Part 2: Basic provisions
25.This Part contains basic provisions about the charge to income tax.
Chapter 1: Charges to income tax
26.This Chapter sets out the provisions of the Income Tax Acts where the main charges to income tax are to be found and contains basic rules about the annual nature of income tax.
Section 3: Overview of charges to income tax
27.This section is based on section 1(1) of ICTA.
28.Subsection (1) lists the principal provisions that contain charges to income tax, which are all in ITEPA and ITTOIA.
29.Subsection (2) makes it clear that there are also charges to income tax in other legislation. The main ones are shown, but the list is not exhaustive.
Section 4: Income tax an annual tax
30.This section is based on sections 1(2), 2(2) and 832(1) of ICTA.
31.Section 2(1) of ICTA, which provides for the due proportion of income tax to be charged for every fractional part of one pound, has not been rewritten as it is otiose.
Section 5: Income tax and companies
32.This section provides that income of companies that is liable to corporation tax is not charged to income tax. It is based on sections 6(2) and 11(1) of ICTA.
33.In brief, a company’s income (other than income arising to it in a fiduciary or representative capacity) is within the charge to corporation tax if:
the company is UK resident; or
the company is non‑UK resident and:(a)
the income is trading income arising through or from a permanent establishment in the United Kingdom of the company; or(b)
the income arises from property or rights used by, or held by or for, the permanent establishment.
See the commentary on section 835 in relation to the residence of companies.
Chapter 2: Rates at which income tax is charged
34.This Chapter sets out all the rates of income tax and provides rules about the rates of tax at which income is charged. It is based on sections 1, 1A, 1B and 686(1A) of ICTA.
35.Two main principles are at work:
first, the rate of tax depends on the type of income concerned; and
second, income may be subject to progressively higher rates of tax depending on the overall amount of income of the person concerned.
36.The second principle applies only to individuals (subject to a special rule about the first £1,000 of trustees’ trust rate income in Chapter 6 of Part 9 of this Act).
Section 6: The starting rate, basic rate and higher rate
37.This section sets out the main rates at which income tax is charged. It is based on section 1(2) of ICTA.
38.With some exceptions, notably savings and dividend income (see sections 12 and 13), any income of an individual is taxed at either the starting rate, the basic rate or the higher rate, depending on the level of the individual’s income.
39.Subsection (2) specifies that the main rates are determined each year by Parliament.
40.Other rates at which income tax is charged do not have to be specified by Parliament annually and are instead set out in the sections signposted by subsection (3).
Section 7: The savings rate
41.This section sets out the savings rate of income tax. It is based on section 1A(1B) of ICTA.
42.The “savings rate” is a new name for what is called “the lower rate” in the source legislation.
Section 8: The dividend ordinary rate and dividend upper rate
43.This section sets out these two rates of income tax that apply to dividend income. It is based on section 1B(2) of ICTA.
Section 9: The trust rate and dividend trust rate
44.This section sets out the two rates of income tax that apply, in particular, to accumulation or discretionary income of trustees. It is based on section 686(1A) of ICTA.
45.The “trust rate” is a new name for what is called “the rate applicable to trusts” in the source legislation.
Section 10: Income charged at the starting, basic and higher rates: individuals
46.This section sets out that the three main rates of income tax charged on the income of individuals are charged in three slices. It is based on section 1(2) of ICTA.
47.The first slice (subsection (1)) is income up to the starting rate limit – the starting rate band. The second slice (subsection (2)) is income between the starting rate limit and basic rate limit – the basic rate band. The third slice (subsection (3)) is income above the basic rate limit – the higher rate band.
48.Subsection (4) is a signpost to provisions that apply different rates of tax to certain types of income falling within each band. Income has to be placed in order so that the rates which would otherwise apply can be established. The rules on how this is to be done are in section 16.
Section 11: Income charged at the basic rate: other persons
49.This section charges tax at the basic rate on income of persons other than individuals. It is based on section 1(2) of ICTA.
50.Of the three main rates, only the basic rate applies. But other rates apply to specific sorts of income. In particular, savings income is charged at the savings rate and dividend income at the dividend ordinary rate. And income of discretionary and accumulation settlements is charged at the trust rates. There is a signpost to these exceptions in subsection (2).
Section 12: Income charged at the savings rate
51.This section charges savings income at the savings rate to the extent that it would otherwise fall within the basic rate band. It is based on section 1A(1) of ICTA.
52.There are a number of exceptions that provide that certain savings income is charged differently, usually at the trust rate. These are signposted in subsection (2).
Section 13: Income charged at the dividend ordinary and dividend upper rates: individuals
53.This section applies either the dividend ordinary rate or the dividend upper rate to dividend income of individuals. It is based on sections 1A(1), (1AA), (1A) and (4) and 1B(1) of ICTA.
