Clause 187: Professions and vocations

760.     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 188: Application of Chapter

761.     This clause defines the basic concepts. It is based on ESC B38.

762.     The relief applies both to amounts owed to the trader and to amounts that have been paid to the trader. Relief is allowed if some, or all, of those amounts cannot be remitted to the United Kingdom because of foreign exchange restrictions. The different definitions of "unremittable" in subsections (2) and (3) reflect the differences between an amount that has been paid and an amount owed.

763.     The relief is available to any trader, including a financial trader.

764.     Subsection (4) provides a definition of "foreign exchange restrictions". Local foreign exchange restrictions are not defined in the extra-statutory concession but are clearly a key concept in the operation of the concession. This subsection introduces a definition based on section 584(1)(a) of ICTA, which is rewritten as clause 841(3). By basing the definition on section 584 of ICTA the Bill brings the two reliefs into line.

765.     Section 584(1)(a) of ICTA is almost identical to section 585(1)(b) of ICTA. Section 584(1)(a) of ICTA is rewritten as clause 841(3) and section 585(1)(b) of ICTA as clause 835(3). This clause and clauses 841(3) and 835(3) clarify the scope of sections 584(1)(a) and 585(1)(b) of ICTA in two ways.

766.     First, both sections 584(1)(a) and 585(1)(b) of ICTA refer to "the impossibility of obtaining foreign currency in that territory". It could be argued that this condition is not met if it is possible to obtain foreign currency in the overseas territory regardless of whether that currency may be transferred to the United Kingdom. The clauses in this Bill makes clear that it must not be possible to obtain foreign currency that could be transferred to the United Kingdom.

767.     Second, the clauses in this Bill makes clear that the reference to foreign currency in sections 584(1)(a) and 585(1)(b) of ICTA does not include currency of the overseas country or territory. In relation to sterling the currency of the overseas country or territory clearly is foreign but in this context "foreign" means foreign to the local territory.

768.     Sections 584 and 585 of ICTA include a requirement that the inability to transfer the funds is not due to any lack of reasonable endeavours on the part of the taxpayer. That condition has not been repeated in this Bill. See Change 135 in Annex 1.

Clause 189: Relief for unremittable amounts

769.     This clause sets out how the relief is given. It is based on ESC B38.

770.     The clause has more detail than the extra-statutory concession about the mechanics of the relief. This is necessary to give the certainty required for Self Assessment. Relief can be given only against the profits of the trade that include the unremittable amount. It cannot be used to create or increase a loss. But any excess relief is not lost. It is carried forward and set against future profits of the trade.

771.     Subsection (1) sets out the basic condition that relief is given as a deduction in calculating trade profits.

772.     Subsection (2) deals with the case in which the trader has profits but the relief would create a loss. The excess of the unremittable amounts is carried forward to the next period of account in which the trader has sufficient profits to absorb the excess.

773.     Subsection (3) deals with the case in which the trader has losses and the relief would increase those losses. The total of the unremittable amounts is carried forward to the next period of account in which the trader has sufficient profits to absorb the excess.

774.     Subsection (4) allows a deduction for any amounts brought forward in the next period of account in which the trader has made profits.

775.     Subsection (5) prevents the relief creating a loss but, as explained in the commentary on subsections (2) and (3) any excess is not lost but carried forward.

Clause 190: Restrictions on relief

776.     This clause describes the various circumstances in which relief is not allowed. It is based on ESC B38.

777.     Subsection (1) denies a deduction if the funds are applied outside the United Kingdom.

778.     Subsection (2) denies a deduction if a deduction has been allowed under clause 35 on the grounds that the debt has become bad or doubtful.

779.     Subsection (3) denies a deduction if the trader has received an insurance recovery in respect of the debt. This differs from the approach in the extra-statutory concession. Paragraph 4 of the concession denies relief if any part of the debt is insured. This Bill denies, or recovers, relief only if an insurance recovery is received. See part (C) Change 50 in Annex 1.

780.     Subsection (4) denies a deduction if the trader can make a claim under clause 842 that the income is unremittable. This restriction will apply only if the profits of the trade that include the unremittable amounts arise outside the United Kingdom, for example, because the profits arise in an overseas branch.

Clause 191: Withdrawal of relief

781.     This clause sets out the circumstances in which relief is withdrawn and the machinery by which it is withdrawn. It is based on ESC B38.

782.     Subsection (2) lists the events that trigger a withdrawal of the relief. Paragraphs (a) and (d) deal with the straightforward cases in which the amount, or part of it, ceases to be unremittable or is exchanged for an amount that can be remitted. Paragraphs (b), (c), (e) and (f) deal with the events listed in clause 190 that would have prevented relief being given if they had occurred before the deduction was allowed.

