Clause 651: Meaning of "UK estate" and "foreign estate"

1058.     This clause defines "UK estate" and "foreign estate" for the purposes of this Chapter. It is based on sections 699A and 701 of ICTA. The definitions in this clause underpin the whole of this Chapter.

1059.     Subsections (2), (3) and (5) contain the conditions which determine whether an estate is a UK estate for a tax year. A "foreign estate" is an estate which is not a "UK estate" for the tax year.

Clause 652: Estate income: absolute interests in residue

1060.     This clause sets out the basis on which estate income is treated as arising in a tax year in the case of absolute interests in residue. It is based on section 696 of ICTA.

1061.     Subsections (2) and (3) set out the relevant conditions. A payment need not be made in the final tax year because the net amount of estate income in that year is always equal to the assumed income entitlement for that year. Under section 696(5) of ICTA, taxing a person with an absolute interest in a residuary estate depends on whether the person receives payments and, in the final year of administration, on a fictional payment under that section. The same effect is achieved in this clause by determining the liability by considering the assumed income entitlement in all years. Assumed income entitlement is dealt with in clause 665.

Clause 653: Meaning of "the administration period" and "the final tax year"

1062.     This clause defines "the administration period" and "the final tax year". It is based on sections 695, 701 and 702 of ICTA.

1063.     Subsection (1) defines "the administration period" for the purposes of this Chapter. The reference to "the period commencing on the death" in section 695(1) of ICTA suggests that the actual time of death could be important in determining whether income arose before or after death. In general, this will not be the case because income such as earnings, rent, interest and dividends does not arise at a particular time of the day. If such income arises on the date of death, it will be deemed to be income passing to the deceased immediately on the commencement of that day.

1064.     But the administration period has not been defined in this Bill as beginning the day after the date of death. This is because the possibility cannot be excluded that income will arise after the death, but on the same date, as a result of the efforts of the personal representatives and this should properly be regarded as income of the estate.

1065.     Subsection (2) defines when the administration of the estate is completed for Scotland. A full definition for Scotland is required because the completion of the administration of an estate would otherwise have no meaning under Scottish law (although the definition has been updated by replacing the archaic expression "for behoof of"). In contrast, there are cases under English law which have established that the administration is complete when the residue of the estate is ascertained and is ready for distribution. Case law explains what this means in particular circumstances (see, for example, R v Special Commissioners ex parte Dr Barnardo's Homes (1921), 7 TC 646 HL, Daw v CIR (1928), 14 TC 58 HC and CIR v Sir Aubrey Smith (1930), 15 TC 661 CA).

1066.     Subsection (3) defines "the final tax year" to avoid repeating the full meaning throughout the Chapter.

Clause 654: Estate income: limited interests in residue

1067.     This clause deals with estate income relating to limited interests. It is based on section 695 of ICTA.

1068.     The clause sets out the basis on which estate income is treated as arising in a tax year for limited interests in residue. The clause reflects the need to deal with tax years before the final tax year. Also, a limited interest might cease on the death of the beneficiary before the final tax year so that situation has to be provided for.

Clause 655: Estate income: discretionary interests in residue

1069.     This clause deals with estate income relating to discretionary interests in residue. It is based on section 698 of ICTA.

1070.     The clause sets out the basis on which estate income is treated as arising in a tax year for discretionary interests in residue. Estate income is treated as arising if a payment is made in the tax year in exercise of the discretion in favour of the person with the discretionary interest.

Clause 656: Income charged: UK estates

1071.     This clause sets out the amount charged to tax under clause 649 for income from UK estates. It is based on sections 695, 696 and 698 of ICTA.

1072.     As there are fundamental differences between the basis of charge for income from UK and foreign estates, the rules for foreign estates have been dealt with in a separate clause (clause 657).

1073.     Subsection (2) provides that income from a UK estate is charged on the gross amount of the estate income arising in the tax year. This is the basic amount of the income grossed up at the applicable rate. "Basic amount" is a new term. This avoids confusion with the term "net amount" since it is the "net amount" which is actually charged to tax in the case of a foreign estate (except where clause 680 (income treated as bearing income tax) applies).

Clause 657: Income charged: foreign estates

1074.     This clause sets out the amount charged to tax under clause 649 for income from foreign estates. It is based on sections 65, 68, 695, 696, 698 and 699A of ICTA.

1075.     Subsection (5) provides that, so far as the income is not within clause 680, the charge is on the basic amount of that income. Where the income is within clause 680, the charge is on the gross amount of the income calculated in accordance with clause 663.

Clause 658: Special rules for foreign income

1076.     This clause is based on sections 695, 696 and 698 of ICTA. It indicates that estate income arising outside the United Kingdom may be subject to the special rules for foreign income in Part 8 of this Bill.