54.To the extent that the dividend income (other than dividend income charged on the remittance basis) would otherwise fall within the starting rate or basic rate bands, subsection (1) provides that the dividend ordinary rate applies instead.
55.To the extent that the dividend income would otherwise fall within the higher rate band, subsection (2) provides that the dividend upper rate applies instead.
56.Subsection (3) provides that subsections (1) and (2) are subject to any provisions to the contrary.
57.“Dividend income” includes income chargeable under Chapter 5 or 6 of Part 4 of ITTOIA (see the definition in section 19). See Change 1 in Annex 1.
Section 14: Income charged at the dividend ordinary rate: other persons
58.This section applies the dividend ordinary rate to dividend income of persons other than individuals. It is based on section 1A(1), (1A) and (4) of ICTA.
59.Subsection (1) applies the dividend ordinary rate in place of the basic rate to dividend income (other than dividend income charged on the remittance basis). A number of provisions which override this rule (typically to provide that one of the trust rates applies instead), are signposted by subsection (2).
Section 15: Income charged at the trust rate and the dividend trust rate
60.This section provides a signpost to Chapters 3 to 6 of Part 9, which are about the circumstances in which income tax is charged at the trust rate and the dividend trust rate. It is new.
Section 16: Savings and dividend income to be treated as highest part of total income
61.This section provides the ordering rules that determine at what rate a particular type of income would be charged but for the sections imposing the savings rate or the dividend rates. It is based on section 1A(5) of ICTA.
62.Subsection (2) says that the rules apply for all other income tax purposes as well, except in the cases mentioned.
63.Subsections (3) to (5) contain the ordering rules. In essence, dividend income is the top part of income, savings income the middle part, and other income the lowest part.
64.Subsection (6) is a signpost to section 1012 which deals with the relationship between the rules in this section and other rules requiring particular income to be treated as the highest part.
65.Subsection (7) ensures that dividend income charged on the remittance basis does not count as dividend income for the purposes of this section.
Section 17: Repayment: tax paid at basic rate instead of starting or savings rate
66.This section allows a repayment claim outside Self Assessment if a person has suffered tax at the basic rate on income received and the person is only liable at the starting rate or the savings rate on that income. It is based on sections 1(6A) and 1A(6A) of ICTA.
Section 18: Meaning of “savings income”
67.This section defines “savings income”. It is based on section 1A(1AA), (2), (3) and (4) of ICTA.
68.The definition includes income on which personal representatives are liable under section 466 of ITTOIA (gains from contracts for life insurance etc), removing an anomaly in the source legislation. See Change 2 in Annex 1.
Section 19: Meaning of “dividend income”
69.This section defines “dividend income”. It is based on section 1A(1AA), (2), (3) and (8) and section 1B(1) and (3) of ICTA.
Section 20: The starting rate limit and the basic rate limit
70.This section sets out the starting rate limit and the basic rate limit. It is based on section 1(2) to (3) of ICTA.
71.The figures used in this Act are those for 2006-07. They will be updated for 2007-08 by means of an indexation order.
Section 21: Indexation of the starting rate limit and the basic rate limit
72.This section provides for indexation of the starting rate and basic rate limits. It is based on section 1(4) to (6) of ICTA.
73.Subsections (2) and (3) set out in step form how to compute the limit for a given year by reference to the limit for the previous year and the percentage rise in the retail prices index. The words “unless Parliament otherwise determines” in section 1(4) have been omitted as it is always open to a Finance Act to disapply this provision, so no express provision to this effect is needed.
74.Subsection (4) is an administrative provision to reflect the fact that it is usually only known at the time of the Chancellor’s Budget speech whether statutory indexation will apply. This leaves insufficient time before the start of the tax year for employers to update their payroll systems. This rule gives employers until the first pay-day after 17 May to make the necessary changes.
75.Subsection (5) obliges the Treasury to specify the indexed amounts in a statutory instrument which must be made in the tax year before the tax year to which they are to apply.
Chapter 3: Calculation of income tax liability
76.This Chapter deals with the calculation of a person’s income tax liability for a tax year.
77.The calculation sets out how the rules about the rates at which income is charged, and provisions about reliefs, allowances, tax reductions etc, are applied to the components of a person’s total income to arrive at the person’s income tax liability.
78.The calculation does not deal with amounts of tax suffered (eg under PAYE or by way of deduction of tax at source) as these are set off against a person’s liability rather than deducted in arriving at it. See section 59B(1) of TMA.
79.Nor does it deal with relief given by discharge or repayment, as here too the relief can operate only once the amount of a person’s liability has been determined. Examples of such reliefs include paragraph 6 of Schedule 14 to ICTA (life insurance relief for non-residents) and section 416 of CAA (mineral extraction allowance - expenditure on restoration within 3 years of ceasing to trade).
