Clause 261: Provisions which must be given priority over Part 3

1038.     This clause provides the rules to determine which Part takes priority in the event of any overlap of the charge on the profits of a trade and the charge on the profits of an overseas property business or the charge under Chapters 8 and 9 of this Part.

1039.     It is based on section 18 of ICTA and section 65A(1) of ICTA as regards overlap between an overseas property business and a foreign trade. It gives statutory effect to the Crown Option as regards overlap between an overseas property business and a UK trade. See Change 66 in Annex 1.

1040.     It is based on the definitions of Schedule D Cases I and VI in section 18 of ICTA as regards overlap between a trade and the profits of a UK concern or the profits of a UK electric line wayleave. Case VI charges income that is not charged under any other case. So it is correct to give trading income (Case I in the source legislation) priority.

Clause 262: Priority between Chapters within Part 3

1041.     This clause gives an order of priority between Chapter 3 and Chapters 8 and 9 of this Part of the Bill and between Chapters 8 and 9. It is based on sections 119(1) and 120(1) of ICTA.

1042.     Subsection (3) deals with income that falls within both Chapter 8 and Chapter 9 of this Part of the Bill. See Change 5 in Annex 1.

Chapter 2: Property businesses

Clause 263: Introduction

1043.     This clause introduces the Chapter and provides a "road map" to the key provisions. It is new.

1044.     Chapter 2 sets out the key concepts underlying the main component of income within this Part of the Bill by defining "property business" and "generating income from land".

Clause 264: UK property business

1045.     This clause defines "UK property business" and introduces the concept of "generating income from land". It is based on section 15(1) of ICTA.

1046.     It makes it clear that all the income from a person's UK land interests is treated as falling within a single UK property business.

1047.     The term "property business" is not entirely straightforward. The term used in the source legislation - "Schedule A business" - was introduced as part of the 1995 reform of Schedule A. That concept was helpful in providing a vessel to contain all the income from land previously charged under Schedule A and to which the rules for calculating trade profits could be applied. But the concept of a Schedule A business - and a UK property business - is rather more complex than that of a trade. That is reflected in this and the other clauses that, together, define the range of income that is assessed as income of a property business.

1048.     First, the income has to be defined by reference to land law. There are only limited possibilities for simplifying terms which have to link directly with the concepts and language of current land law.

1049.     Second, the concept of the "property business" is, to a certain extent, an artificial one. Unlike the term "trade" it may not always correspond to an activity organised in a way that the proprietor would necessarily describe as a business. As such, the term has to cover:

• "real" businesses where the lettings are organised in a professional way;

• lettings which are not so organised; and

• casual and one-off transactions which may have very little of the qualities normally associated with a business.

Then all of these lettings of different types must be treated as part of the same, single business.

1050.     Although the Chapter builds on the concept of the "business", the approach to defining a "UK property business" differs from the approach in the source legislation. This Part of the Bill uses the term "UK property business" rather than "Schedule A business". Although the terms "UK property business" and "Schedule A business" are defined differently they have the same tax effect.

1051.     Paragraph 1(1) of Schedule A (see section 15(1) of ICTA) provides for tax to be charged on "the annual profits arising from a business carried on for the exploitation, as a source of rents or other receipts, of any estate, interest or rights in or over land in the United Kingdom". Under paragraph 1(2) of Schedule A, "to the extent that any transaction is entered into for [that purpose], it is taken to be entered into in the course of such a business". Paragraph 1(3) of Schedule A treats all businesses and transactions carried on or entered into by a particular person, so far as they are carried on or entered into for that purpose, as together forming a single business for the purposes of Schedule A.

1052.     Section 832(1) of ICTA provides:

"Schedule A business" means any business the profits or gains of which are chargeable to income tax under Schedule A, including the business in the course of which any transaction is by virtue of paragraph 1(2) of that Schedule to be treated as entered into.

1053.     Each of the individual businesses carried on (or, by virtue of paragraph 1(2) of Schedule A, notionally carried on) for the purpose mentioned in Schedule A is thus a "Schedule A business". Under paragraph 1(1) and (3) of Schedule A, the charge to tax is on the profits of the single notional business consisting of all the Schedule A businesses carried on by a single person. It is that notional business that is defined as the person's "UK property business" in clause 264.

