Clause 631: Retained and accumulated income

982.     This clause applies the rule in clause 629 where payments are made to or for the benefit of a minor child of the settlor out of a settlement under which income is retained or accumulated. It is based on section 660B of ICTA.

983.     Subsection (1) provides the general rule. The payment must be made in connection with the settlement out of a trust under which income may be retained or accumulated. The distinction in trust law between "retained" and "accumulated" income (income the trustees have resolved to treat as capital) has been retained.

984.     Subsection (2) provides that such payments are treated as payments of income even though out of capital as long as there is sufficient accumulated or retained income available to make the payment in question.

985.     Subsection (4) sets out what is meant by available retained or accumulated income in subsection (2). Income that has arisen under the settlement must exceed the amounts set out in subsection (5). These are amounts that have been paid out in expenses or already treated as the income of the settlor or another person, including a minor child of the settlor.

986.     Subsections (6) and (7) provide the computation for income subject to income tax of a minor child of the settlor for the purposes of subsection (5)(d). One first computes a figure for the whole of the child's income from all sources less allowances and deductions and then compares that with the sums treated as the child's income under the settlement. If the income less allowances is sufficient to include the child's income from the settlement then that income is deemed to have been subject to tax, ie the settlement income is treated as the top slice of the child's income.

Clause 632: Offshore income gains

987.     This clause provides that gains under the offshore funds legislation are deemed to be paid to a minor where they would have been considered as his or her income were it not for his or her minority. (Section 761(1) of ICTA provides that where there is a disposal in an offshore trust the gain is treated as income of the person disposing of it.) The clause is based on section 660B of ICTA.

Clause 633: Capital sums paid to settlor by trustees of settlement

988.     This clause provides the third charge under this Chapter. It treats as income of the settlor capital sums paid or lent to the settlor by the trustees of the settlement where those payments are matched by undistributed income within the settlement. It is based on section 677 of ICTA.

989.     Subsection (1) and (2) provide the basic rule that capital payments to the settlor are treated as his or her income where there is sufficient available income within the settlement up to the end of that tax year to cover that payment.

990.     Subsection (3) deals with the situation where there is insufficient available income up to the end of the year in which the loan is made. One then takes into account the available income for the following year to the extent that it has not been treated as the settlor's income following a capital payment made in that year. If there is still insufficient available income one takes into account the available income for the year after that and so on.

991.     Subsection (4) allows the rule in subsection (3) to run for up to 10 years subsequent to the capital payment.

Clause 634: Meaning of "capital sum" and "sums paid to settlor"

992.     This clause provides the meaning of two terms used in clause 633. It is based on section 677 of ICTA.

993.     Subsection (1) explains what is meant by "capital sum". It includes sums paid as a loan, loans repaid or sums paid to the settlor or his or her spouse (see subsection (7)) in excess of the market value of goods or services. Settlors cannot therefore avoid tax by extracting income from a settlement in the form of a capital payment by the receiving of loans from the settlement, by the making of loans which are invested by the trustees and then receiving repayment of those loans, or by selling to the trustees of the settlement an item in excess of market value.

994.     Subsection (3) excludes sums from being treated as capital sums which are broadly outside the control of the settlor (see commentary on clause 625(2)).

995.     Subsection (5) prevents a settlor from avoiding a charge under this clause by arranging for the trustees to pay a capital sum to a third party from which the settlor may benefit.

Clause 635: Amount of available income

996.     This clause explains what is meant by available income for the purposes of clause 633. It is based on section 677.

997.     Subsections (2) and (3) give the rules for ascertaining available income. It is the income arising under the settlement which has not been distributed, less sums which have already been taken into account under this rule as a capital payment in a previous year or which have been treated as the settlor's income under clauses 624 or 629 or which represent an amount of tax paid on undistributed settlement income.

998.     Section 677(2) of ICTA, on which subsection (3) is based, excludes from the measure of available income such income as has been treated as income of the settlor in years before 1995-96 under provisions which have been repealed. These paragraphs of section 677(2) are rewritten in Part 8 of Schedule 2 to this Bill.

Clause 636: Calculation of undistributed income

999.     This clause explains for the purposes of clause 635 what is meant by income arising under a settlement that has not been distributed. It is based on section 682 of ICTA.

