

  • treated as a receipt under this Chapter for an accounting period ending after 5 April 2005 as a result of the amendments to section 37(1) of ICTA made under paragraph 20 of Schedule 1 to this Act.

Section 299: Payment of tax by instalments

1228.This section is based on section 34(8) of ICTA.

1229.Section 34(8) of ICTA entitles a taxpayer who receives an amount chargeable to tax under section 34 of ICTA in instalments to pay the tax chargeable by reference to that amount “by such instalments as the Board may allow…”. Section 832(1) of ICTA defines “the Board” as the Commissioners of Inland Revenue.

1230.This section instead attributes the power to determine the amount and timing of the instalments to “the Inland Revenue”. “The Inland Revenue” is defined in section 878(1) of this Act as “any officer of the Board of Inland Revenue”. See Change 149 in Annex 1.

Section 300: Statement of accuracy for purposes of section 282

1231.This section is based on section 35(3) of ICTA.

1232.Section 35(3) of ICTA requires “the inspector” to certify the accuracy of a statement submitted to him or her showing the amount of a chargeable receipt (if any) on the assignment of a lease granted at undervalue if he or she is satisfied as to the statement’s accuracy. “Inspector” is defined in section 832(1) of ICTA as “any inspector of taxes”.

1233.This section provides instead for the statement to be submitted to, and certified by “the Inland Revenue”. “Inland Revenue” is defined in section 878(1) of this Act as “any officer of the Board of Inland Revenue”. See Change 149 in Annex 1.

Section 301: Claim for repayment of tax payable by virtue of section 284

1234.This section provides that if a property is reconveyed on a date other than the date by reference to which tax was paid under section 284 of this Act, the seller must be repaid the difference between the tax paid and the tax which would have been due if the tax had been calculated on the basis of the actual date of reconveyance. It is based on section 36(2)(b) of ICTA.

Section 302: Claim for repayment of tax payable by virtue of section 285

1235.This section provides that if a lease is granted on a date other than the date by reference to which tax was paid under section 285 of this Act, the seller must be repaid the difference between the tax paid and the tax which would have been due if the tax had been calculated on the basis of the actual date on which the lease was granted. It is based on section 36(2)(b) and (3) of ICTA.

Section 303: Rules for determining effective duration of lease

1236.This section contains the rules for determining the effective duration of a lease. It is based on section 38(1) and (6) of ICTA.

1237.Subsection (1) sets out various circumstances in which a lease may be treated as ceasing other than on the date specified in the lease. Rules 1, 2 and 3 in subsection (1) are based on section 38(1)(a), (1)(b) and (1)(c) of ICTA respectively.

Section 304: Applying the rules in section 303

1238.This section is based on section 38(2), (3) and (4) of ICTA.

1239.Section 38(4) of ICTA refers to benefits conferred and payments made for the purposes of securing a tax advantage “in the application of this Part”. Section 38 of ICTA is in Part 2 of ICTA (provisions relating to the Schedule A charge), which consists of sections 21 to 43G of ICTA.

1240.Other than the lease premiums rules in sections 34 to 39 of ICTA, the sections of Part 2 of ICTA which are in force are sections 21 to 21C (calculation of the profits of a Schedule A business), section 24 (construction of Part 2), section 30 (sea walls), sections 31A and 31B (deductions for expenditure by landlords on energy-saving items), section 40 (receipts and outgoings on sale of land), section 42 (appeals against determinations under sections 34 to 36), section 42A (regulations about non-residents) and sections 43A to 43G (rent factoring).

1241.It is considered that the only tax advantage that could be secured in the context of section 38(4) of ICTA would be under sections 34 to 39 of ICTA. So subsection (4) refers instead to a tax advantage “in the application of this Chapter or sections 34 to 39 of ICTA”.

Section 305: Information about effective duration of lease

1242.This section is based on section 38(5) of ICTA.

1243.Section 38(5) of ICTA says that an inspector may issue a notice requiring a person having information relevant to ascertaining the duration of a lease to supply that information within a specified time. “Inspector” is defined in section 832(1) of ICTA as “any inspector of taxes”.

1244.This section provides instead for a notice to be issued by “the Inland Revenue”. “Inland Revenue” is defined in section 878(1) of this Act as “any officer of the Board of Inland Revenue”. See Change 149 in Annex 1.

Section 306: Provisions about premiums

1245.This section is based on section 24(2), (3) and (4) of ICTA. The definitions in section 24(2) to (4) of ICTA are rewritten in this Chapter as they apply only to the lease premiums rules.

Section 307: Interpretation

1246.This section is based on section 24(1), (4) and (5) of ICTA.

1247.Subsection (1) defines “premium” so as to include payments to a person “connected with” the landlord. “Connected person” is defined in section 839 of ICTA (see section 878(5) of this Act).

Chapter 5: Profits of property businesses: other rules about receipts and deductions
Overview

1248.This Chapter contains provisions that supplement the basic calculation rules in Chapter 3 of this Part of the Act.

1249.The provisions in this Chapter are about particular receipts or more unusual circumstances.

Section 308: Furnished lettings

1250.This section brings the “letting” of furniture, when it is part and parcel of the letting of accommodation, within the property income charge. It is based on sections 15 and 65A of ICTA.

1251.Without this provision, rent paid for use of the furniture in furnished lettings would not be included in the property income charge because the “rent” for the furniture does not derive from land.

1252.The purpose ofsubsection (1)(b) is to make it clear that related revenue expenses such as the expenses of repair and insurance of the furniture are deductible in calculating the profits of the property business.

1253.Subsection (2) excludes income and expenses where the hiring of the furniture is not simply incidental to exploiting an interest in land.

1254.Subsection (4) refers to a “caravan and a houseboat”. There is a new Act-wide, uniform definition of “caravan”: see the commentary on section 875 and Change 148 in Annex 1.

1255.There is also a new Act-wide, uniform definition of “houseboat”: see the commentary on section 878(1) and Change 150 in Annex 1.

Section 309: Rent-a-room relief

1256.This section modifies the normal profit calculation rules in Part 3 of this Act when a property business consists of, or includes, rent-a-room lettings as defined in Chapter 1 of Part 7 of this Act. It is new.

1257.When the lettings meet the conditions for rent-a-room relief in Part 7 of this Act the income from these lettings may, depending on the total amount, either be exempt from tax or subject to a special calculation rule. This section ensures that the rent-a-room rules take priority over the usual calculation rules in the property income Part.

Section 310: Acquisition of business: receipts from transferor’s UK property business

1258.This section taxes certain receipts when a continuing UK property business is transferred from one person to another along with the right to receive future business sums to which the transferor is entitled. It is based on sections 21B and 106 of ICTA.

1259.Subsection (1) sets out the circumstances in which the section applies and states the three conditions necessary for it to apply.

1260.Subsection (2) treats the “sum” received as a receipt of the property business. As this rule affects the calculation of the profits of a property business it appears in this Chapter rather than with the post-cessation receipt rules of which, in the source legislation, it forms part.

1261.The source legislation applies “for all purposes”. This section applies for income tax purposes. Section 106(2) of ICTA (as amended by paragraph 85 of Schedule 1 to this Act) applies for corporation tax purposes. Section 37(1) of TCGA ensures that any sums received as a result of the transfer are not charged to capital gains tax.

1262.Subsection (3) makes it clear that these sums are not post-cessation receipts.

Section 311: Reverse premiums

1263.This section sets out the rules for taxing reverse premiums as receipts of a property business. It is based on Schedule 6 to FA 1999.

1264.Subsection (1) refers to a “reverse premium”. In accordance with subsection (6) that expression has the same meaning as in section 99. So this section applies to reverse premiums excluding any of the “excluded cases” within section 100. The subsection also excludes any reverse premium that is charged to tax as a trade receipt by section 101.

1265.Subsections (2) and (3) bring the reverse premium within the scope of the property income rules. The subsections treat the recipient as entering into a transaction for generating income from land (see sections 264 and 265). So, even if the recipient is not already carrying on a property business, the reverse premium is treated as a receipt of a property business.

1266.If a property business is deemed to be carried on, it is a UK property business if the land is in the United Kingdom or an overseas property business if the land is outside the United Kingdom. So the territorial restrictions on the scope of the charge in section 269 for non-resident or remittance basis persons may apply.

1267.Paragraph 72 of Schedule 2 to this Act rewrites the transitional provision in section 54(2) of FA 1999. These sections do not apply to pre-1999 reverse premiums.

Section 312: Deduction for expenditure on energy saving items

1268.This section provides a deduction for certain expenditure on energy saving items where that expenditure would not otherwise be allowable because it is capital. It is the first of three sections that are based on sections 31A and 31B of ICTA.

1269.The source legislation is a closely targeted relieving provision that provides for a deduction for specified energy-saving items installed in let residential property. It applies to all income tax payers including:

  • non-resident companies liable to income tax;

  • those with lettings of overseas property, the income from which is charged in the source legislation under Schedule D, Case V; and

  • income tax paying members of partnerships.

1270.But it is not available in respect of “rent-a-room” properties or furnished holiday lettings (see Part 7 of this Act).

1271.Subsection (1) sets out the basic conditions. Subparagraph (a) makes it clear that relief is available only against property business income in respect of a let dwelling house. “Dwelling house” is not a defined term so it takes its ordinary meaning.

1272.Subsection (1)(c) states the date by which the expenditure must be incurred. Expenditure incurred before that date (and on or after 6 April 2004) is deductible in what is the appropriate period of account on normal accountancy principles.

1273.Subsection (1)(d) states the essence of the relief: it is for expenditure that is incurred wholly and exclusively for the purposes of the property business but which would not otherwise be allowable because it is capital expenditure.

1274.Subsection (2) provides for the deduction and in so doing introduces a change. In the source legislation the relief is given only when a formal claim is made. Section 312 provides for the relief as a simple deduction in calculating the profits of the property business that includes the dwelling house in question. See Change 74 in Annex 1.

1275.Subsection (4) allows an apportionment of the expenditure where only part of it, for whatever reason, falls within the scope of the relief. Examples are when only a part of a single amount of capital expenditure is incurred on qualifying energy saving items or when part of the otherwise qualifying capital expenditure is incurred on a let building other than a dwelling house.

Section 313: Restrictions on relief

1276.This section imposes certain restrictions on the relief that would otherwise be due under section 312. It is based on sections 31A and 31B of ICTA.

1277.Subsection (2) prevents relief when the expenditure is simply part of the build cost of a new property or the purchase price of an acquired one.

1278.Subsection (3) prevents relief in respect of let property that is within Chapter 6 of Part 3 of this Act (commercial letting of furnished holiday accommodation). It makes explicit two aspects that are only implicit in section 31A(11) of ICTA.

1279.The first is that section 31A(11) of ICTA excludes any properties (a) that meet the definition of “commercial letting of furnished holiday accommodation” in section 504 of ICTA and (b) could therefore benefit from the concessions that section 503 of ICTA offers even if they do not, in fact, do so.

1280.The second is that it makes clear the duration of the exclusion. The purpose of the source legislation is to prevent people getting the relief if they are using the property for furnished holiday lettings. A property falls within section 504(4) of ICTA for a year of assessment. Because of the stringency of the conditions in section 504 of ICTA the property can drop in and out of qualifying section 504 of ICTA status from one year to the next. The restriction on relief under these provisions is intended to apply only if the expenditure is incurred in a year of assessment for which the property is within section 504 of ICTA (as described in the previous paragraph) and only for that or those years. So section 313(3) refers specifically to “the tax year”.

1281.Subsection (4) makes it clear that the relief cannot apply when rent-a-room relief is given (see Chapter 1 of Part 7 of this Act). This prohibition does not apply however if neither form of rent-a-room relief is, in fact, taken.

1282.Subsection (5) adapts the general preliminary expenditure deduction rules to the specific circumstances of this relief: the expenditure window is reduced to prevent claims in respect of past expenditure when the dwelling may have been the landlord’s own home and it is later let.

Section 314: Regulations

1283.This section provides for the Treasury’s powers to make regulations for the purposes stated. It is based on section 31A(13) of ICTA.

1284.The relief applies potentially to all income tax payers, including those non-resident companies liable to income tax. Subsection (2) reflects, among other things, the fact that it is not available to companies in respect of their liability to corporation tax.

Section 315: Deduction for expenditure on sea walls

1285.This is the first of four sections that provide relief to a landlord for expenditure on making a sea wall or other embankment to protect let premises against flooding by the sea or a tidal river. They are based on section 30 of ICTA.

1286.Section 315 states the circumstances under which the relief is given. It is based on sections 30 and 65A of ICTA.

1287.Subsection (1)(b) states the subject of the relief. Repair and maintenance of an existing sea wall normally qualify for relief as revenue expenses of a property business but the making of a new wall is capital expenditure and would not qualify for relief without special provision.

1288.Subsection (2) makes it clear that to obtain a deduction for seawalls expenditure, the person carrying on the property business and the person incurring the seawalls expenditure must be the same person. This may appear to be stating the obvious but section 30(1) of ICTA says merely that the person incurring the expenditure is treated as making a payment “for the purpose of computing the profits of any Schedule A business carried on in relation to those premises” (emphasis added). This cannot be taken literally to mean any such business carried on by someone other than the person incurring the expenditure. There would be no point in deeming the payment to be made by that person if it were otherwise. And the provisions on transfer of interests in section 30(2) and (3) of ICTA reflect the notion that the deemed payment, and hence the right to relief, moves from the former owner to the transferee. There is no suggestion of involvement by any other party.

1289.Subsection (3) defines the “deduction period” referred to in subsection (2). Qualifying expenditure is deducted over 21 years in calculating the profits of the property business. The “deduction period” is comparable to the “writing-down period” over which expenditure qualifying for capital allowances is written off. This reflects the similarity between the relief given by the sea walls provisions and certain capital allowances provisions. The relief is for expenditure which would otherwise be capital in nature. And the expenditure is not relieved all at once but over a period, even if there are changes in the person who obtains the relief.

Section 316: Transfer of interest in premises

1290.This section deals with the case where the person who incurred the sea walls expenditure sells the premises during the 21 year period over which the deduction is due. It is based on section 30(2) and 30(3) of ICTA.

1291.Subsection (1) applies to transfers of the relevant interest “whether by operation of law or otherwise”. These words derive directly from the source legislation. They ensure that the provision applies to, for example, successions to estates as well as the sort of merger of interests envisaged in section 317.

1292.Subsection (2)(b) requires any apportionment to be “just and reasonable” whereas section 30(2)(a) of ICTA refers simply to an apportionment that is “just”. This change reflects the approach that was adopted in CAA and which has been followed in similar contexts elsewhere for consistency. There is no practical difference between the two forms of words. See Change 14 in Annex 1.

1293.Subsection (5) makes explicit what is merely implicit in the source legislation, namely, the extent of the transferor’s entitlement to a deduction in subsequent years. In particular, subsection (5)(a) makes it clear that if the transfer is of only part of the premises, the transferor continues to be entitled to a deduction in relation to the part not transferred.

Section 317: Ending of lease of premises

1294.This section deals with the case where the sea walls expenditure is incurred by a lessee and the lease comes to an end before the end of the deduction period. It is based on section 30(3) of ICTA.

1295.The cases to which subsection (3) applies include renewals of the lease to the same person. Then the deduction passes to the immediate reversioner.

1296.In the source legislation “lease” is defined for the purposes of the sea walls provisions in section 24(6)(a) of ICTA. But that definition is redundant and, since it no longer applies to any other provisions, is not rewritten in this Act. It is redundant in the sea walls context for the following reasons.

1297.Section 24(6)(a) of ICTA defines references to a lease as extending only to a lease conferring a right, as against the person whose interest is subject to the lease, to the possession of the premises. It originated as paragraph 16 of Schedule 4 to FA 1963. Notes on Clauses to FA 1963 explain that the reference to possession was to ensure that a “lease” in Schedule A and sections 25 to 31 of ICTA must be one of land and not of incorporeal hereditament. So a lease of sporting rights, or a right of way, would not be covered. However, Street v Mountford [1985], AC 809 established that a “lease” of land which does not confer on the tenant exclusive possession is not, in fact, a lease but a licence.

1298.Section 30(2) of ICTA does not explain the meaning of the transfer of the whole of a person’s interest in any premises or part of any premises. The transfer of the whole of a person’s interest is significant because it can lead to the transfer of entitlement to a deduction for sea walls expenditure. But entitlement to a deduction for sea walls expenditure does not arise anyway unless a person is the owner or tenant of premises. A lease which makes a person a tenant of premises is not a lease of an incorporeal hereditament. So, although section 30 of ICTA does not expressly exclude leases of incorporeal hereditaments, to the extent that they might cover leases of incorporeal hereditaments references to “leases” in that provision are simply redundant.

Section 318: Transfer involving company within the charge to corporation tax

1299.This section ensures that entitlement to a deduction for expenditure on seawalls continues properly when the interest in the premises is transferred between an income tax payer and a corporation tax payer. It is based on section 30(2) of ICTA.

1300.Entitlement to a deduction for expenditure on seawalls can be transferred with ownership of the premises. That transfer can be between an income tax payer and a corporation tax payer. Section 316 deals with transfers between income tax payers. But it cannot deal with a transfer from a corporation tax payer to an income tax payer or the reverse because the provisions in this Act apply only to income tax payers.

1301.Section 318 allows the seawalls provisions in this Act to work properly in respect of the party to the transfer who is subject to income tax.

1302.Subsection (4) signposts the reader to the source provision in ICTA that deals with the party to the transfer who is subject to corporation tax.

Section 319: Relief in respect of mineral royalties

1303.This section provides that only half the net profits received in respect of mineral royalties are charged to income tax. It is based on section 122 of ICTA. The other half of the profits are charged to capital gains tax by section 201 of TCGA.

1304.The section applies only to mineral royalties that are not taxed under Chapter 8 of this Part of the Act. That Chapter taxes rents and royalties from concerns such as mines and quarries. In practice nearly all mineral royalties will be taxed under Chapter 8 of Part 3 of this Act. For this reason this section cross-refers to the definitions in that Chapter.

Section 320: Nature of item apportioned on sale of estate or interest in land

1305.This section preserves the capital or revenue nature of an amount due, or payable in arrears, apportioned to a seller on the sale of land. It is based on section 40(3)(b) of ICTA.

1306.Most of section 40 of ICTA is not rewritten because it has become redundant following the application of Schedule D Case I principles to Schedule A.

1307.The original predecessor of section 40 of ICTA (section 20 of FA 1964) was introduced to deal with a specific problem. That was reflecting, in the calculation of income from land, any apportionments of rent (as a receipt or an expense) that took place between seller and purchaser when land was sold. That required two kinds of rule. The first were calculation rules. They were necessary because at the time section 20 of FA 1964 was introduced the charge on income from land was based on entitlement to incoming rent and payment of outgoing rent. Where there were apportionments on sale there might be neither entitlement nor payment by the “right” person. The second were timing rules to ensure that the consequential adjustments fell in the right tax year.

1308.As a result of the 1995 Schedule A reforms these rules are no longer necessary. Two main factors lead to this conclusion.

1309.The first relates to the object of charge under Schedule A: the profit of a Schedule A business. For there to be a Schedule A business a person has to be exploiting United Kingdom land for rent (section 15(1)1(1) of ICTA). In order to be a receipt (or outgoing) of the Schedule A business it is enough that an amount relates to a period when the person was exploiting the land.

1310.The second factor relates to the time when income within the charge is brought into account. The accruals principle of accounting has been imported from Schedule D Case I into Schedule A. The accruals principle brings an item into account in the period to which it relates. So the rules in section 40(1) to (3) of ICTA about the time of receipt and payment are unnecessary.

1311.Section 40(4) of ICTA is similarly now unnecessary. It provides that any reference in section 40(1) and (2) of ICTA to a party to a contract includes a person to whom the rights and obligations of that party under the contract have passed by assignment or otherwise. Since the test of whether or not an item is to be brought into account under Schedule A is whether it arises from a person’s exploitation of land then whether the rights and obligations under the contract pass by assignment or otherwise, the person to whom they pass will be the person exploiting the land.

1312.Section 40(4A) of ICTA is not rewritten. It is linked to the parts of section 40 of ICTA that are unnecessary and also gives in certain circumstances the wrong result.

1313.Section 40(3)(b) of ICTA has a clear anti-avoidance purpose that is preserved in section 320. But it also contains a timing rule. The timing rule in section 40(3)(b) of ICTA is not rewritten because the accruals principle again attributes the apportioned amount to the correct period.

1314.Section 320 rewrites the anti-avoidance part of section 40(3)(b) of ICTA which preserves the capital or revenue nature of any amount due or paid in arrears and apportioned by the buyer to the seller on the sale of land.

1315.This rule was originally introduced to deal with the common (at the time) practice whereby, under normal conditions of sale, that part of any rent paid in arrears, apportioned to the seller and to be paid to him or her by the purchaser, was adjusted by means of an addition to the sale price. As capital gains tax did not exist the apportioned rent taken as increased sale price escaped tax altogether.

1316.Capital gains tax now takes away much of the incentive to deal with rent in this way. But this rule may still serve a useful deterrent purpose and needs to be preserved.

1317.The time of apportionment referred to in the section is normally the time of completion of the sale.

Section 321: Mutual business

1318.This section makes it clear that the concept of “mutuality” does not apply in the property income context. It is based on section 21C of ICTA.

1319.Mutuality is a concept that has been developed by the courts over a long period. It derives from the principle that one cannot make a profit out of oneself. It may arise in the trading context where a class of contributors to a common fund are entitled, as a class, to share in the surpluses of that fund.

1320.The approach in section 321 is different from that in section 21C of ICTA and simpler. The approach in section 21C of ICTA is to apply the normal profit calculation rules to any “mutual business” and add the result to the profits of the rest of the Schedule A business. Section 321 on the other hand prevents, from the outset, the concept of mutuality operating on amounts within Part 3 of this Act.

Chapter 6: Commercial letting of furnished holiday accommodation
Overview

1321.The sections in this Chapter define the lettings that can qualify for special tax advantages: “the commercial letting of furnished holiday accommodation”. They are based on section 504 of ICTA.

1322.The sections do not themselves provide the tax advantages. That is the function of the particular “relieving” provisions (such as the loss relief provisions) that are cross-referred to.

1323.The primary purpose of this Chapter is to provide a central definition of this particular type of letting, income from which benefits from tax advantages provided for in other Acts.

1324.The location of these sections in a separate Chapter of Part 3 of this Act reflects detailed consideration of the concept of “the commercial letting of furnished holiday accommodation” in the source legislation.

1325.When the provisions which were the predecessors of what are now sections 503 and 504 of ICTA were first introduced they were complete and free-standing in a way which is no longer the case. That is, at that time they:

  • imported a then very valuable “use trade profits calculation rules” principle; and

  • set out the full range of the “trading” treatment that lettings qualifying as the commercial letting of furnished holiday accommodation enjoyed, including the equally valuable capital gains tax reliefs.

1326.Since then however the practical significance of sections 503 and 504 of ICTA has been progressively eroded by changes elsewhere:

  • all property letting now attracts most trade profits calculation rules anyway; and

  • the detail of the main benefits of furnished holiday letting status is set out elsewhere (in the capital allowances and capital gains tax provisions).

1327.Section 504 of ICTA merely defines the commercial letting of furnished holiday accommodation for the purposes of particular rules, the detail of which is set out elsewhere. And section 503 of ICTA refers only to what might be considered rather less significant advantages: trade-type loss relief and the treatment of profits as earned income and “relevant earnings” for pension etc relief.

1328.Where best to locate the definition of “commercial letting of furnished holiday accommodation” was therefore carefully considered. The conclusion was that readers will intuitively expect to find the central definition of a particular type of letting with the property income rules. And that is so even if the tax advantages are not prescribed in the same place. So it is located in Part 3 of this Act.

1329.This income remains part of the single property business in section 264 and chargeable therefore under this Part.

Section 322: Introduction

1330.This section is introductory and explanatory. It is new. It makes clear that the provisions that provide for the tax advantages are to be found elsewhere.

1331.Subsection (2)(f) refers to “relevant earnings”. There are transitional rules in paragraphs 74 and 75 of Schedule 2 to this Act which ensures that the ICTA rules about “relevant earnings” apply until 5 April 2006.

Section 323: Meaning of “commercial letting of furnished holiday accommodation”

1332.This section defines the lettings that can benefit from the special tax treatment. It is based on section 504 of ICTA.

1333.It is not sufficient that the letting is simply of furnished holiday accommodation: it must also be “qualifying holiday accommodation”. Subsection (3)(b) signposts to the sections that define “qualifying holiday accommodation”.

Section 324: Meaning of “relevant period” in sections 325 and 326

1334.This section defines the period during which certain conditions need to be satisfied in order to benefit from the special tax treatment. It is based on section 504(4) of ICTA.

1335.Subsection (1) introduces the concept of “the relevant period”.

1336.Subsection (2) gives the rule for identifying the relevant period for the tax year in which the letting (as furnished accommodation) begins.

1337.Subsection (3) gives the rule for identifying the relevant period for the tax year in which the letting (as furnished accommodation) ends.

1338.Subsection (4) gives the general rule and identifies the relevant period as the tax year for the case where there is established and continuing letting. It follows the source legislation (in section 504(4)(c) of ICTA) by putting the general rule covering what is likely to be the most common case, last. This is because a person still needs to read the first two rules to know whether he or she falls within the general rule.

1339.Subsection (4) defines the “relevant period” by reference to the tax year for non-resident companies liable to income tax in respect of furnished holiday accommodation. See Change 75 in Annex 1.

Section 325: Meaning of “qualifying holiday accommodation”

1340.This section sets out the additional tests the letting must satisfy to qualify for the special treatment. It is based on section 504(3) and section 504(4) of ICTA.

1341.Subsection 504(3) of ICTA is particularly complex. The three tests it imposes in paragraphs (a) to (c) are referred to in this section as, respectively, the “availability”, “letting” and “pattern of occupation” conditions. If all three are met, the accommodation is “qualifying holiday accommodation”.

1342.Subsection (1) introduces the term “qualifying holiday accommodation” and defines it by reference to the three conditions that are set out in the subsequent subsections.

1343.Subsections (4) to (6) are based on section 504(3)(c) of ICTA. Section 504(3)(c) of ICTA is particularly ambiguous and this section seeks to reduce that ambiguity. The approach is different from that in the source legislation and involves a change. See Change 76 in Annex 1.

Section 326: Under-used holiday accommodation: averaging elections

1344.This section allows accommodation that would be “qualifying holiday accommodation”, were it not simply for insufficient actual letting, nevertheless to qualify if, on average, the letting condition in section 325(3) is met. It is based on section 504(6) to (8) of ICTA.

1345.Subsection (1) introduces a new term to denote this accommodation: “under-used accommodation”.

1346.Subsection (4) introduces a change. This changes the period over which lettings are averaged for the purpose of treating infrequently let property as qualifying holiday accommodation from the tax year to the relevant period (as defined in section 324). See Change 77 in Annex 1.

1347.Subsection (5) prevents the same accommodation from being used more than once in an averaging calculation.

1348.Subsection (6) reflects the rewrite approach to aligning time limits with the Self Assessment cycle.

Section 327: Capital allowances and loss relief

1349.This is the first of two sections that provide for separate calculations in order to give effect to the tax advantages of qualifying holiday lettings. It is new.

1350.There is no explicit requirement for separate furnished holiday lettings calculations in section 503 of ICTA. But it is clearly not possible to give effect to the special income tax treatments available to furnished holiday lettings without separating out the relevant income and expenditure. Requiring, where appropriate, separate calculations makes explicit what is only implicit in section 503 of ICTA. Section 327 and section 328 provide a mechanism to ensure that the special rules that can give tax advantages in respect of these lettings work properly and clearly in the context of a UK property business of which the furnished holiday lettings is part: the profit from such lettings must be identified separately but only when there is a practical need to do so.

Section 328: Earned income and relevant UK earnings for pension purposes

1351.This is the second of two sections that provide for separate calculations to give effect to the tax advantages of qualifying holiday lettings. It is new.

Chapter 7: Adjustment income
Overview

1352.This Chapter applies the rules about a change of basis to property businesses, broadly as those rules apply to trades. The main rules for trades are in Chapter 17 of Part 2 of this Act.

1353.Section 21A of ICTA provides that “the profits of a Schedule A business are computed in the same way as the profits of a trade are computed for the purposes of Case I of Schedule D”. And section 21B of ICTA specifically applies the rules for change of accounting basis in FA 1998.

1354.The rules in Schedule 22 to FA 2002 apply to property businesses because they have effect “in place of” the 1998 rules (see section 64(6) of FA 2002), even though the necessary textual amendment to section 21B of ICTA was overlooked.