783.     Paragraph (f) deals with the case of insurance recoveries. It differs from the approach in the extra-statutory concession, which denies any relief if the debt is insured. This Chapter denies or recovers relief only if an insurance recovery is received (see the commentary on clause 190). This follows the approach in clause 843 when a payment is received from the Exports Credit Guarantee Department. See part (C) Change 50 in Annex 1.

784.     Subsection (3) sets out the way the relief is recovered. The amount identified in subsection (2) is treated as a trade receipt for the period of account in which the event occurs. It is possible more than one event will apply to the same amount. Subsection (3)(b) ensures the relief is withdrawn only once.

785.     Subsection (4) applies if the amount of the insurance recovery is less than the amount that is unremittable. In that case the amount of the recovery is limited to the amount of the insurance recovery.

Chapter 14: Disposal and acquisition of know-how

Overview

786.     This Chapter sets out the rules for calculating trade profits if a trader receives a payment for know-how. Payments to non-traders are dealt with by the rules in clauses 583 to 586.

787.     The Chapter refers to the "disposal" of know-how. As Walton J pointed out in John and E Sturges Ltd v Hessel (1975), 51 TC 183 ChD ⁶ (on page 206):

⁶ STC [1975] 127

the mere imparting of "know-how" cannot be equated with the disposal of a capital asset. Just like the schoolmaster's knowledge, it remains the property of the person imparting it as well after as before another is told.

788.     The Bill retains "disposal" because "disclosure" gives rise to difficulties in identifying the person to whom the disclosure is made (who may not be the person who buys the know-how).

Clause 192: Meaning of "know-how" etc.

789.     This clause sets out the meaning of know-how and explains other concepts used in the Chapter. It is based on sections 531(8) and 533(7) of ICTA and section 572 of CAA.

790.     The definition of "mineral deposits" in subsection (2) is restored to what it was before the enactment of CAA. See Change 51 in Annex 1.

791.     Subsections (5) and (6) extend the meaning of "sale" to include an exchange. This rule is based on section 572 of CAA, which applies to section 531 of ICTA in accordance with section 532 of ICTA.

Clause 193: Disposal of know-how if trade continues to be carried on

792.     This clause sets out a general rule for the treatment of payments received for the disposal of know-how. It is based on section 531 of ICTA.

793.     Subsection (1) includes a signpost to the main exceptions to the general rule:

• if the know-how is disposed of as part of the disposal of a trade; and

• if the seller and buyer are under common control.

794.     Subsection (2) is the general rule that consideration for the disposal of know-how is treated as a trade receipt.

795.     Subsections (3) to (6) deal with the case where know-how is disposed of with other assets. The rules are based on section 572 of CAA, which applies to section 531 of ICTA in accordance with section 532 of ICTA.

Clause 194: Disposal of know-how as part of disposal of all or part of a trade

796.     This clause sets out the main exception to the general rule in clause 193. It is based on section 531(2) and (3) of ICTA.

797.     Subsection (1) establishes that the clause applies if the know-how is disposed of as part of the disposal of a trade.

798.     Subsection (2) provides that a payment for know-how as part of the disposal of a trade is generally treated as a capital receipt for goodwill. This rule applies only if the person making the disposal is liable to income tax. If that person is liable to corporation tax the rule in section 531 of ICTA continues to apply.

799.     Subsection (3) deals with the person acquiring the know-how. Again, the payment for the know-how is generally treated as a capital payment for goodwill and the rule applies only if the person acquiring the know-how is liable to income tax.

800.     The capital treatment in section 531(2) of ICTA also applies for capital gains tax purposes. That part of the rule is inserted as a new section 261A into TCGA (see Part 2 of Schedule 1 to this Bill).

801.     Subsection (4) is an exception to the capital treatment in subsections (2) and (3). It applies if the trade was carried on wholly abroad by the person disposing of the know-how.

802.     Subsection (5) allows the parties to the transaction to elect for the payment not to be treated as one for goodwill. The effect of an election for the purchaser is that the payment may qualify for capital allowances under Part 7 of CAA. Or, exceptionally, the purchaser may be able to treat the payment as a trading expense. As such an election may affect both parties to the transaction the election has to be made by both.

803.     The question whether the election is made under this clause or under section 531(3) of ICTA is decided by reference to the position of the person disposing of the know-how. If that person is liable to income tax this clause applies; if the person is liable to corporation tax, ICTA applies.

804.     This clause does not specify that the election is to be made to "the inspector". Clause 878(4) draws attention to the rules in TMA, which apply for the purposes of this Bill. Those rules require elections to be made to "an officer of the Board".

805.     Subsection (6) gives the time limit for the election. Most elections in this Bill have to be made on or before the "first anniversary of the normal self-assessment filing date". But in this case one of the persons making the election may be chargeable to corporation tax. So the time limit for an election is based on the date of the disposal.