1000.     Subsection (1) provides the basic rule with the detail in the remaining subsections. The amounts which may be set against the income arising are classified under three headings which are set out in subsections (2), (4) and (6).

Clause 637: Qualifications to section 636

1001.     This clause gives special provisions that apply to payments made by the trustees in clause 636(2) to (6) and which would otherwise be available to reduce the undistributed income within the settlement. It is based on section 682 of ICTA.

1002.     Subsection (1) disapplies clause 636(2) for payments of interest or payments to connected bodies corporate or other settlements. Such payments are not therefore to be treated as sums which have been distributed under that clause.

1003.     The purpose of subsections (2) to (7) is to prevent certain payments of interest that would not be allowable against tax from reducing the undistributed income. Interest payments that are allowable for tax purposes will already have been allowed in arriving at the income arising under the settlement.

1004.     Disallowable interest payments should not be available to reduce the income treated as the settlor's income. Without special rules loan interest payable by the trustees, which would not be allowed for tax purposes, could reduce the undistributed income and hence the amount chargeable on the settlor.

1005.     Interest can only reduce the amount available for distribution to the extent that it represents an expense against income payments to persons other than the settlor. The formula in subsection (5) apportions the interest paid on these lines. The resulting sum represents the interest paid in respect of income payments made by the settlement to the settlor and that resulting figure is unavailable to set against the undistributed income.

1006.     Subsection (6) removes from the computation interest that has been paid to the settlor or spouse of the settlor since tax will already have been borne on that interest and, but for this, double taxation would arise on those sums.

Clause 638: Capital sums paid by way of loan or repayment of loan

1007.     This clause gives the rules that apply where the capital sums in clause 633 are loans or repayments of loans. It is based on section 677 of ICTA.

1008.     Subsections (1) provides that a capital loan is repaid no part of it is treated as the settlor's income under clause 633 for any year following the year of repayment.

1009.     Subsections (2) and (3) provide that where a second loan is made to the settlor after repayment of the original loan, that loan is only treated as the settlor's income to the extent that it exceeds a previous loan which has been treated as the settlor's income. This is because no repayment of tax is made to the settlor in respect of the repayment of the first loan. He or she has effectively already paid tax on the new amount outstanding.

1010.     Subsections (4) and (5) provide that, where a settlor has made a subsequent loan to the settlement following the repayment of an earlier loan, no part of the repayment on the first loan is treated as the settlor's income after the tax year in which the subsequent loan to the settlement is made, as long as it is not less than the amount of the first loan. The second loan here is treated as a repayment of the capital sum paid out of the settlement as repayment of the first loan.

Clause 639: Loans to participators in close companies

1011.     This clause serves to avoid a double taxation charge as a result of the application of Chapter 6 of Part 4 of this Bill. Under that Chapter loans made by a company to a participator and then written off are treated as income net of tax at the ordinary rate on UK distributions. The rule is that where a charge potentially arises under both this clause and under Chapter 6 of Part 4 of this Bill this clause will take precedence, but if a charge under Chapter 6 of Part 4 of this Bill has already been made, then the charge under this Chapter on the settlor is reduced by a corresponding amount. See clause 418 (relief where borrowers liable as settlors) which rewrites section 421(3) of ICTA. The clause is based on section 677 of ICTA.

Clause 640: Grossing-up of deemed income

1012.     This clause explains the grossing-up procedure for capital sums treated as the settlor's income and the tax allowed against the settlor's liability. It is based on section 677 of ICTA.

1013.     Subsection (1) provides that the settlor is taxed on the grossed up amount of the capital sum treated as his income. Clause 877 explains how sums are grossed up.

1014.     Subsection (2) then allows a set-off of tax against the settlor's tax liability with the result that only higher rates of tax are chargeable on the settlor. The amount that the settlor may set off against his liability is given in the following subsections.

1015.     Subsection (3) explains the amount ("the deductible amount") that can be set against the settlor's liability. This is the lesser of the tax at which the capital sum is grossed up at for the tax year (the rate applicable for trusts) or the amount of tax the trustees are deemed to have paid on the available income (irrespective of the fact that the capital sum is grossed up at the rate applicable to trusts for the tax year in which the loan is treated as the settlor's income). This allows for the fact that where available income to cover the capital sum (see clause 633(2)) arose in earlier years, that income may have been charged at different rates to those in the tax year in which the capital sum is treated as the settlor's income.