1355.So the change of basis rules apply to a Schedule A business.

1356.Section 65A(5) of ICTA provides that “the income from an overseas property business shall be computed … in accordance with the rules applicable to the computation of the profits of a Schedule A business”.

1357.Although the change of basis rules apply to a Schedule A business, they do so by virtue of section 21B of ICTA. That section deals with “other rules applicable to Case I of Schedule D”. On the other hand, section 21A of ICTA deals with rules about the computation of profits of a trade. So section 65A of ICTA imports only the computation rules in section 21A and the change of basis rules do not apply to an overseas property business.

1358.The following trading income rules (in Chapter 17 of Part 2 of this Act) cannot apply to a property business. So there is no corresponding rule in this Chapter:

  • Section 226: Professions and vocations;

  • Sections 236 and 237: Change from realisation basis to mark to market (A property business cannot hold assets that are valued on a mark to market basis.);

  • Sections 238 and 239: Barristers and advocates; and

  • Section 240: Liability of personal representatives if person liable dies. (This section applies if an adjustment income charge is spread: none of the spreading rules applies to a property business.)

1359.The following trading income rules apply to property businesses but are not in separate sections in this Chapter:

  • Section 231: Calculation of the adjustment; (This rule is applied by section 330(1).)

  • Section 234: No adjustment for certain expenses previously brought into account; (This rule is applied by section 330(4).)

  • Section 235: Cases where adjustment not required until assets realised or written off. (A property business cannot have trading stock or work in progress; the rule about depreciation is in sections 333 (2) and 334(2).)

Section 329: Application of Chapter

1360.This section sets out the circumstances in which an adjustment may arise. It is based on section 64 of FA 2002. The equivalent rule for trades is in section 227.

Section 330: Adjustment income and adjustment expense

1361.This section sets out how to calculate an adjustment and how it is treated for tax purposes. It is based on paragraphs 2, 4, 5 and 6 of Schedule 22 to FA 2002.

1362.Subsection (4) is a cross-reference to the trading income rule about expenses for which a deduction has already been made.

Section 331: Income charged

1363.This section sets out the amount charged to tax. In FA 2002 the charge is under Schedule D Case VI. So section 69 of ICTA applies.

Section 332: Person liable

1364.This section states who is liable for any tax charged. In FA 2002 the charge is under Schedule D Case VI. So section 59(1) of ICTA applies.

Section 333: Treatment of adjustment income

1365.This section sets out the rules for the treatment of adjustment income. It is based on paragraphs 4(2) and 7 of Schedule 22 to FA 2002.

1366.Subsection (3) treats the income as property income for the purpose of loss relief. So any losses of the property business brought forward can be set against the income.

Section 334: Treatment of adjustment expense

1367.This section sets out the rules for the treatment of a negative adjustment. It is based on paragraphs 5 and 7 of Schedule 22 to FA 2002.

Chapter 8: Rent receivable in connection with a UK section 12(4) concern
Overview

1368.This Chapter charges as property income rent receivable in connection with a section 12(4) concern. It also provides for certain deductions and reliefs to be given from that income.

Section 335: Charge to tax on rent receivable in connection with a UK section 12(4) concern

1369.This section charges rent receivable in connection with a UK section 12(4) concern to tax. It is based on section 119(1) of ICTA.

1370.The loss regime in section 392 of ICTA applies to income charged under this Chapter and not the regime in sections 379A and 379B of ICTA.

1371.The charge under Schedule D Case III imposed by section 119(2) of ICTA is not rewritten.

1372.Section 119(2) of ICTA provides for the rent to be taxed under Schedule D Case III if the rent is paid in produce of the concern. If section 119(2) of ICTA does not apply the rent is charged under Schedule D Case VI.

1373.When section 119 of ICTA was introduced as section 34 of FA 1934 the lessee was required to deduct income tax when paying rent to the lessor. This was achieved by treating the rent as a royalty paid in respect of the user of a patent. But it would be impractical to deduct income tax if the rent were paid in kind. So what is now section 119(2) of ICTA charged rent paid in kind under Schedule D Case III. This avoided the requirement to deduct income tax because these rents are not a category of income from which tax is deducted.

1374.Since the requirement to deduct income tax from rents taxable under section 119 of ICTA was repealed by FA 1995 a separate charge on rents paid in kind is no longer required.

Section 336: Meaning of “rent receivable in connection with a UK section 12(4) concern”.

1375.This section clarifies:

  • what is meant by “UK section 12(4) concern”;

  • what is meant by “rent”; and

  • when rent is treated as “receivable in connection with” such a concern.

1376.It is based on section 119(1) and (3) of ICTA.

1377.Subsection (1) identifies when rent is receivable in connection with a section 12(4) concern. It uses the language of section 266(1) (meaning of “generating income from land”) to rewrite the phrase “in respect of any land or easement” in section 119(1) of ICTA. Section 266 is based on paragraph 1(1) of Schedule A (section 15(1) of ICTA). That provision identifies the scope of Schedule A. The approach in section 336 assumes that the income taxed by section 119 of ICTA would otherwise be taxed under Schedule A.

1378.The justification for this assumption is that section 119 of ICTA can have no application to income that is already taxed under Schedule D Case VI. Neither is there any question that the rent would go untaxed if it were not for section 119 of ICTA. Rents are clearly annual profits or gains as described in Schedule D Case VI of ICTA. The effect of section 119 of ICTA is to take income that would be taxed under Schedule A and tax it under Schedule D. So in identifying the scope of the charge it is possible to use the ordinary property business definitions and avoid the need to rewrite the complicated definitions of “easement” and “rent” in section 119(3) of ICTA.

1379.The section makes explicit a territorial restriction to the United Kingdom that is implicit in section 119(1) of ICTA. If a section 12(4) concern is located outside the United Kingdom it would be a foreign possession for the purposes of the charge under Schedule D Case V. Any income arising from such a possession would be taxed under Schedule D Case V. Section 119 of ICTA can have no application to income that is already taxed under Schedule D.

1380.Subsection (2) provides that the section applies also to “dead rents”. It is based on section 119(1)(b) of ICTA.

1381.A “dead rent” is usually paid only for the lease of mineral rights. It is a flat rent that is payable whether the minerals are worked or not. The rent is recoverable from the rent due when the minerals are worked. It acts as an economic incentive to work the minerals.

1382.Subsection (3) provides the definition of rent. It is based on section 119(3) of ICTA. As explained in the commentary on subsection (1), this section is based on the assumption that the rents taxed by section 119 of ICTA would otherwise be taxed under Schedule A. This means it is not necessary to reproduce the definition of “rent” in section 119(3) of ICTA.

Section 337: Income charged

1383.This section sets out the amount charged to tax. It is based on section 69 of ICTA.

1384.Subsection (2) is a signpost to the deductions and reliefs that are available against this income.

Section 338: Person liable

1385.This section states who is liable for any tax charged. It is based on section 59 of ICTA.

Section 339: Deduction for management expenses of owner of mineral rights

1386.This section allows a deduction for the expenses of managing mineral rights. It is based on section 121(1) of ICTA.

1387.Subsection (1) sets out the conditions for the section to apply. It does not reproduce the condition that the expenses must be incurred “necessarily”. See Change 78 in Annex 1.

1388.Subsection (2) provides that a deduction is allowed for the qualifying expenses paid in the tax year. This rewrites the requirement that the expenses are “disbursed” in the tax year.

1389.The relief applies only to rents received from a UK section 12(4) concern. If the income is taxed as income from a UK property business, there is no need for special rules identifying what deductions are allowable. The normal rules apply.

Section 340: Relief in respect of mineral royalties

1390.This section provides that only half of the net profit earned in respect of mineral royalties is charged to income tax. It is based on section 122 of ICTA. The other half of the net profits is charged to capital gains tax by section 201 of TCGA.

1391.The provision was introduced in FA 1970 to give relief from the high marginal rates of tax that could arise if the income was liable to betterment levy, surtax and income tax. It has been retained despite the abolition of the first two of those taxes.

1392.Subsection (1) limits the relief to royalties taxed under Chapter 8 of Part 3 of this Act. If the royalty is not taxed under this Chapter the same relief is given by section 157 or section 319.

Section 341: Meaning of “mineral lease or agreement” and “mineral royalties”

1393.This section defines various terms used in section 340. It is based on section 122(5) and (6) of ICTA.

1394.Section 364 includes a definition of “lease” that applies for the purposes of the property income Part. It is based on section 24 of ICTA, which applies for the purposes of Schedule A in the source legislation. Because the definition applies only for Schedule A in strictness it does not extend to the income taxed under section 340. But the definition of “mineral lease or agreement” in section 122(6) of ICTA applies to any agreement to win and work minerals in the United Kingdom. Such an agreement would also satisfy the definition in section 24 of ICTA so there is no change in the law.

Section 342: Extended meaning of “mineral royalties” etc. in Northern Ireland

1395.This section modifies the definition of “mineral royalties” to deal with the different rules that apply to the ownership of mineral rights in Northern Ireland. It is based on section 122(7) of ICTA.

1396.The right to win, and win and work, most minerals in Northern Ireland is vested in the Department of Enterprise, Trade and Investment (DETI). The DETI will grant licences to work the minerals and make compensatory payments to the former owners of the mineral rights under various Acts of the Northern Ireland Parliament. This section treats those payments as mineral royalties for the purposes of section 340.

Section 343: Power of Board to determine what counts as “mineral royalties”

1397.This section allows the Board of Inland Revenue to make regulations concerning the application of the relief in section 340. Any regulations made under this power would apply also to sections 157 and 319 through sections 157(3) and 319(3).

Chapter 9 Rent receivable for UK electric-line wayleaves
Overview

1398.This Chapter rewrites the Schedule D Case VI charge on rent received in respect of a wayleave granted in the United Kingdom. It is based on section 120 of ICTA.

1399.If a landowner receives rent in respect of a UK electric-line wayleave section 120 of ICTA provides that:

  • the rent is charged under Schedule A if the landowner receives other rent in respect of the same land; otherwise

  • the rent is charged under Schedule D.

1400.In practice this means that if the landowner carries on a trade on the land the rent can be treated as a trade receipt. See Change 5 in Annex 1. Otherwise the rent is taxed under Schedule D Case VI.

1401.Section 392 of ICTA gives the rules for dealing with Schedule D Case VI losses. In order to preserve that loss regime it is necessary to isolate the income that ICTA charges under Schedule D Case VI.

Section 344: Charge to tax on rent receivable for a UK electric-line wayleave

1402.This section charges to tax rent receivable for a UK electric-line wayleave to tax. It is based on section 120 of ICTA.

Section 345: Meaning of “rent receivable for a UK electric-line wayleave”

1403.This section provides the definition of “rent receivable for a UK electric-line wayleave”. It is based on section 120(1) and (5) of ICTA.

1404.Section 120(1) of ICTA identifies the right in respect of which the rent is payable as an “easement”. Section 120(5) of ICTA cross-refers to the definition of “easement” in section 119(3) of ICTA. Section 119 of ICTA is rewritten as Chapter 8 of this Part. As explained in the commentary on section 22 both this Chapter and section 22 use the term “wayleave” to describe the right in respect of which the rent is received. In practice this is how most of the payments covered by this section are usually described. But the generality of the words in section 119(3) of ICTA has not been lost. The section also uses the Scottish term for “easement”, “servitude”.

1405.Subsection (2) clarifies the meaning of “electric, telegraph or telephone wire or cable”. It does not repeat the reference to “transformer” in the source legislation. In its context it is clear that “apparatus” would include “transformer”.

Section 346: Extent of charge to tax

1406.This section sets out the two exceptions under which the rent received in respect of a UK electric-line wayleave is not taxed under this Chapter. It is based on section 120(1A) of ICTA.

1407.Subsections (1) and (2) deal with the case in which the taxpayer receives other rent in respect of the land except rent from another wayleave. The rent from the wayleave is taxed as property income.

1408.Subsections (3) and (4) deal with the case in which the taxpayer carries on a trade on the land. See Change 5 in Annex 1. The rent may be taxed as a trade receipt.

Section 347: Income charged

1409.This section sets out the amount charged to tax. It is based on section 69 of ICTA.

Section 348: Person liable

1410.This section states who is liable for any tax charged. It is based on section 59 of ICTA.

Chapter 10: Post-cessation receipts
Overview

1411.This Chapter applies the rules about post-cessation receipts to property businesses, broadly as they apply to trades. The main rules for trades are in Chapter 18 of Part 2 of this Act. The application of the rules to property businesses is based on section 21B of ICTA, which specifically mentions sections 103 to 106 of ICTA.

1412.Section 65A(5) of ICTA provides that “the income from an overseas property business shall be computed … in accordance with the rules applicable to the computation of the profits of a Schedule A business”.

1413.Although the post-cessation receipt rules apply to a Schedule A business, they do so by virtue of section 21B of ICTA. That section deals with “other rules applicable to Case I of Schedule D”. On the other hand, section 21A of ICTA deals with rules about the computation of profits of a trade. So section 65A of ICTA imports only the computation rules in section 21A and the post-cessation receipt rules do not apply to an overseas property business.

1414.The following trading income rules (in Chapter 18 of Part 2 if this Act) cannot apply to a property business. So there is no corresponding rule in this Chapter:

  • Section 241: Professions and vocations;

  • Section 252: Transfer of trading stock or work in progress; (A property business cannot have trading stock or work in progress.)

  • Section 253: Lump sums paid to personal representatives for copyright etc; (Such sums cannot arise from a property business.) and

  • Section 256: Treatment of post-cessation receipts. (Property income cannot be relevant UK earnings or earned income.)

1415.The following trading income rules apply to property businesses but are not in separate sections in this Chapter:

  • Sections 248, 249 and 250: Rules about debts and post-cessation expenditure; (These rules are applied by section 354(2).)

  • Sections 254 and 255: Allowable deductions; (These rules are applied by section 351(2)(a).) and

  • Section 257: Election to carry back. (This rule is applied by section 351(2)(b).)

Section 349: Charge to tax on post-cessation receipts

1416.This section charges post-cessation receipts to tax. It is based on sections 103 and 104 of ICTA, as applied by section 21B.

Section 350: Extent of charge to tax

1417.This section restricts the charge on the post-cessation receipts. It is based on sections 103 and 104 of ICTA.

Section 351: Income charged

1418.This section sets out the amount charged to tax. In ICTA the charge is under Schedule D Case VI. So section 69 of ICTA applies.

Section 352: Person liable

1419.This section states who is liable for any tax charged. In ICTA the charge is under Schedule D Case VI. So section 59(1) of ICTA applies.

Section 353: Basic meaning of “post-cessation receipt”

1420.This section defines post-cessation receipts of a property business. It is based on sections 103 and 104 of ICTA, as applied by section 21B of ICTA.

1421.Subsections (2) and (3) set out the position if a property business is carried on in partnership. It is based on section 110(2) (and sections 111 and 113) of ICTA. A partner who leaves a firm may receive a post-cessation receipt that is charged to tax.

Section 354: Other rules about what counts as a “post-cessation receipt”

1422.This section brings together signposts to rules that operate so as to treat certain sums as post-cessation receipts and to exclude others from the charge. It is new.

1423.Subsection (1) is a signpost to the section that deals with the transfer of a right to receive a post-cessation receipt to a person who does not carry on a property business.

1424.Subsection (2) lists the trading income rules that apply to create post-cessation receipts for the purpose of this Chapter.

1425.Subsection (3) draws attention to the rule in Chapter 5 of this Part of the Act that treats a sum received as not being a post-cessation receipt if the right to it was transferred with a property business. It also mentions the rule in Part 8 of this Act that can treat profits of an overseas property business as post-cessation receipts if they become remittable after the taxpayer has ceased to carry on the business.

Section 355: Transfer of rights if transferee does not carry on UK property business

1426.This section sets out the positions of the transferor and transferee if the right to a post-cessation receipt is transferred for value. It is based on section 106 of ICTA, as applied by section 21B of ICTA.

Section 356: Application to Schedule A businesses

1427.This section deals with the case of a person who receives a sum that arises from a Schedule A business that was carried on before 2005-06. It is new.

1428.Subsection (1) sets out the general rule. The business from which a sum arises for the purpose of section 353 may be either a UK property business (as defined in this Act for 2005-06 and later years) or a Schedule A business. The Schedule A business may be one carried on by an income tax payer before 2005-06 or one carried on by a company.

1429.Subsection (2) deals with the case of a non-resident company liable to income tax. If a company ceases to be liable to corporation tax it is treated as ceasing to carry on its Schedule A business. A post-cessation from that business may be charged to income tax.

Chapter 11: Overseas property income
Section 357: Charge to tax on overseas property income

1430.This section charges overseas property income to tax. It is based on Schedule D Case V in section 18 of ICTA.

Section 358: Meaning of “overseas property income”

1431.This section defines “overseas property income”, in cases where the remittance basis applies. It is new.

1432.Section 65(4) of ICTA provides that, for a person to whom the remittance basis applies, section 65A of ICTA does not apply. This means that there cannot be an overseas property business. And there are no rules in ICTA for calculating the income.

1433.This Chapter uses the expression “overseas property income” to describe income from land outside the United Kingdom which would usually be treated as part of an overseas property business (see section 265) but is not treated in that way because the overseas property business of a remittance basis taxpayer includes only profits from land in the Republic of Ireland (see section 269(3)). So overseas property income does not include any Irish income.

Section 359: Income charged

1434.This section sets out the amount charged to tax and takes the form of a signpost to the remittance basis of assessment in section 832. It is based on section 65(5) of ICTA.

Section 360: Person liable

1435.This section states who is liable for any tax charged on overseas property income when the remittance basis applies. It is based on section 59(1) of ICTA.

Chapter 12: Supplementary
Section 361: Changes in trustees and personal representatives

1436.This section sets out what happens if there is a change in the trustees or personal representatives who are carrying on a property business. It is based on section 113(7) of ICTA, as applied by section 21B of ICTA.

1437.In section 113(1) of ICTA the phrase “change in the persons engaged in carrying on any trade” is wide enough to include a change in trustees. There is no need to treat a property business as ceasing solely on account of a change of trustees. So in section 113 of ICTA subsection (7) overrides subsection (1) “for the purposes of this section”. The same rule applies to personal representatives as to trustees.

1438.The property business is treated as continuing even if there is a complete change of trustees or personal representatives. And, in the case of a partial change of trustees or personal representatives, this section makes it clear that for the purposes of the property income Part no person is treated as ceasing to carry on the property business. There is a similar rule for trading income in section 258.

Section 362: Effect of company starting or ceasing to be within charge to income tax

1439.This section applies only to companies and deems a commencement or cessation of a UK property business to take place in particular circumstances. It is based on section 337 of ICTA.

1440.Section 337 of ICTA is primarily a corporation tax rule. It applies only to companies and originates from the introduction of corporation tax. However it can be relevant to income tax.

1441.That is because non-resident companies are within the charge to income tax in respect of United Kingdom trade profits (when the trade is not carried on through a United Kingdom permanent establishment) and UK property business income. Section 337 of ICTA applies in cases of either inward or outward company migration. Where that involves a continuing trade or UK property business there will be a change of taxing regime from income tax to corporation tax or vice versa.

1442.Section 362 says what happens when a company enters or leaves the income tax regime: then its UK property business income is calculated as though it had commenced or discontinued the business.

Section 363: Overseas property businesses and overseas land: adaptation of rules

1443.This section sets out how the rules for United Kingdom property businesses are to be adapted to apply to overseas property businesses. It is based on section 65A(8) of ICTA.

1444.The section explains how to apply the UK property business rules if foreign property law does not correspond exactly with United Kingdom property law. This is particularly useful when applying the lease premium rules in Chapter 4 of this Part of the Act to foreign leases.

Section 364: Meaning of “lease” and “premises”

1445.This section is based on sections 24 and 65A(5) of ICTA.

Part 4: Savings and investment income

Overview

1446.This Part contains the rules relating to savings and investment income. It consists of income that is charged under Schedule D Cases III, IV, V and VI; Schedule F and non-schedular charges in the source legislation.

1447.There is a separate Chapter for each category of income arranged as follows:

  • interest (Chapter 2);

  • dividends and other distributions from UK resident companies (Chapter 3);

  • dividends from non-UK resident companies (Chapter 4);

  • stock dividends from UK resident companies (Chapter 5);

  • release of loan to participator in close company (Chapter 6);

  • purchased life annuity payments (Chapter 7);

  • profits from deeply discounted securities (Chapter 8);

  • gains from contracts for life insurance etc. (Chapter 9);

  • distributions from unauthorised unit trusts (Chapter 10);

  • transactions in deposits (Chapter 11);

  • disposals of futures and options involving guaranteed returns (Chapter 12); and

  • sales of foreign dividend coupons (Chapter 13).

Structure of Chapters

1448.The basic structure of each Chapter is:

  • charge to tax on income;

  • the amount to be charged to tax;

  • the person liable for the tax charged; and

  • rules specific to that income.

1449.This Part does not contain exemption provisions. Signposts to the exemptions most likely to be relevant have been placed in the charge to tax provisions.

Chapter 1: Introduction
Section 365: Overview of Part 4

1450.This section sets out the income charged in this Part, the approach to exempt income and where to find the priority rules. It is new.

Section 366: Provisions which must be given priority over Part 4

1451.This section provides rules which determine which Part will take priority in the event of any overlap in the charging provisions. It is based on sections 18, 20 and 95 of ICTA, and section 9D of TMA.

1452.Subsection (1) ensures that, if any amount falls within a charge in Part 4 of this Act and the charge on trade profits, Chapter 2 of Part 2 of this Act will charge that amount as a trade receipt. This takes account of section 95 of ICTA which sets out the circumstances in which a distribution made by a UK resident company, or a payment which is representative of such a distribution is brought into account in calculating the profits of a trade.

1453.Section 95 of ICTA brings a distribution into account in calculating the trade profits if the recipient is a dealer in relation to that distribution. Subsection (1) instead focuses on the nature of the receipt. See Change 79 in Annex 1.

1454.Subsection (1) also reflects the decision to give effect to the Crown Option. See Change 66 in Annex 1.

1455.In the case of non schedular charges it is unlikely that there would be any overlap. But in theory it is possible that, for example, stock dividends (Chapter 5 of Part 4 of this Act) and gains from contracts for life assurance (Chapter 9 of Part 4 of this Act) may rank as trade receipts. Taxing such income under Chapter 2 of Part 2 of this Act accords with the policy and practice of taking trade receipts into account in calculating trade profits and not otherwise. See Change 66 in Annex 1.

1456.Subsection (2) ensures that, if any amount falls within a charge in Part 4 of this Act and the charge on a UK property business, Chapter 3 of Part 3 of this Act will charge that amount as a receipt of a UK property business. This reflects the priority of Schedule A over Schedule D and is based on section 18(1)(b) of ICTA and Schedule D Cases III(a) and VI.

1457.Section 95 of ICTA can have no application to property income and there is no overlap between the Schedule A and Schedule F. The rule that Schedule F takes priority over Schedule A has not therefore been reproduced.

1458.Similarly as there is no overlap between Schedule A and the non schedular charges in section 249 of ICTA (stock dividends rewritten in Chapter 5 of Part 4 of this Act) and section 421 of ICTA (release of loan to participator in a close company rewritten in Chapter 6 of Part 4 of this Act) there is no need to exclude these charges from this priority rule.

1459.Subsection (3) ensures that ITEPA takes priority over Part 4 of this Act except for the charging provisions in Chapter 3 of Part 4 of this Act (dividends etc. from UK resident companies) and Chapter 6 of Part 4 of this Act (release of loan to participator in a close company). This reflects the priority that ITEPA has over Schedule D in the source legislation. It is based on section 18(1)(b) of ICTA and Schedule D Cases III(a) and VI of ICTA.

1460.A new provision, section 716A, has been added to ITEPA (see paragraph 615 of Schedule 1 to this Act) which gives priority to Chapter 3 of Part 4 of this Act over charges in ITEPA. This takes account of the fact that Schedule F has priority over ITEPA in the source legislation. It is based on section 20(1) and (2) of ICTA.

1461.In the source legislation there is a potential charge under section 421 of ICTA (which is rewritten in Chapter 6 of Part 4 of this Act (release of loan to a participator in a close company)) and section 188 of ITEPA. Section 189 of ITEPA gives priority to section 421 of ICTA. Section 189 of ITEPA will continue to assign priority to the charge in Chapter 6 of Part 4 of this Act.

1462.Subsection (4) provides that an amount can be used in calculating a chargeable event gain under Chapter 9 of Part 4 (gains from contracts for life insurance etc.) although it may also be used in calculating income under another provision in this Act. This is because the calculation of gains under Chapter 9 of this Part uses different principles from those used in other charges. However, section 527 of this Act ensures that the gain calculated under Chapter 9 is reduced by the amount charged elsewhere, to avoid a double charge on the same amount.

Section 367:Priority between Chapters within Part 4

1463.This section provides rules which determine which Chapter will take priority in the case of any overlaps in the charging provisions within Part 4 of this Act. It is based on sections 18 and 20 of ICTA and Schedule 15 of FA 1996.

1464.Usually, by their nature, the particular amounts charged in Part 4 of this Act can fall only within one Chapter so there is no need to make any special provision. This section covers a couple of exceptions.

1465.Subsection (1) provides the priority rule for two charging sections which are based on Schedule D Case III and Cases IV and V. Chapter 8 (profits from deeply discounted securities) has priority so that discounts continue to be taxed under the special rules for deeply discounted securities (previously relevant discounted securities) rather than under the general charge on interest which includes “all discounts”.

1466.Subsection (2) is concerned with the priority between Chapter 3 (dividends etc. from UK resident companies) and the other Chapters in Part 4 of this Act. Chapter 3 is based on section 20(2) of ICTA which provides specifically for Schedule F to take priority over the other Schedules. But subsection (3) provides for two exceptions to this basic rule. Dividends paid by building societies and by industrial and provident societies are treated as interest.

Section 368: Territorial scope of Part 4 charges

1467.This section provides that income within Part 4 of this Act is only charged to tax if it is from the United Kingdom or, if from outside the United Kingdom, it arises to a UK resident. It is based on section 18(1) of ICTA.

1468.Under section 18(1)(a) of ICTA income from any kind of property arising to a resident of the United Kingdom is chargeable to tax wherever that property is situated, while such income is chargeable on a non-resident only when it is from property within the United Kingdom.

1469.Section 18(1)(b) of ICTA, which charges tax in respect of “all interest of money, annuities and other annual profits or gains not charged under Schedule A or ITEPA and not specially exempted from tax”, does not mention the residence status of the person on whom the income or profits are chargeable.

1470.The exact scope of section 18(1)(b) of ICTA and its relation to the rules in section 18(1)(a) of ICTA is not entirely clear. Section 18(1) of ICTA appeared in broadly its present form in the Income Tax Act 1853, borrowing wording from the Income Tax Act 1842. The 1842 Act is famously impenetrable but the provisions from which the words have been borrowed (sections 100 and 102) may be read as having territorial restrictions. It is difficult to believe that the 1853 provision that is now section 18(1)(b) of ICTA was not intended to share the same territorial restrictions as the provision that is now section 18(1)(a) of ICTA.

1471.Profits charged under Schedule D Case VI may fall within section 18(1)(a) of ICTA where they represent income from any kind of property. But the Income Tax Acts also charge certain specific profits or gains, which would not otherwise be chargeable to income tax, under Case VI and when they are not specified as income from property they fall more comfortably under section 18(1)(b) of ICTA as “annual profits or gains”.

1472.In practice the same territorial restrictions are applied to Case VI profits falling within section 18(1)(b) of ICTA as within section 18(1)(a) of ICTA. This is both by analogy with the Case VI charge on income as well as under a general rule of law on territoriality mentioned below.

1473.Where non-schedular charges do not contain a territorial restriction, in practice the same territorial restrictions are applied as for section 18(1)(a) of ICTA. Again, this is both by analogy with the schedular charges and under a general rule of law on territoriality.

1474.Guidance is, however, available from case law. Since Colquhoun v Brooks (1889), 2 TC 490 HL the courts have followed Lord Herschell’s judgement that (page 499):

The Income Tax Acts, however, themselves impose a territorial limit, either that from which the taxable income is derived must be situate in the United Kingdom or the person whose income is to be taxed must be resident there.

1475.Whether Lord Herschell’s words referred to the statutory rules of the time or to a general statement of the law, it is as the latter that they have been subsequently applied by the courts. For example in Perry v Astor (1935), 19 TC 255 HL Lord Russell of Killowen states (page 280):

There must, of course, be the necessary limitation which is inherent in all our Income Tax legislation, namely, that what is taxed under or by virtue of this provision can only be either (1) income which is here, or (2) income of a person resident here.