806.     Subsection (7) deals with a disposal by an income tax payer to a corporation tax payer. An election under section 531(3) of ICTA is treated as an election under this clause. The corresponding rule for a disposal by a corporation tax payer to an income tax payer is in section 531(3A) of ICTA (inserted by Part 1 of Schedule 1 to this Bill).

Clause 195: Seller controlled by buyer etc.

807.     This clause ensures that if the seller and buyer are under common control:

• the general rule in clause 192 does not apply; and

• the parties to the transaction may not elect for the payment for know-how to be treated as a capital payment for goodwill.

808.     The clause is based on section 531(7) of ICTA.

809.     For the purposes of this clause, "control" is defined (through clause 878(6)) by reference to section 840 of ICTA. The ICTA definition of "control" is identical in effect to that in section 574 of CAA. But as the relevance of "control" in this Bill goes wider than this Chapter, the ICTA definition is used here.

810.     This clause is one of the exceptions to the general rule in clause 847 that a firm is not to be regarded for tax purposes as a separate entity. If a firm is connected with the seller or purchaser of its know-how the payment for know-how is treated as one for goodwill.

Chapter 15: Basis periods

Overview

811.     Profits for a tax year are taxed by reference to the amount of profit earned in the basis period for that tax year.

812.     This Chapter gives the rules that identify the basis period for a particular tax year.

813.     For established, on-going trades with a constant accounting date - the majority of cases -the rules operate very simply: the basis period for a tax year is the twelve month period ending on the accounting date in that year.

814.     But special rules are needed when a trade begins or ends. And further rules have to deal with less common events such as a change of accounting date or if accounts are regularly prepared to a particular day (rather than a particular date) in the year.

815.     The rules in this Chapter are ordered so that the rules dealing with the more unusual cases are located at the end of the Chapter: the simplest cases are fully dealt with by the first six clauses.

Clause 196: Professions and vocations

816.     This clause makes it clear to whom the basis period rules apply. It is new.

Clause 197: Meaning of "accounting date"

817.     The basis period rules operate by reference to the accounting date falling in the tax year. This clause defines the key term "accounting date". It is based on sections 60(5) and 62(2) of ICTA.

818.     Subsection (1) gives the main rule. Sub-paragraph (b) deals with the case where two periods of account end in the same tax year and so there are two accounting dates.

819.     Subsection (2) deals with two particular cases outside the main rule.

820.     Subsection (2)(a) refers to clause 211. That provision applies if the accounts are made up to a particular day in the year rather than a particular date. See the commentary on clause 211 and Change 56 in Annex 1.

821.     Subsection (2)(b) refers to clause 214. That provision extends the definition of "accounting date" to include the date in the tax year to which accounts are treated as being prepared under the change of accounting date rules. That can arise when the period of account ending with the new date starts in, say, year six and ends in year eight: then an accounting date - the new date - is treated as falling in year seven.

Clause 198: General rule

822.     This clause gives the general rule which will apply year on year to most taxpayers unless it is displaced by a special rule. It is based on section 60(3) of ICTA.

823.     Subsection (2) lists the provisions that displace the general rule.

Clause 199: First tax year

824.     This clause gives the rule that applies to the first year of trading. It is based on section 61(1) of ICTA.

825.     Subsection (2) addresses the case where the trade both starts and ends in the same tax year and signposts the reader to the "final tax year" rule in clause 202.

Clause 200: Second tax year

826.     This clause gives the rules that apply to the second year of trading. It is based on sections 60(3)(a) and (b), 61(2) and 63 of ICTA.

827.     It makes explicit what is merely implicit in the source legislation. It covers several possible cases and a separate subsection addresses each.

828.     Subsection (4) applies only when there is no accounting date in the second year and the accounting dates in the first and third years are the same. When there is no accounting date in the second year and the accounting dates in the first and third years are not the same there is a change of accounting date and clause 214(3) applies to give a notional accounting date for the second year. Under clause 197 that is treated as an accounting date for the purpose of the Chapter 15 rules and clause 200(2) or (3) then determines the basis period for the second year depending on when the notional accounting date falls.

Clause 201: Tax year in which there is no accounting date

829.     This clause deals with the case where there is no accounting date in a tax year. It is based on section 60(3)(b) of ICTA.

830.     This clause does not apply if there is no accounting date in a tax year because there is a change of accounting date effected by a period of account which entirely spans the year in question. In that case clause 214 applies and treats an accounting date as falling in the spanned year.

Clause 202: Final tax year

831.     This clause gives the basis period for the final year of trading. It is based on sections 61(1) and 63 of ICTA.

832.     Subsection (1) deals with the more usual case and subsection (2) the less usual case.

Clause 203: Apportionment etc. of profits to basis periods

833.     If the period of account does not coincide with the basis period, profits must be apportioned. This clause gives the rules for the apportionment. It is based on section 72(1) and (2) of ICTA and the non-statutory practice described in paragraph 71025 of the Business Income Manual.

