House of Commons - Explanatory Note
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Session 2002 - 03
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Income Tax (Earnings And Pensions) Bill




1.     These explanatory notes relate to the Income Tax (Earnings and Pensions) Bill. They have been prepared by the Tax Law Rewrite project at the Inland Revenue in order to assist readers of the Bill and to help inform debate on it. They do not form part of the Bill.

2.     The notes need to be read in conjunction with the Bill. They are not, and are not meant to be, a comprehensive description of its contents. So if a clause or part of a clause does not seem to require explanation or comment, none is given.


3.     The main purpose of the Income Tax (Earnings and Pensions) Bill is to rewrite tax legislation relating to income from employment, pensions and social security so as to make it clearer and easier to use.

4.     The Bill also makes some minor changes to the legislation. These are within the remit given to the Tax Law Rewrite project and the Parliamentary process for the Bill.


The Tax Law Rewrite Project

5.     In December 1995 the Inland Revenue presented a report to Parliament on the scope for simplifying the UK tax system (The Path to Tax Simplification). The main recommendation was that UK direct tax legislation should be rewritten in clearer, simpler language.

6.     This recommendation was warmly welcomed, both in Parliament and in the tax community. After further work on important practical issues and a period of preliminary consultation, the then Chancellor of the Exchequer (the Rt Hon Kenneth Clarke MP, QC) announced in his November 1996 Budget statement that the Inland Revenue would propose detailed arrangements for a major project to rewrite direct tax legislation in plainer language.

7.     The project team was given the task of rewriting almost all of the United Kingdom's existing primary direct tax legislation. The aim is that the rewritten tax law should use simpler language and structure than legislation that it replaces. The members of the project are from different backgrounds, including Inland Revenue employees, private sector tax professionals and parliamentary counsel including (as head of the drafting team) a senior member of the Office of the Parliamentary Counsel.

Steering Committee

8.     The work of the project is overseen by a Steering Committee, chaired by Lord Howe of Aberavon CH, QC. The membership of the Steering Committee as at December 2002 is:

         Rt Hon the Lord Howe of Aberavon CH, QC (Chairman)

         Ian Barlow

         Adam Broke

         David Hartnet

         The Rt Hon Michael Jack MP

         Dr John Avery Jones CBE

         Rachel Karp

         Professor Frank Kidd

         James Plaskitt MP

         The Rt Hon Lord Mustill

         David Swaine

Consultative Committee

9.     The work is also reviewed by a Consultative Committee, representing the accountancy and legal professions and the interests of taxpayers. Its members as at December 2002 were:

- Peter Michael CBEChairman
- Graham Aaronson QCRevenue Bar Association
- Derek BrownleeInstitute of Directors
- Adam BrokeSpecial Committee of Tax Consultative Bodies
- Colin CampbellConfederation of British Industry
- Russell ChaplinLondon Chamber of Commerce
- Malcolm Gammie The Law Society of England and Wales
- Terry HopesInstitute of Chartered Accountants in England and Wales
- Isobel d'InvernoLaw Society of Scotland
- Elizabeth LathwoodChartered Institute of Taxation
- Simon McKieInstitute of Chartered Accountants in England and Wales
- Cunnie RankinInstitute of Chartered Accountants of Scotland
- Mavis SargentAssociation of Chartered Certified Accountants
- Simon SweetmanFederation of Small Businesses
- Wreford Voge Chartered Institute of Taxation
- Professor David WilliamsOffice of the Social Security Commissioners
- Mervyn WoodsConfederation of British Industry


10.     The work produced by the project has also been subject to public consultation. This has allowed all interested parties an opportunity to comment on draft clauses. This consultation has taken the form of a series of Exposure Drafts which publish clauses in draft. The relevant ones for this Bill are numbers 6, 11 and 12. They were published in May 1999, January 2001 and December 2001 respectively. A draft Bill was published for further consultation in July 2002. Those who responded to one or more of those documents include:

         Cardiff Law School, Cardiff University

         Chartered Institute of Taxation

         City of London Law Society

         Confederation of British Industry

         Construction Industry Joint Taxation Committee

         Deloitte & Touche

         Ernst & Young

         Global Employment Solutions

         Holborn Law Society


         Institute of Chartered Accountants in England and Wales

         Institute of Chartered Accountants of Scotland

         Institute of Directors

         Institute of Payroll and Pensions Management

         John Jeffrey-Cook


         Law Society of England and Wales

         London Society of Chartered Accountants

         London Tax Study Group

         Low Incomes Tax Reform Group

         Mayer Brown Rowe and Maw

         Share Scheme Lawyers Group

         Special Committee of Tax Law Consultative Bodies

Note: this table excludes those who asked that their responses be treated in confidence.

