Clause 540: When deficiencies arise: events following calculation events

685.     This clause is based on section 549 of ICTA. Under subsections (2) to (4), a deficiency may only arise where:

• there is a chargeable event within certain of the categories of chargeable event listed in clause 484(1);

• there has previously been a gain on a "calculation event" (see clause 491(4)), other than a "personal portfolio bond event", in respect of that policy or contract; and

• the calculation carried out under clause 491 does not produce a gain.

686.     Although the amount of the deficiency ignores any gains on personal portfolio bond events under clause 522, the calculation under clause 491 does not exclude such gains in arriving at the overall "loss".

Clause 541: Calculation of deficiencies

687.     This clause explains how to calculate the amount of a deficiency. It is based on section 549 of ICTA. It uses the "total benefit value" of the policy or contract, and the "total allowable deductions", in respect of the event, as calculated for clause 491, to find the amount. What those terms mean in detail is shown by the calculation methods in clauses 492 and 494 respectively.

688.     There are two possible amounts. Where the investor has made no overall gain, all earlier gains which formed part of that individual's total income are "refunded" as the amount of the deficiency. If there is a gain, but it is less than those earlier gains, the amount of the deficiency is those gains minus the net overall gain.

Clause 542: Replacement of qualifying policies

689.     This clause treats a qualifying policy and another qualifying policy which it replaces as a single policy for the purposes of certain clauses in this Chapter (the general rules for when chargeable events occur and how gains are calculated). The commonest circumstance in which this clause applies is where a life is added to or removed from a policy on marriage or divorce. It is based on paragraph 20 of Schedule 15 to ICTA.

690.     See also clause 546 (Table of provisions subject to special rules for older policies and contracts).

Clause 543: Issue time of qualifying policy replacing foreign policy

691.     This clause substitutes the start date of the old policy as the start date of the new policy for a particular circumstance where one policy has been substituted for another. It is based on section 553 of ICTA.

Clause 544: Application of Chapter to policies and contracts in which companies interested

692.     This clause deals with the circumstance where the application of this Chapter, that is, whether there is a chargeable event and what the amount of the gain is, has to take into account anything that occurred (or may yet occur) in respect of the policy at a time when any liability may, wholly or in part, arise or have arisen under the equivalent corporation tax provisions. It is new.

693.     The clause makes clear that this Chapter applies in respect of any other circumstance regardless of any application of "the corporation tax provisions" at that time. For example, if there has been a chargeable event under clause 509 at a time when liability on the gain arose wholly or in part under section 547(1)(b) of ICTA (so that there was also a chargeable event under, say, section 540(1)(a)(v) of ICTA), that event is taken into account in the later application of this Chapter, even if there would then be no liability under section 547(1)(b) of ICTA.

Clause 545: Minor definitions

694.     This clause provides minor definitions for the purposes of this Chapter.

695.     The definitions of "charitable trust", "friendly society" and "non-charitable trust" are based on section 539 of ICTA.

696.     The definition of "insurance company" is new for the purposes of this charge, although the Tax Acts provide a definition for other purposes. See Change 99 in Annex 1. (There is no Chapter-wide definition of "insurer". Depending on the provision, that word may mean the insurer for the time being or the original insurer with whom the insurance or contract was made. Where a definition is needed, it has been provided for the purposes of the clause in question (for example, see clause 501)).

697.     The definition of "market value" is based on the definition provided by regulation 2(1) of PPB(T)R for the purposes of those regulations. The term is not otherwise defined in the source legislation. See Change 100 in Annex 1.

698.     The definitions in subsection (2) of "premium", and in subsection (3) of "the amount of premiums paid" are based on the definition in regulation 2(2) of PPB(T)R. They clarify rather than replace "premium" as the term is generally understood, and are not regarded (in so far as they apply for the purposes of the Chapter rather than for the special charge on personal portfolio bonds only) as a change to the law.

Clause 546: Table of provisions subject to special rules for older policies and contracts

699.     This clause provides an index to the paragraphs of Parts 6 and 7 of Schedule 2 to this Bill that modify the operation of certain provisions in the Chapter for older policies and contracts. It is new.

700.     The clause also indicates other paragraphs in Part 5 of that Schedule that are relevant to this Chapter, but these do not depend on the date on which the policy or contract was made but on other time factors.

Chapter 10: Distributions from unauthorised unit trusts

Clause 547: Charge to tax under Chapter 10

701.     This clause is based on sections 18(1) and (3) and section 469(3) and (4) of ICTA.

702.     This clause refers to "schemes to which section 469 of ICTA applies" as a definition of "unauthorised unit trusts" would involve setting out a number of provisions used in ICTA 1988.