834.     Subsection (4) legislates that non-statutory practice. It allows apportionment in ways other than the apportionment by reference to days permitted by section 72(2) of ICTA. See Change 52 in Annex 1. The wording of subsection (4) makes it clear that the option to choose an alternative basis of apportionment is exercisable only by the taxpayer, not the Inland Revenue.

Clause 204: Meaning of "overlap period" and "overlap profit"

835.     The basis period rules are designed to ensure that, over the lifetime of a trade, the total profits assessed exactly equal the total profits earned. This clause defines the key concepts of "overlap period" and "overlap profit" that are central to achieving that. It is based on section 63A(5) of ICTA.

Clause 205: Deduction for overlap profit in final tax year

836.     This clause provides the authority for deducting overlap profit in what is probably the more common of the two cases where it may be deducted: in calculating the profits of the final year of trading. (The other, on certain changes of accounting date, is dealt with in clause 220.) It is based on section 63A(3) of ICTA.

837.     This adjustment is a key part of the rules which ensure that, over the lifetime of a trade, the total profits assessed exactly equal the total profits earned.

Clause 206: Restriction on bringing losses into account twice

838.     This clause states a short but important rule which prevents an "overlap loss" from being used more than once in aggregation. It is based on section 63A(4) of ICTA.

Clause 207: Treatment of business start-up payments received in an overlap period

839.     This clause provides a special rule for business start-up payments. It is based on section 127 of ICTA.

840.     The original Enterprise Allowance scheme provided only for weekly payments of £40. When the scheme was changed in 1991-92 the special treatment in section 127 of ICTA applied only to business start-up payments of the sort (known as "enterprise allowance") that had been paid under the original scheme. Any lump sum business start-up payments are not of that sort. So this clause does not apply to lump sum payments.

841.     The charge in ICTA is under Schedule D Case VI. But logically the income is trade profits.

842.     The policy is that business start-up payments should be taxed only once. This clause achieves that result directly, instead of by taking the income out of the calculation of trade profits. See Change 53 in Annex 1. There is a transitional rule in Part 3 of Schedule 2 to this Bill to ensure that the new treatment applies only to payments received after 5 April 2005.

843.     Schedule 1 to this Bill repeals section 127 of ICTA. Subsection (3) of that section treats business start-up payments as earned income and as relevant earnings. This Bill preserves that treatment because the payments are brought into account as receipts of the trade.

844.     Subsection (3) sets out in full what the "corresponding payments" are in Northern Ireland and reflects the effect of the devolution settlements. See Change 19 in Annex 1.

Clause 208: When the late accounting date rules apply

845.     This is the first of three clauses whose purpose is to simplify the normal operation of the basis period rules in particular circumstances. They avoid the creation of very short overlaps (less than six days) between basis periods - and therefore small amounts of overlap profit. They are based on the non-statutory practice described in paragraph 71170 of the Business Income Manual.

846.     That practice benefits taxpayers who, at the start of trading, prepare accounts to 31 March - a popular accounting date. They allow the accounts for the opening years to be treated as though they were prepared to 5 April.

847.     And because it would be illogical to exclude cases where the chosen accounting date would result in overlaps even shorter than those arising from an accounting date of 31 March, accounts prepared to 1 to 4 April are also included. See Change 55 in Annex 1.

848.     Despite the simple purpose of this provision it gives rise to some complex issues. As well as covering those cases involving accounts prepared to dates between 30 March and 5 April, it needs also to deal with cases where:

• trading begins late in the tax year (that is, after 31 March); or

• the first account is for a period longer than twelve months.

849.     And it has to ensure that:

• the application of the rule remains optional (some taxpayers may, depending on their own particular circumstances, wish their opening profits to be dealt with under the normal rules); and

• no profits are assessed twice or slip out of account.

850.     For these reasons the rules are set out in three clauses. The first clause (clause 208) sets the scene and the two following clauses (clauses 209 and 210) state the rules depending on whether or not there is an actual accounting date in the tax year.

851.     Clause 208 sets the scene by stating the purpose of the rules and when they can apply.

852.     Subsection (2) applies the relevant rules. Most taxpayers with a late accounting date will probably wish to take advantage of these rules. So the rules apply automatically unless the taxpayer "elects out". See Change 54 in Annex 1.

853.     Subsection (3)(b) refers to the intention of the taxpayer. This addresses practical difficulties that arise when the accounting date is only an intended accounting date at the time the return is made.

854.     Subsection (4) states the time limit for an opt out election. It has been made as straightforward as possible by adopting the procedures and time limits of the Self Assessment cycle.