1016.     Subsections (4) to (7) provide that, in order to ascertain the appropriate rates of tax for subsection (3)(c), the capital sum is matched against available income arising in earlier years before later years and the given rates of tax are applied for each tax year in which the available income representing the grossed-up sum arose. This includes a nil rate of tax where the available income would not have been subject to UK tax because the available income arose outside the United Kingdom to a non-UK resident. Subsection (6)(b) reflects the change in the rate applicable to trusts in FA 2004. The net effect of these subsections is that the credit available against the tax charge broadly represents the tax paid on the available income which represents the grossed-up capital sum. The nil rate applies in relation to any income in any tax year which falls within subsection (6)(a)(i) and (ii).

1017.     Subsection (5) provides for grossing-up at the appropriate rate, that is to say the rates given in subsection (6), in order to ascertain the tax credit to set against the settlor's income (the "deductible amount"). This is a separate grossing-up exercise to that in subsection (1), which provides that the charge on the settlor's income is always on the amount grossed up at the rate applicable to trusts.

Clause 641: Capital sum paid to settlor by body connected with settlement

1018.     This clause provides a variation on the preceding rule. It ensures that capital sums paid by a corporate body connected with the settlement are treated as income of the settlor where the payment of that capital sum can be identified with a payment made to the corporate body by the settlement. Thus payments of capital from the settlement to the settlor but dog-legged through a connected third party will not avoid a tax charge on the settlor. The clause is based on section 678 of ICTA.

1019.     Under subsections (1) and (2) where a capital sum is paid to the settlor by a body corporate connected with the settlement and an associated payment is made directly or indirectly to that body corporate by the trustees, the capital sum paid by the body corporate is treated, to the extent that it falls within the associated payment, as if it were paid directly by the trustees to the settlor and clause 633 applies accordingly.

1020.     Where an associated payment follows the year in which the payment is made by the corporate body to the settlor, the capital sum is treated as the settlor's income for that tax year and so on, up to the amount covered by the associated payment, for each subsequent year (subsections (4) to (6)).

1021.     See the entry in Part 8 of Schedule 2 to this Bill for the application of this clause in respect of payments to the settlor made before 1995-96 by a body corporate connected with the settlement.

Clause 642: Exception for certain loans or repayments of loans

1022.     This clause provides time limits for clause 641. Where the capital sum paid to the settlor is repaid within 12 months or loans made to the settlor by a body corporate connected with the settlement are not outstanding for more than 12 months in five years, the capital sum is not treated as the settlor's income. The clause is based on section 678 of ICTA.

Clause 643: Interpretation of sections 641 and 642

1023.     This clause provides definitions of and further information on terms used in clauses 641 and 642. It is based on section 678 of ICTA.

1024.     Subsection (1) provides the same tests as clause 633 in ascertaining whether a capital sum has been paid to a settlor.

1025.     Subsection (4) widens the meaning of payments made by or to another body corporate. It enables clauses 641 and 642 to apply where the body corporate making the payment to the settlor is a different body corporate to that receiving the payment from the trustees, whether directly or indirectly, but where both bodies corporate are associated.

Clause 644: Application to settlements by two or more settlors

1026.     This clause explains how the provisions of this Chapter apply where there is more than one settlor. It is based on sections 660E and 682A of ICTA.

1027.     The Chapter is written in terms of a single settlor and the rules in subsections (2) to (5) allow the property originating from each settlor to be considered in isolation.

Clause 645: Property or income originating from settlor

1028.     This clause explains what is meant by property or income originating from a settlor for the purposes of clause 644. It is based on sections 660E and 682A of ICTA.

1029.     Subsection (1) rewrites section 660E(5) of ICTA. Section 660E(5) of ICTA provides under paragraph (c) that property originating from a settlor means property that represents property provided by the settlor and other property as, on a just apportionment, represents the property so provided. This is rewritten as "on a just and reasonable apportionment". See Change 14 in Annex 1.

Clause 646: Adjustments between settlor and trustees etc.