703.     For the purposes of this Bill unit holders liable to income tax are treated as receiving "income" rather than "annual payments". But for other tax purposes, for example sections 348 and 349 of ICTA, unit holders continue to be treated as receiving annual payments which are subject to deduction of tax. This is achieved by consequential amendment to section 469(3) of ICTA. This is a temporary measure until those provisions which impact on distributions from unauthorised unit trusts which are not rewritten in this Bill are rewritten.

Clause 548: Income charged

704.     This clause sets out the amount of income treated as received by a unit holder from an unauthorised unit trust scheme which is charged to tax. It is based on section 469 of ICTA.

705.     Subsection (2) contains a method statement setting out the steps to be taken to calculate the amount of income on which the investor is charged to tax. The definition of "distribution period" in section 469(6) of ICTA has been provided in subsection (5) to assist in the calculation.

Clause 549: Person liable

706.     This clause states who is liable for any tax charged. It is based on sections 59(1) and 469(3) of ICTA.

Clause 550: Income tax treated as paid

707.     This clause is based on sections 348(1)(d) and 469(3) of ICTA.

708.     Where the unit trust has been treated as making annual payments under section 348 of ICTA (payment out of profits or gains brought into charge to income tax) or under section 349 of ICTA (payment not out of profits or gains brought into charge to income tax) the tax deducted will be treated as tax paid by the unit holder.

709.     Under section 348(1)(d) of ICTA tax deducted from annual payments under section 348(1)(b) of ICTA is treated as paid by the recipient. Case law extends this to tax deducted under section 348(2) of ICTA and section 349 of ICTA. In allowing all tax deducted under sections 348 and 349 of ICTA to be treated as tax paid by the unit holder clause 550 fills a gap currently filled by case law. For more detail see the commentary on clause 426.

Chapter 11: Transactions in deposits

Overview

710.     This Chapter charges profits from the disposal of deposit rights to tax. It is based on sections 56 and 56A of ICTA.

711.     Until 2003, "deposit rights" generally took the form of a "certificate of deposit". A certificate of deposit is created when money has been deposited with a person who issues a certificate containing a promise to pay a certain amount, with or without interest, to whoever holds the certificate. Such certificates are transferable. There is a paperless version of this arrangement, where no certificate is issued but someone is entitled to call for its issue.

712.     What is now section 56 of ICTA was introduced by section 26 of FA 1973. The purpose of the legislation was to stop a tax avoidance device whereby certificates of deposit were sold just prior to maturity. The certificates were sold at a profit but, because the increase in value was not interest, the seller escaped tax under Schedule D Case III. Furthermore, because certificates of deposit do not constitute a debt on a security, the seller also escaped capital gains tax. Section 26 of FA 1973 stopped the avoidance by providing that, where the right to receive the amount stated in a certificate of deposit is disposed of, the gain arising is treated as an annual profit or gain charged to tax under Schedule D Case VI.

713.     Under the source legislation, paperless deposit rights (that is, those deposit rights not evidenced by a paper certificate, where the holder is nevertheless entitled to call for the issue of a certificate) are dealt with by section 56A of ICTA. That provision was introduced by section 34 and Schedule 8 of F(No 2)A 1992. It applies the charge under section 56 of ICTA.

714.     Administration of the UK market in certificates of deposit and their paperless equivalents, and other forms of money market instrument, has become increasingly centralised and computerised. In 2001 the Treasury made regulations under section 207 of the Companies Act 1989 to facilitate the computerisation of the market (the Uncertificated Securities Regulations 2001, SI 2001/3755). The regulations introduced the concept of "units of a security to be evidenced otherwise than by a certificate and transferred otherwise than by a written instrument".

715.     After a period of preparation, existing money market instruments, including certificates of deposit, migrated to a new, wholly computerised and uncertificated system in September 2003. It remains possible, in theory at least, for a paper certificate of deposit to be issued (and a paper version of other types of money market instrument). But conventionally it is now units of an "eligible debt security" that are issued.

716.     The Treasury made regulations in June 2003, again under section 207 of the Companies Act 1989, amending SI 2001/3755 to cater for, among other things, "eligible debt securities" (the Uncertificated Securities (Amendment) (Eligible Debt Securities) Regulations 2003, SI 2003/1633 - the "2003 regulations"). That term is defined in regulation 3(h) as:

(a) a security that satisfies the following conditions-

(i)     the security is constituted by an order, promise, engagement or acknowledgement to pay on demand, or at a determinable future time, a sum in money to, or to the order of, the holder of one or more units of the security; and

(ii)     the current terms of issue of the security provide that its units may only be held in uncertificated form and title to them may only be transferred by means of a relevant system;

(b) an eligible Northern Ireland Treasury Bill; or

(c) an eligible Treasury Bill.

