Part 5: Employment income: deductions allowed from earnings

Background

1377.     This Part provides for deductions allowed from earnings.

1378.     The charge to tax on employment income is a charge to tax on income of two types: "general earnings" and "specific employment income" (see clause 6(1)); and, in the case of "general earnings", (a term defined in clause 7(3)), the amount charged to income tax is the "net taxable earnings" from the employment in the tax year (see clause 9(2)). Clause 11 then provides that the net taxable earnings from an employment in a tax year consist of the total amount of the taxable earnings from the employment less the total amount of any deductions allowed from those earnings (as listed in clause 327(3) to (5)). It is with that final component of "net taxable earnings" that this Part of this Bill is concerned.

1379.     In ICTA, the deductions provisions are very difficult to unravel. Some individual provisions are straightforward. But there are many connections between provisions. They interact in ways which are not always easy to follow. Several fictions have been adopted to make the provisions work.

1380.     One major source of complexity is that the expenses of an employee may be met in several possible ways, taxed under different sections of ICTA. The mechanism for making a deduction may vary according to the circumstances.

1381.     For example, consider the position of a director making a train journey to attend a meeting. The table below shows some of the various ways in which the employer might fund the trip, how the director would be taxed and how the director might obtain a deduction in respect of the expenses of the train ticket. (References to sections are to sections of ICTA.).

1382.     There are numerous other possibilities.

1383.     Another major source of complexity is that the central provision relating to deductions, section 198 of ICTA, is used by other provisions of ICTA and is used in different ways. For example:

• under section 156(8) of ICTA, the cost of a benefit provided is allowed as a deduction under section 198, or other provisions, if it would be allowed as a deduction if paid out of emoluments;

• under section 193(3) of ICTA, certain travel expenses are treated as having been necessarily incurred in the performance of the duties of an overseas employment for the purposes of section 198(1);

• under section 193(7) of ICTA, references to section 198, and to deductions under section 198, are treated as including references to section 193(3), and to deductions under that subsection; and

• under section 200A(1) of ICTA, incidental overnight expenses are not regarded as emoluments if they would not be deductible under section 198.

1384.     In this Bill the number of provisions that cross-refer to other deductions provisions has been much reduced. The view has been taken that it is more helpful, in the case of each deduction provision, to set out in full the conditions that must be met. In setting out those conditions, Inland Revenue practice has been followed. As a result of this approach, this Bill does not directly rewrite sections 194(1) and 195(11) of ICTA, which provide for provisions to be construed with other provisions.

Overview

1385.     In this Part, in order to make each individual deduction provision as simple as possible, Chapter 1 states some general propositions about deductions. This saves them having to be repeated in the individual provisions, so the deductions clauses can then concentrate on the rules applying for the particular deduction in question.

1386.     The provisions relating to deductions are then grouped in different chapters according to the type of deduction. So there are separate chapters for:

• deductions for employee's expenses (Chapter 2);

• deductions from benefit code earnings for costs which would have been deductible if they had been paid by the employee (Chapter 3);

• deductions for employee's expenses covered by fixed allowances (Chapter 4);

• deductions for earnings which represent expenses borne by the employer (Chapter 5); and

• deductions from seafarers' earnings (Chapter 6).

1387.     Within Chapter 2 and 5, the provisions are then grouped according to the type of expense involved. For example, in Chapter 2, clauses 337 to 342 deal with travel expenses.

1388.     Within this Part, very many of the clauses that allow deductions are drafted in accordance with the general formula that a deduction from earnings is allowed for an amount whose characteristics are then specified.

Chapter 1: Deductions allowed from earnings: general rules

Overview

1389.     This is the first of six chapters dealing with deductions allowed in charging earnings to income tax.

1390.     After the introductory clause 327, this Chapter sets out some general propositions which are applicable to most of the deductions dealt with in the next five chapters. Those propositions relate to:

• the income from which deductions may be made (clause 328);

• the general prohibition on deductions exceeding earnings (clause 329);

• the prevention of double deductions (clause 330); and

• the order in which deductions are to be made (clause 331).

1391.     This Chapter concludes with clause 332, which lists "the deductibility provisions".

Introduction

Clause 327: Deductions from earnings: general

1392.     This clause sets the scene. It gives information about the contents of this Part, and places this Part within a wider context.

1393.     The clause is new, although it draws on material contained in section 131(1) of ICTA.

1394.     Subsection (1) provides the essential link between this Part of this Bill and clause 11(1), which is in Part 2. The subsection states that this Part provides for deductions that are allowed from the taxable earnings from an employment in a tax year for the purpose of calculating the "net taxable earnings" from the employment in the tax year for the purposes of Part 2 of this Bill.