1054.     Clause 859 explains how the "one business per person" rule applies in the case of a business carried on (or a transaction entered into) in partnership.

Clause 265: Overseas property business

1055.     This clause defines "overseas property business". It is based on section 65A of ICTA.

1056.     The definition is identical to that of "UK property business" except that the land from which the income arises is outside the United Kingdom. That is the only difference between a UK and an overseas property business: income from land outside the United Kingdom can arise only in an overseas property business; income from land in the United Kingdom can arise only in a UK property business.

1057.     For the purpose of deciding whether there is an overseas property business, overseas land law is interpreted in accordance with clause 363.

1058.     The priority rules in the trading income Part of this Bill (clause 4) make it clear that a charge under Part 3 of this Bill as United Kingdom property income has priority over a charge under Part 2 as trading income. This reflects the rule in Schedule D Case I (section 18(3) of ICTA). The sort of receipt to which this rule might apply is rent received by a property developer from the temporary letting of land awaiting development. The rent is taxed as property income, even if it could properly be regarded as a trade receipt.

1059.     In the case of a foreign trade and foreign property, the rule in section 65A(1)(b) of ICTA is the reverse of that in section 18(3) of ICTA. An overseas property business does not include "income to which section 65(3) of ICTA applies (income immediately derived from carrying on a trade ..)". So the priority rule in clause 261 preserves this position.

Clause 266: Meaning of "generating income from land"

1060.     This clause defines "generating income from land". It is based on sections 15(1), 24 and 65A of ICTA.

1061.     The clause defines what may be described as the essence of the property business. That is, exploiting rights of land ownership for profit. But it is not intended to identify everything that must be taken into account in calculating the profits of such a business. The concept of the property business is wider than that. "Property business" includes, for example, amounts specifically charged under other provisions such as certain insurance recoveries (see clause 106 applied by clause 272(2)).

1062.     Subsection (1) states the basic definition of "generating income from land".

1063.     Subsection (2) extends the meaning of "rent" and is based on section 24(6)(b) of ICTA. It applies to payments by tenants, whether made to the landlord or to someone else, in respect of maintenance or repair of the leased premises that the tenant is not required by the lease to carry out. Including this extension in the main clause (in the source legislation it is relegated to a "construction" section) keeps all the relevant definitions together.

1064.     Subsection (3) explains "other receipts" in subsection (1). This list is not exhaustive but amounts that are not listed here would have to be of a similar nature to those that are listed to come within the definition.

1065.     Subsection (4) extends the charge to particular types of receipt. The source legislation cross-refers to a definition of "caravan" in the Caravan Sites and Control of Development Act 1960. There is a Bill-wide, uniform definition of "caravan": see the commentary on clause 875 and Change 148 in Annex 1.

1066.     There is also a new Bill wide, uniform definition of "houseboat" which introduces changes in the law: see the commentary on clause 878(1) and Change 150 in Annex 1.

Clause 267: Activities not for generating income from land

1067.     This clause excludes certain "land-related" income from property income and cross-refers to the trading income provisions under which that income is charged. It is based on sections 15(1) and 65A of ICTA.

Chapter 3: Profits of property businesses: basic rules

Clause 268: Charge to tax on profits of a property business

1068.     This clause charges the profits of a property business to tax. It is based on sections 15 and 18 of ICTA.

Clause 269: Territorial scope of charge to tax

1069.     This clause sets out the limitations on the charge to tax on a UK property business and an overseas property business. It is based on sections 18 and 65A of ICTA.

1070.     Subsection (1) establishes that the profits of a UK property business are charged to tax whatever the residence status of the taxpayer.

1071.     Subsection (2) establishes that the profits of an overseas property business are charged to tax only if the taxpayer is a UK resident.

1072.     Income from an overseas property business is assessable under Schedule D Case V. So the charge to tax is subject to the territorial restriction in Schedule D. A non-resident person is taxable only on income from "property" in the United Kingdom (see paragraph (a)(iii) of Schedule D in section 18(1) of ICTA). So a non-resident is not charged to tax on the income from overseas property.