1030.     This clause enables a settlor to recover from the trustees or others tax which has been charged on him or her under clauses 624 or 629 as well as requiring him to repay to the trustees any tax repayment which would not have arisen to him or her apart from the charge under these two sections. The clause is based on section 660D of ICTA.

1031.     Subsection (1) enables the settlor to recover from the trustees, or whoever else has received the settlement income, the tax payable by the settlor as a result of a charge under clauses 624 or 629. Since the settlor has not in fact received the income it is considered inequitable that he or she should have to pay the additional tax. The net effect where such a recovery is made is that the trustees or beneficiary of the settlement effectively pay the tax on the income but at the settlor's highest tax rate.

1032.     Subsection (2) enables the settlor to request a certificate of tax paid from the Inland Revenue which is conclusive, under subsection (2), of the facts in it.

1033.     Section 660D(1)(b) refers to "an officer of the Board". Similar references have been replaced in this Bill by the term "Inland Revenue" to achieve a more consistent approach. This is not a change in the law since clause 878(1) defines "the Inland Revenue" as "any officer of the Board of Inland Revenue".

1034.     Subsections (4) and (5) require a repayment of tax to the trustees or other persons receiving the settlement income which a person would not have received but for a charge under clauses 624 and 629. This is most likely to arise where the income charged on the settlor has had tax deducted at source and a repayment of tax is made to the settlor because there is a surplus of allowances or reliefs to set against that income. The repayment may be apportioned where the settlement income was received by more than one person.

1035.     Section 660D(2) of ICTA refers to "a person" obtaining a repayment of income tax. This is rewritten here as "a settlor". The person referred to can only be the settlor and the use of "person" simply reflects the language of FA 1922, on which that section is based, which refers to the settlor as "a person making a disposition".

1036.     Subsection (8) ensures that a charge on settlement income in respect of settlor-interested settlements and settlements in respect of minor children of the settlor may still be made on the trustees as recipients of the income.

Clause 647: Power to obtain information

1037.     This clause allows the Inland Revenue to require parties to a settlement to provide them with information within a specified time limit. It is based on section 660F of ICTA.

1038.     Section 660F refers to "an officer of the Board". Similar references have been replaced in this Bill by the term "Inland Revenue" to achieve a more consistent approach. This is not a change in the law since clause 878(1) defines "the Inland Revenue" as "any officer of the Board of Inland Revenue".

Clause 648: Income arising under a settlement

1039.     This clause explains what is meant by income arising under a settlement. It is based on section 660G of ICTA.

1040.     Subsection (1) includes all income chargeable to tax on a UK resident from sources within or outside the United Kingdom.

1041.     Subsections (2) to (5) apply where the settlor is either not resident in the United Kingdom or not domiciled or not ordinarily resident here. In that case any foreign source income is excluded unless it is remitted to the United Kingdom and the settlor would be chargeable to tax in respect of it if it were his own income. In that case it is included in the income arising under a settlement in the year of remittance.

1042.     The net effect of this clause is to include all UK source income within income arising under a settlement but to exclude foreign source income if the settlor is non-UK resident. If the settlor is domiciled or ordinarily resident in the United Kingdom he is only charged on foreign source income to the extent that it is remitted here.

Chapter 6: Beneficiaries' income from estates in administration

Overview

1043.     This Chapter charges to income tax income paid or payable by personal representatives to residuary beneficiaries from estates in administration. The Chapter rewrites sections 695 to 698 and 699 to 702 of ICTA. Section 698A of ICTA, which deals with rates of tax, is not rewritten in this Chapter. It will be rewritten together with other provisions dealing with rates of tax.

1044.     Personal representatives are taxable only at the basic rate, lower rate or the dividend ordinary rate (Schedule F ordinary rate in the source legislation) on any income they receive during the administration period. When the income which arises to the personal representatives is paid to the residuary beneficiaries, it is treated as having borne tax at those rates. So this Chapter ensures that beneficiaries liable at the higher rate are chargeable at the higher rate or, as appropriate, the dividend upper rate (Schedule F upper rate in the source legislation), as well as allowing beneficiaries liable at the lower rate, or not liable to income tax, to reclaim some or all of the tax paid by the personal representatives.