1395.     Subsection (2) sets out how two key expressions are used in this Part. References to the earnings from which deductions are allowed are references to the taxable earnings mentioned in subsection (1), and references to the tax year are references to the tax year mentioned there.

1396.     Subsection (3) states that the deductions for which this Part provides are those allowed under Chapters 2 to 6; and the contents of those Chapters are indicated.

1397.     Subsection (4) lists other provisions, not in this Part, which make further provisions about deductions; and subsection (5) lists other provisions, not in this Part, which make further provision about deductions from income including employment income.

General rules

Clause 328: The income from which deductions may be made

1398.     This clause is the first of four which sets out a general proposition relating to deductions from earnings. It deals with the income from which deductions may be made.

1399.     The most important single source for this clause is section 198(1) of ICTA, which includes the proposition that an amount paid "out of the emoluments of the office or employment .. may be deducted from the emoluments to be assessed". This clause also draws on a considerable number of other passages in Part 5 of ICTA and in section 50 of FA 1989.

1400.     Subsection (1) sets out the general rule that deductions under this Part are allowed from any earnings from the employment in question, but not from earnings from any other employment.

1401.     An example of how this rule operates in practice is given in Inland Revenue guidance in SE 31658:

"An individual is employed as a teacher and separately employed as coach to a local youth football team. As coach she is paid £100 a year but she incurs expenses of £1,000 a year in travelling to away matches. She pays the expenses herself and is not reimbursed by her employer.

She is only allowed a deduction of £100 for her travelling expenses under section 198(1) of ICTA. She cannot claim a loss for the remaining £900 and nor can she deduct that amount from her teaching income."

1402.     The general rule is subject to a number of qualifications. These are dealt with in the rest of this clause.

1403.     Subsection (2) deals with one case where the general rule is not wide enough. Expenses of a minister of religion (see clause 351) are allowed from earnings from any employment as a minister of a religious denomination.

1404.     Subsections (3) to (5) deal with cases where the general rule is too wide: for example there are some cases where the deductions are allowed only from earnings with particular characteristics - either relating to the source of the earnings or to the manner in which the earnings are charged to tax.

1405.     Subsection (3) provides that deductions under section 368 are only allowed from earnings payable out of the public revenue.

1406.     Subsections (4) and (5) deal with "deductions limited to specified earnings": for, in the cases of some provisions, deductions are allowed from earnings from the employment which qualify as taxable earnings under certain of the charging provisions of Chapters 4 and 5 of Part 2, but not from other earnings from the employment.

Clause 329: Deductions from earnings not to exceed earnings

1407.     This clause is the second of four which sets out a general proposition relating to deductions from earnings. It deals with the proposition that deductions from earnings may not exceed earnings.

1408.     As in the case of clause 328 the most important single source for this clause is section 198(1) of ICTA, which allows a deduction for an amount if "the holder of an office or employment is obliged to incur and defray [that amount] out of the emoluments of the office or employment". This clause also draws on a considerable number of other passages in Part 5 of ICTA and in section 50 FA 1989.

1409.     Subsection (1) sets out the general rule that deductions may not exceed the earnings from which they are deductible. That general rule is then elaborated in subsections (2) to (4).

1410.     Inland Revenue guidance makes it clear that the employee does not generally have to demonstrate that an expense has literally been paid out of the emoluments rather than out of some other source of money. It is generally sufficient that the emoluments charged to tax in a particular tax year are equal to, or greater than, the deductions to be made from those emoluments. As the Inland Revenue does not generally trace the source of funds used by the employee to pay expenses, the requirement that the employee must pay the expenses out of the emoluments of the employment is not stated in general terms in this Bill. See Change 81 in Annex 1.

1411.     Subsection (5) deals with a matter which follows on from the fact that this Bill does not reproduce any general requirement that expenses must be paid out of the emoluments of the employment. This Bill rewrites numerous provisions that refer to expenses that would be allowable if the employee paid them out of the emoluments of the employment. Those provisions ("the deductibility provisions") are listed in clause 332. Since the general requirement in subsection (1) that deductions from earnings are not to exceed earnings is assumed to be met in the deductibility provisions (because of the references in them to the employee being assumed to have paid the amounts or expenses out of emoluments), this subsection provides that this clause is to be disregarded for the purposes of the deductibility provisions.

1412.     Subsection (6) provides a signpost to section 380 of ICTA, a section drafted on the basis that there may be Schedule E losses which may be set against other income of the tax year, or carried back to earlier tax years.

Clause 330: Prevention of double deductions

1413.     This clause is the third of four which sets out a general proposition relating to deductions from earnings. It deals with the prevention of double deductions.

1414.     The proposition in this clause is not articulated in general terms in ICTA, although it seems true as a matter of income tax law. There are statements of this proposition in particular contexts in sections 194(9), 195(12) and 198(3) of ICTA.