Section 22: Overview of Chapter
80.This section provides an overview of the Chapter. It is new.
81.The persons liable to income tax include individuals, trustees, personal representatives, non-UK resident companies, and companies acting in a fiduciary or representative capacity.
82.But where non-UK resident companies carry on a trade in the United Kingdom through a permanent establishment, they are liable to corporation tax instead of income tax on their chargeable profits. See the commentary on section 5.
Section 23: The calculation of income tax liability
83.This section sets out the steps to be taken in calculating a taxpayer’s liability to income tax for a tax year. It is based on many provisions in the source legislation, in particular section 835 of ICTA.
84.Step 1 brings together all the amounts of income on which a taxpayer is charged to income tax for the tax year. The sum of these amounts is called “total income”, and each of the amounts is a “component” of total income.
85.In the source legislation there were some contexts in which “total income” was used in a different sense (eg in section 1 of ICTA, where it meant what is defined in Step 2 as “net income”). But in this Act it is used consistently to denote this first stage result. And the consequential amendments to other legislation in Schedule 1 ensure that it will always be used in this sense elsewhere.
86.Step 2 deals with those reliefs (other than personal allowances) which are given by deduction from income.
87.Most of the reliefs listed in section 24 may be deducted from any type of income. But some may only be deducted from certain components of total income. See section 25(3).
88.Step 2, combined with the provisions about the reliefs themselves and the rules in section 25 about the way in which deductions are made, ensures that the reliefs are allowed in the proper way to arrive at “net income”.
89.It is important that this is done by reference to the components of total income, to pave the way for Step 4.
90.Step 3 deals with the deduction of the personal allowance and blind person’s allowance from the components of net income. This step only affects individuals. The rule that these deductions come last is based on section 835(5) of ICTA.
91.Again, it is important that this is done by reference to the components of total income, to pave the way for Step 4.
92.Step 4 applies the rates of tax specified in Chapter 2 (and, where the taxpayer is a trustee, the relevant Chapters of Part 9 of this Act) to the amounts of the components remaining after Step 3.
93.Step 5 adds together the amounts of tax on each component.
94.Step 6 then deducts any tax reductions. These are listed in section 26. Further rules about how these tax reductions are made are in sections 27 to 29.
95.Step 7 then adds on certain other amounts of income tax for which a taxpayer may be liable, as listed in section 30.
Section 24: Reliefs deductible at Step 2
96.This section lists all the reliefs that may be deducted from components of total income at Step 2 of the calculation. It is based on many provisions in the source legislation.
97.The section is arranged to highlight those reliefs which apply only to individuals, and to avoid duplication of references to particular reliefs.
98.This section, and others in the Chapter, contains lists of provisions some of which are in this Act and some which are elsewhere. Such lists are arranged by reference to the order that the provisions appear in this Act and by reference to the date on which other legislation was enacted.
99.The entries in the lists are not each given their own sub-paragraph reference. This will reduce the scope for confusion should any amendments need to be made to the lists in future Finance Acts.
100.One of the reliefs deducted at this step is for annual payments and patent royalties under Chapter 4 of Part 8. See Change 81 in Annex 1 and the overview commentary on Chapter 4 of Part 8.
101.The opportunity has been taken to clarify the way in which reliefs under sections 446 and 454 of ITTOIA work. See the amendments made to those sections in Schedule 1.
102.The list of reliefs does not include section 811 of ICTA. That section allows a reduction of a component of income for foreign tax suffered on that income where no credit is available. It has been excluded on the basis that the relief reduces the amount of income from the source (and where appropriate can create or augment a trading loss) before it enters into the calculation in section 23.
103.For the same reason, the list does not include relief under section 798C of ICTA which was introduced by FA 2005.
104.For the rules about what (if anything) may be done with any excess relief over the amount of income from which it can be deducted it is necessary to refer to the particular provisions dealing with the relief concerned. But see also the provisions of section 25.
Section 25: Reliefs and allowances deductible at Steps 2 and 3: supplementary
105.This section contains rules about the way deductions are made against components of income. It is based on section 835(3), (4) and (5) of ICTA.
106.The main rule, in subsection (2) is that deductions are allowed in the way that results in the greatest reduction of income tax liability.
107.This rule means that where a deduction may be set against more than one component of income or there are two or more deductions available, they are allowed in the way that produces the least income tax liability. The order in which deductions that are allowable against a particular component of income are made under Step 2 cannot affect the liability for the tax year concerned. If there is sufficient income then all deductions are allowed in full. If there is insufficient income then unrelieved income is nil. But the order in which they are made can affect the amount of relief that is available to carry forward or back (in the case of reliefs where that is a possibility).
108.Subsection (3) is a signpost to provisions that modify the rule in subsection (2), in particular in the case of reliefs given only against certain types of income.