A brief history of the taxation of employment income

11.     Income tax was introduced in 1799; Schedules A to E first appeared in 1803; and the income tax legislation of the Napoleonic period was given its final shape in an Act of 1806. That Act was also drafted in terms of the five Schedules A to E. Schedule E related to every public office or employment of profit; and the general rule was that income tax was to be "detained and stopped" at the public office. The Napoleonic wars ended in 1815, and income tax was then abolished.

12.     Income tax was reintroduced in 1842, in an Act agreed to have been modelled on the 1806 Act, and the five Schedules accordingly reappeared. Income tax has been in continuous existence ever since.

13.     Some provisions in the income tax legislation relating to Schedule E, therefore, now have a considerable history. One of these is the central provision concerning the deductibility of expenditure, with its requirement that the expenditure should be expended "wholly, exclusively and necessarily" in the performance of the duties of the employment (see clause 336 in Part 5 of this Bill). For well over a century this provision also included a reference to keeping and maintaining a horse in order to enable the employee to perform the duties of the employment; and only in 1998 was this reference removed.

14.     In the years following 1842 the charge to income tax under Schedule E applied only if the office or employment held or exercised was of a public nature. If it was not, income tax was charged under Schedule D (the residual Schedule). There were fewer public offices than some had thought: in Great Western Railway Co - v - Bater (1922) 8 TC 231, [1922] 2 AC 1, the House of Lords, undoing the accepted practice of decades, placed a railway clerk in Schedule D and not in Schedule E. But the charge to income tax under Schedule E was widened by section 18 of FA 1922, which provided that profits or gains arising from employments chargeable under Schedule D, "other than the profits or gains chargeable under Case V of Schedule D", should be transferred to Schedule E. The profits or gains from some employments accordingly continued to be chargeable under Schedule D Case V; but that possibility disappeared when section 10 of FA 1956 provided that all income from employments was to be chargeable under Schedule E, and divided Schedule E into three Cases.

15.     The twentieth century saw major increases in the revenue obtained from income tax, in the rates of that tax, and in the importance of income tax to central finance. It became a matter of major operational importance, therefore, (and not least during the Second World War) that employees should account for income tax on their earnings. The result was the Pay As You Earn (PAYE) system. The developments leading to the introduction of that system are discussed in greater detail in the introductory explanatory notes for Part 11 of this Bill; and that Part deals with the primary legislation relating to the PAYE system.

16.     Since the Second World War both earnings and income tax rates have been very high by historical standards; and national insurance contributions may well make further demands on both employer and employee.

17.     Against this background, it might well be worthwhile for employers and employees to try to arrange for payments and benefits to be received in a way that minimises income tax - and for the Revenue to contest those arrangements. There are, accordingly, numerous cases in which the Revenue has alleged, and the taxpayer has denied, that the receipt of a particular advantage was within the ambit of the Income Tax Acts. Hochstrasser - v - Mayes (1959) 38 TC 673, [1960] AC 376 is one example that may represent others. And against this same background it was also to be expected that the legislation relating to income tax charged under Schedule E would become more extensive and more complicated.

18.     One legislative consequence related to the subject described in Part 3 of this Bill as "the benefits code" - and dealt with in that Part. Legislation on this subject featured in FA 1948, and has been extended in other Finance Acts since - not least in FA 1976.

19.     A second legislative consequence was that the charge to income tax under Schedule E was extended to receipts with characteristics specified in the legislation in question. The first, and very important, example was the legislation relating to payments and benefits received on the termination of an employment, originally enacted in FA 1960. In this Bill these provisions may be found in Part 6. The provisions of that Part do not deal with earnings from an employment, charged to income tax under Schedule E by virtue of paragraph 1 of section 19(1) of ICTA 1988, but with other payments and benefits specifically charged to income tax under Schedule E by virtue of paragraph 5 of section 19(1). In this Bill this income is referred to as "specific employment income", and it is distinguished, very carefully, from "general earnings" (see clause 6(1) of this Bill).

20.     A third legislative consequence concerned share-related income, dealt with in Part 7 of this Bill. Companies might well wish to reward employees by allowing them to acquire shares on advantageous terms - including arrangements designed to minimise income tax. The income tax legislation on this matter accordingly consists in part of legislation designed to counteract schemes that have been in existence at various times, and in part of legislation designed to promote share schemes with meritorious characteristics. These matters are discussed in greater detail in the introductory Explanatory Notes for Part 7 of this Bill. That Part is extensive. It occupies 138 clauses and four Schedules with a total of 245 paragraphs (and there is further material in Schedule 6 dealing with consequential amendments). Some of this material is very recent: of the provisions just mentioned 43 of the clauses and 159 of the paragraphs in the Schedules derive from legislation on topics first dealt with in FA 2000.