1415.     Subsection (1) sets out the general rule: a deduction from earnings under this Part is not allowed more than once in respect of the same costs or expenses.

1416.     Subsection (1) is expressed to apply to "costs and expenses". These words are intended to cover all potential deductions under this Part, even though the amount of the deduction may not be computed by reference to an actual amount of expenditure - as is the case under Chapter 4 of this Part, which deals with fixed allowances for employee's expenses.

1417.     Subsection (2) deals with the case where a cost or expense qualifies both for an allowance under Chapter 4 of this Part and for a deduction under some other provision. In such a case only one of the deductions is allowed. This provision codifies Inland Revenue practice on these topics. See Change 82 in Annex 1

Clause 331: Order for making deductions

1418.     This clause is the last of four which sets out a general proposition relating to deductions from earnings. It deals with the order in which deductions may be made.

1419.     Subsection (1) sets out the general rule that section 835 of ICTA, which provides for deductions to be allowed in the order which results in the greatest reduction of liability to income tax, applies in the present context.

1420.     Subsection (2) qualifies the general rule. The subsection specifies two provisions which impose a requirement to consider deduction provisions in a particular order.

Clause 332: Meaning of "the deductibility provisions"

1421.     This Bill rewrites numerous provisions that refer to amounts or expenses whose deduction would be allowed if the employee incurred and paid them out of the emoluments of the employment (or in some cases just incurred or just paid them). See Change 81 in Annex 1.

1422.     The provisions of the Bill that rewrite these provisions are listed in this clause, where they are defined as "the deductibility provisions". There are a number of reasons why it is convenient to group these provisions.

1423.     The requirement that amounts or expenses be incurred and paid out of emoluments of the employment is not, in general, being rewritten: so the deductibility provisions do not rewrite the words "out of the emoluments". Instead, they refer to amounts or expenses that would be allowed as a deduction if the employee had incurred and paid them.

1424.     Since the general requirement in clause 329(1) that deductions from earnings are not to exceed earnings is assumed to be met in the deductibility provisions (because of the references in them to the employee being assumed to have paid the amounts or expenses out of emoluments), clause 329(5) provides that clause 329 is to be disregarded for the purposes of the deductibility provisions.

1425.     In the case of the deduction under clause 353, where the requirement for payment out of earnings has survived, it is provided that, for the purposes of the deductibility provisions, the expenses are to be assumed to have been paid out of the earnings in question. (See clause 353(4).)

Chapter 2: Deductions for employee's expenses

Overview

1426.     This Chapter deals with the most familiar situation in which deductions from earnings are allowed - where the employee has paid an expense of the employment. The Chapter also deals with the situation where someone else (usually the employer) pays the expense on the employee's behalf. The Chapter therefore deals with section 198 of ICTA, with the related provisions in Schedule 12A, and with a number of other provisions, such as sections 201, 201AA and 201A of ICTA, which allow deductions for particular expenses paid by the employee.

1427.     The Chapter may be divided into the following components:

• introductory provisions (clauses 333 to 335);

• the general rule governing the deduction of expenses (clause 336);

• further rules allowing the deduction of particular expenses, grouped according to the type of expense involved (clauses 337 to 352);

• special rules for earnings with a foreign element (clauses 353 to 355); and

• rules which prohibit or restrict deductions (clauses 356 to 360).

Clause 333: Scope of this Chapter: expenses paid by the employee

1428.     This clause sets out the distinguishing condition for the deductions allowed under this Chapter: the amount in question must have been paid by or on behalf of the employee.

1429.     Subsection (1) sets out this basic proposition.

1430.     The most important single source for this clause is section 198(1) of ICTA, which allows a deduction for an amount where the holder of an office or employment is obliged to "incur and defray" that amount. There are also a number of other provisions in Part 5 of ICTA which have similar wording.

1431.     There is, however, another point that arises in relation to this part of section 198(1) of ICTA and other corresponding provisions. A deduction may be allowed where the employee has incurred the expense but the actual liability is met by someone else, usually the employer. Where the employee's pecuniary liability is met in this way it is an emolument. It is taxed under section 19(1) paragraph 1 of ICTA. As the expense is met in a way that constitutes emoluments, it is accepted that it has been defrayed out of those emoluments. The employee, accordingly, is allowed a deduction if the liability met comes within the wording of section 198(1) of ICTA or some other corresponding provision. This, in practice, is how those provisions are operated. Subsection (1)(b) of this clause therefore provides for a deduction to be allowed for such an amount if that amount is paid on the employee's behalf by someone else and is included in the earnings. See Note 36(A) in Annex 2.

1432.     The source legislation does not state explicitly that a deduction is allowed where the employee incurs the expense but the liability is met by someone else. Subsection (2) makes the position clearer by providing that the employee is treated as paying the expense where the actual liability is met by someone else and constitutes earnings of the employee.