717.     The 2003 regulations also modify numerous provisions to cater for the new type of money market instrument where legislation applies to one or other type of migrated instrument. Paragraph 6 of Schedule 2 to the regulations deals with certificates of deposit. In an enactment to which paragraph 3 applies

(a) a reference to a certificate of deposit includes a reference to uncertificated units of an eligible debt security where the issue of those units corresponds, in accordance with the current terms of issue of the security, to the issue of a certificate of deposit which is a certificate of deposit for the purposes of that enactment; and

(b) a reference to an amount stated in a certificate of deposit includes a reference to a principal amount stated in, or determined in accordance with, the current terms of issue of an eligible debt security of the kind referred to in subparagraph (a).

718.     Although the modification applied by the 2003 regulations does not amend the text of the statute in question, it has the same effect as an amendment. Clause 552 therefore defines "deposit rights" to encompass all types of deposit, old and new.

719.     While the vast majority of deposit rights in 2005-06 and later years will take the form of units of uncertificated eligible debt securities, there will be a small number of extant old certificates of deposit (or the previous paperless equivalent) or new certificated deposits to which this Chapter will apply.

720.     A number of consequential amendments in Schedule 1 of this Bill add, for income tax purposes, the modification applied by the 2003 regulations (see, for example, the amendment of section 349 of ICTA). As regards the reference to "rights" in section 398 of ICTA (which modifies loss relief under sections 392 or 396 of ICTA in relation to the disposal of deposit rights), the modification applied by the 2003 regulations is provided, for income tax purposes, through the consequential amendment in that Schedule inserting a reference to this Chapter.

721.     In so far as sections 56 and 56A of ICTA continue to apply after 2004-05 for corporation tax purposes (but see section 56(4A) and (4B) of ICTA), the modification is still provided by the 2003 regulations. For corporation tax purposes, the reference to "rights" in section 398 of ICTA is modified accordingly.

722.     For the purposes of the exemptions provided by section 56(3)(b) and (c) of ICTA, which are not rewritten in this Bill, the modification is also still provided by the 2003 regulations.

723.     This Chapter does not rewrite section 56(3)(a) of ICTA, under which there is no charge in respect of a right to receive an amount stated in a certificate of deposit issued before 7 March 1973. As certificates of deposit are in practice issued for a maximum term of five years, section 56(3)(a) of ICTA is obsolescent, if not obsolete. Part 5 of Schedule 2 to this Bill provides a saving for extant pre-7 March 1973 certificates (if any).

Clause 551: Charge to tax on profits from disposal of deposit rights

724.     This clause is based on sections 56 and 56A of ICTA.

725.     As deposit rights consist of the right to receive interest and the right to the return of the principal amount, subsection (2) makes clear that receiving the principal amount is a disposal of rights for the purposes of the charge to tax but receiving interest is not. Such interest will be taxable under Chapter 2 of this Part.

Clause 552: Meaning of "deposit rights"

726.     This clause is based on sections 56 and 56A of ICTA, as modified by the 2003 regulations.

727.     Subsection (2) defines various terms. The definitions of terms in relation to "uncertificated eligible debt security units" are based initially on the modification provided by the 2003 regulations, although the definitions themselves are based individually on earlier regulations. The definition of a "certificate of deposit" is based on sections 56(5) and 56A(4) of ICTA. The definition of a "security" is based on section 56(5) of ICTA, which uses the definition in section 132 of TCGA. The definition of an "uncertificated right" is based on section 56A(1) of ICTA.

Clause 553: Income charged

728.     This clause sets out the amount of income charged to tax. It is based on section 69 of ICTA.

Clause 554: Person liable

729.     This clause states who is liable for any tax charged. It is based on section 59 of ICTA.

730.     Section 56(2) of ICTA, as extended by section 56A(3)(a) of ICTA, sets out in rather elaborate terms the persons whose exercise of a deposit right results in the profits being charged to tax. But section 59 of ICTA achieves the same effect by simpler means, so those parts of sections 56 and 56A of ICTA are not rewritten.