1476.Additionally there is the general principle of United Kingdom law that, unless the contrary intention appears, an enactment is taken as not applying to matters outside the United Kingdom.

1477.The Schedule F charge on dividends and other distributions from UK companies contains its own territorial restriction, namely where the income arises from a company resident in the United Kingdom.

1478.Subsections (1) and (2) are drafted in terms of the “source” of the income. Although section 18 of ICTA refers to profits or gains from “property”, the usual statutory term elsewhere in the Income Tax Acts and in case law for the same concept is “source” and this has been adopted as the more familiar and modern term.

1479.However, while the term “source” may apply to the majority of receipts chargeable to income tax it does not apply to all such receipts. “Source” is something from which income arises and not all sums charged to income tax are by nature income. “Source” may not be the appropriate term where the amount charged to tax represents a profit on a transaction which is not by nature income and would not be charged to income tax without a specific charge. Indeed, the chargeable profit may arise on the disposal of an income source. This restricted meaning of “source” is supported by Lord Hoffmann’s judgement in Walker v Centaur Clothes Group Ltd (2000), 72 TC 379(7) HL and a more detailed discussion of this topic may be found in the commentary on Chapter 1 of Part 8 of this Act.

1480.It has therefore been necessary to consider how to express the territorial scope in cases where there is no natural source of income.

1481.Subsection (3) is broadly worded to catch such income. Where the connection such income has to the United Kingdom is comparable to the connection that income with a source in the United Kingdom has to the United Kingdom, then it is treated for the purposes of this section as income from a source in the United Kingdom.

Chapter 2: Interest
Overview

1482.This Chapter charges to tax interest and income that is treated as interest.

Section 369: Charge to tax on interest

1483.This section charges all interest to tax, whether from a source within or outside the United Kingdom. It is based on Schedule D Cases III(a), IV and V in section 18 of ICTA.

1484.Subsection (1) sets out the charge to tax.

1485.This section does not reproduce the separate charging provision in section 18(3)(c) of ICTA for “income from securities which is payable out of the public revenue of the United Kingdom or Northern Ireland”. All the income which would fall into this category can be charged to tax under other provisions of this Act.

1486.Neither has the section reproduced the words “of money whether yearly or otherwise” in section 18(3) Case III (a) of ICTA.

1487.The cases of Re Euro Hotel (Belgravia) Ltd (1975), 51 TC 293(8) HC and Riches v Westminster Bank Ltd (1947), 28 TC 159 HL demonstrate that the reference to “of money” is to the debt upon which the interest itself is payable rather than the interest. Since the words “of money” add nothing to “interest” they have been dropped.

1488.The words “yearly or otherwise” follow the historical recognition by tax legislation of a distinction between yearly interest and short interest. Although the separate charging rules for these two types of interest were merged in 1918 the reference to “yearly or otherwise” was retained. The distinction between yearly and short interest is still relevant in some areas, for example the deduction of tax provisions in section 349(2) of ICTA, but as the words do not add anything to the charge to tax on “any interest…” in section 18(3)(a) of ICTA, they have not been reproduced in this section.

1489.The words in section 18(3) Case III (a) of ICTA “whether such payment is payable within or out of the United Kingdom” have not been reproduced. The place of payment is only one of a number of factors derived from case law which may be taken into account in determining the source of interest.

1490.The section charges interest to tax whether or not it arises within the United Kingdom. Whether interest arises from a source outside the United Kingdom will, as explained, depend on a number of factors. Some of these are considered in Westminster Bank Executor and Trustee Co (Channel Islands) Ltd v National Bank of Greece SA (1970), 46 TC 472 HL.

1491.For individuals, unless a particular charge specifies otherwise, interest arising from a source outside the United Kingdom is taxed under Schedule D Case IV if it arises from securities outside the United Kingdom but otherwise under Case V. This treatment is confirmed by Lord Manton’s Trustees v Steele (1927), 11 TC 549 CA and Westminster Bank Executor and Trustee Co (Channel Islands) Ltd v National Bank of Greece SA (1970), 46 TC 472 HL.

1492.Not all the income within this Chapter can have a foreign source and in some cases it would be most unusual for interest from a source outside the United Kingdom to arise. This is so with building society dividends and share interest from an industrial and provident society. In other cases it may be impossible for such income to have a foreign source. The following paragraphs look at foreign source income in relation to particular categories of income treated as interest under this Chapter.

Building Societies

1493.Under section 66 of FA 1988 a society incorporated under the Building Societies Act 1986 will be resident in the United Kingdom through incorporation. As long as dividends are paid by a UK resident company they have a UK source under the principle in Bradbury v The English Sewing Cotton Company Ltd (1923), 8 TC 481 HL.

1494.But a society may be non-resident where it satisfies a residence test in the territory of a treaty partner and the treaty awards residence to that other territory. Section 249 of FA 1994 will then apply to treat the society as non-resident. Theoretically dividends paid by a building society may therefore arise from a source outside the United Kingdom. This would be most unlikely, however, since a building society may only be incorporated under the Building Societies Act 1986 if its principal office is in the United Kingdom. With the place of incorporation and the principal office in the United Kingdom a residence test is unlikely to be satisfied in another territory.

Open-ended Investment Companies

1495.The definition of an open-ended investment company in section 468(10) of ICTA carries a limitation that the company should be incorporated in the United Kingdom under the OEIC regulations of 1996. Section 468(10) of ICTA is inserted in section 468 of ICTA by Regulation 10(4) (Open-ended Investment Companies (Tax) Regulations 1997 SI 1997/1154). All open-ended investment companies within the definition in section 468(10) of ICTA are therefore subject to the company residence rule in section 66 of FA 1988 (“regarded for the purposes of the Taxes Acts as resident”). Open-ended investment company interest distributions treated as made by a UK resident company will be UK source income. Although, as explained in connection with industrial and provident societies, it may be theoretically possible for section 249 of FA 1994 to make such companies non-resident, this is most unlikely in practice.

Authorised Unit Trusts

1496.It is possible for the FSA to recognise a non UK unit trust scheme for marketing into the UK. However, only those UK tax resident unit trusts that are “authorised” by the FSA come within section 468 of ICTA. Section 468(1) of ICTA provides that the Tax Acts apply to UK authorised unit trusts and shall have effect as if the trustees of the authorised unit trust were a company resident in the United Kingdom. Although the application of section 468(1) of ICTA is by reference to the trustees' income (and relief for capital expenditure), the treatment of the trustees as a UK resident company carries through for the purposes of taxing interest distributions treated as made to unit holders. That is because section 468L(2) of ICTA provides that the Tax Acts shall have effect as if such interest distributions were made “by the company referred to in section 468(1)”. As these distributions are treated as made by such a company, that is a UK resident company, they can only be UK source income.

Industrial and Provident Societies

1497.Under section 66 of FA 1988 a society registered under the Industrial and Provident Societies Acts will be resident in the United Kingdom through incorporation. A society may, however, be non-resident where it also satisfies a residence test in the territory of a treaty partner of the United Kingdom and the treaty awards residence to that other territory. Section 249 of FA 1994 will then apply to treat the society as non-resident.

1498.Section 486(4) of ICTA provides that share or loan interest is chargeable under Schedule D Case III. Theoretically therefore payments by a registered society may arise outside the United Kingdom but be charged under Schedule D Case III and not able to benefit from treatment specific to Schedule D Cases IV and V. For the sake of consistency this section treats such income arising outside the United Kingdom as relevant foreign income and therefore able to benefit from the special rules in Part 8 of this Act. See Change 131 in Annex 1.

1499.Section 18(3)(b) of ICTA charges “all discounts” to tax under Case III. Although these words could be read as embracing discounts that arise outside the United Kingdom, it has long been the practice to charge discounts with a foreign source under Schedule D Cases IV or V. There is however little direct authority in case law for this approach, although it is fully accepted by the commentaries.

Section 370: Income charged

1500.This section sets out the amount of interest charged to tax on sources both within and outside the United Kingdom. It is based on sections 64, 65 and 68 of ICTA.

1501.Subsection (1) sets out the amount of interest charged to tax. This is the full amount of interest arising in the tax year.

1502.Section 64 of ICTA sets out the basis of assessment for income chargeable under Schedule D Case III. It requires that income tax should be computed “…on the full amount of the income…without any deduction”. There are no specific provisions allowing deductions from the amount charged to tax under Schedule D Case III and it is not clear what such deductions would represent. There are no rules allowing expenditure in earning Schedule D Case III income. The words “full amount of the income” carry some weight in suggesting that the amounts chargeable are without deduction.

1503.In relation to certain sources of income falling within Schedule D Case III, for example interest on savings bank deposits or private loans, the phrase “without any deduction” will not usually have any significance, as interest in such cases necessarily represents net income. There may, however, be such items as costs of collection but these cannot be deducted. Likewise in the case of discounts no set off can be made for losses incurred where the assessment is made under Schedule D Case III.

1504.The charging provision for Schedule F in section 20(1) of ICTA, which charges “all dividends and other distributions…of a company resident in the United Kingdom” does not state that the dividends are without any deduction. The words would be superfluous since no provision exists to give deductions from dividends from UK companies.

1505.For these reasons it is thought that the words are superfluous in the context of Schedule D Case III and they have therefore been omitted.

1506.The omission of these words also affects the following ‘income charged’ sections in this Act which are based on Schedule D Case III, section 424 (Chapter 7 of Part 4 of this Act, purchased life annuities) and 684 (Chapter 7 of Part 5 of this Act, annual payments not otherwise charged). In each case the income charged is expressed as: “Tax is charged under this Chapter on the full amount of the [annuity payments] [annual payments] arising in the tax year”.

1507.The word “arising” has been the subject of a number of tax cases. “Arising” includes received and also credited to a bank account (Parkside Leasing v Smith (1984), 58 TC 282(9) HC). However, “arising” has a wider meaning than this. For example, it was held in Dunmore v McGowan (1978), 52 TC 307(10) CA, to include the “swelling of a person’s assets”, even where the person had no immediate right of access to the income. In view of the wide meaning given to “arising”, and the fact that it is a term with which practitioners are familiar, the word has been retained.

1508.Subsection (2) makes subsection (1) subject to the rules in Part 8 of this Act. This enables income that is non-UK source and which would have been charged under Schedule D Cases IV or V to obtain the benefit of the special rules for such income.

Section 371: Person liable

1509.This section states who is liable for any tax charged. It is based on section 59(1) of ICTA.

1510.Section 59 of ICTA gives the person chargeable as the person “receiving or entitled to” the income.

1511.The phrase “receiving or entitled to” has been considered at length by the courts, although no clear definition of it has emerged. In early cases the courts placed greater emphasis on the concept of receipt than on entitlement - see, for example, Dewar v Commissioners of Inland Revenue (1935), 19 TC 561 CA. Later, equal importance was attached to each part of the phrase - see, for example, Aplin v White (1973), 49 TC 93(11) HC. The most recent cases, such as MacPherson v Bond (1985), 58 TC 579(12) HC, and Peracha v Miley (1990), 63 TC 444(13) CA, have hinged on whether or not any benefit has accrued to the taxpayer.

1512.As the phrase is well established in case law, it is retained in the rewritten legislation. It is not, however, considered appropriate to include any further explanation of the phrase because of its wide interpretation by the courts.

Section 372: Building society dividends

1513.This section treats building society dividends as interest. It is based on section 477A of ICTA.

1514.Subsection (1) provides that any building society dividend is to be treated as paid by way of interest for the purposes of this Act. See Change 80 in Annex 1. The wording “for the purposes of this Act” is necessary here since building society dividends are not treated as interest for all income tax purposes. They are treated as dividends for the purposes of deducting tax, by virtue of regulations made under section 477A(1) of ICTA (regulation 3(1) of the Income Tax (Building Societies) (Dividends and Interest) Regulations 1990 SI 1990/2231) or by virtue of section 349(3A) of ICTA.

Section 373: Open-ended investment company interest distributions

1515.This section and the two sections that follow provide investors, who are liable to income tax, with the information required to determine their taxable income from the open-ended investment company (OEIC). The tax provisions relevant to the OEIC, which is liable to corporation tax, are not in this Act.

1516.This section is based on section 468L of ICTA and the Open-ended Investment Companies (Tax) Regulations 1997 SI 1997/1154. These regulations provide that the tax treatment of investors (shareholders) in an OEIC generally follows the tax treatment of investors (unit holders) of an authorised unit trust (AUT). For an outline of the treatment of investors in an AUT see the commentary on section 376.

1517.The section provides for amounts that are not interest and would otherwise be something else to be treated as interest received by the investors. The amounts so treated are charged to tax by section 369 and are subject to the deduction of tax rules in section 349 of ICTA as amended by section 468L(4) of ICTA.

Section 374: Date when interest payments under section 373 made

1518.This section is based on sections 468H and 468L of ICTA and the Open-ended Investment Companies (Tax) Regulations 1997 SI 1997/1154. It applies to the amounts treated as interest.

Section 375: Interpretation of sections 373 and 374

1519.This section is based on sections 468H and 832 of ICTA and the Open-ended Investment Companies (Tax) Regulations 1997 SI 1997/1154.

1520.The regulations contained in SI 1997/1154, in so far as they apply to invoke the AUT rules for the tax charge on OEIC investors liable to income tax, are rewritten in the preceding sections. The regulations remain in place in respect of investors liable to corporation tax and all other aspects concerning OEICs. A saving has been made in Part 5 of Schedule 2 to this Act to preserve the power in section 152 of FA 1995 so that regulations may continue to be made for achieving any purpose that could be achieved by such regulations before enactment of these sections.

Section 376: Authorised unit trust interest distributions

1521.This section and the two sections that follow provide investors, who are liable to income tax, with the information required to determine their taxable income from the authorised unit trust (AUT). The tax provisions relevant to the AUT are not in this Act. This is because the AUT trustees are treated as a company liable to corporation tax under section 468(1)(a) of ICTA.

1522.This section is based on section 468L of ICTA which is part of the special tax rules for AUTs. These rules provide that AUTs are treated for tax purposes as though all of the money shown in their distribution accounts, as available for distribution or in the case of investors holding accumulation units, for adding to the capital value of their share of the fund, is actually paid out to unit holders. This means that the investors are taxed when they receive the benefit of the distribution made by the AUT rather than when they sell their units.

1523.The investors are treated as receiving a payment of interest or a dividend depending on how the AUT has allocated the money in its accounts. There are various rules which determine how and when this allocation can be made by the AUT.

1524.The amounts treated as interest are charged to tax by section 369 and are subject to the deduction of tax rules in section 349 of ICTA as amended by section 468L(4) of ICTA. The amounts treated as dividends are dealt with in section 389.

Section 377: Date when interest payments under section 376 made

1525.This section is based on sections 468H and 468L of ICTA. It applies to the amounts treated as interest.

Section 378: Interpretation of sections 376 and 377

1526.This section is based on sections 468H and 832 of ICTA.

Section 379: Industrial and provident society payments

1527.This section provides that share interest from industrial and provident societies is treated as interest. It is based on section 486 of ICTA.

1528.Section 486(4) of ICTA provides that share or loan interest is chargeable under Schedule D Case III. The definition of “share interest” in section 486 of ICTA is “any interest, dividend, bonus or other sum….”. This section treats the dividend, bonus and other sums as interest. See Change 81 in Annex 1.

1529.Subsections (2) to (5) are definition subsections. The reference to “the Department of Agriculture for Northern Ireland” in section 486(12) of ICTA is rewritten in subsection (5) as the “the Department of Agriculture and Rural Development”, its current title.

1530.The closing words of section 486(12) of ICTA (“and references to the payment of share interest or loan interest include references to the crediting of such interest”) are not rewritten. They are relevant to the rules within that section on the deduction of tax rather than the charge.

Section 380: Funding bonds

1531.This section provides for an issue of funding bonds in respect of a liability to pay interest to be treated as a payment of interest. It is based on section 582 of ICTA.

1532.There is one specific situation where a funding bond is chargeable to tax under Schedule D Case VI rather than Schedule D Case III. Section 582(2)(a) of ICTA provides that where funding bonds are issued some bonds have to be retained on account of income tax. However, section 582(2)(b) of ICTA provides that where it is “impracticable” to do this the recipient is chargeable to tax under Schedule D Case VI on the amount of interest treated as having been paid by the issue of the bonds. This section charges this income also as interest for income tax purposes. One consequence is that all funding bond interest will be included in what was Schedule D Case III income in section 1A of ICTA as consequentially amended. See Change 82 in Annex 1.

1533.Relief for losses under the former Schedule D Case VI provisions will still be available under section 392 of ICTA.

1534.Section 582(1) of ICTA treats the issue of funding bonds as a payment of interest and they are taxed accordingly. The deemed interest is equal to the value of the bond at the time of issue. This section clarifies that the value which applies is the market value of the bond and not its nominal value. If the value were the nominal value a change in value could only occur in the unlikely circumstance of a change in the face value of the bond after issue. Moreover, tax could be easily avoided by issuing bonds with a low face value but repaying at a premium.

Section 381: Discounts

1535.This section treats discounts taxed under Schedule D Case III(b) as interest. It is based on section 18 of ICTA.

1536.Although section 18 of ICTA includes discounts as a separate category of charge without treating them as interest, this section provides for them to be charged as if they were interest. See Change 83 in Annex 1.

Chapter 3: Dividends etc. from UK resident companies etc..Introduction
Section 382: Contents of Chapter

1537.This section explains the scope of the Chapter. The Chapter contains the charge to tax on dividends and other distributions (and amounts treated as dividends) from companies resident in the United Kingdom. It also contains special provisions about dividends paid in respect of shares awarded under approved share incentive plans (“SIPs”). And, it contains provisions about tax credits and deduction of tax.

1538.Exemptions from the charge to tax under this Chapter are signposted in subsection (3).

1539.The exemptions include section 498 of ITEPA which is part of the SIP code (see further the commentary on section 392 of this Act and the overview to the SIP provisions). The SIP code provides various exemptions from tax for persons participating in an approved SIP. The code also imposes tax charges in certain circumstances, for example, if shares are not held within the plan for the prescribed period of time. Section 498 of ITEPA provides an exemption from the charge to income tax that arises if dividend shares cease to be subject to the plan, if the participant is a “good leaver”. In the source legislation, section 498 of ITEPA is expressed as a proviso to section 251C of ICTA (see section 251C(6) of ICTA). But as the charge to tax in respect of all dividends and other distributions of a UK resident company falls under Chapter 3 of Part 4 of this Act, section 498 of ITEPA is signposted as an exemption from the tax charge under this Chapter.

1540.Subsection (4) replicates the position under the source legislation by ensuring that stock dividends that are taxed under Chapter 5 of Part 4 of this Act are not dividends for the purposes of this Chapter. (Despite their name, they do not count as dividends for the purposes of Schedule F. See further the commentary on Chapter 5 of Part 4 of this Act.)

1541.See the commentary on paragraph 10 of Schedule 1 to this Act for an explanation of the repeal of Schedule F.

Section 383: Charge to tax on dividends and other distributions

1542.This section charges to tax dividends and other distributions from UK resident companies. It is based on Schedule F in section 20 of ICTA.

1543.The section charges to tax “dividends and other distributions”. The expression “distribution” is not defined in this Act except by reference to section 832(1) of ICTA (see the index of defined expressions in Part 2 of Schedule 4 to this Act).

1544.The main reason for not rewriting “distribution” in this Act is the importance of the expression in a corporation tax context (because, for example, distributions of companies resident in the United Kingdom are not taken into account in computing profits for corporation tax purposes - see section 208 of ICTA - and do not give rise to a tax deductible expense for the distributing company - see section 337A of ICTA). The expression therefore needs to be retained in a corporation tax context. Rewriting it in an income tax context would mean maintaining similar but not identical provisions for different purposes (some of the provisions - for example, section 209(5) to (7) of ICTA - are not relevant for income tax purposes). This is not thought to be straightforward or convenient for users of the legislation.

1545.Section 20(1) paragraph 1 of ICTA charges to tax all dividends and other distributions. But this is subject to section 95(1A)(a) of ICTA (taxation of dealers in respect of distributions). Section 95(1A)(a) of ICTA provides that tax is not charged under Schedule F where a dealer receives a “relevant distribution”. Instead, tax is charged under Schedule D Case I or II. Section 383 does not explicitly rewrite the proviso in section 20(1) of ICTA but the effect of the proviso is replicated by section 366(1) of this Act (which gives charging priority to Chapter 2 of Part 2 of this Act for income which is a receipt of a trade). So a distribution made by a UK resident company which is a receipt of a trade is charged to tax under Part 2 of this Act and not under this Chapter.

1546.The charge to tax under Schedule F in the source legislation is also subject to section 171(2) of FA 1993 (Lloyd’s underwriters: taxation of profits and allowance of losses) (see section 20(2) of ICTA). As with dealers, the tax charge in the source legislation is Schedule D Case I and not Schedule F. But section 171(2) of FA 1993 additionally provides that the amount of the profits arising from assets in an ancillary trust fund is calculated under the relevant Schedule or Case. Again, section 383 does not explicitly rewrite the proviso in section 20(2) of ICTA but the effect of that section is replicated by section 366(1) of this Act (which gives charging priority to Chapter 2 of Part 2 of this Act). And section 2(4) of this Act ensures that the calculation can be made under this Chapter.

1547.Subsections (2) and (3) confirm that the distribution is regarded as income for all income tax purposes even if it would otherwise be treated as capital (a capital dividend is a distribution – see section 209(2)(a) of ICTA).

Section 384: Income charged

1548.This section sets out the amount charged to tax and is based on section 20(1) paragraphs 1 and 2 of ICTA. The amount charged is the amount or value of the dividends paid and distributions made in the tax year. But if the recipient of the distribution is entitled to a tax credit, the amount charged is the amount or value of the distribution plus the tax credit (see subsection (3)).

1549.Dividends are treated as paid for the purposes of the Corporation Tax Acts “on the date when they become due and payable, except in so far as Chapter III of Part XII makes other provision for dividends treated as paid by virtue of that Chapter” (see section 834(3) of ICTA).

1550.The “Corporation Tax Acts” means the enactments relating to the taxation of the income and chargeable gains of companies and company distributions (including provisions relating to income tax) (see section 831(1) of ICTA). Chapter 3 of Part 12 of ICTA (referred to in the previous paragraph) specifies the date on which dividends which an authorised unit trust is treated as paying, are paid. So in all other cases the date on which a dividend is paid is the date on which the dividend becomes due and payable.

1551.The date when a final dividend becomes due and payable is usually established by a resolution of the company. The dividend becomes due when the date on which it is expressed to be payable arrives. Only then is payment enforceable. In the case of a final dividend where a date for payment is not specified, an immediately enforceable debt is created so that the date of declaration of the dividend is the due and payable date.

1552.An interim dividend can be varied and rescinded at any time before payment and can therefore only be regarded as “due and payable” when the date for payment arrives.

1553.The main case law authority for the above propositions is Potel v CIR (1970), 46 TC 658 HC (which particularly indicates that the declaration of a dividend by a company and its payment are two separate matters). Paragraph 2007b of the Inland Revenue’s Company Taxation Manual (CT2007b) provides the Inland Revenue’s interpretation of section 834(3) of ICTA and the meaning of “paid”.

Section 385: Person liable

1554.This section states who is liable for any tax charged.

1555.Under the source legislation there is no provision expressly stating who is liable for the tax charged. Although section 20(1) paragraph 1 of ICTA makes it clear that the charge to tax encompasses all distributions of a UK resident company made in a tax year, and includes a reference to the recipient, it does not actually specify the person liable.

1556.The person liable can however be deduced from the legislation as a whole (and this has been reflected in subsection (1)).

1557.Section 20(1) of ICTA refers to recipients of distributions and persons entitled to tax credits. Paragraph 1 of section 20(1) of ICTA provides that distributions are regarded as income “…however they fall to be dealt with in the hands of the recipient”; paragraph 2 of that section provides that where “…a person is entitled to a tax credit” in respect of a distribution it is the aggregate of the distribution and the tax credit which is taxed.

1558.Section 231(1) of ICTA (tax credits for certain recipients of qualifying distributions) provides that a UK resident “receiving” a qualifying distribution is entitled to a tax credit. And section 232 of ICTA (tax credits for non-UK residents) refers to distributions “received” by certain individuals. Section 231(4) of ICTA deals with the case where a distribution “is, or falls to be treated as, or under any provision of the Tax Acts is deemed to be, the income of a person other than the recipient”, so that other person is treated as receiving the distribution for the purposes of section 231 of ICTA. So, section 231(4) of ICTA suggests that where the distribution actually belongs to someone other than the recipient, or under any provision of the Tax Acts is treated as belonging to someone other than the recipient, that other person is liable for the tax charged.

1559.Section 209 of ICTA is the main provision which defines the term “distribution”. Section 209(1) of ICTA provides that “The following provisions of this Chapter, together with section 418 of ICTA, shall, subject to any express exceptions, have effect with respect to the meaning of “distribution” and for determining the persons to whom certain distributions are to be treated as made ...”.

1560.Where an asset or liability is transferred by a company to a member, section 209(4) of ICTA requires an amount to be treated as a distribution made to the member.

1561.Distributions are made, in most circumstances, to shareholders. For the purposes of Part 6 of ICTA (company distributions, tax credits etc) section 254(12) of that Act regards something done “in respect of a share” as being done to the shareholder, or to someone who has at a particular time been the shareholder. This suggests that someone to whom a distribution is treated as made for the purposes of Part 6 of ICTA is liable.

1562.The definition of distribution is extended by section 418(1) of ICTA to include any amount which is required to be treated as a distribution by section 418(2) of ICTA. Under section 418(2) of ICTA, where a close company incurs expense in providing a benefit or facility for a participator “the company shall be treated as making a distribution to him of an amount equal to so much of that expense as is not made good to the company”. While it does not explicitly identify the person liable in respect of the distribution, in practice the participator is regarded as the person liable.

1563.So, while there is no express person liable provision (as there is for Schedule D for example), there are provisions covering:

  • the person to whom a distribution is made or to whom it is treated as made for the purposes of Part 6 of ICTA – sections 209(1) and (4), 254(12) and 418(2) of ICTA;

  • the person receiving a distribution – sections 20(1)1, 231(1) and (4) and 209(4) of ICTA;

  • the person entitled to the distribution – sections 20(1)2 and 231(4); and

  • the person to whom the distribution, under any provision of the Tax Acts, is treated as belonging (where that person is not the recipient) – section 231(4) of ICTA.

1564.A provision stating who is liable for any tax charged on distributions from UK resident companies needs to cover all these possibilities save the last one. If a distribution is treated under any provision of the Tax Acts as the income of a person other than the recipient, that legislation will provide who is liable for the tax.

Section 386: Open-ended investment company dividend distributions

1565.This section and the two sections that follow provide investors, who are liable to income tax, with the information required to determine their taxable income from the open ended investment company (OEIC). The tax provisions relevant to the OEIC, which is liable to corporation tax, are not in this Act.

1566.This section is based on section 468J of ICTA and the Open-ended Investment Companies (Tax) Regulations 1997 SI 1997/1154. These regulations provide that the tax treatment of investors (shareholders) in an OEIC generally follows the tax treatment of investors (unit holders) of an authorised unit trust (AUT). For an outline of the treatment of investors in an AUT see the commentary on section 376.

1567.The section provides for amounts that are not dividends and would otherwise be something else to be treated as dividends received by the investors. The amounts so treated are charged by section 383 and the provisions about tax credits or tax being treated as paid at sections 397 to 399 will apply as appropriate.

Section 387: Date when dividends paid under section 386

1568.This section is based on sections 468, 468H and 468J of ICTA and the Open-ended Investment Companies (Tax) Regulations 1997 SI 1997/1154. It applies to the amounts treated as dividends.

Section 388: Interpretation of sections 386 and 387

1569.This section is based on sections 468H and 832 of ICTA and the Open-ended Investment Companies (Tax) Regulations 1997 (SI 1997/1154).

1570.The regulations contained in SI 1997/1154, in so far as they apply to invoke the AUT rules for the tax charge on OEIC investors liable to income tax, are rewritten in the preceding sections. The regulations remain in place in respect of investors liable to corporation tax and all other aspects concerning OEICs. A saving has been made in paragraph 78 of Schedule 2 to this Act to preserve the power in section 152 of FA 1995 so that regulations may continue to be made for achieving any purpose that could be achieved by such regulations before enactment of these sections.

Section 389: Authorised unit trust dividend distributions

1571.This section and the two sections that follow provide investors, who are liable to income tax, with the information required to determine their taxable income from the authorised unit trust (AUT). The tax provisions relevant to the AUT are not in this Act. This is because the AUT trustees are treated as a company liable to corporation tax under section 468(1)(a) of ICTA.