1433.     To be allowed a deduction under this Chapter, an employee must satisfy subsection (1), read, if necessary, with subsection (2), although there are some provisions where it is perhaps unlikely that subsection (2) will be in point. The inclusion of these propositions here means that it becomes unnecessary to say something to the same effect in each of the individual deduction provisions in this Chapter.

1434.     Subsection (3) deals with the two exceptions to subsection (1). In the case of these two exceptions, subsection (2) is also disapplied.

1435.     Subsection (4) consists of a signpost to the following Chapter. That Chapter deals with deductions from benefits code earnings for costs that would have been deductible if the employee had paid them. It therefore covers cases where an expense is met by the employer in the form of a taxable benefit.

Clause 334: Effect of reimbursement etc.

1436.     This clause contains provisions dealing with the effect of reimbursement.

1437.     Under the source legislation, a reimbursed amount is dealt with for income tax purposes in either of two ways:

• if the reimbursed amount constitutes part of the earnings from the employment, and then the deduction is allowed in full; or

• if the reimbursed amount did not constitute part of the earnings from the employment, the deduction of the expense is not allowed to the extent that reimbursement is made. The speeches of Lord Guest and Lord Pearce in Pook (HM Inspector of Taxes) v Owen (1969) 45 TC 571 envisage that a reimbursed amount may be dealt with in this way.

1438.     Against this background, this clause has been included in this Bill with the object of making explicit provision for cases where an amount is reimbursed. This clause is not derived directly from the source legislation, but it reflects Inland Revenue practice in cases where amounts deductible for income tax purposes are reimbursed. See Note 36(B) in Annex 2.

1439.     This clause also includes wording to ensure that the provisions of this Chapter apply where a payment is made to the employee in respect of the expenses in question, and that payment is included in the employee's earnings. This wording guards against the argument that, in such a case, it is the person making the payment to the employee who pays the amount in question, and not the employee.

1440.     Subsection (3) provides that this clause does not apply to expenses allowed under clause 351 (expenses of ministers of religion).

1441.     Subsection (4) provides that this clause is disregarded for the purposes of the deductibility provisions (as defined in clause 332).

Clause 335: Application of deductions provisions: "earnings charged on receipt" and "earnings charged on remittance"

1442.     This clause provides that the availability of certain deductions under this Chapter depends on whether or not the earnings are "earnings charged on receipt" or "earnings charged on remittance".

1443.     The clause is new, but it draws on material in section 198(2) of ICTA.

1444.     The expressions "earnings charged on receipt" and "earnings charged on remittance" are defined in subsection (4) for the purposes of this Part of this Bill. The ambit of the expression "earnings charged on receipt" is the same as that of Cases I and II of Schedule E in section 19(1), paragraph 1, of ICTA; and the ambit of the expression "earnings charged on remittance" is the same as that of Case III of Schedule E in section 19(1) of that Act.

Clause 336: Deductions for expenses: the general rule

1445.     This clause states the general rule relating to deductions allowed from earnings.

1446.     The clause derives from section 198(1)(b) of ICTA. This provision has been the subject of much litigation.

1447.     Subsection (1) states the general rule: a deduction from earnings is allowed for an amount if the employee is obliged to incur and pay it as holder of the employment, and the amount is incurred wholly, exclusively and necessarily in the performance of the duties of the employment.

1448.     Subsection (2), which is new, provides that the following clauses in this Chapter contain additional rules allowing deductions for particular kinds of expenses, and rules preventing particular kinds of expenses from being deductible. This subsection, accordingly, emphasises the fact that deductions under the later clauses in this Chapter do not depend on this clause being satisfied first.

1449.     Subsection (3) provides that no deduction is allowed under this clause for an amount that is deductible under clauses 337 to 342 (travel expenses).

Clause 337: Travel in performance of duties

1450.     This clause allows a deduction from earnings for travel expenses if the expenses are necessarily incurred on travelling in the performance of the duties of the employment.

1451.     The clause is the first of two dealing with the proposition, contained in section 198(1)(a) of ICTA, that a deduction is allowed for "qualifying travelling expenses". This clause deals with the part of that definition in section 198(1A)(a) of ICTA.

1452.     Although the label "qualifying travel expenses" appears in section 198(1)(a) of ICTA, that label is used only at the beginning of section 198(1A) of that Act. The label is not used in this Bill.

1453.     Subsection (1) provides that a deduction is allowed from earnings for the travel expenses. In subsection (1)(b), the word "incurred" has replaced the word "expended"; but the practical application of this clause should be precisely the same as that of the legislation it replaces: subsection (1)(a) provides that the travel expenses must be both incurred and paid.