Chapter 12: Disposals of futures and options involving guaranteed returns

Overview

731.     This Chapter rewrites the provisions in Schedule 5AA to ICTA on guaranteed returns on transactions in futures and options. It taxes as income profits and gains on a disposal of a future or option which, but for this Chapter, would be taxed as chargeable gains.

Clause 555: Charge to tax under Chapter 12

732.     This clause charges to tax profits and gains arising on a disposal of a future or option to which the Chapter applies. It is based on paragraph 1 of Schedule 5AA to ICTA.

733.     The clause refers to "profits and gains", as in the source legislation, since the profits arising may also be gains for the purposes of TCGA. There are provisions to ensure that a double charge under both this Chapter and TCGA does not arise. See proposed new section 148A of TCGA (futures and options involving guaranteed returns) in Part 2 of Schedule 1 to this Bill.

734.     The word "disposal" (see clause 562 (when disposals of futures or options occur: general)) replaces "transaction to which this Schedule applies" since a gain can only arise on a disposal, although not all transactions are necessarily disposals.

735.     Subsection (1) refers to a disposal of a future or option rather than a disposal of futures or options as in paragraph 2(1) of Schedule 5AA to ICTA. A taxpayer is taxed on a disposal of a future or an option. A similar reference to a disposal of a future or option appears in clauses 559 and 560 where the underlying legislation refers to a disposal of futures or options.

736.     Subsection (2) provides that profits which, but for this Chapter, would be capital profits, may be charged under this Chapter.

737.     Profits and gains from a trade, whether arising in the United Kingdom or abroad, are excluded and dealt with under Part 2 of this Bill. See clause 366(1) which gives the charge in Part 2 priority. That aside, the charge under this Chapter is to both United Kingdom and foreign profits and gains. See Change 101 in Annex 1.

Clause 556: Income charged

738.     This clause sets out the amount charged to tax on profits and gains that arise on the disposal of a future or option. It is based on paragraph 1 of Schedule 5AA to ICTA.

739.     Schedule 5AA to ICTA provides no precise computational rules for computing the profit or gain arising on the future or option chargeable to tax. It refers only to the profits being "realised". This is rewritten by providing that the profits are the full amount of profits and gains arising when the disposal occurs. In most cases the quantum of profits will be the difference between the disposal proceeds and the acquisition cost of the future or option.

Clause 557: Person liable

740.     This clause states who is liable for any tax charged. It is based on paragraph 1 of Schedule 5AA to ICTA.

Clause 558: Meaning of "future", "option" etc.

741.     This clause explains what is meant by future and option for the purposes of this Chapter. It is based on paragraphs 4 and 4A of Schedule 5AA to ICTA.

742.     Subsection (2) reproduces the definition of "traded option" in section 144(8) of TCGA rather than relying on a cross-reference to that Act, as paragraph 4(6) of Schedule 5AA does. But the clause does not employ the term "traded option". The distinction between a traded option and any other option is relevant only for paragraph 4(3) of Schedule 5AA to ICTA. Clause 562 (when disposals of futures or options occur: general), which rewrites that paragraph, applies the substance of the definition without using the term.

743.     Subsection (3) has, for the sake of convenience, been introduced from TCGA.

Clause 559: When disposals involve guaranteed returns

744.     This clause explains for the purposes of this Chapter when a disposal involves guaranteed returns. It is based on paragraph 2 of Schedule 5AA to ICTA.

745.     Subsection (1) provides that where the conditions in subsections (2) to (4) are met a disposal will involve guaranteed returns. These conditions are that there must be at least one other related transaction, apart from the disposal giving rise to the charge, and that this, and the related transaction, are intended to produce a guaranteed return. (What is meant by "related transactions" is explained by clause 566 (when transactions are related)). The guaranteed return should consist of the return from the disposal in question or a number of disposals of which the disposal in question is one.

746.     Subsection (5) explains the phrase used in the first condition "two or more related transactions designed to produce a guaranteed return". A "main purpose test" is applied to the two or more related transactions. Considering them together, it must be reasonable to assume that their main purpose or one of their main purposes is to produce that guaranteed return.

747.     Subsection (6) then explains what factors may be considered in making a "reasonable assumption". These are the same factors as in clause 566 (when transactions are related).

Clause 560: Production of guaranteed returns

748.     This clause explains, for the purposes of this Chapter, what is meant by producing a guaranteed return from a disposal of a future or option. It is based on paragraph 3 of Schedule 5AA to ICTA.

749.     Subsection (1) gives the basic rule for ascertaining whether a guaranteed return is produced from a disposal of a future or option. A risk of fluctuations in the underlying subject matter (defined at subsection (6)) of the future or option must be eliminated or reduced so that the return on the disposal meets the two conditions in subsections (3) and (4).

