Clause 103: Connected persons and property arrangements

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

Clause 104: Distribution of assets of mutual concerns

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

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

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

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

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 That section is repealed (see Schedule 1).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

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

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

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

Clause 105: Industrial development grants

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

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

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

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

Clause 106: Sums recovered under insurance policies etc.

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

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

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

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

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

Chapter 7: Trade profits: gifts to charities etc.

Clause 107: Professions and vocations

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

Clause 108: Gifts of trading stock to charities etc.

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

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

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

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

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

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

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

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

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

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

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

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

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

Clause 110: Meaning of "designated educational establishment"

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

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

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

Chapter 8: Trade profits: Herd basis rules

Overview

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

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

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

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

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

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

Clause 111: Election for application of herd basis rules

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

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

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

Clause 112: Meaning of "animal", "herd", "production herd" etc.

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

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

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

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

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

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

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

Clause 113: Other interpretative provisions

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

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

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

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

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

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

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

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

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

Clause 114: Initial cost of herd and value of herd

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

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

Clause 115: Addition of animals to herd

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

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

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

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

Clause 116: Replacement of animals in herd

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

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

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

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

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

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

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

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

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

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

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

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

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

Clause 118: Sale of animals from herd

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

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

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

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

Clause 119: Sale of whole or substantial part of herd

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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