1572.This section is based on section 468J of ICTA which is part of the special tax rules for AUTs. For an outline of the treatment of investors in an AUT see the commentary on section 376.

1573.The amounts treated as dividends received by the investors are charged by section 383 and the provisions about tax credits or tax being treated as paid at sections 397 to 399 will apply as appropriate.

Section 390: Date when dividends paid under section 389

1574.This section is based on sections 468H and 468J of ICTA. It applies to the amounts treated as dividends.

Section 391: Interpretation of sections 389 and 390

1575.This section is based on sections 468H and 832 of ICTA.

Shares in approved share incentive plans (“SIPs”)
Overview

1576.Section 392 and the following four sections are based on sections 251A to 251C of ICTA which are part of the legislation relating to SIPs. The SIPs legislation was originally contained in Schedule 8 to the FA 2000 (introduced by section 47 of FA 2000) and was rewritten in ITEPA. The majority of the SIP code is contained in Chapter 6 of Part 7 of and Schedule 2 to ITEPA.

1577.The SIP code is designed to encourage employee share ownership. The core of the SIP code is that a company establishes a share incentive plan. Under the plan various types of share can be acquired or awarded - free shares, partnership shares and matching shares. In addition, scheme participators may, with the dividends paid on their shares, acquire “dividend shares”.

1578.The shares awarded or acquired under the plan are held on behalf of the scheme participant by the trustees of the scheme. Therefore, any dividend paid by the company on those shares is paid to the trustees.

1579.The participant may choose (or the company may require) that all cash dividends paid on the shares be reinvested in further shares. If so, the cash dividend is used by the trustees of the scheme to acquire further shares. Those shares are called dividend shares.

1580.Section 493 of ITEPA (which is rewritten as section 770(2)(a) of this Act) provides that a scheme participant is not liable to income tax on the amount applied by the trustees in acquiring dividend shares on the participant’s behalf.

1581.But a tax charge may arise if the dividend shares subsequently cease to be subject to the approved SIP. The special rules applying when dividend shares cease to be subject to the plan are rewritten in section 394.

1582.If the trustees cannot reinvest the cash dividend either because the amount of the cash dividend is not sufficient to acquire a share or because there is an amount remaining after acquiring shares, the trustees may keep the cash dividend and carry it forward with a view to reinvestment at a later date (see paragraph 68(2) of Schedule 2 to ITEPA). In that case, section 496 of ITEPA (rewritten as section 770(1)(b) of this Act) provides that the participant is not liable to income tax in respect of the amount of the cash dividend held by the trustees.

1583.But if the trustees subsequently pay over the cash dividend to the participant, the tax charge may revive. The special rules applying when the cash dividend held by the trustees is paid over to the participant is rewritten in section 393.

Section 392: SIP shares: introduction

1584.This section introduces the special rules about SIPs. It is based on section 251A of ICTA.

1585.Subsections (2) to (7) ensure that sections 393 to 396 apply only if the participant has benefited from the tax advantages of an approved SIP. Those tax advantages apply to an individual who is chargeable to tax under Part 2 of ITEPA in respect of eligible employment (as defined in subsection (4)) or, if the shares were awarded before ITEPA came into force, under Schedule E.

Section 393: Later charge where cash dividends retained in SIPs are paid over

1586.This section is based on section 251B of ICTA.

1587.The trustees of the scheme may only hold on to a cash dividend and carry it forward for three years from the date the dividend is paid by the company. Additionally, any amount not reinvested must be paid to the participant if the participant ceases to be in “relevant employment” or if a termination notice is issued in respect of the plan (see paragraph 68(4) of Schedule 2 to ITEPA).

1588.Subsection (2) ensures that in any of these circumstances, the participant is charged to income tax for the tax year in which the dividend is paid over.

1589.Tax is charged on the amount of the cash dividend paid over and not on the amount of the cash dividend originally paid by the company (subsection (3)).

1590.Whether the participant is entitled to a tax credit and, if so, the amount of it, is determined by reference to the tax year in which the cash dividend is paid over by the trustees and not by reference to the tax year the company actually paid the dividend (see subsection (5)).

1591.Section 251B of ICTA is rewritten so that the original tax charge is postponed (contrast section 394 which deems a further distribution to be made). This approach has rendered the phrase “except to the extent that it represents a foreign cash dividend” redundant. In effect, the cash dividend paid over by the trustees does not lose its original character as either a cash dividend paid by a UK resident company (in which case it is dealt with under this Chapter) or a cash dividend paid by a non-UK resident company (in which case it is dealt with under Chapter 4 of Part 4 of this Act).

1592.But the definition of “foreign cash dividend” in section 251D of ICTA does suggest that it is the date that the company originally paid the dividend that determines, under the source legislation, whether the tax charge falls under Schedule F (if UK resident company) or Schedule D Case V (if non-UK resident company). This is rewritten in subsection (6).

Section 394: Distribution when dividend shares cease to be subject to SIP

1593.This section is based on section 251C of ICTA and applies if the dividend shares acquired with the cash dividend cease to be subject to the approved SIP within three years of acquisition.

1594.Subsection (2) deems a distribution to have been made to the participant in the tax year in which the dividend shares cease to be subject to the plan.

1595.Subsection (3) confirms that tax is charged on the amount of the cash dividend applied to acquire the shares (which have ceased to be subject to the plan) rather than, for example, the amount or value of the dividend shares.

Section 395: Reduction in tax due in cases within section 394

1596.This section is based on section 251C of ICTA and applies if tax has been paid in respect of any capital receipts received in connection with the holding of the dividend shares which cease to be subject to the approved SIP.

1597.Subsection (2) operates to reduce the amount of tax due under section 394.

Section 396: Interpretation of sections 392 to 395

1598.This section is based on section 251D of ICTA.

Section 397: Tax credits for qualifying distributions: UK residents and eligible non-UK residents

1599.This section and the following four sections deal with:

  • a person’s entitlement to a tax credit attaching to qualifying distributions;

  • the tax treatment of qualifying distributions where the person is not entitled to a tax credit; and

  • the tax treatment of non-qualifying distributions.

1600.The sections are based on sections 231, 232 and 233 of ICTA.

1601.By virtue of sections 231(1) and 232 of ICTA tax credits are available to certain recipients in respect of certain qualifying distributions from companies resident in the United Kingdom.

1602.Tax credits attach to qualifying distributions which are made either to residents of the United Kingdom or to certain non-UK resident persons. The source legislation has been rearranged so that there is a single provision dealing with both categories of recipients (UK resident and non-UK resident) who are entitled to tax credits.

1603.Most distributions of companies resident in the United Kingdom are “qualifying distributions” (see section 14(2) of ICTA). Only the issue of redeemable share capital (unless that share capital is taxed under the stock dividends legislation) or the issue of securities in respect of shares or securities of a company otherwise than wholly for new consideration, are non-qualifying distributions.

1604.In line with the decision not to define the expression “distribution” in this Act, the expression “qualifying distribution” is likewise not defined (other than by reference to section 832(1) of ICTA).

1605.Subsection (1) sets out who is entitled to the tax credit, in what circumstances and what the value of that tax credit is. Those entitled to the tax credit include “eligible non-UK residents”.

1606.Subsection (2) deals with how the tax credit may be used and rewrites section 231(3) of ICTA. Section 231(3) in the source legislation is subject to section 231(3AA) of ICTA. This is rewritten in a slightly different way. Subsection (3) treats the tax credits attaching to qualifying distributions as reduced if those distributions are not brought into charge to tax. So, for example, if an individual’s total income is reduced by deductions (for example, personal allowances) such that the qualifying distributions are not, or are not wholly, brought into charge to tax, the value of the tax credits attaching to those distributions are correspondingly reduced. So a person may be entitled to a tax credit whose value is nil.

1607.Although companies resident in the United Kingdom are expressly excluded in section 231(3) of ICTA, (because section 231(3) of ICTA applies to a person “not being a company resident in the United Kingdom”) this exclusion has not been adopted. See Change 84 in Annex 1.

1608.Subsection (4) defines eligible non-UK resident. Section 232 of ICTA extends the entitlement to tax credits to certain non-UK resident individuals. These are referred to as individuals who:

having made a claim in that behalf, [are] entitled to relief under Chapter I of Part VII by virtue of section 278(2) …

1609.The words about making the claim in section 232 of ICTA are unnecessary because the individual will have to make a claim for personal allowances under section 278(8) of ICTA before the tax credit can be taken into account.

1610.Also, section 278 of ICTA does not specify whether the individual concerned has to come within one of the given categories (eg Commonwealth citizen or EEA national) throughout the tax year in question or merely at any time during the tax year in question. However, given personal allowances are available to these individuals simply for falling within a particular category, subsection (4) has followed this approach and has used the words “at any time”.

1611.Subsection (5) rewrites section 231(4) of ICTA. The words “(and accordingly the question whether he is entitled to a tax credit in respect of it shall be determined by reference to where he, and not the actual recipient, is resident)” have been omitted. The revised wording of the section makes the words unnecessary.

Section 398: Increase in amount or value of dividends where tax credit available

1612.This section is based on section 20(1) of ICTA (including the proviso “other than section 95(1)”). It applies for all income tax purposes including the case where the recipient of the distribution is a member of Lloyd’s. But the section does not apply if the recipient of the distribution is a dealer (in which case only the net amount of the distribution is taken into account in calculating the profits of the dealer).

Section 399: Qualifying distributions received by persons not entitled to tax credits

1613.This section deals with the tax treatment of qualifying distributions received by persons not entitled to a tax credit (for example, because they are non-resident and do not fall within the definition of “eligible non-UK resident”). As mentioned in the commentary on section 397(3), a person may be entitled to a tax credit whose value is nil. The person is nevertheless entitled to a tax credit and therefore this provision does not apply to such a person. It is based on section 233(1) and (1A) of ICTA.

1614.Subsection (2) provides that the non-UK resident is treated as having paid income tax at the dividend ordinary rate (Schedule F ordinary rate in the source legislation) on the amount or value of the distribution.

1615.The amount or value of the distribution will either be the actual amount of the distribution (if the person is a non-UK resident company receiving the qualifying distribution in a beneficial capacity) or that amount is “grossed up” by reference to the dividend ordinary rate. Subsections (3) and (4) explain when the grossed up amount (as defined in subsection (5)) is substituted for the actual amount.

1616.The words “not being a company resident in the United Kingdom” in section 233(1) of ICTA and “any person who is not a company” in section 233(1A) of ICTA create the same difficulties as those in section 231(3) of ICTA. So this section follows a similar approach to that taken in section 397(2) by rewriting sections 233(1) and 233(1A) of ICTA without any exclusion for companies. See Change 84 in Annex 1.

1617.Section 233(1)(c) of ICTA treats the amount or value of the distribution as not brought into charge to tax for the purposes of sections 348 and 349 of ICTA. Section 233(1)(c) of ICTA is not rewritten in this Act. But rather than leaving the provision “stranded” in section 233 of ICTA, it has been incorporated in section 348 of ICTA as paragraph (a) of a new subsection (4) (see paragraph 147(3) of Schedule 1 to this Act).

Section 400: Non-qualifying distributions

1618.This section is based on section 233(1) of ICTA and applies when a person receives a non-qualifying distribution.

1619.A non-qualifying distribution is defined as any distribution which is not a qualifying distribution (see subsection (6)). A qualifying distribution is defined in section 14(2) of ICTA. Broadly, a non-qualifying distribution is an issue of redeemable share capital (unless the share capital is taxed as a stock dividend) or of securities in respect of shares or securities of the issuing company otherwise than wholly for new consideration. A non-qualifying distribution does not carry a tax credit.

1620.Subsection (2) treats the recipient of the non-qualifying distribution as having paid income tax at the dividend ordinary rate (Schedule F ordinary rate in the source legislation) on the actual amount of the non-qualifying distribution (that is, there is no grossing up).

1621.The words “not being a company resident in the United Kingdom” in section 233(1) of ICTA create similar difficulties to those in sections 231(3) and 233(1A) of ICTA. See Change 84 in Annex 1.

1622.Subsections (4) and (5) are based on section 233(1B) of ICTA. In the case of trustees of accumulation or discretionary trusts, the trustees are taxed on the amount or value of the distribution at the dividend trust rate (Schedule F trust rate in the source legislation). However, the trustees’ tax liability is reduced by an amount of income tax equivalent to the dividend ordinary rate (Schedule F ordinary rate in the source legislation).

Section 401: Relief: qualifying distribution after linked non-qualifying distribution

1623.This section is based on section 233(2) of ICTA.

1624.A non-qualifying distribution is generally the first part of an event that will eventually be a qualifying distribution. So the issue of redeemable share capital (unless a stock dividend) is a non-qualifying distribution (see section 14(2)(a) of ICTA) but the repayment of that share capital is a qualifying distribution. So section 233(2) of ICTA provides relief to avoid double taxation for higher rate taxpayers.

1625.The section applies where a taxpayer pays income tax at the dividend upper rate (Schedule F upper rate in the source legislation) on the receipt of a non-qualifying distribution and is liable to income tax at the dividend upper rate (Schedule F upper rate in the source legislation) on the receipt of the linked qualifying distribution. Subsection (1) enables a taxpayer to set his or her extra tax liability (ie, the higher rate element) arising on the non-qualifying distribution against the extra liability arising on the qualifying distribution so that the taxpayer is only liable to pay the balance.

1626.Subsections (5) and (6) explain how the extra liability is calculated in earlier tax years (because the rates at which higher rate taxpayers have paid tax have changed over the years).

Chapter 4: Dividends from non-UK resident companies
Overview

1627.This Chapter introduces a separate charge to income tax on dividends from companies not resident in the United Kingdom.

1628.Under section 18(3) of ICTA, there are no individual charges according to types of income within the Schedule D Case IV or V charge. But the system of identifying and classifying income by Schedule and Case has been replaced in this Act by individual charges on types of income.

1629.Income which, under the source legislation, is charged to tax under Schedule D Cases IV or V, has, where appropriate, been fully integrated with the equivalent income arising from a UK source. In the case of dividends from non-UK resident companies there is no exact equivalent in terms of UK source income. The closest equivalent is the charge to tax on dividends and other distributions from UK resident companies (section 20 of ICTA, Schedule F in the source legislation). But there is no precise overlap. The UK charge, by the adoption of the definition of “distribution” from Part 6 of ICTA (see the commentary on Chapter 3 of Part 4 of this Act) can include dividends or distributions of a capital nature and can also operate to convert payments that would otherwise be treated as interest into distributions. Any charge on distributions from non-UK resident companies must be confined to income only. For this reason (and also because the basis of assessment is different – see the commentary on section 403 elow), it is not thought appropriate to integrate the charges. So a separate charge is needed to cover dividends from non-UK resident companies.

Section 402: Charge to tax on dividends from non-UK resident companies

1630.This section charges to tax dividends of companies not resident in the United Kingdom. It is based on section 18(1) and (3) of ICTA.

1631.For the reasons explained in the overview, the expression “distribution” has not been adopted. It is possible that a non-UK resident company may make a distribution of income which would not fall within Chapter 4 of Part 4 of this Act because it is not a “dividend”. But if the distribution comprises income it will fall to be dealt with either under alternative specific charges (eg interest) or within “income not otherwise charged”, the charge on which appears in Chapter 8 of Part 5 of this Act.

1632.The term “dividend” is not defined in this Act. “Dividend” is a widely used and understood term and is defined only in very specific circumstances not applicable in this context (see, for example, section 49 of ICTA – dividends held in the name of Treasury). It is not thought appropriate to attempt to define “dividend” here. It will usually be a matter of referring to the relevant company law to determine whether or not a payment made by a company is a dividend.

1633.Subsection (2) highlights an exemption from income tax for dividends paid under approved share incentive plans (“SIPs”) and subsection (3) signposts section 498 of ITEPA. See further the commentary on the SIPs legislation in Chapter 3 of Part 4 of this Act and Chapter 9 of Part 6 of this Act (particularly the commentary on section 770 of this Act).

1634.Subsection (4) ensures that dividends of a capital nature do not fall within the charge to tax under this Chapter. In determining whether a payment is income in nature, it is necessary (as it is under the source legislation) to analyse the payment under local law (see CIR v Trustees of Joseph Reid (dec’d) (1949), 30 TC 431 HL and Rae v Lazard Investment Co Ltd (1963), 41 TC 1 HL). Whiteman on Income Tax, Third Edition, on page 1107, comments in this context “the proper test in such circumstances is, applying the local law, whether or not the corpus of the asset is left intact after the distribution. If it is not, the receipt will be a capital receipt; if it is, the payment will be chargeable”.

Section 403: Income charged

1635.This section sets out the amount charged to tax and is based on section 65(1) of ICTA.

1636.Subsection (1) charges tax on the full amount of the dividends arising in the tax year. The term “arising” has been retained (see the commentary on income charged in Chapter 2 of Part 4 of this Act). The arising basis is different from the paid basis which applies to the charge to tax on dividends and other distributions from UK resident companies (for a discussion of the paid basis see the commentary on Chapter 3 of Part 4 of this Act) and, given they do not mean exactly the same, “paid” has not been used in this context.

1637.Subsection (2) makes the basis of assessment in subsection (1) subject to the SIPs rules and Part 8 of this Act. Part 8 contains the special rules which apply to foreign income (see further the commentary on Part 8 of this Act).

Section 404: Person liable

1638.This section states who is liable for any tax and is based on section 59(1) of ICTA.

Section 405: SIP shares: introduction

1639.This section and the following three sections are based on sections 68A to 68B of ICTA which were inserted into ICTA by ITEPA. They are part of the SIPs code. See also the commentary on the SIPs legislation in Chapter 3 of Part 4 of this Act.

1640.This section introduces the special rules about charges to tax on SIP dividends.

1641.Subsection (2) provides that sections 406 to 408 apply only if the participant has benefited from the tax advantages of an approved SIP. Those tax advantages will only apply to an individual who is chargeable to tax under Part 2 of ITEPA in respect of eligible employment, or, in the case of shares awarded before ITEPA came into force, under Schedule E.

Section 406: Later charge where cash dividends retained in SIPs are paid over

1642.This section is based on section 68B of ICTA.

1643.SIP trustees may only retain a cash dividend and carry it forward for three years from the date the dividend is paid by the company. Any amount not reinvested must be paid to the participant if the participant ceases to be in “relevant employment” or if a termination notice is issued in respect of the plan (see paragraph 68(4) of Schedule 2 to ITEPA).

1644.This section makes provision about amounts so paid over.

1645.The definition of “foreign cash dividend” in section 68C of ICTA suggests that it is the date that the company originally paid the dividend that determines whether the tax charge falls under Schedule F or Schedule D Case V in the source legislation. This is rewritten in subsection (5).

Section 407: Dividend payment when dividend shares cease to be subject to SIP

1646.This section is based on section 68B(2) of ICTA and applies if the dividend shares acquired with the cash dividend cease to be subject to the approved SIP within three years of acquisition.

Section 408: Reduction in tax due in cases within 407

1647.This section is based on section 68B(3) of ICTA. Subsection (1) provides that the section applies if the participant has paid tax in respect of any capital receipts received in connection with the holding of the dividend shares which cease to be subject to the approved SIP.

1648.Subsection (2) operates to reduce the amount of tax otherwise due under Chapter 4 of Part 4 of this Act by an amount equal to the tax paid on the capital receipts.

Chapter 5: Stock dividends from UK resident companies
Overview

1649.This Chapter deals with the charge to income tax on stock dividend income.

1650.“Stock dividend” is a term often given to particular form of dividend made by a UK resident company which is subject to a particular charge to income tax.

1651.A bonus issue of non-redeemable shares by a company is not a distribution (see, for example, CIR v Blott (1921), 8 TC 101 HL, CIR v Fisher’s Executors (1926), 10 TC 302 HL, and CIR v Wright (1926), 11 TC 181 CA). Without any special provision it would not have any income tax consequences for the shareholder.

1652.A bonus issue of redeemable shares, however, is a distribution (see section 209(2)(c) of ICTA). Without any special provision it would be charged to tax under the source legislation under Schedule F. However, there is a special provision – the charge to tax on stock dividends under section 249 of ICTA. And, under section 230 of ICTA, anything that is a stock dividend:

  • is not a distribution for Schedule F purposes;

  • is not treated as a distribution for the purposes of section 210 of ICTA (repayment of share capital followed by bonus issue); and

  • does not count as a bonus issue for the purposes of section 211 of ICTA (bonus issue followed by repayment).

1653.In this Chapter, the term “stock dividend income” is defined by reference to the issue of the share capital by a UK resident company in two circumstances. These circumstances are set out in section 249(1) and (2) of ICTA. These subsections are not rewritten in this Act because of their relevance to corporation tax.

1654.The first circumstance is where share capital is issued as a result of the shareholder exercising an option to choose whether to receive an ordinary cash dividend or additional share capital (section 249(1)(a) of ICTA).

1655.The second circumstance is where the company issues “bonus share capital” in respect of shares which, under their terms (whether original or otherwise), carry the right to bonus share capital (section 249(1)(b) and (2) of ICTA). (This is distinct from a bonus issue which arises from a specific resolution and not from the terms of the shares themselves.)

1656.Section 249(7) of ICTA is spent and is therefore repealed by this Act. Subsections (8) and (9) of section 249 of ICTA are open-ended and so have been retained in ICTA (but are amended by paragraph 119(4) and (5) of Schedule 1 to this Act).

Section 409: Charge to tax on stock dividend income

1657.This section charges stock dividend income to tax. It is based on section 249 of ICTA.

Section 410: When stock dividend income arises

1658.This section explains when and to whom stock dividend income is treated as arising. It is based on section 249(4) to (6) of ICTA.

1659.If stock dividends are issued to personal representatives during the administration period, stock dividend income is treated as arising (see subsection (4)) but that income is not taxed under Chapter 5 of this Part. Instead, that income forms part of the aggregate income of the estate for the purposes of Chapter 6 of Part 5 of this Act or section 701(8) of ICTA. “Personal representatives” is defined in section 878 of this Act.

Section 411: Income charged

1660.This section sets out the amount charged to tax and is based on section 249(4) and (6) of ICTA.

1661.Subsection (2) defines the amount charged to tax. It is the cash equivalent of the stock dividends issued (see section 412) grossed up at the dividend ordinary rate (the Schedule F ordinary rate in the source legislation). For the meaning of “grossing up” see section 877 and the commentary on that section.

Section 412: Cash equivalent of share capital

1662.This section explains how to calculate the cash equivalent of the stock dividend (in other words the net amount of the stock dividend income to be grossed up). It is based on section 251 of ICTA. This section also rewrites part of Statement of Practice A8.

1663.The source legislation is complex, particularly where the stock dividend is bonus share capital. Section 412 simplifies the rules for both types of stock dividend (ie, stock dividends in lieu of cash dividends and bonus share capital). See Change 85 in Annex 1.

1664.Subsection (1) deals with stock dividends within section 249(1)(a) of ICTA – an issue of share capital in lieu of a cash dividend. The cash equivalent of such share capital is the amount of the cash dividend alternative unless subsection (2) applies.

1665.Subsection (2) applies if the difference between the cash dividend alternative and the share capital’s market value equals or exceeds 15% of that market value. In that case, the cash equivalent is not the amount of the cash dividend alternative but rather the market value of the share capital.

1666.Subsection (3) deals with stock dividends within section 249(1)(b) of ICTA - bonus share capital. The cash equivalent of such share capital is its market value.

1667.Section 251(2)(a)(ii) and (4) of ICTA have been omitted, making the rule relating to bonus share capital more straightforward. See Change 85 in Annex 1.

1668.Subsection (4) specifies the date on which the “market value” is to be taken for the purposes of these provisions. It is based on section 251(2) and (3) of ICTA.

1669.Subsection (5) gives definitions for “listed” and “market value”. Section 251(3) of ICTA includes more complicated references to the relevant provisions in TCGA. Subsection (5) instead simply imports the definition of “market value” in sections 272 to 273 of TCGA save for subsection (2) of section 272 of TCGA.

Section 413: Person liable

1670.This section states who is liable for any tax charged and is based on section 249(4) to (6) of ICTA.

1671.Subsection (2) deals with individuals who are beneficially entitled to the stock dividend income. Such individuals could include outright owners, a beneficiary of a bare trust or one with an interest in possession, or the beneficial owner under a nominee arrangement.

1672.Subsection (3) indicates that the trustees of an accumulation and discretionary trust are the persons liable if:

  • stock dividends are issued to them; and

  • had the trustees been paid a cash dividend in respect of the shares, any of that cash dividend would be income to which section 686 of ICTA applies (accumulation and discretionary trusts: special rates of tax).

1673.Subsection (4) deals with stock dividend income arising to personal representatives during the administration of a deceased person’s estate. As personal representatives are not charged to tax under Chapter 5 of this Part they are not “persons liable”. This means that they are not treated as having paid income tax under section 414 but see further the commentary on section 680.

1674.Subsections (5) and (6) deal with joint ownership of share capital and are based on section 249(3) of ICTA.

Section 414: Income tax treated as paid

1675.This section explains how a person’s income tax liability is satisfied (in whole or in part). It is based on section 249(4) and (6) of ICTA.

1676.Under subsection (1), the taxpayer is treated as having paid income tax at the dividend ordinary rate (Schedule F ordinary rate in the source legislation) on the amount charged to tax. The words “and where trustees are so liable … the income is treated as if it were chargeable to tax at that rate” are based on section 249(6)(b) of ICTA and have been retained because they were considered significant in Howell and another v Trippier 2004(14) EWCA Civ 885.

1677.Subsection (2) provides that the tax treated as paid is not repayable. This applies even if the person liable is a non-taxpayer.

1678.Subsections (3) to (5) ensure that individual taxpayers cannot be given credit for income tax on more than the amount charged to income tax. So, for example, if the individual’s total income is reduced by deductions (for example, personal allowances) such that the stock dividend income is only partially brought into charge to tax, credit will only be given for so much of the stock dividend income as is so taxed.

1679.Section 249(4)(c) of ICTA deals with tax rates and treats the stock dividend income as not brought into charge to tax for the purposes of sections 348 and 349 of ICTA. Section 249(4)(c) of ICTA is not rewritten in this Chapter. But rather than leaving it “stranded” in section 249 of ICTA, it is rewritten in amendments to sections 1A and 348 and 349 of ICTA (see paragraphs 3 and 147(3) of Schedule 1 to this Act respectively).

Chapter 6: Release of loan to participator in close company
Section 415: Charge to tax under Chapter 6

1680.This section is based on sections 421(1) and 422(5) and (6) of ICTA. It imposes a charge to tax if a close company lends money to a participator and subsequently releases or writes off all or part of the debt.

1681.“Close company” and “participator” are defined in the interpretative provisions of Part 6 of ICTA (see sections 414 and 417 of that Act). Broadly, a close company is a UK resident company controlled by five or fewer participators (or any number of participators who are also directors of the company). A UK resident company may also be close if on the winding-up of the company more than half of the assets of the company would be distributed to five or fewer participators (or any number of participators who are also directors of the company). “Participator” is given a very wide meaning and includes any person having a share or interest in the capital or income of the company.

1682.Subsection (1) sets out the circumstances giving rise to the charge to tax. The expressions “releases”, “writes off”, “debt”, “loan” and “advance” have been preserved from the source legislation. There is no compelling reason to change any of these words and they need to be preserved to maintain the link with section 419 of ICTA.

1683.The tax charge under subsection (1) is subject to section 418 (seesubsection (2)). This prevents double taxation under this Chapter and Chapter 5 of Part 5 of this Act.

1684.Subsections (3) and (4) rewrite section 422(5) and (6) of ICTA. If a loan is made by a company (“B”) which is controlled by a close company (“A”), in circumstances where section 419 of ICTA would not otherwise apply, section 422(1) of ICTA treats the loan as made by A (so section 419 of ICTA applies). If B releases or writes off the loan, section 422(5) of ICTA effectively treats A as having released or written off the loan (so section 421 of ICTA applies). Further, section 419(2) of ICTA gives “loan” an extended meaning. So, if a person incurs a debt to a close company or a debt due from a person to a third party is assigned to a close company, the close company is treated as having made a loan. This extended meaning of loan is applied to B by section 422(6) of ICTA.

Section 416: Income charged

1685.This section sets out the amount charged to tax and is based on section 421(1) of ICTA.

Section 417: Person liable

1686.This section states who is liable for any tax charged.

1687.Subsection (1) explains that it is the person to whom the loan or advance was made unless that person has died or the loan or advance was made to trustees of a trust which has come to an end (subsection (2)).