750.     Subsection (2) supplements the rule in subsection (1) where there is more than one disposal.

751.     Subsections (3) and (4) provide two conditions that must be met for the basic rule to apply. Broadly, the return on the investment must be predictable and have more similarity to interest than to the risk expected on a future or option.

752.     Subsection (5) extends the circumstances in which risks are treated as eliminated or reduced. A main reason for the choice must be the expectation that the value of an asset of that nature will be liable to only minimum fluctuation.

Clause 561: The return from one or more disposals

753.     In order to ascertain whether there is a guaranteed return for the purposes of this Chapter, clause 559 (when disposals involve guaranteed returns) requires a consideration of "the return from one or more disposals". This clause explains what is meant by "the return from one or more disposals". It is based on paragraph 5 of Schedule 5AA to ICTA.

754.     Subsection (1) contains the basic rule. The charge under clause 555 (charge to tax under Chapter 12) is on a profit or gain from an individual disposal. But, in deciding whether there is a guaranteed return, more than one disposal in the scheme or arrangement can be taken into account and the overall result of that disposal or those disposals considered, that is to say the profits or gains less losses on those disposals or on all but an insignificant part of them.

755.     Subsection (2) provides that profits or gains or losses are to be treated as made by the same person, notwithstanding that they are realised by different persons, if they are made by persons who are associated with each other.

756.     Subsections (3) to (6) explain when persons are associated with each other. (This is quite unconnected with the associated person test in section 227 of ICTA.) All disposals must be part of the same scheme or arrangements (defined in subsection (7)) and all must share in the net return of all the profits and losses incurred on those disposals in a sharing arrangement agreed for that scheme or arrangements.

757.     The references in paragraph 5(3) of Schedule 5AA to ICTA to "associated companies" have not been reproduced. See Change 102 in Annex 1.

Clause 562: When disposal of futures or options occur: general

758.     Tax is charged under this Chapter on the profits and gains arising from a disposal of a future or option. This clause explains when there is a disposal. It is based on paragraph 4 of Schedule 5AA to ICTA.

759.     Subsection (1) refers to the relevant sections of TCGA which decide whether and when a disposal occurs. Section 143(5) and (6) of TCGA treat as disposals futures contracts which are closed out by entering into another contract or which are settled by payment. Section 144 of TCGA treats as disposals grants and abandonments of options (but not the exercise of an option). Section 144A of TCGA provides that the exercise of an option which is settled by cash is treated as a disposal both in respect of the grantor of the option and the grantee. These two sections also provide rules as to when a future or option in these circumstances has been disposed of.

760.     The assumptions that apply in interpreting subsection (1) are set out in subsections (2) to (4).

761.     Subsection (2) requires, for the removal of doubt, that all futures are to be considered as assets in applying the TCGA sections. (Options are already listed as chargeable assets in section 21(1) of TCGA.)

762.     Subsection (3) requires section 143(5) and (6) of TCGA to be read without the words "in the course of dealing in commodity or financial futures" since the range of futures transactions covered by this Chapter extends beyond commodity and financial futures as defined in section 143 of TCGA.

763.     Subsection (4), by requiring references to a financial option in section 144 of TCGA to exclude only listed options, extends the provisions of that section to cover options that would otherwise be excluded under the definition in subsection 144(8) of TCGA. (Section 144 of TCGA provides for the grant and abandonment of options to be treated as disposals and for premiums to be included in the computation of the gain or loss.) These listed options are referred to as "traded options" in paragraph 4 of Schedule 5AA to ICTA. The context demands that the listing should be at the time of disposal and this has been added for clarification.

764.     Subsection (5) provides a cross-reference to clauses 563 (timing of certain grants of options where related disposals occur later) and 564 (deemed disposal where futures run to delivery or options are exercised).

765.     Clause 563 provides timing rules for deemed disposals where futures run to delivery or option contracts are exercised. Clause 564 provides that futures running to delivery and options exercised are treated as disposals for the purposes of this Chapter if they would not otherwise be.

766.     This clause does not rewrite paragraph 4(1) of Schedule 5AA to ICTA. That subparagraph explains that a disposal is a disposal of futures or options if it is the disposal of one or more futures or one or more options or both combined. Because a taxpayer is charged on a disposal of a future or option and more than one future or option may already be taken into account in ascertaining whether there is a guaranteed return (see clause 561), it is considered that this sub-paragraph adds nothing to the Chapter but simply serves to confuse.