1073.     Subsection (3) is the special rule for Irish income. It is based on section 68 of ICTA. Even if a person is entitled to the remittance basis for other foreign income Irish income is assessable on the basis of the income arising. But it is not clear how the current rules in sections 65(4) and 68 of ICTA interact. This clause makes it clear that the rules for an overseas property business are used in calculating the income from Irish property. See Change 67 in Annex 1.

1074.     Subsection (4) is a signpost to the special rule in Chapter 11 of Part 2 of this Bill for the non-Irish foreign income of a person who is assessable on the remittance basis. The overseas property business rules in section 65A of ICTA are disapplied in the case of a remittance basis person by section 65(4) of ICTA.

Clause 270: Income charged

1075.     This clause states the amount charged to tax. It is based on sections 21 and 65 of ICTA.

1076.     The clause refers simply to "profits" rather than "annual profits" used in the source legislation. Omitting "annual" is consistent with the approach adopted for trading and savings and investment income - the word adds nothing to the meaning of "profits".

Clause 271: Person liable

1077.     This clause states who is liable for any tax charged. It is based on sections 21 and 59 of ICTA.

Clause 272: Profits of a property business: application of trading income rules

1078.     This is the main rule for calculating the profits of a property business. It is based on sections 21A and 65A of ICTA.

1079.     The same basic rules apply to the calculation of both UK and overseas property businesses.

1080.     From 1995, the profits of a Schedule A business charged to income tax are calculated by treating the business as similar to a trade and applying the calculation rules of Schedule D Case I.

1081.     In the source legislation this is achieved by section 21A of ICTA. But, at the margins, the application of certain of the Case I rules to Schedule A is not altogether clear.

1082.     First, the relationship of section 21A(2) of ICTA to section 21A(1) of ICTA is uncertain. Section 21A(2) of ICTA refers to provisions that apply "in accordance" with section 21A(1). It is open to debate whether section 21A(2) of ICTA merely contains examples of the Schedule D Case I provisions that apply in accordance with the general rule in section 21A(1) of ICTA or whether it contains an exhaustive list of those provisions. The former appears the better view and the one best reflecting the underlying policy.

1083.     Second, some Schedule D Case I provisions that are applied to Schedule A are inherently incapable of applying to income from land. The "herd basis" provisions in section 97 of and Schedule 5 to ICTA (rewritten in Chapter 8 of Part 2 of this Bill) are an example. They are among the provisions of Chapter V of Part 4 of ICTA that are applied to Schedule A specifically (subject to stated exceptions) by section 21A(2) of ICTA. But they are not among the exceptions referred to in section 21A(4) of ICTA.

1084.     On the other hand, some Schedule D Case I provisions outside Chapter V of Part 4 of ICTA that seem potentially more relevant, such as the car hire provisions in sections 578A and 578B of ICTA, are not applied specifically.

1085.     Clause 272 clarifies these matters by listing all the clauses in Part 2 of this Bill that are relevant to property business profits.

1086.     Some of the clauses in Part 2 of this Bill that are applied to a property business contain rewrite changes. Those changes are carried through to property income. Details of those changes are recorded in the Annex 1 notes on the particular clauses in Part 2 of this Bill.

1087.     Subsection (1) states the general principle that the profits of a property business are calculated in the same way as the profits of a trade. This reflects the fact that there are provisions not included in Part 2 of this Bill which may affect the calculation of profits. For example, the pension contributions deductions provisions in FA 2004 and certain anti-avoidance provisions in ICTA that apply to all income types.

1088.     Subsection (2) lists all the clauses in Part 2 of this Bill that are relevant to property business income. It reflects the principle that section 21A(1) of ICTA applies all Schedule D Case I calculation provisions to Schedule A unless they are expressly disapplied elsewhere. Provisions that are expressly disapplied in the source legislation are excluded from the list.

1089.     Also excluded are provisions which are attracted to Schedule A in the source legislation either expressly by section 21A(2) of ICTA or under the general principle expressed in section 21A(1) of ICTA, but which are incapable of applying once carried over to the context of the property business. Exclusion is achieved simply by omitting them from the list of provisions that do apply.

1090.     The majority of the provisions in Part 2 of this Bill that can apply to a property business are applied by subsection (2). But in some cases later clauses set out the provisions specifically (Chapter 7 (adjustment income) and Chapter 10 (post-cessation receipts)).