1688.There is no reference, here or in the source legislation, to the position where the burden of the debt has been passed to a third party. This is because it is not possible in law for a debtor to assign a debt. Any transfer of debt must be made by way of novation, which would involve the existing debtor being released from the debt and the new debtor taking on a new debt. In such a case, therefore, a charge to tax under section 421 of ICTA would arise on the release of the existing debtor. The interpretation is based on the cases of Collins v Addies and Greenfield v Bains (1992), 65 TC 190 CA(15).

Section 418: Relief where borrowers liable as settlors

1689.This section is based on sections 421(3) and 677(3) of ICTA. Together these provisions prevent double taxation on the release or writing off of a loan where a sum in respect of the loan is treated as the borrower’s income in his or her capacity as settlor of a settlement.

1690.Section 677 of ICTA charges a settlor to income tax where the trustees of the settlement directly or indirectly make a capital payment to the settlor. A charge to income tax is only made if, and to the extent that, the payment can be matched against income retained within the settlement.

1691.So, it is possible that in respect of a particular tax year the borrower is liable to income tax in his or her capacity as settlor on a sum in respect of a loan and is also liable to tax under section 421 of ICTA in respect of amounts released or written off. Likewise, it is possible that the borrower has been liable to income tax in an earlier tax year in his or her capacity as settlor on a sum in respect of a loan or under section 421 of ICTA in respect of amounts released or written off.

1692.Section 421(3) of ICTA provides relief for sums which fall to be included as income under section 677 of ICTA. It suggests that section 677 of ICTA takes precedence:

This section shall not have effect in relation to a loan or advance made to a person if any sum falls in respect of the loan or advance to be included in his income by virtue of section 677, except so far as the amount released or written off exceeds the sums previously falling to be so included (without the addition for income tax provided for by subsection (6) of that section).

1693.But section 677(3) of ICTA provides:

Where any amount is included in a person’s income by virtue of section 421 in respect of any loan or advance, there shall be a corresponding reduction in the amount (if any) afterwards falling to be so included in respect of it by virtue of this section.

1694.This suggests that section 421 of ICTA takes precedence.

1695.The purpose of these provisions (which were introduced in the same Finance Act) is to prevent the same sum being taxed both under section 421 of ICTA and section 677 of ICTA. It is believed that “afterwards falling to be so included” in section 677(3) of ICTA is a reference to later tax years. So, for the purposes of section 677 of ICTA amounts charged in earlier tax years under section 421 of ICTA will be taken into account, but within the same tax year section 677 of ICTA will take precedence. This would mean that “previously falling to be so included” in section 421(3) of ICTA would include amounts charged to tax under section 677 of ICTA in the same and earlier tax years.

1696.So section 418:

  • makes it clear that section 677 of ICTA (rewritten as section 633 of this Act) takes precedence over section 421 of ICTA; and

  • ensures that the same sum is not taxed twice.

1697.Subsections (2) to (6) set out the steps to be taken to determine whether tax is charged under section 415. In particular, subsections (2) and (3) require the “total amount previously charged” (that is, sums taxed under section 633 of this Act either in previous tax years or in the same tax year and amounts taxed under this Chapter) to be compared with the “total amount released”. Only if the total amount released exceeds the total amount previously charged, is tax charged under this Chapter.

1698.Any amount that is charged to tax under section 415 is grossed up at the dividend ordinary rate (Schedule F ordinary rate in the source legislation) in the usual way (see subsection (3)).

1699.Subsection (5) provides that, when calculating the amount that has already been charged under section 633of this Act, only the net amount is taken into account, not the amount produced by the grossing up required under section 640(1) of this Act.

Section 419: Loans and advances to persons who die

1700.This section deals with who is liable for any tax charged where the original debtor has died and the loan is released or written off during the administration of the estate, or at some later point. It is based on section 421(2) of ICTA.

1701.If the conditions in subsection (1) are met, subsection (2) confirms that there is no charge under section 415. Instead, the amount that would have been charged under that section is treated as forming part of the aggregate income of the estate and may be charged under Chapter 6 of Part 5 of this Act or section 701(8) of ICTA.

1702.If subsection (2) does not apply,subsection (3) will (so that tax is charged under this Chapter).

Section 420: Loans and advances to trustees of trusts that have ended

1703.This section is based on section 421(2) of ICTA and applies where a loan has been made to trustees of a trust and the loan is released or written off after the trust has come to an end.

Section 421: Income tax treated as paid

1704.This section explains how a person’s income tax liability is satisfied (in whole or in part). It is based on section 421(1)(b) of ICTA.

1705.Under subsection (1), the person liable is treated as having paid income tax at the dividend ordinary rate (Schedule F ordinary rate in the source legislation) on the gross amount released or written off.

1706.If the debt is released or written off during the administration of a deceased person’s estate, the personal representatives are not charged to tax under this Chapter but the amount of income that would otherwise be so charged forms part of the aggregate income of the estate for the purposes of Chapter 6 of Part 5 of this Act or section 701(8) of ICTA. As personal representatives are not charged to tax under this Chapter they are not “persons liable”. This means that they are not treated as having paid income tax under this section (but see the commentary on section 680). “Personal representatives” is defined in section 878 of this Act.

1707.Subsection (2) provides that the tax treated as paid is not repayable. This applies even if the person is a non-taxpayer.

1708.Subsections (3), (4) and (5) ensure that an individual cannot be given credit for income tax on more than the amount of the loan released or written off which is charged to tax.

1709.Section 421(1)(c) of ICTA deals with tax rates and treats the amount charged to tax as not brought into charge to tax for the purposes of sections 348 and 349 of ICTA. Section 421(1)(c) of ICTA is not rewritten in this Chapter. But rather than leaving it “stranded” in section 421 of ICTA it is rewritten in amendments to sections 1A of ICTA and 348 and 349 of ICTA (see paragraphs 3 and 147(3) of Schedule 1 to this Act respectively).

Chapter 7: Purchased Life Annuity Payments
Overview

1710.Annuity payments made under a purchased life annuity are annual payments and taxable under the source legislation by section 18 of ICTA under Schedule D Case III or Case V. However, because of the special exemption that applies to payments made under a purchased life annuity (see the commentary on Chapter 7 of Part 6 of this Act) and because such payments are generally regarded as investment income, a specific charge has been carved out of the residual annual payments charge (which is in Chapter 7 of Part 5 of this Act).

1711.In line with the approach of bringing together all exemptions in one Part, the exemption for part of the purchased life annuity payment is in Chapter 7 of Part 6 of this Act.

Section 422: Charge to tax on purchased life annuity payments

1712.This section is based on section 18(1) and Schedule D Case III and Case V in section 18(3) of ICTA. It charges to tax annuity payments made under a purchased life annuity.

Section 423: Meaning of “purchased life annuity”

1713.This section rewrites the definition of “purchased life annuity” in section 657(1) of ICTA.

Section 424: Income charged

1714.Section 424 sets out the amount charged to tax on annuity payments and is based on section 64 and section 65(1) of ICTA. The amount charged may be reduced if the exemption in section 717 (exemption for part of purchased life annuity payments) applies.

1715.The words “without any deduction” in section 64 of ICTA have not been reproduced. They are considered unnecessary. There are no provisions in the source legislation allowing deductions from Schedule D Case III income and one of the defining characteristics of an annual payment is that it represents pure income profit in the hands of the recipient. See further the commentary on section 370. In the case of annuity payments arising from a source outside the United Kingdom, subsection (2) makes subsection (1) subject to the special rules for foreign income in Part 8 of this Act (see further the commentary on Part 8).

Section 425: Person liable

1716.This section is based on section 59(1) of ICTA and states who is liable for any tax charged. The phrase “receiving or entitled to” has been retained because it is generally understood and has been widely interpreted by the courts. See further the commentary on section 371.

Section 426: Annuity payments received after deduction of tax

1717.This section provides that if income tax has been deducted by the payer of the annuity, the recipient is treated as having paid that income tax. It is based on section 348(1)(d) of ICTA and case law.

1718.The policy has been adopted that only those tax deduction rules which both relate to the recipient and to amounts of tax treated as paid, will be rewritten in this Act. So, section 348(1)(c) of ICTA, for example, is not rewritten.

1719.Under section 348(1)(d) of ICTA, tax deducted from annual payments under section 348(1)(b) of ICTA is treated as paid by the recipient. Case law extends this proposition to tax deducted under sections 348(2) and 349 of ICTA. This section fills the legislative gap otherwise filled by case law.

1720.Section 348(1) of ICTA deals with annual payments within Schedule D Case III (other than interest) which are payable wholly out of profits or gains brought into charge to income tax. Under section 348(1)(b) of ICTA the payer is entitled, but not obliged, to deduct and retain out of the annual payment a sum representing income tax. Under section 348(1)(c) of ICTA the recipient has to allow the tax to be deducted by the payer. The recipient is charged to tax on the full amount of the payment (that is, the actual payment received plus the tax deducted) but is treated as having paid income tax equal to the amount of the sum deducted (see section 348(1)(d) of ICTA).

1721.Sections 348(2) and 349 of ICTA provide for certain other payments also to be made after deduction of tax, but there is no equivalent provision to say that the tax deducted should be treated as tax paid by the recipient. Various tax cases, however, extend the effect of section 348(1)(d) of ICTA to these provisions.

1722.In Allchin v Corporation of South Shields (1943), 25 TC 445 HL, Viscount Simon LC said (on page 461):

If and in so far as the annual payment is not payable and paid out of profits or gains brought into charge, the person making the payment is bound to deduct from it Income Tax at the current rate and to account to the Crown for the amount deducted. In effect, the payer in such a case acts as collector for the Crown of the tax due from the recipient. The requirement that the recipient must allow the deduction and treat the payer as acquitted of liability in respect of this amount is not repeated in Rule 21, but must be implied.

1723.The final sentence quoted clearly follows the text of section 348(1)(c) of ICTA and effectively extends it to section 349 cases. The words of section 348(1)(d) of ICTA are not mentioned but the obiter words, “In effect, the payer in such a case acts as collector for the Crown of the tax due from the recipient”, amount to the same thing because it follows from them that once deduction has occurred, the recipient has paid his or her tax.

1724.In Stokes v Bennett (1953), 34 TC 337 HC, a divorced wife received maintenance payments, “free of tax”, under a UK court order from her former husband who was not resident in the United Kingdom. There was no evidence that tax was deducted from the payments and no such tax was accounted for to the Inland Revenue. Also, there was no evidence that the husband received income which was subject to UK income tax. The wife was taxed under Schedule D Case III on the amounts received.

1725.It was held in the High Court, however, that the wife should be treated as having received sums from which tax had been deducted and no further assessments could therefore be made. As the order was for an amount to be paid “free of tax”, and because the husband had paid the same amounts as the free of tax amounts (rather than the grossed up amounts), the court thought that the correct inference was that he had deducted tax.

1726.As there was no evidence that the payments were out of taxed income, it was a case within what is now section 349 of ICTA, rather than section 348 of ICTA. Deduction of tax was presumed to have occurred and Lord Simon’s dicta from Allchin v Corporation of South Shields were applied so that the requirement that the recipient must allow the deduction and treat the payer as acquitted of his liability had to be implied. It followed that the wife could not sue her husband for the tax because she would be met with the defence that he was acquitted of his liability. Therefore the wife fell to be treated as the recipient of an amount that had borne tax. Collection of the tax was a matter between the payer and the Crown. The husband had become in effect an agent for the Crown, as the collector for the Crown of the tax due from (and in effect paid by) the wife. This is tantamount to the provision in section 348(1)(d) of ICTA.

1727.Section 349 of ICTA is regarded as applying to annual payments made under United Kingdom court orders etc not wholly out of profits or gains bought into charge to income tax even where the payer is not UK resident.

1728.In Grosvenor Place Estates Ltd v Roberts (1960), 39 TC 433 CA, the National Coal Board failed to deduct tax from certain payments which were not made out of profits or gains brought into charge to tax. The recipient company was taxed on the full amount of the payments. On appeal the company contended that as the National Coal Board was obliged to deduct tax no assessment could be made on the recipient. It was held, however, that the recipient could be assessed to tax where the payer failed to deduct tax, notwithstanding the express rights of the Inland Revenue to assess the payer. Donovan LJ said (on page 453):

The power and duty of the General Commissioners to make assessments upon annual payments charged with tax under Schedule D where such payments are made out of profits or gains not brought into charge to tax still remains. This does not involve liability to double taxation, once by deduction at source and again by assessment upon the same income. It is true there is nothing in the Act expressly prohibiting such an injustice, but the prohibition is implicit in its provisions, as the Courts have frequently said.

1729.In effect this means that section 349 of ICTA impliedly contains the provision in section 348(1)(d) of ICTA, that the deduction is treated as tax paid by the payee.

Chapter 8: Profits from deeply discounted securities
Overview

1730.This Chapter rewrites the provisions in Schedule 13 to FA 1996 that deal with “relevant discounted securities”. FA 2003 introduced various changes to Schedule 13, principally repealing reliefs for losses and allowances for expenditure, but with transitional rules for securities held since before 27 March 2003. Since these losses and allowances continue to apply for securities held since that date it was considered more helpful to set out the law relating to them in this Chapter rather than relegate them to Schedule 2 to this Act.

Section 427: Charge to tax on profits from deeply discounted securities

1731.This section charges to tax profits on deeply discounted securities which arise when the security is disposed of (for whatever reason) or, in certain circumstances, is treated as being disposed of. It also ensures that gains which would not otherwise be income are treated as such. The section is based on paragraph 1 of Schedule 13 to FA 1996.

1732.Although Schedule 13 to FA 1996 refers to a “relevant discounted security”, this Act uses the term “deeply discounted security”. This seems a more appropriate term to reflect both the nature of the security and the nature of the tax charge while distinguishing this regime from the “deep gain securities” regime of Schedule 11 to FA 1989.

Section 428: Income charged

1733.This section sets out the amount charged to tax on profits that arise on a disposal of securities that are within or outside the United Kingdom. It is based on sections 64, 65 and 68 of ICTA and on paragraph 1 of Schedule 13 to FA 1996.

1734.Paragraph 1(1) of Schedule 13 to FA 1996 provides that profits arising from a security out of the United Kingdom are chargeable under Schedule D Case IV. This allows the assessment rules for Case IV income in section 65 of ICTA to apply.

1735.Subsection (3)(a) treats such profits as arising from a source outside the United Kingdom. This links to the definition of “relevant foreign income” in section 830, thus attracting the special rules for such income in Part 8 of this Act.

1736.Subsection (3)(b) then makes the rule in subsection (1) subject to the rules in Part 8 of this Act for such profits.

Section 429: Person liable

1737.This section states who is liable for any tax charged. It is based on paragraph 1 of Schedule 13 to FA 1996.

Section 430: Meaning of “deeply discounted security”

1738.This section provides a general definition of “deeply discounted security” for the purposes of Chapter 8. It is based on paragraph 3 of Schedule 13 to FA 1996.

1739.The main test to identify relevant discounted securities is spread over paragraph 3(1), (3) and (4) of Schedule 13 to FA 1996. The test compares the amount payable on redemption with the issue price of the security to see whether, under its terms of issue, it is capable of yielding a “deep discount” on redemption.

1740.A security is capable of yielding a “deep discount” if the amount payable on redemption could exceed the issue price by more than a specified percentage of the amount payable on redemption. In the rare case where the security has an expected life of 30 years or more, the percentage specified is 15%. In all other cases the percentage specified is equal to half the number of years between the date of issue and the date of redemption.

1741.This means that a deep discount occurs where the amount payable on redemption could exceed the issue price and the potential difference amounts to more than 0.5% of the amount payable on redemption for each year of the security’s life. For example, a five year bond issued for £90 and redeemable for £100 is a deeply discounted security because the discount is more than the specified 2.5% (that is, 0.5% for each year of the bond’s life). This is expressed in subsection (1) by means of a formula.

Section 431: Excluded occasions of redemption

1742.This section exempts from the charge under this Chapter certain securities which were not issued to gain a tax advantage and where redemption is not within the power of the holder. It is based on paragraph 3 of Schedule 13 to FA 1996.

1743.Under section 430(1) the test for a deep discount can be applied on maturity or any possible occasion of redemption. Those occasions of redemption are ignored if the conditions in subsection (2) or (3) of this section are met.

1744.In subsection (2) the conditions in paragraphs 3(1A) and 3(1C) of Schedule 13 to FA 1996 have been amalgamated and renamed “the third-party option conditions”. These apply where the achieving of a tax advantage (defined in section 460(2)) is not a main benefit and the security is issued to a person who is not connected with the issuer (see subsection (7) and section 878(5) of this Act) and is not redeemable by the holder.

1745.Subsection (3) provides the second conditions which have been renamed “the commercial protection conditions”. These exempt from charge securities which can only be redeemed as the result of an event which in practice is likely to be outside the power of the holder and which could not have been anticipated when the securities were issued.

1746.Under subsection (4) neither of these two sets of conditions is considered as met simply because an occasion of redemption happens to takes place coincidentally at the same time that one of these sets is met.

1747.For the “third-party option conditions” to apply the security must be issued to a person who is not connected with the issuer. Subsection (5) provides that where those conditions are met but the security is then acquired by a connected person (or the holder becomes such a person) the conditions will cease to apply.

1748.Subsection (6) deals with the reverse of the condition provided for in subsection (5). Where a person who is not connected with the issuer acquires a security which fails to satisfy the “third-party option conditions” only because it was issued to a person connected with the issuer, then it ceases to be a deeply discounted security from that date. This subsection also applies where a security which is a deeply discounted security as a result of subsection (5) is acquired.

Section 432: Securities which are not deeply discounted securities

1749.This section excludes certain specified securities from the scope of the general definition of deeply discounted security in section 430. It is based on paragraph 3 of Schedule 13 to FA 1996.

Section 433: Meaning of “excluded indexed security”

1750.This section explains what is meant by an “excluded indexed security” referred to in the previous section. It is based on paragraph 13 of Schedule 13 to FA 1996.

1751.Subsection (1) explains that a security is an “excluded indexed security” if the amount payable on redemption depends on any future change in the value of certain assets or on the change in an index of the value of certain assets.

1752.Some securities provide for the investor to get back a percentage of his or her original investment if the value of the assets (or the index) fails to rise to a certain level. This will not prevent the security being a deeply discounted security provided the specified percentage is not more than 10% of the issue price (subsection (2)). This means that if £100 is invested the investor must get no more than £10 back, losing the other £90. Unless the investor can lose 90% of the original investment it is not an excluded indexed security but a deeply discounted security.

1753.Subsection (3) ensures that interest on redemption is ignored in the calculation under this section. It is clear that this is the intention of the legislation from the fact that paragraph 3(2)(c) of Schedule 13 to FA 1996 takes excluded indexed securities outside the definition of deeply discounted securities and that paragraph 3(6) of that Schedule (rewritten in section 430(4)) excludes interest from the general calculation of deep discounts.

1754.Subsection (4) defines “redemption period” for the purpose of this test. This definition differs from the one for the deeply discounted security test in section 430 to allow flexibility for the chargeable assets referred to in subsection (1) to be valued on dates other than, but close to, the issue and redemption dates. Likewise, an index of the value of chargeable assets may not be computed for the actual issue and redemption dates and some approximation is required.

1755.Subsection (5) defines “chargeable asset” for the purpose of this test. The underlying premise is that where the disposal of the asset whose value is linked to the security would be within the scope of capital gains tax, then disposals of securities fully linked to the value of such assets should also be subject to capital gains tax and excluded from the income tax regime.

1756.“Chargeable asset” is defined, in paragraph 13(6) of Schedule 13 to FA 1996, as an asset which on disposal can give rise to a chargeable gain for the purposes of TCGA. In order to make this test work it is necessary to make some assumptions about the asset (found in paragraph 13(7) of that Schedule) and these are set out in subsection (6). Section 100 of TCGA applies mainly for corporation tax purposes and unauthorised unit trusts are the only persons liable to income tax benefiting from subsection (6)(b).

Section 434: Securities issued in separate tranches: preliminary

1757.This section introduces two special rules for determining whether securities issued in tranches under a single prospectus are deeply discounted securities. The first rule is called “the basic rule” and the second rule “the nominal value rule”. Broadly, where securities are issued in tranches under a single prospectus, either all of them are treated as deeply discounted securities or none of them is. The section is based on paragraphs 3 and 10 of Schedule 13 to FA 1996.

1758.Subsection (2) explains that following an initial issue of deeply discounted securities under a prospectus the nominal value rule will not apply to any of the securities issued at any time under that prospectus but the basic rule will apply.

1759.Subsection (3) explains the position where, in contrast to the position in subsection (2), the original issue does not include any deeply discounted securities. In that case both rules may apply to later issues.

Section 435: Securities issued in separate tranches: basic rule

1760.This section sets out the first rule, known as the basic rule. It is based on paragraph 3 of Schedule 13 to FA 1996.

1761.Subsection (1) provides that if any of the securities issued under a prospectus at any time are not deeply discounted securities under section 430, then any securities issued subsequently will not be deeply discounted securities, even if they would be deeply discounted securities under that section. But this will not be the case if a security is a deeply discounted security because it is issued to a person connected with the issuer or acquired by a person who becomes so connected (see subsection (2)).

1762.The words “(disregarding that paragraph)” from paragraph 3(2)(f) of Schedule 13 to FA 1996 are not rewritten. They may be read in such a way as to conflict with the words “subject to paragraph 10” at the beginning of paragraph 3(2)(f) of that Schedule, which are clearly intended to prevail.

Section 436: Deeply discounted securities issued in separate tranches: nominal value rule

1763.This section sets out the second rule, known as the nominal value rule. It is based on paragraph 10 of Schedule 13 to FA 1996.

1764.Subsection (3) sets out the condition that must be satisfied for the rule in this section to apply. It is that the aggregate nominal value of deeply discounted securities issued after an original non-deep discount issue should exceed the aggregate nominal value of all the other securities issued under the prospectus up to that time.

1765.Subsection (4) provides the rule, which is that if the condition in subsection (3) is satisfied, all the securities issued under the prospectus will be treated, for the purposes of any later acquisition or disposal, as if they were deeply discounted securities when they were acquired. This applies even if the securities are not deeply discounted securities within the terms of section 430 or are not deeply discounted securities because of the application of the basic rule in section 435.

1766.Subsections (5) and (6) provide that a security is not a deeply discounted security for the purpose of applying this rule if it is only a deeply discounted security because it is issued to a person connected with the issuer or acquired by a person who becomes so connected as set out in section 435(2) and the person holding it at the relevant time is not so connected.

Section 437: Transactions which are disposals

1767.This section defines the events giving rise to the income tax charge (or loss relief) relating to deeply discounted securities. It is based on paragraphs 1, 4 and 5 of Schedule 13 to FA 1996.

1768.Subsection (1) brings together the occasions in Schedule 13 to FA 1996 which give rise to profits. The subsection includes occasions when someone “transfers” a deeply discounted security or “becomes entitled ... to any amount on its redemption” (paragraph 1(2) of that Schedule) and a profit is realised. It also includes the conversion of the security into shares or other securities.

1769.The essential point is that the person no longer owns the security and has realised a profit, or sustained a loss, when ownership ceases. The events giving rise to the tax charge are referred to by the section as “disposals” and all the circumstances in which a disposal occurs (apart from under the special rules applying for strips of government securities) are described in this one section.

1770.Subsection (3) deals with a deemed transfer of a deeply discounted security to personal representatives immediately before death, in the source legislation found in paragraph 4(2) of Schedule 13 to FA 1996. It crystallises the increase in value at the time of death. “Personal representatives” is defined in section 878(1) of this Act.

Section 438: Timing of transfers and acquisitions

1771.In most cases it is clear when a disposal occurs. But this section provides a timing rule for transfers and acquisitions where that may be less clear; for example, where the holder of a security enters into an agreement to sell the security to someone else at a future date. The section is based on paragraph 4 of Schedule 13 to FA 1996.

1772.The section provides for the security to be treated as transferred (or acquired) when the agreement for the transfer of the security is made, so long as the person receiving it becomes entitled to it at that time. Where an agreement to transfer a security is conditional, the agreement is treated as made when the condition is satisfied.

1773.The words in brackets in paragraph 4(4) of Schedule 13 to FA 1996 (“whether by the exercise of an option or otherwise”) have been omitted as an unnecessary example.

Section 439: Calculating the profit from disposals

1774.This section provides the rules for computing the profit on a disposal. It is based on paragraph 1 of Schedule 13 to FA 1996.

1775.Subsection (2) disallows any deduction for incidental costs on acquisition or disposal of a deeply discounted security. But (subsection (3)) this is subject to the deductions rule in subsection (4) and the rule on securities held since 26 March 2003 in section 455.

1776.Subsection (4) allows a deduction from the profits on disposal for incidental expenses if incurred before 27 March 2003. The term “relevant costs” in Schedule 13 to FA 1996 has been replaced with “incidental expenses”.

1777.Subsection (5) deals with the case where a security has been sold and re-acquired, ensuring that it is the later acquisition only that is relevant for ascertaining the profit.

Section 440: Market value disposals

1778.This section deals with the situations in which the amount payable on disposal is determined to be the market value. It is based on paragraphs 4, 6, 8 and 9 of Schedule 13 to FA 1996.

1779.In Schedule 13 to FA 1996 these rules importing market values occur in five separate paragraphs but have now been put into this one section. There are now two rules.

1780.Subsection (1) introduces the first rule in which the transfer of a security of a type within subsection (2) is treated as disposed of for an amount equal to its market value at the time of the disposal. This is subject to the second rule, in subsection (4).

1781.Subsection (4) is the second rule. It is a qualification of the first rule and applies for a particular type of transaction. Where a deeply discounted security is converted into shares or other securities the security is instead treated as disposed of for an amount equal to the market value of the shares or securities acquired. But this is subject to a special rule for strips which has been signposted at subsection (5).

Section 441: Market value acquisitions

1782.This section deals with all the situations in which the acquisition cost of deeply discounted securities is to be determined at market value. It is based on paragraphs 4, 5, 8 and 9 of Schedule 13 to FA 1996.

1783.Subsection (2) provides a list of the disposals giving rise to acquisitions to which the rule in subsection (1) applies. The list includes the acquisition of a deeply discounted security as the result of the conversion of a security into shares or other securities – subsection (2)(b). See Change 86 in Annex 1.

1784.Also included in subsection (2)(a) of the list is the acquisition of a security transferred to a legatee by personal representatives. See Change 86 in Annex 1.

Section 442: Securities issued in accordance with qualifying earn-out right

1785.This section provides rules for ascertaining the acquisition value of a security which forms the whole or part of the consideration on the disposal of a business. It is based on paragraph 3A of Schedule 13 to FA 1996.

1786.This section prevents a profit on deeply discounted securities being charged to capital gains tax as well as to income tax under this Chapter. Where a right to securities to be issued at some future date is part of the consideration for the disposal of a business (an “earn-out right”), a chargeable gain will arise on the difference between the right to receive those securities and their value when issued.

1787.When the securities are eventually disposed of, a deep discount may arise on the difference between the value of the right when granted (as for the chargeable gain described above) and the disposal proceeds. But this may include the increase in value that has already been included in the computation of a chargeable gain. By making the acquisition value for the deep discount legislation the same as the disposal value of the right for capital gains tax purposes, the double counting of that proportion of the discount for income tax purposes is avoided.

1788.The provision is rewritten by providing the valuation rule for securities issued as a “qualifying earn-out right” in subsection (2) and then defining a “qualifying earn-out right” in subsections (3) to (6).

Section 443: Application of this Chapter to strips of government securities

1789.This section acts as an introduction to sections providing special rules for computing profits and gains on strips of securities issued by the government of any territory. It is based on paragraph 14 of Schedule 13 to FA 1996.

Section 444: Meaning of “strip” in Chapter 8

1790.This section defines “strip” for the purposes of this Chapter. It is based on section 47 of FA 1942.

1791.FA 2003 widens the definition of “strip” for Schedule 13 to FA 1996 by including securities issued by any government. This applies to strips acquired after 26 March 2003. In accordance with our intention of including within Chapter 8 the rules relating to strips acquired before 27 March 2003 the previous, narrower, definition has been retained in subsection (1)(c). Whether the strips fall under subsection (1)(b) or (c) the conditions set out in subsections (2) to (5) must be met.

1792.Subsections (2) to (5) rewrite the relevant conditions in section 47 of FA 1942. The definition in Schedule 13 to FA 1996 cross-refers to that section.

Section 445: Strips of government securities: acquisitions and disposals

1793.This section provides the rules necessary for computing profits on the disposal of government securities. It is based on paragraph 14 of Schedule 13 to FA 1996.

1794.Subsection (1) is the first rule. It determines, by means of a formula, the acquisition cost where a gilt-edged security which is not a strip (and therefore under section 432(1)(b) not a deeply discounted security) is “stripped”. The acquisition cost of each strip is computed by apportioning the market value of the underlying security between all the strips acquired.