Clause 649: Charge to tax on estate income

1045.     This clause charges estate income to tax. It is based on sections 695, 696, 698 and 701 of ICTA.

1046.     The approach of Part 16 of ICTA is to deem sums to have been paid as income for all tax purposes. In the case of UK estates, the income is not charged under a particular Schedule or Case and it is implicit that tax is charged on those sums. For foreign estates, a charge is imposed under Schedule D Case IV. This clause applies to both UK and foreign estates. And it has now been made explicit that the charge to tax applies to all estate income which is treated as arising under the Chapter from a deceased person's estate.

1047.     Subsection (2) provides a definition of "estate" and "estate income". It provides that the charge under this clause applies to all estate income. This includes income from both UK and foreign estates.

1048.     Subsection (3) ensures that estate income is treated as income for income tax purposes. Without the rules in this Chapter (and Part 16 of ICTA for corporate beneficiaries within the charge to corporation tax), payments by personal representatives to residuary beneficiaries would, in law, be payments of capital.

1049.     Subsection (4) recognises that an estate may be divided into different parts with different residuary dispositions. Where, for instance, a proportion of an estate is subject to different dispositions from the remainder and each set of dispositions involve there being a residue, each part of the estate should be treated for the purposes of this Chapter as if they were separate estates. While this subsection applies where the testator has property abroad which he disposes of by a separate will, it can also apply to dispositions in the same will. For example, a testator could leave a limited interest in half his residuary estate to one child and half to the other with the capital comprising each half share to their respective issue. This would be treated, for the purposes of this Chapter, as two separate estates.

Clause 650: Absolute, limited and discretionary interests

1050.     This clause defines the three types of interest in the whole or part of the residue of an estate. It is based on sections 698 and 701of ICTA.

1051.     Subsection (1) defines an absolute interest in the whole or part of the residue of an estate. Subsection (1)(a) refers to the capital being properly payable to the person with the interest if the residue had been ascertained. This simply reflects the fact that the amount of any residue, and the income from it, can only be an estimate until the residue has been ascertained.

1052.     Subsection (2) defines a limited interest in the whole or part of the residue of an estate. Subsection (2)(b) mirrors subsection (1)(a) of this clause.

1053.     Subsection (3) defines what is referred to as a "discretionary interest" in the whole or part of the residue of an estate for the purposes of this Chapter. The income has to be properly payable to the person with the discretionary interest "if the residue had been ascertained at the beginning of the administration period". Effectively, this imposes a working assumption that there will be sufficient income from the residue to make the discretionary payments when the residue has been ascertained.

1054.     Subsection (4) covers the following four situations:

• income/capital properly payable directly to the person with the interest;

• income/capital properly payable to the person with the interest indirectly through a trustee or other person;

• income/capital properly payable for the benefit of the person with the interest to another person in that person's right, and that income/capital is paid directly to that other person; and

• income/capital properly payable for the benefit of the person with the interest to another person in that person's right, and that income/capital is paid indirectly through a trustee or other person.

1055.     An amount is only treated as properly payable to a person if it is "properly payable to the person, or to another in the person's right, for the person's benefit". This makes it clear that, whether the amount is properly payable to the beneficiary or to another in the beneficiary's "right", it must still be payable for the beneficiary's benefit (eg where a payment is made to a person having a power of attorney for a beneficiary). An example of a situation in which this condition is not met is where the residuary beneficiary is in bankruptcy. The income/capital would not be properly payable to the residuary beneficiary but would be payable to the trustee in bankruptcy in his or her right. But any payments would not be made for the benefit of the trustee in bankruptcy as the trustee receives them in a fiduciary capacity.

1056.     Subsection (5) deals with the situation where personal representatives would have an absolute or limited interest in the residue of another deceased person's estate if a right they have as personal representatives were vested in them for their own benefit. In these circumstances they are treated as having that interest. The term "personal representatives" is defined in clause 878(1).

1057.     Subsection (6) makes it clear that for the purposes of subsection (4) it does not matter whether the payment is made directly to the beneficiary by the personal representatives or through a trustee or other person. For example, the payment may be made to the guardian of a child or to whoever is appointed to look after the finances of a mentally incapacitated adult.