1091.     The following clauses that are applied by subsection (2) merit specific mention. These are:

• clauses 48 to 50: expenses of car hire;

• clauses 188 to 191: deduction for unremittable amounts.

1092.     Including these accurately reflects the effect of the source legislation but their application to property income may not hitherto have been generally recognised.

1093.     Although the list in subsection (2) excludes clauses in Part 2 of this Bill that are inherently incapable of applying to a property business it does not exclude those that are merely unlikely to apply. This recognises the possibility of certain provisions applying in unusual circumstances. Examples are clause 87 and clause 88 (scientific research). Although their relevance to a property business is unlikely, it is not inconceivable and they are needed to cater for the possibility of a landlord funding an activity that would qualify as "scientific research". An example might be research on the decontamination of brown land with a view to building an investment property on it.

1094.     Subsection (3) ensures that the trading income provisions cross-referred to in subsection (2) work properly in the context of the property business.

Clause 273: Amounts not brought into account as part of a property business

1095.     This clause excludes from the profits of a property business certain income from land that, exceptionally, may be taxed as profits of a trade. It is based on sections 15 and 65A of ICTA.

1096.     Subsection (1) signposts to the relevant provisions.

• See Change 3 in Annex 1 in respect of caravans.

• See Change 4 in Annex 1 in respect of surplus business accommodation.

• See Change 5 in Annex 1 in respect of payments for wayleaves.

Clause 274: Relationship between rules restricting and permitting deductions

1097.     This clause determines the interaction between those provisions that allow a deduction and those provisions that prohibit a deduction. It is new. See Change 6 in Annex 1.

1098.     This clause does a similar job in the property income Part to that which clause 31 does in the trading income Part. The general principle is that a rule allowing a deduction takes priority over a rule prohibiting a deduction. But that is subject to the exceptions the clause mentions.

1099.     Subsection (4) makes it clear that the effect of this priority rule extends to the large number of trading income rules that apply to property income indirectly through clause 272.

Clause 275: Apportionment of profits to tax year

1100.     This clause deals with cases where the period of account does not coincide with a tax year. It is based on sections 21A, 72 and 65A of ICTA.

1101.     This clause is necessary because the charge under clause 270 is on the property business profits arising in the tax year.

1102.     In the source legislation section 72 of ICTA is one of the provisions applied to Schedule A specifically by section 21A(2) of ICTA. Section 72 of ICTA is rewritten for trade profits in clause 203. But simple cross-reference to that trading income clause would not work very well for property income because that clause is drafted in terms of basis periods and basis periods are not relevant to property income. So clause 275 is a specific property income version.

1103.     Subsection (4) adopts the approach of clause 203(4) in permitting an alternative basis of apportionment if its use is reasonable and consistent. 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.

Chapter 4: Profits of property businesses: lease premiums etc.

Overview

1104.     This Chapter contains rules for the taxation of premiums, and certain other amounts paid in respect of leases, which would otherwise generally be amounts of a capital nature. It is based on sections 34 to 38 of ICTA.

1105.     The effect of section 34 of ICTA is that premiums for leases with an effective duration of 50 years or less, and certain other amounts treated as premiums, are treated wholly or partly as income in the hands of the recipient. Premiums in respect of leases with a duration of one year or less are treated wholly as income. For premiums in respect of leases with a duration of between one and 50 years, the amount treated as income is calculated on a sliding scale according to the duration of the lease. Similar provision is made for amounts treated as premiums under section 34(4) and (5) of ICTA. See clauses 277 to 281.

1106.     Section 35 of ICTA applies when a lease for 50 years or less is granted for a premium less than market value and is then reassigned at a profit. The assignor is treated as receiving as income an amount calculated on a sliding scale according to the duration of the lease. See clauses 282 and 283.

1107.     Section 36(1) and (2) of ICTA apply when an estate or interest in land is sold with a condition that it may be required to be sold back to the vendor. The vendor is treated under section 36(4A) of ICTA as receiving as income an amount calculated on a sliding scale according to the earliest date on which the interest could fall to be reconveyed. Section 36(3) makes similar provision where the terms of the sale provide for the grant of a lease to the vendor. See clauses 284 to 286.