1795.Subsection (2), which contains the second rule, deals with a deemed transaction which counts as a disposal. This is the deemed transfer, followed by immediate reacquisition under subsection (3), of a strip held on 5 April.

1796.Paragraph 14(4) of Schedule 13 to FA 1996 provides for a deemed reacquisition on 6 April for the same value as the disposal on 5 April. This is rewritten as disposal and immediate reacquisition. See Change 87 in Annex 1.

1797.See paragraph 80 of Schedule 2 to this Act for the application of this rule for 2005-06.

1798.Subsection (5) ensures that incidental expenses are not allowed in respect of these deemed transfers even where they were incurred before 27 March 2003.

1799.The rules in subsections (2) to (5) ensure that anyone holding a strip of a government security is taxed year by year on the increase in value of the strip. This is intended to prevent investing in strips, rather than in unstripped government securities (where interest would be taxed year by year), to defer tax liability.

1800.Subsection (6), which contains the final rule, deals with the situation where two or more strips are brought together and turned into a single security. Each strip is disposed of for an amount equal to its market value on consolidation.

1801.Subsections (7) and (8) ensure that both the first and final rules take precedence over both the rule on timing and transfers in section 438 and the market value rules at sections 440(4) and 441.

Section 446: Strips of government securities: relief for losses

1802.This section allows relief for losses that arise on disposals of strips of government securities. It is based on paragraph 14A of Schedule 13 to FA 1996.

1803.Subsection (7) prevents a double claim for loss relief by providing that relief cannot be claimed under this section if section 454 (listed securities held since 26 March 2003: relief for losses) applies.

Section 447: Restriction of profits on strips by reference to original acquisition cost

1804.This section restricts profits to the amount by which disposal proceeds exceed the original acquisition cost. Because there is a 5 April revaluation of strips on a deemed disposal each year the cost taken into account on actual disposal is the last 5 April value. This section ensures that in such cases a profit cannot exceed the difference between the disposal proceeds and the original cost of the security. It prevents taxation of an artificial gain and is the obverse of the loss restriction in section 448. See paragraph 81 of Schedule 2 to this Act where strips are acquired before 15 January 2004. The section is based on paragraph 14D of Schedule 13 to FA 1996.

1805.Subsection (1) sets out when the rule in this section applies, namely when a profit would, apart from this section, arise on disposal but the market value of the strip is less than the amount paid by the person to acquire the strip, thus giving rise to a greater profit than would be the case if the market value had not replaced the cost.

1806.Subsections (2) and (3) restrict that profit to the excess of the disposal proceeds over the cost of acquisition. If there is no excess because the acquisition cost does not exceed the market value, no profit is made.

1807.Subsections (4) and (5) require that the deemed disposal on 5 April (section 445) is to be ignored in considering the original acquisition cost. Paragraph 14D(6)(b) of Schedule 13 to FA 1996, which provides that the original acquisition cost should reflect the open market value rules, is not rewritten. It is considered unnecessary given that the purpose of the open market value rules for acquisition costs applies for the purposes of the whole Chapter (section 441).

Section 448: Restriction of losses on strips by reference to original acquisition cost

1808.This section restricts losses to the amount by which disposal proceeds exceed the original acquisition cost. Because there is a 5 April revaluation of strips on a deemed disposal each year the cost taken into account on actual disposal is the last 5 April value. This section ensures that in such cases a loss cannot exceed the difference between the disposal proceeds and the original cost of the security. The section is based on paragraph 14D of Schedule 13 to FA 1996.

1809.Subsection (1) sets out when the rule in this section applies, namely when a loss would, apart from this section, arise on disposal but the market value of the strip is less than the amount paid by the person to acquire the strip, thus giving rise to a greater loss than would be the case if the market value had not replaced the cost.

1810.Subsections (2), (3) and (4) restrict that loss to the excess of the disposal proceeds over the cost of acquisition. If there is no excess because the acquisition cost does not exceed the market value, no loss is made.

Section 449: Strips of government securities: manipulation of acquisition, sale or redemption payments

1811.This section applies where there is a scheme or arrangement and the main, or one of the main, benefits that is expected to accrue is the obtaining of a tax advantage. It substitutes market value in any case where the acquisition cost is more than the market value, or the disposal or redemption proceeds are less than market value. The section is based on paragraph 14B of Schedule 13 to FA 1996.

Section 450: Market value of strips etc.

1812.This section provides the rule for ascertaining the market value of a strip or a security exchanged for a strip. It is based on paragraph 14E of Schedule 13 to FA 1996.

Section 451: Market value of strips etc. quoted in foreign stock exchange lists

1813.This section provides the rules for ascertaining the market value of overseas strips or securities quoted on a foreign stock exchange. It is based on paragraph 14E of Schedule 13 to FA 1996.

1814.Subsections (4) and (5) make provision for cases where the mechanics of overseas stock exchanges might differ from those in the United Kingdom, in particular where separate buy and sell prices are not given.

1815.Subsection (6) acts as a tie-breaker where the strip or security is listed on more than one foreign exchange.

Section 452: Power to modify this Chapter for strips

1816.This section allows the Treasury to make regulations for the treatment of strips as a response to future developments in the strips market. It is based on paragraph 14 of Schedule 13 to FA 1996.

Section 453: Application of sections 454 to 456

1817.This section is the first of four sections providing special rules for securities held since 26 March 2003. FA 2003 introduces several changes to Schedule 13 to FA 1996 which affect securities held after that date. It is based on paragraph 6 of Schedule 39 to FA 2003.

1818.With the one exception for government strips, loss relief is no longer available for disposals on or after 27 March 2003, nor is there a deduction for incidental expenses incurred on or after that date. Where, however, a deeply discounted security held since before that date is disposed of, loss relief is still available if the security is listed on a recognised stock exchange. Although the provisions for these reliefs are repealed by FA 2003 for securities acquired after 26 March 2003 they are rewritten in this Chapter to make it easier for the taxpayer with securities acquired before 27 March 2003 to ascertain the relevant rules. Paragraph 7 of Schedule 13 to FA 1996 which deals with losses on certain exempt income is rewritten in paragraphs 82 and 83 of Schedule 2 to this Act as it is of limited application.

Section 454: Listed securities held since 26th March 2003: relief for losses

1819.This section provides for any loss sustained on the disposal of a listed deeply discounted security to be relieved by set-off and explains when a loss is incurred. It is based on paragraphs 2 and 6 of Schedule 13 to FA 1996.

1820.Subsection (2) provides that a loss is incurred where the amount paid on acquisition exceeds the amount paid on disposal disregarding any incidental costs. Incidental costs may increase the loss but not create a loss. See section 455 for how the loss is computed.

1821.Subsection (3) signposts section 455(2) to (4) which allow costs in computing the profit where the security has been continuously held since 26 March 2003.

1822.The set-off rules for persons who are not trustees (subsection (4)) differ from those for trustees (subsection (5)).

1823.See paragraphs 82 and 83 of Schedule 2 to this Act for further provisions on trustees.

Section 455: Listed securities held since 26th March 2003: calculating the profit or loss on disposals

1824.This section gives the rules for computing profits and losses on disposals of securities held continuously since 26 March 2003. Deductions for incidental expenses of acquiring and disposing of deeply discounted securities are only available for listed securities held on 26 March 2003. The section is based on paragraphs 1, 2, 14 and 15 of Schedule 13 to FA 1996.

1825.Subsections (2) and (3) explain how to compute the loss referred to in section 454(2). The loss sustained is effectively increased by the deduction of the incidental expenses incurred in connection with the acquisition and disposal of the security. This is expressed by allowing the costs, which include both sets of incidental expenses and the cost of acquisition, as a deduction from the disposal proceeds.

Section 456: Securities issued to connected persons etc. at excessive price: subsequent transfers to connected persons

1826.This section prevents a loss arising on the transfer of deeply discounted securities where securities are issued at a value above that at which they are subsequently transferred and the issue and transfer are to connected persons. The section is based on paragraph 9A of Schedule 13 to FA 1996.

1827.The market value rules in sections 440 and 441 do not apply to securities on issue but only to subsequent disposals. The application of those rules therefore produces a loss where a security has been issued at above the market value to a connected person and is then transferred to another connected person at market value. These transactions thereby benefit from the fact that the market value rules do not apply on issue, and when they might apply, on a transfer, the price is at market value.

1828.Subsection (1) provides the general rule that no loss will arise where certain conditions are met. These conditions are set out in subsections (2) to (6).

1829.The conditions insubsections (2) and (3) must both apply, together with either the condition in subsection (4) or those in both subsections (5) and (6). These conditions provide that the person disposing of the security was either connected with the issuing company or controlled it and that the security was acquired on issue at above market value.

1830.It is considered unnecessary to rewrite paragraph 9A(2)(b) of Schedule 13 to FA 1996, because if the transferor were connected with the issuer condition C (paragraph 9A(1)(b) of that Schedule) would apply.

1831.Subsections (5) and (7) ensure that the rule also applies where a deeply discounted security is issued by a close company where the person to whom it is issued, together with others, controls the issuing company, wherever the company is resident.

Section 457: Trustees

1832.This section gives rules for applying this Chapter to trustees. It is based on paragraph 6 of Schedule 13 to FA 1996.

1833.Under section 429 the person liable is the person making the disposal.

1834.Subsection (2) ensures that the profits are treated, for the purposes of Chapter 5 of Part 5 of this Act, as income arising under a settlement and therefore potentially chargeable on the settlor.

1835.Subsection (3) ensures that the profits are treated as income in applying the rules on the liability of trustees in Chapter 1C of Part 15 of ICTA.

1836.Paragraph 6(1) of Schedule 13 to FA 1996 refers to amounts “treated as income chargeable to tax”. This must simply mean ‘chargeable to tax’ since paragraph 1 of that Schedule makes use of a straightforward charge on the gain rather than a deemed income approach. The “deemed” wording has not been reproduced. But the wording of the charge has been reflected in section 427.

1837.Subsection (5) disapplies subsections (2) to (4) in the case of unauthorised unit trusts. Under section 469(2) of ICTA income arising to the trustees of unauthorised unit trusts is regarded as income of the trustees and not as income of the unit holders and such income is chargeable at the basic rate.

Section 458: Non-UK resident trustees

1838.This section provides that non-UK resident trustees are not charged to tax on profits and gains from deeply discounted securities. It is based on paragraph 6 of Schedule 13 to FA 1996.

Section 459: Transfer of assets abroad

1839.Sections 739 and 740 of ICTA provide rules to counter avoidance of income tax by the transfer of assets abroad. They depend on income being payable to a person resident or domiciled outside the United Kingdom which a person domiciled or resident within the United Kingdom has the power to enjoy. This section provides that profits on a disposal of deeply discounted securities by a non-UK resident or non-UK domiciled person are regarded as income paid to that person for the purpose of those rules. The section is based on paragraph 12 of Schedule 13 to FA 1996.

Section 460: Minor definitions

1840.This section provides some minor definitions for the provisions in this Chapter. It is based on section 103 of FA 1996 and paragraph 15 of Schedule 13 to FA 1996 and paragraph 14 of Schedule 25 to FA 2002.

Chapter 9: Gains from contracts for life insurance etc.
Overview

1841.This Chapter charges to tax the investment profit from life insurance policies, life annuity contracts and capital redemption policies. It is based on Chapter 2 of Part 13 of ICTA.

1842.The Chapter uses “gains” to describe what is charged to tax, as in the source legislation. The term “profits” is not used because it has different, well established meanings in the context of policies of life insurance etc. For example, the insurance industry uses “profits”, as in “with profits” policies, to describe bonuses which are not “gains” within the meaning of this charge.

1843.Whereas the source legislation often deals separately with each type of policy and contract falling within this charge, the Chapter deals with all three types at the same time, so far as possible, while still preserving any differences in the rules for each type.

1844.Most of the policies and contracts to which the Chapter applies are held by individuals or on trusts created by individuals. But the Chapter deals with all circumstances under which gains are charged to income tax, irrespective of the capacity of the policy holder.

1845.Where the gain is charged to corporation tax (that is, when the rights under the policy or contract are held by a company, or on trusts created by a company, or as security for a debt owed by a company, and the company is within the charge to corporation tax), the relevant provisions are in Chapter 2 of Part 13 of ICTA, as amended by Schedule 1 to this Act.

1846.The income tax provisions in this Chapter for charging gains and the corporation tax provisions in ICTA apply independently to any policy or contract. In practice, the same event will occur, and the amount of the gain will be the same, under both sets of provisions. But a charge to tax under one or other tax (sometimes to both taxes) only arises if someone is liable for the respective tax on the gain by virtue of sections 464 to 467 of this Act or section 547(1)(b) of ICTA. The corporation tax provisions do not include the equivalent of sections 530 to 537 (income tax treated as paid and top slicing relief) and 539 to 541 (relief for deficiencies).

1847.Life insurance policies certified by the Inland Revenue as “qualifying policies”, under paragraph 21 of Schedule 15 to ICTA, do not generally give rise to gains under this Chapter. The rules in Schedule 15 to ICTA include that:

  • the policy must have a minimum term of ten years from the date it was made to the date it is due to end; and

  • premiums of fairly even amounts must be payable at regular intervals in every year for at least ten years.

1848.Qualifying policies generally give rise to gains chargeable to tax if a “chargeable event” occurs:

  • before the earlier of ten years from the beginning of the policy or three-quarters of the term for which it is due to run; or

  • after the policy has – before the earlier of those two periods – been made a “paid up” policy (that is, no further premiums need be paid).

1849.The Chapter makes a number of minor changes to the law. And it includes provisions based on extra-statutory concessions.

1850.The Chapter also incorporates, so far as relating to the income tax charge, the secondary legislation for the special charge on personal portfolio bonds (the Personal Portfolio Bonds (Tax) Regulations 1999 SI 1999/1029, as amended by SI 2001/2724 and SI 2002/455). In this commentary, those regulations are abbreviated as “PPB(T)R”.

1851.Date-related provisions (that is, provisions which apply only to policies or contracts issued before a particular date) are located in Parts 6 and 7 of Schedule 2 to this Act rather than in this Chapter. Part 6 is organised chronologically so that policy holders can see, in relation to their own policies or contracts, which rules qualify the provisions in the Chapter. Part 7 is wholly concerned with policies issued in respect of an insurance made before 17 March 1998 and contracts made before that date. Section 546 indicates when Schedule 2 to this Act modifies the operation of the section and the relevant paragraph(s) of the Schedule.

1852.A few date-related provisions have been retained within this Chapter where it would be unhelpful to remove them (for example, section 507(4) (method for making periodic calculations under section 498)).

1853.Some provisions in Part 5 of Schedule 2 to this Act (paragraphs 85 to 91) also apply. These depend on dates other than the date of issue of a policy or contract.

1854.The Chapter is laid out as follows-

  • charge to tax under Chapter 9 (sections 461 to 463)

  • person liable etc. (sections 464 to 472)

  • policies and contracts to which Chapter 9 applies (sections 473 to 483)

  • when chargeable events occur: general (sections 484 to 490)

  • calculating gains: general (sections 491 to 497)

  • part surrenders and assignments: periodic calculations and excess events (sections 498 to 509)

  • transaction-related calculations and part surrender or assignment events (sections 510 to 514)

  • personal portfolio bonds (sections 515 to 526)

  • reductions from gains (sections 527 to 529)

  • income tax treated as paid and reliefs (sections 530 to 538)

  • deficiencies (sections 539 to 541)

  • supplementary (sections 542 to 546)

Section 461: Charge to tax under Chapter 9

1855.This section charges gains from policies and contracts to tax. It is based on, and combines:

  • the income tax charge in section 547(1) of ICTA (which stands outside the schedular system);

  • the charges under Schedule D Case VI in sections 547(6) and 553(6) of ICTA; and

  • the special charge on personal portfolio bonds under section 547 of ICTA by virtue of regulation 6 of PPB(T)R.

1856.The exemption mentioned in subsection (4) is not an exhaustive statement of exemptions that may apply.

Section 462: When gains arise from policies and contracts

1857.This section explains when a gain arises and introduces the concept of a “chargeable event”. It is based on sections 540, 542, 545 and 546C of ICTA.

Section 463: Income charged

1858.This section is based on section 547 of ICTA. It sets out the amount charged to tax.

1859.Subsection (2) flags the one circumstance where the gain to be charged for a tax year may have arisen in an earlier tax year. That is, the tax year for the charge is not the tax year in which the chargeable event occurred.

Section 464: Person liable for tax: introduction

1860.This section and the following three sections determine who is liable for tax charged under this Chapter. (Sections 466(3) and 468 indicate when a gain arising under this Chapter is not charged under the Chapter but may instead be taken into account for certain other income tax charges.) The section is based on section 547 of ICTA.

1861.The source legislation does not preclude an overlap between the attribution of liability to one “person liable” and to another (say, both to an individual who placed a policy in trust and to the trustees who hold the legal rights in the policy). In practice, liability of a UK resident individual normally prevails over other liability and the gain is not doubly charged to tax. See also the commentary on section 467 as it applies where the rights are held by trustees on charitable trusts (when liability falls on the trustees rather than the settlor).

1862.Subsection (3) provides that references in sections 464 to 467 to a surrender or assignment of rights refer, where appropriate, to a surrender or assignment of a part of, or share of, the rights. A part of the rights means one or more discrete rights provided by the policy or contract. A share in the rights means part of the ownership, where there are multiple owners, of such a discrete right or rights or of all the rights in the policy or contract. (The rule applied in this subsection is also found elsewhere in the Chapter. See in particular section 469(7) (two or more persons interested in policy or contract).)

Section 465: Person liable: individuals

1863.This section sets out three ways of holding or owning the rights under a policy or contract by virtue of any of which an individual may be liable to tax on the gain. Where an individual is so liable, the amount charged is treated as part of the individual’s “total income” (section 835 of ICTA). This section is based on section 547 of ICTA.

1864.Although unfettered beneficial ownership of the rights may be the most commonly met circumstance, policies and contracts are also commonly placed in trust for beneficiaries (whether for the settlor and/or other beneficiaries). Policies and contracts may also be used to secure a loan (such as a mortgage of property). If any of the three ways of holding or owning the rights applies, that is sufficient to attribute liability for tax on the gain to that individual. (But see section 467 when the rights are held on charitable trusts created by the individual.)

1865.Subsection (1) incorporates part of ESC B53. Under the concession, the Inland Revenue does not pursue liability to tax on a gain, where a non-UK resident individual is liable, in any of the circumstances mentioned in this subsection. The section achieves the same net effect by a different route. It simply limits attribution of liability to UK resident individuals, so that the non-UK resident individual is not liable to tax on the gain in the first place. See Change 88 in Annex 1.

1866.Chapter 1 of Part 4 of this Act provides a general territorial limitation on the scope of the Part. As regards income arising outside the United Kingdom, it limits the charge to such income arising to a UK resident. See section 368 (territorial scope of Part 4 charges) and the related commentary on that Chapter. This section overlaps and supplements that Chapter to ensure that a non-UK resident individual is not liable to tax under this Chapter on any gains, whether arising in the United Kingdom or elsewhere.

1867.Subsection (6) indicates that an individual is treated as creating a trust, for the purposes of this Chapter, when a policy or contract is placed in trust under any of three specific Acts. Such trusts are commonly created, for example, when a policy (such as a mortgage protection policy) is to benefit one or both parties to a marriage. But the subsection is not an exhaustive definition of all the circumstances in which trusts are created by an individual.

Section 466: Person liable: personal representatives

1868.This section sets out how a gain is charged to tax when the rights under the policy or contract are held by the personal representatives of a deceased person’s estate. It is based on sections 547 and 553 of ICTA. The term “personal representatives” is defined in section 878 of this Act.

1869.There are two possible treatments. The first is conditional on the policy or contract being one that, were an individual liable to tax in respect of the gain arising on that policy or contract, no lower rate income tax allowance would be available under section 530. Broadly, that allowance is not given where the investment profits underlying the policy or contract are not subject to tax in the hands of the insurer. That may be because the investment profits were not so taxed in the hands of a UK based insurer or the policy or contract was held with a non-UK based insurer (and there was no equivalent foreign tax charge on investment profits in the hands of the insurer).

1870.Where this condition applies, the gain is taxable on the personal representatives as their income in that capacity. The personal representatives are thus liable for the tax.

1871.If the condition does not apply, the gain is not charged on the personal representatives under this Chapter. Instead, the gain falls into the “aggregate income of the estate of the deceased” for the purposes of Chapter 6 of Part 5 of this Act (see section 664 (the aggregate income of the estate)) and of Part 16 of ICTA.

Section 467: Person liable: UK resident trustees

1872.This section sets out to what extent UK resident trustees are liable for the tax charged on a gain. It is based on section 547 of ICTA. The section sets out four circumstances under any of which trustees are liable. All four circumstances depend wholly or partly on how the rights under the policy or contract are held immediately before the chargeable event in question occurs. There are significant differences of treatment between trustees of charitable trusts and non-charitable trusts.

1873.Where the rights are held on charitable trusts, the liability falls on the trustees rather than on any settlor. However, the tax charge on the trustees is at the lower rate only. So there is no net liability where the lower rate income tax allowance under section 530 is available.

1874.If the rights are held on non-charitable trusts, the trustees are liable where:

  • the settlor is non-UK resident, or is dead, or is a company or foreign institution that no longer exists (that is, the settlor could not be liable to tax on the gain or – as regards a foreign institution – be instrumental in the gain being taken into account for the purposes of section 740 of ICTA – see section 468); or

  • the rights are held in any other circumstances excluding those already taken into account under sections 465 (where an individual is liable) or 466(1) (where personal representatives are liable), or under section 547(1)(b) of ICTA (where a company is liable).

1875.The trustees of both charitable trusts and non-charitable trusts are liable where condition D applies.

1876.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 468: Non-UK resident trustees and foreign institutions

1877.This section sets out in what circumstances a gain treated as arising under this Chapter is taken into account under section 740 of ICTA (liability of non-transferors). It is based on section 547 of ICTA.

1878.It applies when the rights under the policy or contract are held by, or held as security for a debt owed by:

  • non-UK resident trustees; or

  • a “foreign institution”.

1879.As regards trustees, the same four circumstances (conditions A to D) of section 467 apply, with the substitution of non-UK resident trustees for UK resident trustees, to determine whether this section applies. But the section makes no other distinction between cases where rights are held on charitable trusts or non-charitable trusts.

1880.A gain taken into account for the purposes of section 740 of ICTA, as modified by this section, is not charged under this Chapter.

1881.Subsection (6)qualifies the meaning of “rights”, where there has been an assignment or surrender of a part of or share in the rights, in the same way as does section 464 (see the commentary on that section).

Section 469: Two or more persons interested in policy or contract

1882.This section, together with sections 470 to 472, is based on section 547A of ICTA. These sections deal with cases where the rights in a policy or contract (or a share in those rights) are held immediately before the chargeable event:

  • by more than one person;

  • by one person in respect of different shares held in different capacities; or

  • on non-charitable trusts created by two or more persons.

1883.The most common instance of this is where a husband and wife are co-owners of a policy or contract.

1884.The section apportions the gain in proportion to the “material interest” of each person with such an interest (see section 470). It treats each person with a material interest separately, for the purpose of assigning liability to tax etc, disregarding for this purpose how the Chapter applies in respect of a material interest held by another person. It also apportions deficiencies for the purposes of the relief given by section 539.

1885.Although the source legislation has effect for the purposes of section 547 of ICTA only, this section operates by reference to provisions that apply for the purposes of the Chapter. As a result of the significant reordering of the source legislation when rewriting it, section 547 of ICTA is the basis of numerous sections at various locations. The application of this section to sections that operate in a Chapter-wide context is a necessary consequence of the rewrite of section 547 of ICTA.

1886.Subsection (6) applies the section to someone who has two or more interests in a policy or contract exactly as the section applies where two or more persons have such interests. For example, a person may hold one interest beneficially and the other as a trustee. Each of those interests is treated separately. But there is an exception where all the material interests are held by that person only (that is, the interests are not shared) and are held in the same capacity. For example, one share may be beneficially owned by A, but held in a trust, and another share held by A absolutely. Both shares are held in the same capacity.

1887.Subsection (7) is similar in effect to the equivalent subsection in section 464 and section 468. See the commentary on section 464.

Section 470: Interests in rights under a policy or contract for section 469

1888.This section provides the meaning of “material interest” for the purposes of section 469. It is based on section 547A of ICTA. The circumstances in which someone is regarded as having an interest in rights under a policy or contract for this purpose mirror the circumstances set out in sections 465 to 468 (and, as regards companies chargeable to corporation tax, in section 547 of ICTA) for attributing liability to tax on gains or otherwise taking gains into account for tax purposes.

Section 471: Determination of shares etc.

1889.This section determines each person’s share of the rights in the policy or contract where, because the rights are held jointly by, or as security for a debt owed by, two or more persons, that share has to be established to work out the liability of one or more persons in respect of a gain. It is based on section 547A of ICTA.

1890.Subsections (2) to (5) deal with a person’s interest in a policy or contract held as security for one or more debts owed by two or more persons. Each debtor is treated as the sole debtor in respect of a separate debt. For each liable person, the share of any gain is proportionate to the share of the total debt for which security was provided.

1891.Subsection (7) deals with the case where different rights under a policy or contract are held by different people. For example, the right to a death benefit under a policy may be held by one person and the right to critical illness benefit under the same policy may be held by another person. The rights are shared between them on a just and reasonable basis. See Change 14 in Annex 1.

Section 472: Trusts created by two or more persons

1892.This section determines each settlor’s share of the rights, or of a share in the rights, in policies or contracts where, immediately before the chargeable event in question, the rights (or that share) are held on non-charitable trusts created by two or more persons. It also sets out how that share is determined if the property held on trust was added by different settlors, whether at the time the trust was created or at a later date. It is based on section 547A of ICTA.

1893.Subsections (3) to (7) determine the appropriate share if settlors contribute different property to the trust or a new settlor adds property to a trust already created. The trust is treated as if it had been created by all of them, including the new settlor where applicable, and each is treated as the only settlor for the purposes of this section. The rules set out explicitly when someone is regarded as having contributed property to the trust. For example, subsection (7) applies when A contributes property to what is essentially B’s settlement because B has made an equivalent contribution to A’s settlement. Although B’s contribution is treated as property provided by A for the purposes of subsection (6), A’s contribution under reciprocal arrangements with B is disregarded.

1894.Subsection (4)(c) allocates a bundle of types of property between settlors on the basis of a “just and reasonable” apportionment where this is necessary for the purposes of subsections (2) and (3). See Change 14 in Annex 1.

Section 473: Policies and contracts to which Chapter 9 applies: general

1895.This section is based on section 539 of ICTA.

1896.Subsection (2) provides definitions. The definition of a “life annuity” is by reference both to this Act and to ICTA because the policy holder and the person liable (whether the tax charge is to income tax or corporation tax) may not be the same and may not be subject to charges under the same tax. The Chapter does not provide a definition for the more readily understood term “policy of life insurance” (nor is one provided in the source legislation). But section 545 indicates that “policy”, unless the context otherwise requires, means both a policy of life insurance and a capital redemption policy.

1897.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 474: Special rules: qualifying policies

1898.This section is based on sections 553 and 553A of ICTA. “Qualifying policy” is defined in section 832(1) of ICTA as “a policy of insurance which is a qualifying policy for the purposes of Chapter 1 of Part 7 [of ICTA]”. That is, it is in effect a policy meeting the conditions set out in Schedule 15 to ICTA.

1899.Subsection (4) takes away qualifying policy status from a policy issued by a non-UK resident insurer once it ceases to meet one of the conditions in paragraph 24(3) of Schedule 15 to ICTA (by virtue of which it was a qualifying policy). Broadly, the conditions in that paragraph are met when the policy forms part of business done through the insurer’s UK permanent establishment.

1900.Subsection (5) denies qualifying policy status to a policy which is part of the overseas life assurance business of the insurer, that is, a policy taken out by a non-UK resident policy holder with an insurer operating in the United Kingdom. The subsection applies only in relation to the chargeable event in question.

Section 475: Special rules: personal portfolio bonds

1901.This section is new.

Section 476: Special rules: foreign policies

1902.Although gains from foreign policies and contracts are taxable under this Chapter alongside gains from UK policies and contracts, there are a number of differences of treatment. Primarily, these arise from the fact that the underlying investment profit has not usually been subject to UK tax (or to an equivalent tax regime). However, subject to these differences, any rule in this Chapter referring to a policy or contract, or to one or more of the insurance products listed in section 473(1), applies to foreign policies and contracts. This section is based on sections 553, 553A and 553B of and paragraph 24(1) of Schedule 15 to ICTA.

