House of Commons - Explanatory Note
Income Tax (Trading and Other Income) Bill - continued          House of Commons

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Clause 79: Additional payments

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

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

325.     The clause 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.

Clause 80: Payments made by the Government

328.     This clause 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 clause 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.

Clause 81: Personal security expenses

331.     This clause 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 clause normally falls foul of the "wholly and exclusively" rule in clause 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 Schedule 1 to this Bill). 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. Clause 81 can accordingly apply only to expenses of a revenue nature because clause 33 is not overridden. There are parallel rules in section 33 of CAA which deal with similar expenditure of a capital nature.

335.     Clause 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.

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

338.     This is the first of five clauses 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 clauses 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 clause 34).

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 clause 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 clause 108). 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 clause 878(5).

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 .

Clause 83: Meaning of "local enterprise organisation"

346.     This clause lists some of the organisations that qualify for deductions to be allowed under clause 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 clauses 84 and 85.

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 clause are still exercised only by the Secretary of State.

350.     Subsections (3) to (5) deal with other bodies to which clause 82 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.

Clause 84: Approval of local enterprise agencies

351.     This clause and clause 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 clause sets out the basic procedure for approving a local enterprise agency. The references to "relevant national authority" are explained in clause 83(2).

Clause 85: Supplementary provisions with respect to approvals

353.     This clause and clause 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 clause are explained in clause 83(2).

Clause 86: Meaning of "urban regeneration company"

355.     This clause 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.

Clause 87: Expenses of research and development

356.     This clause 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.

Clause 88: Payments to research associations, universities etc

357.     This clause 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 clause 878(1) 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 clause, "the Secretary of State" is the Secretary of State for the Department of Trade and Industry.

Clause 89: Expenses connected with patents

362.     This clause 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 clause is an exception to the general rule in clause 56.

Clause 90: Expenses connected with designs or trade marks

365.     This clause 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 clause is an exception to the general rule in clause 56.

Clause 91: Payments to Export Credits Guarantee Department

368.     This clause 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 clause 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 Export Credits Guarantee Department. So the reference to the Secretary of State in section 88 of ICTA is not rewritten in this clause.

371.     Section 88 of ICTA allows a trader to deduct "sums paid" to the ECGD under an agreement entered into under arrangements. This clause instead allows a deduction for any "sum payable" by the trader. See Change 24 in Annex 1.

Clause 92: Expenses connected with foreign trades

372.     This is the first of three clauses that set out the special rules for expenses of a foreign trade. The clauses 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 clause 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 clause 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 one end of the journey. This clause does not include that further condition. See Change 25 in Annex 1.

377.     Subsection (1)(d) makes it clear that the clause 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 clause 34) 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 clause 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 clause refers directly to the remittance basis, which is explained in clause 878(2).

379.     The clause 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 clause.

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".

Clause 93: Allocation of expenses

382.     This clause 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 Bill are made on a "just and reasonable" basis. This clause uses "just and reasonable". See Change 14 in Annex 1.

Clause 94: Family expenses

384.     This clause 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 clause 92(3)(c).

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 Bill. So the Family Law Reform Act ensures that illegitimate children are within the clause.

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.

Clause 95: Profession and vocations

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

Clause 96: Capital receipts

388.     This clause corresponds to clause 33 (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:

5 STC [1987] 510

[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, clause 106 (sums recovered under insurance policies etc.).

Clause 97: Debts incurred and later released

396.     If an amount owed by a trader is released, this clause treats the amount released as a trading receipt. The clause 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 clause 259). 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 clause 249).

Clause 98: Acquisition of trade: receipts from transferor's trade

399.     This clause 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). But, if the right to receive the sum is transferred with the trade to a person who takes over the trade, this clause 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 clause applies for income tax purposes. Section 106(2) of ICTA (as amended by Part 1 of Schedule 1to this Bill) 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 clause 251).

Clause 99: Reverse premiums

404.     This is the first of a group of five clauses 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 clauses.

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 clause is applied for the purpose of clause 311 by subsection (6) of that clause.

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

Clause 100: Excluded cases

410.     This clause 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.

Clause 101: Tax treatment of reverse premiums

411.     This clause 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 clause 311.

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 clause 102.

Clause 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 clause 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 clause in clause 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.

 
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Prepared: 3 December 2004