1077.     Subsection (2) provides that the special rules in Part 8 of this Bill for "relevant foreign income" only apply to foreign estates. This preserves the effect of the source legislation under which those special rules only apply to income charged under Schedule D Cases IV or V of ICTA. And under the source legislation, only income from foreign estates is charged under Schedule D Case IV.

Clause 659: Person liable

1078.     This clause states who is liable for any tax charged under clause 649. It is based on sections 695, 696 and 698 of ICTA.

1079.     The person who is liable will very much depend on the nature of the interest held by the beneficiary. The various interests are set out in the clause together with the person liable for each of those interests.

Clause 660: Basic amount of estate income: absolute interests

1080.     This clause explains how to calculate the basic amount of estate income for absolute interests. It is based on section 696 of ICTA.

1081.     For years before the final tax year, the basic amount is the total of all sums paid in the tax year in respect of the interest or the person's assumed income entitlement, whichever is the lower. Surplus payments are excluded because an absolute income beneficiary may receive sums which comprise both capital and income but the clause taxes only the income element. For the final tax year, it is the person's assumed income entitlement for that year which is taxed.

1082.     This clause removes all the deeming of amounts to have been paid in Part 16 of ICTA. Instead, it looks at either amounts actually paid or the assumed income entitlement. It then catches all previously untaxed income due to the absolute interest holder by taxing the assumed income entitlement in the final year. This avoids the two stage process inherent in section 696(5) of ICTA.

1083.     Subsection (3) introduces a new rule allowing excess estate deductions in the final tax year to be set off against the basic amount of estate income for that year. See Change 106 in Annex 1.

Clause 661: Basic amount of estate income: limited interests

1084.     This clause explains how to calculate the basic amount of estate income for limited interests. It is based on section 695 of ICTA.

1085.     Essentially, the basic amount of estate income is all the sums referred to in clause 654 falling within a particular tax year added together. It is impossible for there to be sums within both clause 654(3)(c) and (4)(c) in the same tax year.

Clause 662: Basic amount of estate income: discretionary interests

1086.     This clause identifies the basic amount of estate income relating to discretionary interests. It is based on sections 695 and 698 of ICTA.

Clause 663: The applicable rate for grossing up basic amounts of estate income

1087.     This clause provides for basic amounts of estate income to be grossed up, as appropriate, for the purposes of the income charged clauses (clause 656 for UK estates and clause 657 for foreign estates) by reference to the rate at which tax is borne by the aggregate income of the estate. The aggregate income of the estate is defined in clause 664. Clause 663 is based on sections 699A and 701 of ICTA

Clause 664: The aggregate income of the estate

1088.     This clause explains what is meant by the "aggregate income of the estate" for a tax year. It is an important definition of general application. Essentially, the aggregate income is all the taxable income of the personal representatives plus certain sums which are treated as having borne income tax at particular rates. The clause is based on sections 249, 421, 547, 701 and 702 of ICTA.

1089.     Subsection (2) defines the income and amounts within the aggregate income of the estate. Subsection (2)(a) brings in income chargeable to UK income tax. Subsection (2)(b) brings in foreign source income.

1090.     Subsection (4) provides that the amount of income falling within subsection (2)(b) takes account of any deductions which would have been available if it had been subject to UK income tax. So subsection (4) brings foreign source income into line with UK source income.

1091.     Subsection (5) provides that two types of income are excluded from the aggregate income of the estate. This subsection excludes income from property devolving on the deceased's personal representatives otherwise than as assets for payment of the deceased's debts. The subsection also excludes from the aggregate income of the estate, income to which any person may become entitled under a specific disposition. This second exclusion is new to the definition of the aggregate income of the estate although it is similar to section 697(1)(b) of ICTA which deals with amounts which are deductible from the aggregate income in calculating the residuary income of the estate.

1092.     It does not seem appropriate for income from specific dispositions or income from contingent interests to be treated as part of the aggregate income of the estate. See Change 107 in Annex 1.

1093.     Section 698(1) of ICTA deals with the position where the deceased person ("A"), whose estate is being administered by personal representatives, had an absolute or limited interest in the residue of the estate of another deceased person ("B"). Section 698(1) of ICTA deems the personal representatives to have the same interest as "A" "notwithstanding that that right is not vested in them for their own benefit". The substance of this is rewritten in clause 650(5). Section 698(1) of ICTA also deems any income in respect of such an interest to be part of the aggregate income of A's estate. This part of the source legislation is not rewritten because such income will fall within the definition of the aggregate income of the estate anyway, once the personal representatives are deemed to have the interest, because it will be the income of the deceased's personal representatives as such. It is immaterial for this purpose that that right in relation to the estate of another deceased person "is not vested in them for their own benefit".