Employment income, pensions and social security

21.     As mentioned above, employment income is taxed under Schedule E in ICTA. During the course of the work leading up to the production of this Bill, it became apparent that it would be more sensible to rewrite the whole of Schedule E, rather than just picking out those parts relevant to employment income.

22.     The grouping of employment income, pensions and social security income represents income within Schedule E as set out in section 19 of ICTA. Rewriting the charging provisions for these categories of income makes possible a repeal of Schedule E as a whole.

23.     In order to have all the charging provisions relating to pensions in one place, Part 10 of the Bill also includes some pensions within Schedule D as set out in section 18 of ICTA.


24.     The Bill has 725 clauses and eight Schedules.

25.     The clauses are arranged as follows:

    Part 1 (Overview) sets out what is covered in the Bill and where to find abbreviations and definitions.

    Part 2 (Employment income: charge to tax) introduces the concept of "the employment income Parts" to cover Parts 2 to 7 and sets out the charging provisions for employment income.

    Part 3 (Employment income: earnings and benefits etc. treated as earnings) deals with the general earnings element of employment income, setting out what kinds of income and benefits should be brought into account.

    Part 4 (Employment income: exemptions) gives details of a number of exemptions from various kinds of income that would otherwise be chargeable to tax under the employment income Parts.

    Part 5 (Employment income: deductions allowed from earnings) sets out various deductions that may be allowed from earnings in computing taxable earnings.

    Part 6 (Employment income: income which is not earnings or share-related) covers payments to and benefits from non-approved pension schemes and payments and benefits on termination of employment etc.

    Part 7 (Employment income: share related income and exemptions) contains provisions about share-related remuneration and the various share option schemes and incentive plans.

    Part 8 (Former employees: deductions for liabilities) sets out that certain deductions may be made from a former employee's total income.

    Part 9 (Pension income) contains the charging provisions for pension income, including any exemptions from those charging provisions.

    Part 10 (Social security income) contains the charging provisions for taxable social security benefits including any exemptions from those charging provisions.

    Part 11 (Pay As You Earn) sets out the framework for the operation of PAYE and provides for the making of PAYE regulations.

    Part 12 (Payroll giving) sets out the rules for the payroll deduction scheme for charitable donations.

    Part 13 (Supplementary provisions) contains provisions that have effect across the other Parts of the Bill.

26.     The Schedules are:

    Schedule 1: Abbreviations and defined expressions

    Schedule 2: Approved share incentive plans

    Schedule 3: Approved SAYE option schemes

    Schedule 4: Approved CSOP option schemes

    Schedule 5: Enterprise management incentives

    Schedule 6: Consequential amendments

    Schedule 7: Transitionals and savings

    Schedule 8: Repeals and revocations


27.     At the end of the commentary there is more detailed supporting material in three annexes.

28.     Annex 1 contains details of the minor changes in the law made by the Bill.

29.     Annex 2 gives notes on technical points of interpretation of the clauses. These notes concentrate on points where it may not be immediately apparent that the Bill preserves the effect of the existing law.

30.     Annex 3 contains a table of destinations for the Extra-Statutory Concessions to which this Bill would give statutory effect.



31.     The commentary uses a number of abbreviations. They are listed below.

APSapproved profit sharing
CAA 2001the Capital Allowances Act 2001
CSOPcompany share option plan
CTSACorporation Tax Self Assessment
EMIsenterprise management incentives
ESCextra-statutory concession
FA 1971Finance Act 1971 (and similarly FA 1985 and so on)
F(No.2)AFinance (No. 2) Act
ICTAthe Income and Corporation Taxes Act 1988
ICTA 1970the Income and Corporation Taxes Act 1970
ITA 1918the Income Tax Act 1918 (and similarly ITA 1945)
PAYEPay As You Earn
PSAPAYE settlement agreement
SAYESave As You Earn
SE manualthe Inland Revenue's Schedule E manual - references to paragraphs in the manual take the form SE 12345
SI 1993 No 744the Income Tax (Employments) Regulations 1993 ("the PAYE regulations")
SIPsshare incentive plans
TCGA 1992the Taxation of Chargeable Gains Act 1992
TMA 1970the Taxes Management Act 1970
VATvalue added tax

32.     There is a list of abbreviations used in the Bill at the start of Schedule 1 to the Bill.

Part 1: Overview

Clause 1: Overview of contents of this Act

33.     This clause summarises the charges to tax and other matters covered in the Bill. It also provides, in subsection (2), the link to the general charge to income tax in section 1(1) of ICTA. It is new.