1903.The source legislation uses the terms “new non-resident policy”, “overseas policy” and “new offshore capital redemption policy”. The “new” in those terms indicates such policies were issued on or after the commencement date for the legislation that introduced special rules. The terms used in this Chapter simply add “foreign” to the descriptions used for comparable UK policies and contracts.

1904.The definitions for a “foreign policy of life insurance” and a “foreign capital redemption policy” each contain two categories. This reflects the introduction at different times of the modifications of treatment for policies of life insurance and capital redemption policies, which:

  • are issued by a non-UK resident insurer (introduced by FA 1984); or

  • are other policies forming part of the insurer’s overseas life assurance business (introduced by FA 1998).

1905.Some policies in the second category may also fall into the first. However, other than for the construction of the definitions themselves, certain rules in sections 474 and 531, and paragraphs 106 and 110 of Schedule 2 to this Act, the distinction between the categories is not material to the operation of this Chapter.

1906.There is no provision in the Chapter (or relevant paragraph of Schedule 2 to this Act) that applies exclusively to a foreign contract for a life annuity (although most of the contracts affected by, say, section 531(3)(c) are foreign). No definition is therefore provided for such contracts.

1907.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 477: Special rules: certain older policies and contracts

1908.This section is new.

Section 478: Exclusion of mortgage repayment policies

1909.This section is based on section 539 of ICTA. It excludes a particular type of policy taken out in connection with a mortgage. Other types of policy taken out in that connection may be affected by the rules for qualifying policies, such as section 485. See section 879 of this Act for the meaning of “mortgage” in the application of this section to Scotland.

Section 479: Exclusion of pension policies

1910.This section is based on section 539 of ICTA. The term “registered pension scheme” reflects the FA 2004 rules about pension schemes which apply from 6 April 2006 and include a substituted definition in section 539 of ICTA. Paragraph 86 of Schedule 2 to this Act ensures that the unamended definition of a “pension policy” in section 539 of ICTA applies for the tax year 2005-06.

Section 480: Exclusion of excepted group life policies

1911.This section is based on section 539(2) and (3) of ICTA. A group life policy is typically one taken out for members of trades unions, professional associations and partnerships, paying out successively on the death of any of the lives insured. But for the exclusion provided by this section, each such death would give rise to a chargeable event under section 484(1)(b).

1912.See also section 546 (table of provisions subject to special rules for older policies and contracts) and paragraph 90 of Schedule 2 to this Act (gains from contracts for life insurance etc: pure protection group life policies).

Section 481: Excepted group life policies: conditions about benefits

1913.This section is based on section 539A of ICTA. The conditions set out here and in the next section ensure that the only policies benefiting from the exclusion are those:

  • providing death benefits on equal terms for all lives covered; and

  • having a minimal surrender value (if any).

1914.For example, condition A (subsection (2)) sets an upper age limit of 75 for any age-related restriction of the payment of benefits on death in any circumstances. It also disregards any limitation on payment of death benefits for particular reasons (for example, suicide) if the same limitation (“the same specified circumstances”) applies to all lives assured.

Section 482: Excepted group life policies: conditions about persons intended to benefit

1915.This section completes the conditions relating to an excepted group life policy. It is based on section 539A of ICTA.

1916.Subsection (3) uses the term “connected”. Section 878 of this Act applies section 839 of ICTA (how to tell whether persons are connected) for this purpose.

Section 483: Exclusion of credit union group life policies

1917.This section excludes a particular type of group life policy. It is based on section 539 of ICTA.

1918.Subsection (2) defines “credit union group life policy” in terms of the single stringent condition such a policy must meet to qualify for exclusion.

Section 484: When chargeable events occur

1919.This section is the first of a group of sections which set out what does or does not constitute a chargeable event under this Chapter. This section is based on sections 539, 540, 542, 545 and 546C of ICTA, and regulation 6 of PPB(T)R. Later sections in this Chapter operate by reference to this list of chargeable events (see sections 485, 491, 493, 496, 499, and 540).

1920.Subsection (1) groups together in paragraph (a) the events applicable to all policies and contracts and, in paragraphs (b) to (e), the events specific to one or more type of policy or contract.

1921.The source legislation treats the events in subsection (1)(a)(iii), (d) and (e) as a surrender of the rights under the policy or contract, which then triggers a chargeable event (see sections 539(4) and 542(2) of ICTA). The section treats the events themselves as chargeable events without the preliminary treatment of them as surrenders.

1922.Subsection (1)(e) makes clear that, where a capital sum is taken as an alternative to annuity payments, such payments include future payments.

1923.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 485: Disregard of certain events in relation to qualifying policies

1924.This section is based on section 540 of ICTA. It deals with circumstances in which qualifying policies do not give rise to chargeable events.

1925.Broadly, there is no chargeable event if:

  • the event is:

    • the death of a person whose life is insured; or

    • the maturity of the policy; or

  • the policy has run for a period measured by the earlier of:

    • ten years; or

    • three-quarters of the policy’s term;

so long as the policy has not been made “paid-up” within that same period.

1926.Subsection (6) re-starts this time calculation of how long the policy has run from the date of variation, if the policy is varied to increase the premiums payable.

1927.Subsections (2) and (3) do not rewrite the words in brackets in the opening of section 540(1)(b) of ICTA “whether or not the premiums thereunder are eligible for relief under section 266”. These words add nothing of substance.

1928.Paragraph (b) in each of subsections (2) and (3) reflects a circumstance in which the restriction of what is a chargeable event for a qualifying policy is itself disapplied. It operates where a company would, by virtue of section 547(1)(b) of ICTA, be a person liable to corporation tax on a gain treated as arising on the policy or contract. As described in the commentary on section 464, attribution of corporation tax liability to that company does not prevent other persons, such as an individual, also being attributable with income tax liability in respect of the gain. This rule operates at a level – what is a chargeable event – where there is no difference between the two tax regimes. See also section 546 (table of provisions subject to special rules for older policies and contracts).

1929.Such a disapplication of the restriction is unnecessary in subsection (5). This subsection is based on section 546B of ICTA. Section 540(5A) of ICTA (on which the restriction in subsections (2) and (3) is based) does not apply to the restriction provided for qualifying policies by section 546B(1A) of ICTA, in relation to events that are found by applying section 546B of ICTA (see section 546C(7)(a) of ICTA for when such events arise).

1930.Subsection (7) deals with the circumstance where a qualifying policy replaces another policy (which may not have been a qualifying policy). It requires certain terms in paragraph 25 of Schedule 15 to ICTA to be met. The new policy will in part have been designated a qualifying policy under Schedule 15 to ICTA because those circumstances were met. This subsection is based on section 553 of ICTA.

Section 486: Exclusion of maturity of capital redemption policies in certain circumstances

1931.This section is based on section 545(1) of ICTA. The source legislation refers in part to “annual payments chargeable to tax under Schedule D”. The income tax charge on such income is rewritten in the Chapters listed in the section. The corporation tax charge on such income is still under Schedule D.

Section 487: Disregard of certain assignments

1932.This section is based on sections 540, 542, 544 and 545 of ICTA. In the source legislation the assignments mentioned here are ignored only for the purposes of particular provisions under which assignments are chargeable events. But, because the assignments in question are disregarded for the purposes of this Chapter, not only is such an assignment not a chargeable event, it is ignored, as regards that policy or contract, in the operation of the rest of the Chapter.

Section 488: Disregard of some events after alterations of life insurance policy terms

1933.This section and the next are based on ESC A96. See Change 89 in Annex 1.

1934.The disregard applies where a policy which is at least 20 years old is effectively made paid-up by the insurer. A chargeable event which might have arisen afterwards as a result of that variation is disregarded if the changes made to the policy would not themselves give rise to a chargeable event.

1935.Subsection (3) extends the disregard to a replacement policy issued by the insurer in lieu of the old, where the issue of such a policy is what the insurer does to give effect to the alteration of the original policy’s terms.

Section 489: Conditions applicable to alterations of life insurance policy terms

1936.This section is based on ESC A96. See Change 89 in Annex 1. The conditions in subsections (2) to (8) ensure among other things that the disregard provided by section 488 falls away if the policy is reactivated for investment purposes.

Section 490: Last payment under guaranteed income bonds etc. treated as total surrender

1937.This section supplements section 484. It is based on section 79 of FA 1997.

1938.Section 504 deals with the treatment of payments under guaranteed income bonds prior to the last payment. Subsection (7) of that section defines the term “guaranteed income bond contract”. See the commentary on that section for further background.

Calculating gains: general
Overview

1939.Section 491 to 497 set out how to calculate a gain on a chargeable event other than one arising on any part surrender or part assignment, or an event in respect of the special charge for personal portfolio bonds.

1940.Section 491 introduces a number of terms which are used throughout the Chapter for the computation of gains (and defines them in subsection (4)). These are:

  • “calculation event” (an umbrella term for events, the occurrence of which is dependent on the outcome of one of several prescribed calculations); and

  • “excess event”, “part surrender or assignment event” and “personal portfolio bond event” (the types of event which may flow from such a calculation).

Section 491: Calculating gains: general rules

1941.This section deals with the calculation rules for all chargeable events other than those triggered by a part surrender or part assignment of rights under the policy or contract, or by the special charge on personal portfolio bonds. It is based on sections 541, 543 and 545 of ICTA and section 79 of FA 1997. (For the relevance of section 79 of FA 1997, see section 490.)

1942.Subsection (2) introduces the concepts of the “total benefit value” and the “total allowable deductions”. These terms are used in other sections in this Chapter (for example, section 541 (calculation of deficiencies)).

1943.Subsection (5) indicates that gains on a previous calculation event include gains on a “related policy” (defined in subsection (6)). See Change 90 in Annex 1.

Section 492: The total benefit value of a policy or contract

1944.This section is based on sections 541, 543, 545 and 548 of ICTA, and section 79(3) of FA 1997.

1945.The “total benefit value” of a policy or contract consists of the value of the policy or contract in relation to the event (paragraph (a)) added to capital sums (or benefits or amounts treated as such) derived from the policy or contract prior to the chargeable event itself (paragraph (b)).

1946.Subsection (2) makes clear that capital amounts derived from a related policy are brought in for this purpose.

Section 493: The value of a policy or contract

1947.The value of a policy or contract is determined by reference to the particular kind of event. This section is based on sections 541, 542, 543, and 545 of ICTA, and section 79 of FA 1997.

1948.Subsections (1) and (2) provide for the value in the majority of events.

1949.In relation to the reference in subsection (6) to connected persons, see section 878 of this Act (which applies section 839 of ICTA).

Section 494: The total allowable deductions for a policy or contract

1950.This section is based on sections 541, 543, 545 and 548 of ICTA.

1951.Step 1 in subsection (1) lists amounts to be taken into account as deductions. Paragraph (a) deals with the vast majority of cases, where the only item to be taken into account is the total of premiums paid before the chargeable event. See also section 546 (table of provisions subject to special rules for older policies and contracts).

1952.Step 2 in subsection (1) reduces the total allowable deductions for a purchased life annuity by the exempt amount (or capital element) in payments to date. The exempt amount is determined under Chapter 7 of Part 6 of this Act and (as regards the capital element) under ICTA as appropriate (see the commentary on section 473).

1953.Paragraph (b) in Step 1 deals with the repayment of loans which were treated as a part surrender of the rights under the policy or contract.

1954.Subsection (2) caters for assignments for money or money’s worth of capital redemption policies. In the case of such assignments paragraph (a) in Step 1 in subsection (1) applies to the price paid in respect of the most recent such assignment instead of the premiums paid before that assignment.

1955.Subsection (3) makes clear that premiums etc. paid in respect of a related policy (as defined in section 491) are included in the calculation of total allowable deductions.

Section 495: Disregard of certain amounts in calculating gains under section 491

1956.This section contains rules which exclude various amounts from the calculation of the total benefit value under section 492 and the total allowable deductions under section 494 in arriving at the amount of a gain under section 491. It is based on sections 541, 543 and 545 of ICTA.

1957.Subsections (1) and (2) deal with a retained replacement policy premium. This disregard is based on paragraph 20 of Schedule 15 to ICTA, which deals with the replacement of one qualifying policy by another, where the value of the old policy is used as a premium for the new policy. The old and new policies are treated as a single policy (see section 542). The value of the old policy is disregarded both in working out the total benefit value of that single policy and, as regards use of the value of the old policy as a premium for the new policy, in working out the total allowable deductions for the single policy.

1958.Subsection (4) reflects an amendment in FA 2002 of a rule introduced by FA 2001, under which an assignment which is not for money or money’s worth (such as a gift) is not treated as giving rise to a chargeable event. But assignments which were not for money or money’s worth still have to be taken into account in calculating gains if they occurred in an “insurance year” (see section 499) ending before 6 April 2001.

Section 496: Modification of section 494: qualifying endowment policies held as security for company debts

1959.Although this section refers to a policy held as security for a company’s debt (a circumstance in which liability to corporation tax on a gain arises under section 547(1)(b) of ICTA), this modification is part of the income tax rules because liability on that gain can also be attributable to a person to whom sections 464 to 468 apply or are relevant. It is based on section 541 of ICTA. Where this section applies, the eligible amount of the debt is substituted for premiums paid under the policy in calculating any gain. A claim by the debtor company is required.

Section 497: Disregard of trivial inducement benefits

1960.This section is based on ESC B42. It excludes non-monetary benefits costing no more than £30, which are offered as inducements to attract life insurance business, from the computation of any gain under this Chapter. See Change 91 in Annex 1.

1961.ESC B42 refers to “gifts” but the section refers to “benefits” as a more accurate description of what is provided. It also matches more closely the drafting of the various sections for calculating gains.

1962.Subsection (3) provides for a future increase (or increases), but not for any decrease, in the monetary limit set on this disregard. See section 873 of this Act for the procedural rules which apply to secondary legislation made under powers in this Act.

1963.The monetary limit is applied by reference to the “policy or contract and any linked policy or contract” taken as one. This caters for an insurance industry practice of issuing “clusters” of policies to give the policy holder any required flexibility in managing the total investment.

Part surrenders and assignments: periodic calculations and excess events
Overview

1964.Sections 498 to 509 perform the same function for chargeable events which are excess events as do sections 491 to 496 for the chargeable events those sections relate to. They set out when this type of part surrender or assignment (including something treated as a part surrender) gives rise to a chargeable event, and how to calculate the amount of the gain arising on that event. The calculation of the gain is made by reference to the history of the policy or contract from when the insurance or contract was made up to the end of the insurance year in which the surrender or assignment occurred. This is the more commonly occurring type of chargeable event arising on a part surrender and assignment.

1965.The sections introduce further expressions, such as “periodic calculations” (this term is not defined but refers to situations where sections require calculations and the incidence of chargeable events is linked to the result of the calculation).

1966.The meaning of “insurance year” and “final insurance year” is provided by section 499. These terms are widely used in this Chapter in calculating gains and in determining when a gain arises and when a chargeable event occurs.

Section 498: Requirement for periodic calculations in part surrender or assignment cases

1967.This section based on sections 540, 542, 545 and 546 of ICTA.

1968.Subsection (1) states that the section applies when there has been an assignment for money or money’s worth or a surrender. The section omits the requirement in the source legislation that a calculation is carried out at the end of each insurance year, regardless of whether there has been any such assignment or surrender. But, in an “event-less” year, there could not be any gain, so the calculation would be pointless. See Change 92 in Annex 1.

Section 499: Meaning of “insurance year” and “final insurance year”

1969.This section is based on sections 546, 546B and 546C of ICTA.

1970.Subsection (1) defines an “insurance year”. The definition is applied for the purposes of this Chapter, whereas in the source legislation the application of the definition of “year” is more limited. The source legislation to which the definition is relevant, section 546 of ICTA, is rewritten in a great number of locations in this Chapter. It is no longer practical, or indeed necessary, to limit the application of the definition.

1971.Subsection (3) sets out how the basic rule is varied when the sequence of insurance years is broken by certain of the events listed in section 484(1). Where such an event occurs, the year ends at that point and is called the “final insurance year”. An assignment of all the rights under the policy or contract is not such an event, as the policy or contract continues in existence despite the change of ownership of the rights.

1972.Where the term “final insurance year” is used in this Chapter, it therefore indicates that one of the specified events in section 484(1) has occurred.

1973.One of those events is “a death giving rise to benefits” under a policy of life insurance. The source legislation for the meaning of “insurance year” merely refers to a “death”, and does not cross-refer to the definition of a chargeable event in sections 540, 542 and 545 of ICTA. A cross-reference to events under section 484, rather than words describing the event, is more precise. It also disregards a death which does not give rise to benefits.

1974.Subsection (5) caters for when the final insurance year would begin and end in the same tax year. But for the rule in this subsection, the previous insurance year would end in the same tax year as the final year, and any part surrender or assignment in that year might give rise to a gain that would be charged for that year in addition to the gain on the final event. To avoid (in most cases) the complexity of two sets of computations in one tax year, the previous insurance year is merged with the final year as a single insurance year, the “final insurance year”.

1975.Where the year is the final insurance year, section 509(5) accordingly sets aside any chargeable event that would arise on a periodical calculation under section 507 following a part surrender or assignment,. But, where the circumstances in section 510 apply, and the year in question is the final insurance year, there will be more than one computation in that year, and there may be a gain on a transaction-related calculation as well as a gain under section 491. In most cases the persons liable in respect of the gain on the transaction-related calculation and the gain on the final event are different.

Section 500: Events treated as part surrenders

1976.This section deals with some circumstances that would not otherwise be regarded as a surrender of part of the rights under a policy or contract. Paragraph (a) is based on section 539 of ICTA, paragraph (b) on section 542 of ICTA, paragraph (c) on section 548 of ICTA and paragraph (d) on section 79 of FA 1997.

1977.Note that an “event” within this section is not a “chargeable event”, unless:

  • the calculation under section 507 results in a gain; and

  • there is a chargeable event by virtue of section 509 or section 514.

1978.Paragraph (b) makes explicit the treatment of the circumstance where a capital sum is taken as an alternative to part of annuity payments under a contract for a life annuity. See Change 93 in Annex 1.

1979.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 501: Part surrenders: loans

1980.This section is based on section 548 of ICTA. It counters the avoidance of tax when the profit accrued on the policy or contract is paid to the policy or contract holder in the form of a loan.

1981.The section includes references to a loan to a company, and to section 547 of ICTA, for reasons comparable to those given in the commentary on sections 485 and 496.

1982.See paragraph (c) of step 1 in section 494(1) for the inclusion, as an allowable deduction in certain calculations, of any repayment in whole or in part of a loan which is treated by virtue of this section as a part surrender under section 500.

1983.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 502: Exception from section 501 for loans to buy life annuities

1984.This section is based on section 548 of ICTA.

Section 503: Exception from section 501 for certain loans under qualifying policies

1985.This section is based on section 548 of ICTA.

1986.Condition B reflects the saving provided for certain loans made before 6 April 2000 by paragraph 18(3) of Schedule 4 to FA 1999 (when tax relief for interest was largely withdrawn).

Section 504: Part surrenders: payments under guaranteed income bonds etc.

1987.This section is based on section 79 of FA 1997. It applies to payments by the insurer from a certain type of life insurance policy – “guaranteed income bonds” – that would otherwise be taken into account for tax purposes as interest or an annual payment.

1988.Subsection (6) strips such a payment of any character it has as interest or an annual payment so that it is not charged to income tax in that capacity. It is treated instead as a part surrender of the rights under the contract under section 500.

1989.The meaning of “guaranteed income bond contract” is given, in subsection (7), by reference to the statutory instrument regulating insurance business (under powers provided by the Financial Services and Markets Act 2000).

1990.Subsection (5) excludes the final such payment from the application of this section. But see section 490, under which that payment is treated as the surrender of all remaining rights under the contract.

Section 505: Assignments etc. involving co-ownership

1991.This section and section 506 are based on section 546A of ICTA. They cater for changes in the person(s) having beneficial ownership of the whole or a part of, or a share in, the rights under the policy or contract, however the change comes about. That ownership is described in these sections as the “ownership interest” (see subsection (4)). But this section does not apply when there is a complete change of ownership of that interest (for example, when all the rights are assigned by the old owner or owners to a completely different person or persons).

1992.These sections ensure that only those owners who have reduced their share in the ownership interest (whether partly or completely) are treated as having made an assignment which may give rise to a gain and a chargeable event. Whether the deemed assignment is an assignment for money or money’s worth (which is material for section 498(1)) depends on how the change of ownership was effected between the parties.

1993.This section applies for the purposes of the Chapter (other than this section and section 506, which of necessity refer to the actual assignment). References elsewhere to an assignment have therefore to be construed in accordance with the rules in these sections.

Section 506: Assignments occurring when there is a co-ownership transaction

1994.This section introduces the term “co-ownership transaction” to describe a transaction to which section 505 applies. It is based on section 546A of ICTA.

1995.Subsections (2) to (4) define the deemed assignment for the particular permutation of before and after ownership described in each. They should be construed in the light of subsections (5) and (6), which substitute ownership in equal shares (so that each owner is treated as having a distinct share) for joint ownership (where all owners have an interest in all rights attached to the share).

1996.Subsections (2) and (4) deal with the reduction in a person’s share in the rights under the policy or contract. Subsection (3) deals with the complete disposal of a person’s share in the rights.

Section 507: Method for making periodic calculations under section 498

1997.This section provides the core calculation rules which determine whether there is a gain and, if so, the amount of the gain, when there has been an assignment for money or money’s worth or a surrender of part of, or a share in, rights under the policy or contract. The calculation introduces the terms “net total value of rights surrendered or assigned” and “net total allowable payments”. Subsequent rules (see section 509) determine whether a chargeable event occurs in respect of that gain. It is based on sections 540, 541, 542, 543, 545, and 546 of ICTA.

1998.But the calculation under this section is displaced when certain transactions have occurred (see section 510).

1999.Subsection (4) sets out how the net total value of rights surrendered or assigned is found. Step 1 identifies, and step 2 totals, all relevant amounts from the current and previous insurance years. Step 3 then subtracts all such amounts taken into account on previous “calculation events”. That leaves the total of those amounts since the last such event. These amounts may relate to a period of one or more insurance years, depending on when the latest calculation event occurred (the value of the rights assigned or surrendered may have been too low for this calculation to show a gain). Section 508 contains rules for how the values of part surrenders or assignments of rights are to be measured.

2000.Subsection (5) sets out how to calculate net total allowable payments, that is, the amount that may be deducted from the product of the calculation in subsection (4). It is similar in approach to the calculation of total allowable deductions in section 494, but treats the premiums paid in a special way. An allowance is made, equal to 5% for each insurance year to date (including the year in which the premium was paid), of each premium payment or payments. The allowance, in respect of any particular premium payment, or the payments for a particular year, cannot exceed 100% of that premium or premiums.

2001.Through the definition of “allowable payment”, subsection (6) excludes a “retained replacement policy premium” from the amounts that can be taken into account as allowable payments in the calculation under subsection (5). As mentioned in the commentary on section 495, a retained replacement premium is a sum which becomes payable by the insurer in connection with the ending of the policy, but which is retained by the insurer and used to meet some or all of the premiums payable under a later policy.

2002.The source legislation provides that retained replacement premiums are to be ignored in calculating the amount of premiums taken into account under sections 540 and 541 of ICTA. But, in the case of a chargeable event within section 540(1)(a)(v) of ICTA, it is section 546 of ICTA that provides the method of calculating gains. In particular, section 546(1)(b) of ICTA deals with premiums to be taken into account in the calculation of part surrenders and assignments. Clearly, it is that section that paragraph 20(3) of Schedule 15 to ICTA was intended to affect, although it does not refer to section 546 of ICTA.

2003.The calculation of net total allowable payments in subsection (5), read with the definition of “allowable payment” in subsection (6), therefore rewrites the source legislation so that retained replacement premiums are ignored in the calculation of the gain arising on a part surrender or assignment.

2004.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 508: The value of rights partially surrendered or assigned

2005.This section is based on section 546 of ICTA and section 79 of FA 1997.

2006.Subsection (1) sets out the general rule for valuing part surrenders. It is similar to the rule for valuing the surrender of all rights under a policy or contract (see section 492(1) and (2)). This rule fills a gap in the source legislation. In the FA 1968 legislation for taxing chargeable event gains, a gain (including a gain on a part surrender or assignment) was calculated by reference to “the amount or value of the sum payable or other benefits arising by reason of the event” (see paragraph 12(1)(b) of Schedule 9 to that Act). However, when introducing the provisions now in the source legislation, FA 1975 used slightly different wording for gains in respect of part surrenders and assignments. Section 546(1) of ICTA refers to “the value, as at the time of surrender or assignment, of any part of or share in the rights conferred by the policy or contract...”.

2007.No change was intended from the value used previously for the regime. The wording in section 546(1) of ICTA was intended to refer to the amount that is paid as a result of the part surrender or assignment; that is, what the policy holder receives for the part surrender or assignment. So this section provides that, where there is a surrender of a part of, or share in, rights under a policy or contract, the value of the part or share surrendered is the amount or value of the sum payable or other benefits arising because of the surrender, unless another rule applies.

2008.Subsection (2) is based on section 548 of ICTA. That section provides that, in the case of the loan in question, the same results are to follow as if, at the time the sum was lent, there had been a surrender of part of the rights conferred by the policy or contract, and the sum had been paid as consideration for the surrender. This section drops the fiction that the amount of a loan is the consideration for a surrender.

Section 509: Chargeable events in certain cases where periodic calculations show gains

2009.This section is based on sections 540, 542, 545, 546 and 546B of ICTA.

2010.The transactions mentioned in conditions A and B are those that trigger the operation of section 510. Subsection (6) signposts what happens in such circumstances.

2011.The effect of condition C is that there cannot be a chargeable event as a result of a gain arising under the calculation in section 507 when the insurance year is the final insurance year.

Transaction-related calculations and part surrender or assignment events
Overview

2012.These sections perform the same function as sections 498 to 509 for a particular circumstance. This is where, in any insurance year, there has been:

  • a part assignment of rights under the policy or contract for money or money’s worth; or

  • an assignment of such rights by gift after a part surrender of rights in that year.

2013.Each transaction in that year is the subject of a separate calculation. The rules here ensure that liability attaches to the person who profits from the transaction regardless of the change in the ownership of the rights in the policy or contract (otherwise liability on the gain would attach to the new owner).

Section 510: Requirement for transaction-related calculations in certain part surrender and assignment cases

2014.This section is based on section 546C of ICTA.

2015.Where the section applies, subsection (2) substitutes a fresh calculation under section 511, for each “relevant transaction” in the insurance year, for the discarded single calculation for that year under section 507. This is a change of approach from that taken in the source legislation, which is drafted in terms of a “section 546 excess occurring at the end of any year” being charged to tax under section 546C of ICTA. But the outcome is the same whichever approach is taken.

2016.Any assignment for money or money’s worth in that year of a part of, or share in, the rights is relevant. Any surrender in that year of a part of, or share in, the rights is relevant. That is, the section applies to any such surrender in the year, regardless of whether that surrender was instrumental in triggering the section or whether it preceded or followed an assignment of any kind. This is described by subsection (3) as a “relevant transaction”. That term is used also in sections 511 to 514.

2017.By carrying out a series of calculations, any of which may give rise to a chargeable event (see section 514), the gain is attributed to those liable at the time of that event, in accordance with sections 464 to 468, rather than to those liable by reference to how the rights are held in respect of chargeable events occurring at the end of the insurance year.

2018.Subsection (6) indicates that subsections (2) and (4) are modified by the rules in section 513 for the final insurance year (which provides that no subsequent calculations are made once a “gains limit” has been reached).

Section 511: Method for making transaction-related calculations under section 510

2019.This section and the next set out the calculation required by section 510. This section is based on section 546C of ICTA.

2020.The calculation in these sections is designed to isolate, for each relevant transaction, the value of the transaction in question and how much of the premiums paid to the end of the insurance year in question is available to set against that value. The excess of that value over the available premium is the chargeable gain.

Section 512: Available premium left for relevant transaction

2021.This section is based on section 546C of ICTA. Subsection (1) provides a calculation method to isolate the available premium for the purposes of section 511. This is described as the excess of the “available net allowable payments” over the “available net total values”.

2022.The method works by identifying how much is left, after franking certain amounts, of the gross amount of allowable premiums paid under the policy or contract to the end of the insurance year, applying the twentieths rule in section 507(5). This is step 1 in subsection (3). As a result of applying the rule in section 507 for net total allowable payments, so much of the premiums as has been deducted in calculating gains on a calculation event in a previous insurance year has already been removed from the pool of allowable premiums.