1094.     It is not considered necessary to expand on the two types of excluded income mentioned in subsection (5) of this clause (with the exception of subsection (6) of this clause) since it will be clear when such income arises. Consequently, section 701(6) and (7) of ICTA are not rewritten.

Clause 665: Assumed income entitlement

1095.     This clause explains the new concept of the "assumed income entitlement". It is based on section 696 of ICTA.

1096.     The concept of "assumed income entitlement" has been introduced as a tool for calculating the basic amount of estate income for absolute interests. It is similar to the "aggregated income entitlement" in section 696 of ICTA but applies in a more straightforward way.

1097.     Subsection (1) sets out the steps to be considered to determine whether a person has an assumed income entitlement for a tax year. The assumed income entitlement is the amount by which the absolute holder's share of residuary income (after, in the case of UK estates, deduction of tax at the applicable rate) for tax years up to and including the tax year in question exceeds the total of the basic amounts for which he is chargeable for all previous tax years. Thus, for example, if the beneficiary receives his share of the residuary income in each tax year up to the year in question, then the assumed income entitlement is the basic amount of his share of the residuary income for that year.

1098.     Step 4 in subsection (1) deals also with situations where a corporate beneficiary liable to income tax was, at some earlier point during the administration period, chargeable to corporation tax. It also deals with other situations where a non-UK resident beneficiary becomes UK-resident, when the estate is a foreign estate.

Clause 666: The residuary income of the estate

1099.     This clause explains how the residuary income of the estate is calculated. Beneficiaries with absolute interests need to know the residuary income of the estate for a tax year in order to work out their assumed income entitlement. The clause is based on sections 697 of ICTA.

1100.     Subsection (2) lists the "allowable estate deductions". This is a new label for the items which may be deducted from the aggregate income of the estate. Subsection (2)(a) refers to "all interest paid in that year by the personal representatives ..". Section 697(1)(a) of ICTA refers to "the amount of any annual interest, annuity or other annual payment for that year which is a charge on residue ..". The requirements that interest must be annual and also a charge on residue have not been reproduced. See Change 108 in Annex 1.

1101.     In practice, the Inland Revenue allow income from specific dispositions to be deducted from the aggregate income of the estate in calculating the residuary income of the estate in the year of assent and later years. But it is considered simpler for it merely to be excluded from what counts as the aggregate income and not be deducted from it. See Change 107 in Annex 1.

1102.     Subsection (2)(b) deals with annual payments. Because of the restricted meaning given to annual payments, much of the wide definition in section 701(6) and section 702(d) of ICTA is otiose. Any liabilities which are annual payments will now have to meet only the requirement that they are properly payable out of residue and this is also a requirement of section 701(6) of ICTA. Omitting the remainder of the definition removes unnecessary material. As a consequence of the change, section 701(7) of ICTA, which limits the meaning of "charges on residue" in relation to specific dispositions, does also not need to be rewritten.

1103.     The clause does not contain an ordering rule for allocating allowable estate deductions against different categories of income. It is not considered appropriate to state explicitly that the taxpayer may choose whichever allocation is most advantageous. This is implicit in the clause.

Clause 667: Shares of residuary income of estate

1104.     This clause is based on section 696 of ICTA. It explains the rules for determining the share of residuary income treated as arising from a person's absolute interest in the whole or part of the residue of an estate.

Clause 668: Reduction in share of residuary income of estate

1105.     This clause provides that the share of the residuary income of the estate of a person with an absolute interest is reduced at the end of the administration period in certain circumstances. It is based on sections 4 and 697 of ICTA.

1106.     This is beneficial to a person with an absolute interest because a lower share of the residuary income results in a lower (or no) assumed income entitlement. The clause ensures that the beneficiary is not charged to tax on more income than he or she actually enjoys. The reduction may apply where, for example, the debts of the estate exceed the amount ultimately realised from the capital assets available for their payment and so part of the income received from the assets is also used, leaving only part available for the residuary beneficiary.

1107.     Subsection (2) and (3) provide that if there is an excess within subsection (1), that excess is available to reduce the person's share of the residuary income in the final tax year. If that share is reduced to nil then any remaining excess is available to reduce the share of the residuary income in the previous tax year and so on.

1108.     Subsection (5) provides that, for the purposes of subsection (1)(b), a sum paid during the administration period is grossed up by reference to the basic rate for the tax year in which it was paid in the case of UK estates. And it provides that a sum payable at the end of the administration period is grossed up by reference to the basic rate for the final tax year in the case of UK estates. Section 4(1) of ICTA provides that any provision requiring, permitting or assuming the deduction of income tax shall be construed as referring to deduction or payment of income tax at the basic rate. This has been made explicit in subsection (5) itself.

Clause 669: Reduction in residuary income: inheritance tax on accrued income

1109.     This clause deals with the case where an absolute interest holder is a higher rate taxpayer and income accruing before death has been taken into account both in calculating the residuary income and for inheritance tax purposes. The clause is based on section 699 of ICTA.