Clause 2: Abbreviations and defined expressions

34.     This is another new clause. It provides information on where to find lists of the various abbreviations and defined expressions used in the Bill.

Part 2: Employment income: charge to tax

Chapter 1: Introduction

Clause 3: Structure of employment income Parts

35.     This clause sets out what is in Parts 2 to 7 of the Bill and provides "the employment income Parts" as a collective label for them. It is new.

Clause 4: "Employment" for the purposes of the employment income Parts

36.     This clause is new. It casts some light on what is meant by "employment". It is not an attempt to delineate the boundary between employment and self-employment. That boundary depends on fact and the degree to which a number of indicators exist. This clause is simply intended to confirm that employments that are clearly nowhere near that boundary are squarely within this Bill, by providing a non-exhaustive definition.

37.     This change of approach is explained in detail in Note 1 in Annex 2.

Clause 5: Application to offices and office-holders

38.     This clause sets out that the employment income Parts apply to offices and office holders in the same way as they apply to employments and employees.

39.     Subsection (3) provides a non-exhaustive definition of the term "office". It is based on guidelines derived from case law. This change in approach is explained in detail in Note 1 in Annex 2.

Chapter 2: Tax on employment income

Clause 6: Nature of charge to tax on employment income

40.     This clause provides in subsection (1) that the charge to tax on employment income under Part 2 is split into a charge to tax on "general earnings" and "specific employment income". The labels "employment income", "general earnings" and "specific employment income" are new, and are explained in clause 7.

41.     Subsection (2) provides a signpost to clause 9 which sets out how to work out the amount of general earnings or specific employment income is charged to tax in a particular tax year.

42.     Subsection (3) is a pointer to Chapters 4 and 5 which derive from the Cases of Schedule E. Those Chapters set out the rules relating to residence, domicile etc that apply to general earnings. Those Chapters have no application to "specific employment income".

43.     Subsection (4) provides a signpost to clause 13 which in turn makes clear who is liable for tax under this Part.

44.     Subsections (1) to (4) are new, although subsection (1) derives in part from paragraphs 1 and 5 of section 19(1) of ICTA.

45.     Subsection (5) provides the one exception to the basic rule that employment income is charged to tax on income from employments. This Bill replaces all charges to tax under Schedule E, but there is one category of income from employment that is not charged to tax under Schedule E. The employment duties of specified types of divers and diving supervisors are treated as if they constitute a trade and are charged to tax under Schedule D. Subsection (5) of this clause reflects the effect of section 314(1) of ICTA in removing the income from employment of those divers and diving instructors from the scope of Schedule E.

Clause 7: Meaning of "employment income", "general earnings" and "specific employment income"

46.     This clause sets out the definitions of these terms introduced in the preceding clause. It is new. See Notes 2 and 3 in Annex 2.

47.     Those Notes explain in full why it is necessary to distinguish between the two elements to the employment income charged in this Part. The first element is "general earnings", which relate to "emoluments" brought into charge by paragraph 1 of section 19(1) of ICTA. The basis of assessment for "general earnings" depends on the residence, ordinary residence and domicile status of the employee. The second element, "specific income", relates to the free-standing charges under Schedule E, chargeable under paragraph 5 of section 19(1) of ICTA. The basis of assessment for "specific employment income" is blind to issues of residence, ordinary residence and domicile.

Clause 8: Meaning of "exempt income"

48.     This clause provides the definition of exempt income for the purposes of the employment income Parts. It is new.

Chapter 3: Operation of tax charge

Clause 9: Amount of employment income charged to tax

49.     This is a new clause that explains what amounts are charged to tax for each stream of employment income. Subsection (2) sets out that for earnings, the amount charged to tax is "net taxable earnings" - this is another new label. It describes the amount of income from the employment that has been allocated to a particular tax year by reference to the timing rules as determined by the Cases of Schedule E in section 19(1) of ICTA (now contained in Chapters 4 and 5 of this Part), less any available deductions.

50.     Subsection (3) explains where to find the mechanics of how to calculate net taxable earnings in the following provisions of Part 2.

51.     Subsection (4) sets out that, for specific employment income, the amount charged to tax is "net taxable specific income" - this is another new label. It is the amount allocated to that year by the relevant provisions less any available deductions.

52.     Subsection (5) explains where to find the mechanics of how to calculate net taxable specific income in the following provisions of this Chapter.

53.     Subsection (6) makes it clear that tax may only charged under this Chapter for a particular year on taxable earnings and taxable specific income. Paragraph (a) derives from the closing words of paragraph 1 of section 19(1) of ICTA. Paragraph (b) is new.

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Prepared: 5 December 2002