109.Subsections (4) and (5) ensure that a deduction is only given to the extent that there is income to absorb the deduction, taking into account deductions already made.
110.Some, but not all, of the source provisions contain the rule that income cannot be reduced below nil, but even where not explicitly mentioned, it has always been the accepted practice that a deduction can only be made from income to the extent that there is income to absorb the deduction. The position is now explicit for all income deductions.
111.A similar point arises in connection with deductions that operate as tax reductions. See the commentary on section 29.
Section 26: Tax reductions
112.This section lists the tax reductions that are allowed in terms of tax at Step 6 of the calculation in section 23. It is based on many provisions in the source legislation.
113.The approach adopted to the layout of this section is in line with that adopted in relation to section 24.
114.One of the tax reductions is for relief under section 539 of ITTOIA. See Change 3 in Annex 1.
Section 27: Order of deducting tax reductions: individuals
115.This section provides rules about the order in which tax reductions are to be given for individuals. It is based on many provisions in the source legislation.
116.In the source legislation, many of the provisions dealing with tax reductions contain rules which specify how that reduction interacts with other tax reductions. These rules, so far as they relate to individuals, are brought together in subsections (4) to (6).
117.But those rules are not comprehensive. As well as bringing the existing rules together into one place, the section introduces a new rule in subsections (2) and (3) providing that, subject to the following subsections, the reductions are allowed in the way that gives the greatest reduction in liability for the year. See Change 4 in Annex 1.
118.Subsections (4) and (5) list those provisions where rules setting out some priority are contained in the source legislation. Subject to the point mentioned in the next paragraph, the provisions are listed in the order in which the source rules require the reliefs to be allowed. If any other reduction (except double taxation relief) is due then it may be allowed at whatever stage (before or after any of the provisions in subsection (5)) gives the maximum reduction.
119.It is clear from section 256 of ICTA that reductions under Chapter 1 of Part 7 of ICTA are given after all other reductions (except double taxation relief), but no order of priority between the two reductions within that Chapter is given. Since the reduction for married couples and civil partners is transferable whereas the reduction under section 273 of ICTA is not, it will always be beneficial if any reduction under section 273 of ICTA comes first. Subsection (5) reflects this. See Change 4 in Annex 1.
Section 28: Order of deducting tax reductions: other persons
120.This section provides rules about the order in which tax reductions are to be given for persons other than individuals. It is based on sections 790(3) and 796(1) of ICTA and sections 26 and 27(1) of FA 2005.
121.There are fewer tax reductions available than for individuals, so the rules are less complex. Subsection (2) corresponds to section 27(2) in providing a new rule that the reductions are allowed in the way that gives the greatest reduction in liability. See Change 4 in Annex 1 and the commentary on section 27.
122.Subsection (5) is a special rule concerning the tax reduction given to certain trustees under section 26 of FA 2005.
Section 29: Tax reductions: supplementary
123.This section contains additional rules about the giving of tax reductions. It is based on a number of provisions in the source legislation.
124.Subsections (2) and (3) ensure that a reduction is only given to the extent that there is tax to absorb the reduction, taking into account reductions already made. Many of the source provisions contain the rule that the tax cannot be reduced below nil (see for example section 256(2) of ICTA). And top-slicing relief under section 535 of ITTOIA cannot give a greater tax reduction than the tax increase resulting from including the gain concerned within total income. The position is now explicit for all tax reductions. See the commentary on section 25.
125.Subsection (4) ensures that the rules in this section limiting the amount of a tax reduction by reference to the amount of tax against which it is set will not affect the calculation under section 796 of ICTA of the limit on income tax credit relief for double taxation. It also ensures that those rules will not affect the operation of any other provisions limiting the amount of a tax reduction.
126.Subsection (5) ensures that any reference in this Chapter to double taxation relief under section 788 of ICTA brings in relief allowed in accordance with arrangements made under that section.
Section 30: Additional tax
127.This section lists provisions under which amounts of tax are added to the tax liability at Step 7 of the calculation. It is based on a number of provisions in the source legislation.
Section 31: Total income: supplementary
128.This section provides supplementary rules, in particular about the tax year in which income received under deduction of tax or with a tax credit is to be taken into account. It is based on section 835(6) and (7) of ICTA.
Section 32: Liability not dealt with in the calculation
129.This section lists income tax liabilities not dealt with in the calculation. It is new.
130.These liabilities arise in connection with:
the recovery of excessive relief (eg the withdrawal or reduction of EIS relief or the recovery of excess credit for overseas tax) where the taxpayer’s self-assessment for the tax year is final;
deduction of tax at source (eg Chapters 15 to 17 of Part 15 and the reverse charge provisions), where the liability is not in respect of the person’s own liability; and
stand-alone charges (eg Chapter 1 of Part 13, or in relation to the administration of pension schemes).