1108.     Section 37 of ICTA contains rules under which:

• there may, in certain circumstances, be a reduction in the amount of another receipt under section 34 or 35 of ICTA - see clauses 287 to 290; and/or

• the tenant under the lease may be entitled to a deduction in calculating the profits of his or her property business - see clauses 291 to 294.

1109.     A tenant who uses land subject to a lease in respect of which there is a receipt under section 34 or 35 of ICTA in connection with a trade, profession or vocation may be entitled under section 87 of ICTA to a deduction in computing the profits of that trade, profession or vocation. Section 87 of ICTA is rewritten in clauses 60 to 65.

1110.     Section 38 of ICTA contains rules for determining the duration of a lease for the purposes of sections 34 to 36 of ICTA. See clauses 303 to 305.

Clause 276: Introduction

1111.     This clause is new.

1112.     Subsection (3) refers to "any lease" in the case of sums payable instead of rent or for the variation or waiver of the term of a lease. See commentary on clauses 279 and 281 and Change 68 in Annex 1.

1113.     Subsection (6) defines a "short-term" lease as "a lease whose effective duration is 50 years or less". The "effective duration" of a lease is its duration for the purpose of the lease premium rules. This may not be the same as the contractual duration. See commentary on clauses 303 and 304.

Clause 277: Lease premiums

1114.     This clause contains the basic rule for the amount treated as a receipt if a premium is paid on the grant of a short-term lease. It is based on sections 34(1), (6) and (7A) and 37(2) of ICTA.

1115.     Section 34(1) of ICTA treats a landlord who receives a premium as receiving an amount by way of rent. Section 34(6) of ICTA treats a person other than a landlord who receives a premium as receiving income as a result of entering into a transaction within paragraph 1(2) of Schedule A in section 15(1) of ICTA.

1116.     This clause instead treats both landlords and non-landlords as entering into a transaction mentioned in clause 264 (if the land to which the lease relates is in the United Kingdom) or clause 265 (if the land to which the lease relates is outside the United Kingdom).

1117.     Clause 264 in Chapter 2 of Part 3 of this Bill provides that a person's UK property business consists of:

(a)     every business which the person carries on for generating income from land in the United Kingdom, and

(b)     every transaction which the person enters into for that purpose otherwise that in the course of such a business.

1118.     Clause 269(1) provides that the profits of a UK property business are charged to tax under Chapter 3 of Part 3 of this Bill whether the business is carried on by a UK resident or a non- UK resident.

1119.     Clause 265 in Chapter 2 of Part 3 of this Bill provides that a person's overseas property business consists of:

(a)     every business which the person carries on for generating income from land outside the United Kingdom, and

(b)     every transaction which the person enters into for that purpose otherwise that in the course of such a business.

1120.     Clause 269(2) and (3) provides that the profits of an overseas property business are charged to tax under Chapter 3 of Part 3 of this Bill only if the business is carried on by a UK resident but in the case of a UK resident to whom the remittance basis applies, only in respect of land in the Republic of Ireland.

1121.     The effect of clauses 264 and clause 265 is that the transaction which subsection (2) of this clause treats the person as entering will be included in the person's UK or overseas property business, or will constitute the person's UK or overseas property business if that person is not already carrying on such a business.

1122.     The approach adopted in subsections (2) to (4) of clause 277 is also followed in rewriting the rules on:

• sums payable instead of rent in clause 279;

• sums payable for the surrender of a lease in clause 280;

• sums payable for the variation or waiver of the term of a lease in clause 281;

• assignments for profit of lease granted at undervalue in clause 282;

• sales with right to reconveyance in clause 284; and

• sale and leaseback transactions in clause 285.

1123.     Section 34(1) of ICTA treats rent treated as received by a landlord as received when the lease is granted. Section 34(7A) of ICTA provides that an amount treated as received as rent must be taken into account for the chargeable period in which it is treated as received. There is no corresponding rule for non-landlords in section 34(6).

1124.     Subsection (3) requires the person to whom the premium is due (both landlord and non-landlord) to bring an amount into account in calculating the profits of the property business for the tax year in which the lease is granted. See Change 69 in Annex 1.