2023.Subsection (3) continues by deducting (in step 2) the total of the transaction values for any previous relevant transactions in this insurance year that did not give rise to a gain when the calculation in section 511 was made. This effectively mops up the equivalent amount of the gross allowable premiums.

2024.Subsection (4) next calculates an amount labelled the “available net total values”, for the purpose of the calculation in subsection (1). This is the amount found by deducting:

  • the total value of all part surrenders and part assignments for money or money’s worth in the insurance year (step 2); from

  • the total value of all part surrenders and part assignments (as in section 507(4) steps 1 and 2; that is, including assignments not for money or money’s worth if they are in an insurance year beginning on or before 5 April 2001) less all such values taken into account in gains on calculation events in previous insurance years (step 1).

2025.The computation in subsection (4) isolates and quantifies the value of any part surrender or part assignment between the last calculation event and the beginning of the present insurance year. That value will have been insufficient to give rise to a gain in the relevant insurance year. Again this effectively uses up the equivalent amount of the allowable premiums.

2026.Having thus deducted:

  • the amount of allowable premiums used in earlier calculation events (subsection (3) step 1, by virtue of the calculation under section 507(5));

  • the amount of any values for part surrenders and part assignments in years since then, but before the current year (subsection (4)); and

  • the amount of any values in relevant transactions of this year which did not produce a gain (subsection (3), step 2);

there is available, against the transaction value of the relevant transaction in question, any “allowable payment” (that is, part of the premiums) accrued between the last calculation event in an earlier year and the end of the present year, as reduced by the amounts mentioned in the second and third bullets.

2027.Subsection (2) short-circuits the whole process for any relevant transaction of the year which occurs after the first relevant transaction to yield a gain. For such subsequent relevant transactions, the amount of available premium is nil. The gain equals the transaction value for the relevant transaction.

Section 513: Special rules for part surrenders and assignments in final insurance year

2028.This section is based on section 546D of ICTA. The purpose of the section is to ensure that the total amount of gains calculated under section 511 on relevant transactions, added to the gain subsequently calculated under section 491 on the event that brings the final insurance year to an end, is not greater than the gain on the final event would have been without relevant transaction calculations.

2029.For this purpose, the gain under section 491 is calculated disregarding gains on relevant transactions (as defined in section 510(3)). That re-calculated gain acts as a cap on the total gains to be charged in respect of the policy or contract for that year.

2030.In effect, that cap is placed on the latest gain on a relevant transaction, where that gain, added to previous gains on relevant transactions, would exceed the cap. Where that happens, so much of the gain as would exceed the cap is ignored, and the gain on any subsequent relevant transaction or on the event that brings about the end of the final insurance year is treated as nil. But the value of such transactions will already have been taken into account as appropriate in calculating the gains limit, and so have contributed to the size of the cap.

2031.Subsection (4) expresses this as a reduction in the transaction value for the particular relevant transaction in relation to which the total of the transaction values for the first and successive relevant transactions in the year (see subsection (2)) first exceeds the “gains limit”. The reduction in the transaction value for that relevant transaction is the amount that eliminates the excess over the gains limit.

Section 514: Chargeable events where transaction-related calculations show gains

2032.This section provides that, if the calculation under section 511 shows a gain, the relevant transaction is itself the occurrence of a chargeable event at that time. This contrasts with chargeable events under section 509, which occur at the end of the insurance year, regardless of when in that year the part surrender or part assignment took place. This section is based on sections 546B and 546C of ICTA.

2033.Subsections (3) and (4) nevertheless allot the gain on the chargeable event under this section, for the purposes of sections 464 to 467, to the tax year in which the insurance year ends where liability to tax on the gain would otherwise fall into the preceding tax year. The date of the chargeable event may therefore be in an earlier tax year than that for which the gain is charged.

2034.Subsection (5) clarifies the order in which chargeable events take place in the final insurance year, when there is a transaction-related chargeable event in that year. The order prescribed here avoids any suggestion that amounts relevant only to the calculation on the final event enter into the calculations under section 511, even though both calculations take the full period of the final insurance year into account.

Section 515: Requirement for annual calculations in relation to personal portfolio bonds

2035.Sections 515 to 526 set out the special charge in respect of personal portfolio bonds.

2036.This section is modelled on the approach taken in sections 498 and 510. It is based on regulation 5(1) of PPB(T)R.

2037.Subsection (1) makes clear that it is the status of the policy or contract as at the end of the insurance year, that is, whether it is a personal portfolio bond at that time, which determines whether this requirement applies.

2038.Subsection (3) gives the time as at which the calculation is to be done. Section 553C of ICTA (the section providing the powers used to make PPB(T)R) does not use “insurance year” but instead refers to a “yearly charge”, using section 546(4) of ICTA to construe “yearly”. The latter section is the source legislation for the definition of “insurance year” in section 499. The section makes explicit that “yearly” refers to an insurance year.

2039.Subsection (4) provides that the calculation required by this section is to be made regardless of any other calculation also required by this Chapter. So a gain, treated under section 525 as arising on the chargeable event mentioned in subsection (3) of that section, is added to any other gains arising in the same tax year on other chargeable events in respect of the personal portfolio bond.

Section 516: Meaning of “personal portfolio bond”

2040.This section is based on regulation 4 of PPB(T)R. All of the types of policy or contract mentioned in section 473(1) have the potential to be a personal portfolio bond, if conditions A and B in this section are met. But, even if those conditions were met, the exclusions mentioned in section 473(3) would apply to take such policies and contracts out of the scope of this special charge.

2041.Subsection (2) sets out condition A. This is the portfolio element in a personal portfolio bond.

2042.Subsection (4) sets out condition B. This is the personal element in a personal portfolio bond. The list of persons who may be able to select property or an index includes, for example, a financial adviser who acts on behalf of a policy holder, as well as anyone “connected” with the policy holder. Section 878 of this Act applies the “connected persons” rules in section 839 of ICTA for the purposes of this Act.

2043.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 517: Policies and contracts which are not personal portfolio bonds

2044.This section introduces a let-out from the charge on personal portfolio bonds for policies and contracts where an index or property is, broadly speaking, of a public or not unusually restricted nature (as defined in sections 518 to 521). Many unit-linked policies benefit from this let-out. This section is based on regulation 4 of PPB(T)R.

Section 518: The index categories

2045.This section is based on regulation 4 of PPB(T)R.

2046.Schedule 4 to this Act indicates that the definitions of “retail prices index” in section 833(2) of ICTA and “recognised stock exchange” in section 841(1) of ICTA apply.

Section 519: The index selection conditions

2047.This section is based on regulation 4 of PPB(T)R. The selection conditions seek to ensure that the opportunity to select is not narrowly restricted. While occasionally such an opportunity is made available to all policy holders of an insurer, or their agents (the “general selection condition”), more often various products are linked to a number of indices, when the opportunity to select is offered to one or more large classes of policy holder, or their agents (the “class selection condition”).

2048.It is made explicit that it is immaterial, in respect of both the general and the class selection conditions, whether the opportunity is offered to the policy holders themselves or to their agents (such as financial advisers).

Section 520: The property categories

2049.This section is based on regulation 4 of PPB(T)R.

2050.Categories 1 to 4 and 7 are types of collective investment scheme, whether based in the United Kingdom or elsewhere, which satisfy the appropriate rules of investment regulatory bodies.

2051.Category 5 is cash, so long as the cash is not held to realise a profit on selling it. Such a profit may only be realised on foreign currency.

2052.Category 6 is an investment in a policy or contract to which this Chapter applies, other than one that is, or is in any way related to, a personal portfolio bond. “Related property”, a term used in subsection (3)(c), in relation to any policy or contract (or the premiums paid on it), means income which derives directly or indirectly from holding the policy or contract, or investing in it. In the source legislation, this term is defined by reference to section 660A(10) of ICTA, but that provision is rewritten in Chapter 5 of Part 5 of this Act.

Section 521: The property selection conditions

2053.This section is based on regulation 4 of PPB(T)R. The commentary on section 519 applies equally here.

Section 522: Method for making annual calculations under section 515

2054.This section is based on regulation 5 of PPB(T)R. It takes a similar approach to that used in the other required calculations in this Chapter, that is, a calculation formula plus supporting method statements to find the amounts relevant to the formula.

2055.However, whereas in those other calculations the figure found by applying the formula produces the amount of the gain, subsection (4) sets the gain at 15% of the figure found by applying the formula.

2056.Any year in which the policy or contract was not a personal portfolio bond nevertheless enters the calculation. So the relevant premiums, previous gains under this section and excess events are those of any insurance year of the policy or contract. Where regulation 5 of PPB(T)R refers to a year in which the bond was in existence, this means a year when the policy or contract was in existence, rather than a year in relation to which the policy was a personal portfolio bond. The term “personal portfolio bond” is used in the regulation merely to identify the policy or contract in question.

Section 523: The total amount of personal portfolio bond excesses

2057.This section is based on regulation 5 of PPB(T)R.

Section 524: The total amount of part surrender gains

2058.This section is based on regulation 5 of PPB(T)R.

2059.The exclusions made by subsections (4) and (5) affect assignments. That type of transaction has frequently been used in tax planning to avoid the charge rewritten in this Chapter.

2060.Because of the change of approach mentioned in the commentary on section 510, the calculations under sections 507 and 511 are independent (albeit sharing some features). It is therefore unnecessary to rewrite paragraph 5(2B)(c) of PPB(T)R, as the provisions mentioned there contribute only to the calculation under section 511.

Section 525: Chargeable events where annual calculations show gains

2061.This section is based on regulations 5 and 6 of PPB(T)R.

Section 526: Power to make regulations about personal portfolio bonds

2062.This section is based on section 553C of ICTA. But the powers given here for the Treasury to make regulations apply only to certain aspects of the charge on gains treated as arising under section 525. See Change 94 in Annex 1.

2063.The regulations contained in PPB(T)R, in so far as they apply to determine the amount of the gain under the special charge and how that gain is charged to income tax, are rewritten in the preceding sections. The regulations remain in place in respect of calculating and charging gains to corporation tax. The regulations also remain in place as regards the duties of insurers in sections 552 to 552B of ICTA.

2064.To the extent that the regulations are rewritten for income tax purposes in these sections, the powers in section 553C of ICTA are spent.

2065.The power given is to make regulations about the administration of this charge, which in practice means regulations in connection with the duties of insurers.

Section 527: Reduction for sums taken into account otherwise than under Chapter 9

2066.This section is based on section 547 of ICTA. It prevents a double charge to tax where a sum, which is taken into account in calculating a gain under this Chapter, also falls to be taken into account in computing another type of taxable income. For example, it might also constitute a trading receipt.

2067.This rule is provided because the process for determining when a chargeable event occurs, and how much the gain is, does not sit well with the usual procedure for ensuring that income is taxed under one charging provision only (such as the priority rules in section 366 of this Act). That is, it may be necessary for such receipts to be brought into a calculation under this Chapter before it can be determined whether a chargeable event has occurred or a gain has arisen. Section 366(4) permits inclusion of such receipts in more than one computation.

2068.Although the source legislation is in terms of an amount taxable under section 547(1) of ICTA and an “amount which is chargeable to tax” apart from that subsection, this section reduces the gain otherwise chargeable by the “amount of the receipt or other credit item” taken into account in the other calculation. “Credit item” is not a defined term, but is used in, for example, section 4of this Act. See Change 95 in Annex 1.

Section 528: Reduction in amount charged: non-UK resident policy holders

2069.This section is based on section 553 of ICTA. In effect, it exempts the part of the gain on foreign policies that represents investment profit for the period when the policy holder was not resident in the United Kingdom. The reduction does not apply to gains arising on life annuity contracts.

2070.The reduction is proportionate to the period during the course of the policy, measured to the date the chargeable event occurred, in which the policy holder was not UK resident. This method reverses the approach in the source legislation, where the calculation produces the amount of the reduced gain, rather than the amount by which the gain is reduced.

2071.The policy holder and the person or persons liable to tax on the gain may not be the same.

2072.Subsections (5) and (6) provide a special rule for a “new policy”. Under paragraph 17 of Schedule 15 to ICTA, a “new policy” is a policy which is issued in substitution for, or on the maturity of, an earlier policy (as a result of exercising an option contained in the earlier policy). Where there has been one or more replacement policies, the course of the policy is taken to run from the earliest original policy.

Section 529: Exceptions to section 528

2073.This section is based on section 553 of ICTA.

2074.Because the reduction under this section is not made if the policy is held by non-UK resident trustees, it is the unreduced gain which is taken into account for the purposes of section 740 of ICTA where section 468 applies.

2075.Subsection (2) applies the rules in section 110 of FA 1989, which determine when a body of trustees, one or more of whom would be regarded as resident in the United Kingdom and one or more of whom would not be so regarded, are all to be regarded as resident in the United Kingdom or not so resident.

2076.The source legislation does not take account of section 110 of FA 1989. Although section 110 of FA 1989 applies only to 1989-90 and subsequent years, it is applied here in respect of all earlier years where necessary, as it would be impractical to apply the provision using two different tests of residence status. See Change 96 in Annex 1.

2077.See also section 546 (table of provisions subject to special rules for older policies and contracts). Change 96 is not applied in paragraph 106 of Schedule 2 to this Act as that paragraph refers to a time wholly before the rule introduced by FA 1989 applies (see paragraph 106(3)).

Section 530: Income tax treated as paid etc.

2078.This section sets out when (subject to section 531) an income tax allowance is available to set off against the tax chargeable on the gain. It is based on section 547 of ICTA.

2079.The allowance is an amount equivalent to the lower rate of income tax on the gain (see section 1A(1B) of ICTA). It is treated as tax paid by the individual or trustees liable to tax on the gain. The allowance is not available to personal representatives who are so liable.

2080.An individual whose income is chargeable at the higher rate (see section 1(2)(b) of ICTA) will pay tax at that rate on the gain, against which the allowance can be set.

2081.The trustee or trustees of a non-charitable trust pay tax at the rate applied by section 686(1AA)(b) of ICTA, subject to the set-off of the allowance. The trustee or trustees of a charitable trust pay tax on gains at the lower rate (see section 467(7)(a)), and therefore have no net liability where the allowance is due.

2082.Taxpayers whose income is chargeable at the starting, lower or basic rates only, and non-taxpayers, have no further income tax liability when the allowance is due.

2083.Subsection (2) provides that the tax treated as paid is not repayable even if the individual (or the trustee or trustees) is a non-taxpayer or the allowance exceeds the tax charged on the gain.

2084.Subsection (3) caps the allowance when the net income chargeable to tax is reduced below the amount of the gain because of other deductions. The allowance is reduced accordingly.

2085.Subsection (6) ensures that the starting rate of tax (section 1(2)(aa) of ICTA) does not apply when calculating the liability to tax on a gain of an individual who is entitled to the allowance.

2086.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 531: Exceptions to section 530

2087.Broadly, this section denies the income tax allowance provided by section 530 to policies and contracts where the underlying investment profit is not subject to UK tax. Where this section applies, the tax charge for the person liable includes the starting rate of income tax (section 1(2)(aa) of ICTA) where applicable. It is based on sections 547, 553 and 553A of ICTA.

2088.This section is disregarded for the purposes of a top-slicing relief calculation (see sections 535 to 537) so that the calculation assumes there was an income tax allowance.

2089.And the income tax allowance may be available where the policy or contract is with a European Economic Area (“EEA”) or other non-UK resident insurer (subsection (2)), or where a foreign policy of life insurance is issued by the UK permanent establishment of a non-UK resident insurer (subsections (5) and (6)). In these circumstances, the underlying investment profit has been subject to UK tax or to comparable tax in an EEA or other country.

2090.Subsection (5) refers only to policies which are foreign policies of life insurance under the first part of the definition in section 476(3), and not to policies under the second part. This preserves the intended operation of section 553(7) of ICTA for such policies despite the apparent override of that provision in section 553A(3) of ICTA for all foreign policies. See Change 97 in Annex 1.

2091.Subsection (3) sets out the types of policies and contracts which are excepted by this section from section 530.

2092.Paragraph (a) makes clear that life annuity contracts issued by a friendly society in its tax-exempt business are within the exception, as well as life insurance policies so issued, despite the reference in the source legislation to policies only. Section 547(7) of ICTA applies to gains under both sections 541 and 543 of ICTA. Its opening words are “Where under section 541, 543 or 546C(7)(b), a gain is to be treated as arising in connection with a policy…”. However, while section 541 of ICTA deals with gains on policies, section 543 of ICTA deals with gains on contracts for life annuities. Section 547(7) of ICTA therefore applies to contracts for life annuities.

2093.Paragraph (b) indicates section 530 does not apply to a gain on a foreign policy of life insurance unless the policy meets conditions which indicate that the underlying investment profit earned by the policy has borne UK tax.

Section 532: Relief for policies and contracts with European Economic Area insurers

2094.This section and the following section are based on sections 547 and 553 of ICTA. This section sets out when the income tax allowance provided by section 530 may be available for a gain on a foreign policy or contract, despite the exception in section 531. It applies where:

  • a claim is made under this section;

  • the insurer conditions (conditions A and B) are satisfied; and

  • reinsurance of a particular type (see the definition of “excluded reinsurance contract” in subsection (5)) has not been made in respect of the policy or contract (condition C).

2095.In relation to “policies”, the section makes clear that the relief provided extends to foreign capital redemption policies as well as to life insurance policies.

2096.Subsection (1) sets out that a claim under this section must simply be made, rather than made to the Inland Revenue, or (as in the source legislation) to the Board of Inland Revenue. See Change 149 in Annex 1.

2097.The definition of “policy period” in subsection (5) excludes any period when the policy or contract has already been subject to UK tax on the underlying investment profit.

Section 533: Meaning of “comparable EEA tax charge”

2098.This section sets out the requirement for the purposes of section 532 that the tax charge applied to the EEA insurer is at least broadly equivalent to that applying to insurers operating in the United Kingdom. This section is based on sections 547 and 553 of ICTA.

2099.The term “insurer” in subsection (1) recognises that the range of bodies issuing policies or contracts in another EEA country may be different from that met in the United Kingdom, and is not necessarily equivalent to an insurance company. And for that reason, the term “insurance company” (which is defined in section 545) has not been used here.

Section 534: Regulations providing for relief in other cases where foreign tax chargeable

2100.This section is based on section 56(3) of FA 1995. It gives the Board of Inland Revenue power to make regulations which provide the same relief as does section 532 where:

  • the insurer is not resident in a EEA country or territory;

  • the insurer is subject to tax in that non-EEA country or territory (as described in section 532); and

  • a claim for the relief is made.

2101.No regulations have been made yet under section 56(3) of FA 1995.

Section 535: Top slicing relief

2102.This section, and sections 536 and 537, are based on section 550 of ICTA. They provide a relief where the gain charged under this Chapter takes an individual’s taxable income into the higher rate of tax. The relief reduces or eliminates the higher rate charge.

2103.The relief is given by reducing the amount of tax charged on the gain, or by repayment. It is given without a claim being required. See Change 98 in Annex 1.

2104.The relief is calculated by comparing the tax chargeable on the gain (or gains) with the tax that would be chargeable on a fraction of the gain, in both cases after setting off the appropriate income tax allowance under section 530. The fraction (the “annual equivalent”) is calculated by reference to the number of years the policy or contract has been in existence. The relief is the difference between the tax otherwise chargeable on the full gain and the tax that would be charged if the full gain were taxed at the rate of tax chargeable on the fraction.

2105.How to determine the fraction, and how the tax chargeable on the fraction is calculated, depends on whether the individual is taxable under this Chapter in the tax year on a gain from one chargeable event (section 536) or on gains from more than one event (section 537).

2106.Subsection (3) sets out how to calculate the tax on the gain(s) before any relief under this section has been given. The gain is treated as the “top slice” of the individual’s total income.

2107.Subsection (5) ignores certain items of income in working out an individual’s “total income” for these purposes. Section 835 of ICTA defines “total income”, in relation to any person, as “the total income of that person from all sources estimated in accordance with the provisions of the Income Tax Acts”.

Section 536: Top slicing relieved liability: one chargeable event

2108.This section is based on sections 550 and 553 of ICTA.

2109.The method employed in subsection (1) takes three steps. The first step determines a fraction of the gain (called the “annual equivalent”). The second calculates the net tax charge that would apply to that fraction. The third step works out the tax on the whole gain (called the “relieved liability”) by multiplying the tax calculated under step 2 by the factor (“N” – see step 1) which was used to find the fraction.

2110.“N” represents the number of complete years the policy or contract has run before the chargeable event.

2111.Subsections (2) to (8) contain rules which modify how “N” is worked out. For example, where the gain is from a “calculation event”, that is, a part surrender or assignment that gives rise to a gain, subsection (2) substitutes the number of years since the latest “calculation event” which arose on that policy or contract. (But, where the policy is a “new policy” (see subsection (5)) in relation to a replaced policy, any calculation event which arose on the replaced policy is disregarded for the purposes of subsection (2), even though the life of the “new policy” is, under subsection (4), dated from the commencement of the earlier replaced policy.)

Section 537: Top slicing relieved liability: two or more chargeable events

2112.This section is based on section 550 of ICTA. It employs the same method approach as section 536, and the same rules modifying the calculation of the factor (“N”) by which each gain is to be divided for the purposes of the calculation.

2113.However, the actual method employed differs in two respects. First, the fractions (the “annual equivalent”) of each gain are totalled, so that the tax calculation under step 2 is made in respect of the totalled amount.

2114.Second, the relieved liability is found by multiplying the net tax on the total annual equivalents by the aggregated gains and dividing the result by the total annual equivalents. (Roughly speaking, this gives a result based on a weighted average of “N”.) This method statement expresses explicitly the calculation described in section 550(6) of ICTA for such cases.

2115.The product of this calculation is compared with the unrelieved liability on the full gains (as calculated under section 535(3)) to work out how much top slicing relief is available.

2116.For example, if an individual is chargeable on gains totalling £31,000 under this Chapter (say, gains of £6000 from one policy where “N” is four years and gains of £25,000 from another policy where “N” is ten years), and the net tax chargeable on those gains before relief (the “unrelieved liability”) would be, say, £2400:

  • the “total annual equivalent” is £4000 (£1500 from the first policy plus £2500 from the second);

  • the “total relieved liability” on the total annual equivalent is, say, £200;

  • the relieved liability is £1550 (the total relieved liability £200 multiplied by the total gains £31,000, divided by the total annual equivalent £4000);

  • top-slicing relief is £850 (unrelieved liability £2400, less relieved liability £1550).

Section 538: Recovery of tax from trustees

2117.This section provides a right of recovery for an individual who, although the rights in question under the policy or contract are held by non-charitable trustees, is liable to tax on a gain or gains under this Chapter because section 465(1)(b) applies. It is based on section 551 of ICTA.

2118.Subsection (1)(c) defines the tax that may be recovered from the trustees. Broadly, it is the extra tax paid on the gain or gains after any top slicing relief. Where top slicing relief is available and there is more than one chargeable event in the year, with at least one gain giving liability by virtue of section 465(1)(b), subsection (4) provides that the relief is to be apportioned between the gains charged in working out the extra tax.

2119.Subsection (3) sets a cap on the amount that can be recovered from trustees, by reference to what they have derived from the relevant chargeable event.

2120.Subsections (5) and (6) allow the individual to require the Inland Revenue (rather than the Board of Inland Revenue) to certify an amount recoverable from the trustees. See Change 149 in Annex 1.

Section 539: Relief for deficiencies

2121.Together with sections 540 and 541, this section is based on section 549 of ICTA. These sections provide a sort of “loss” relief where:

  • the overall gain on a policy or contract is less than the amounts that were charged as gains on chargeable events occurring in earlier policy years; and

  • the individual in question was the person liable to tax on those gains.

2122.The relief is only available to an individual. It only reduces tax charged at the higher rate or the “dividend upper rate” (the Schedule F upper rate in the source legislation).

2123.Under subsection (1), the relief is only given to an individual who would have been liable on a gain, had one arisen on the chargeable event in question. For this purpose, the requirement in section 465(1), that an individual must be UK resident to be liable, is disregarded. The effect of this is that a non-UK resident individual, who is not liable under section 465(1), but is chargeable to income tax on other income, is not denied the benefit of this relief.

2124.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 540: When deficiencies arise: events following calculation events

2125.This section is based on section 549 of ICTA. Under subsections (2) to (4), a deficiency may only arise where:

  • there is a chargeable event within certain of the categories of chargeable event listed in section 484(1);

  • there has previously been a gain on a “calculation event” (see section 491(4)), other than a “personal portfolio bond event”, in respect of that policy or contract; and

  • the calculation carried out under section 491 does not produce a gain.

2126.Although the amount of the deficiency to be relieved ignores any gains on personal portfolio bond events under section 522, the calculation under section 491 does not exclude such gains in arriving at the overall “loss”.

Section 541: Calculation of deficiencies

2127.This section explains how to calculate the amount of a deficiency. It is based on section 549 of ICTA. It uses the “total benefit value” of the policy or contract, and the “total allowable deductions”, in respect of the event, as calculated for section 491, to find the amount. What those terms mean in detail is shown by the calculation methods in sections 492 and 494 respectively.

2128.There are two possible amounts. Where the investor has made no overall gain, on comparing the “total benefit value” of the policy or contract and the “total allowable deductions”, all earlier gains which formed part of that individual’s total income are “refunded” as the amount of the deficiency. If there is a gain, but it is less than those earlier gains, the amount of the deficiency is those gains minus the net overall gain. (In determining for this purpose whether there has been an overall gain and, if so, its amount, the earlier gains are themselves disregarded.)

Section 542: Replacement of qualifying policies

2129.This section treats a qualifying policy and another qualifying policy which it replaces as a single policy for the purposes of certain sections in this Chapter (the general rules for when chargeable events occur and how gains are calculated). The commonest circumstance in which this section applies is where a life is added to or removed from a policy on marriage or divorce. It is based on paragraph 20 of Schedule 15 to ICTA.

2130.See also section 546 (table of provisions subject to special rules for older policies and contracts).

Section 543: Issue time of qualifying policy replacing foreign policy

2131.This section substitutes the start date of the old policy as the start date of the new policy for a particular circumstance where one policy has been substituted for another. It is based on section 553 of ICTA.

Section 544: Application of Chapter to policies and contracts in which companies interested

2132.This section deals with the circumstance where the application of this Chapter, that is, whether there is a chargeable event and what the amount of the gain is, has to take into account anything that occurred (or may yet occur) in respect of the policy at a time when any liability may, wholly or in part, arise or have arisen under the equivalent corporation tax provisions. It is new. (Paragraph 210 of Schedule 1 to this Act inserts section 539ZA of ICTA for the equivalent corporation tax purposes.)

2133.The section makes clear that this Chapter applies in respect of any other circumstance regardless of any application of “the corporation tax provisions” at that time. For example, if there has been a chargeable event under section 509 at a time when liability on the gain arose wholly or in part under section 547(1)(b) of ICTA (so that there was also a chargeable event under, say, section 540(1)(a)(v) of ICTA), that event is taken into account in the later application of this Chapter, even if there would then be no liability under section 547(1)(b) of ICTA.

Section 545: Minor definitions

2134.This section provides minor definitions for the purposes of this Chapter.

2135.The definitions of “charitable trust”, “friendly society” and “non-charitable trust” are based on section 539 of ICTA.

2136.The definition of “insurance company” is new for the purposes of this charge, although the Tax Acts provide a definition for other purposes. See Change 99 in Annex 1. (There is no Chapter-wide definition of “insurer”. Depending on the provision, that word may mean the insurer for the time being or the original insurer with whom the insurance or contract was made. Where a definition is needed, it has been provided for the purposes of the section in question (for example, see section 501)).

2137.The definition of “market value” is based on the definition provided by regulation 2(1) of PPB(T)R for the purposes of those regulations. The term is not otherwise defined in the source legislation. See Change 100 in Annex 1.

2138.The definitions in subsection (2) of “premium”, and in subsection (3) of “the amount of premiums paid” are based on the definition in regulation 2(2) of PPB(T)R. They clarify rather than replace “premium” as the term is generally understood, and are not regarded (in so far as they apply for the purposes of the Chapter rather than for the special charge on personal portfolio bonds only) as a change in the law.

Section 546: Table of provisions subject to special rules for older policies and contracts

2139.This section provides an index to the paragraphs of Parts 6 and 7 of Schedule 2 to this Act that modify the operation of certain provisions in the Chapter for older policies and contracts. It is new.

2140.The section also indicates those paragraphs in Part 5 of that Schedule that are relevant to this Chapter but depend on time factors other than the date on which the policy or contract was made.

Chapter 10: Distributions from unauthorised unit trusts
Section 547: Charge to tax under Chapter 10

2141.This section is based on sections 18(1) and (3) and section 469(3) and (4) of ICTA.

2142.This section refers to “schemes