1110.     The overlap in the two tax charges may arise where income has accrued before death but is received after death. The clause provides for a reduction in the residuary income in such circumstances.

1111.     Subsections (1) and (2) explain the basic principle. The reduction applies when pre-death income (as defined) is taken into account both in calculating the residuary income of the estate for a tax year and in determining the value of the deceased's estate for inheritance tax purposes.

1112.     Subsection (4) sets out a method statement for calculating the reduction in three steps. For liabilities to be deductible from pre-death income, they have to have affected both the value of the estate for inheritance tax purposes and the residuary income of the estate for the tax year. In the latter case, they might have been deducted in calculating the aggregate income of the estate or have been deducted from the aggregate income in calculating the residuary income.

1113.     Subsections (7) and (8) are administrative provisions. They provide that the amount of inheritance tax chargeable and the value of the estate cannot be reopened once agreed or settled in proceedings. The reference to "the Board" in section 699 of ICTA has been replaced in this clause by "the Inland Revenue" which is defined in clause 878(1). See Change 149 in Annex 1.

1114.     Section 699(6)(b) of ICTA, which provides that references to inheritance tax include references to capital transfer tax, is not rewritten; it is spent.

Clause 670: Applicable rate for determining assumed income entitlement (UK estates)

1115.     This clause sets out the calculation of the applicable rate for the purposes of calculating income tax to be deducted from the residuary income in step 2 of clause 665(1). The clause is based on section 701 of ICTA.

Clause 671: Successive absolute interests

1116.     This clause explains the position where two or more absolute interests in the residue of an estate are held successively by different people. It is based on sections 697 and 698 of ICTA.

1117.     In each tax year in which a payment is made in respect of an absolute interest, it is necessary to calculate the beneficiary's assumed income entitlement. The assumed income entitlement works on a cumulative basis, so the share of the residuary income of the absolute interest holder and the basic amounts of previous tax years are taken into account. In order to give a true picture of the assumed income entitlement of someone who has an absolute interest in succession to another person, the position of the previous holder needs to be brought into the calculations. Otherwise, in certain circumstances, an element of the residuary income might escape taxation.

1118.     Subsections (1) and (2) apply where successively there are different persons with absolute interests in the residue of an estate of a deceased person or in parts of such a residue. They apply primarily for situations where one absolute interest is succeeded by another. This might occur where, for example, an absolute interest holder dies or there is a deed varying the will so that the interest passes for income tax purposes to another beneficiary from the date of the deed etc.

1119.     Subsection (3) contains an ordering rule to ensure that all determinations under subsection (2) or clause 672(2) are made in relation to the person with the earlier interest before the person with the later interest. This subsection has been inserted to make explicit what is already implicit in the source legislation.

1120.     Subsection (4) provides a special rule where there are two or more absolute interests in the final tax year. It is intended to ensure that it is the last absolute interest which is charged to tax on the assumed income entitlement, which will comprise all the residuary income, in the final year. This is because the last absolute interest holder will receive the capital of the residue (and also all outstanding income in respect of it).

1121.     Subsections (5) and (6) contain special rules where clause 668 (reduction in share of residuary income of estate) applies and there are successive absolute interests. These subsections provide that the calculation under clause 668(1)(a) and (b) is to be made by reference to all the absolute interests taken together. Then, after applying the reduction to the last absolute interest under clause 668(1) and (2), any remaining excess is applied to the previous absolute interest holders working backwards from the beginning of the last interest. See Change 109 in Annex 1.

Clause 672: Successive interests: assumed income entitlement of holder of absolute interest following limited interest

1122.     This clause (and clause 673) explains the position of the absolute interest holder where successive limited and absolute interests in the residue of an estate are held by different people. It is based on section 698 of ICTA.

1123.     The clause only applies where the later interests arise or are created on the cessation of the previous interest otherwise than by death (the position of limited interests which cease on the death of the holder before the final tax year are dealt with in clause 654(4)). All sums paid or remaining payable in respect of that interest after the tax year of death are treated as estate income arising in the tax year of death.

1124.     Examples of situations, in relation to limited interests, that are covered by the clause include:

• the disclaiming of a life interest which accelerates an existing interest under the will; and

• an interest which is only held until marriage or attaining a certain age.

1125.     Subsections (3) and (4) contain the two rules introduced by subsection (2). They deal with the limited interest which ceases otherwise than on death. They also explain how such an interest is brought into the calculation of whether the person with the absolute interest has an assumed income entitlement and, if so, its amount. The assumed income entitlement works on a cumulative basis, so the share of the residuary income of the absolute interest holder and the basic amounts of previous years are taken into account.

Clause 673: Successive interests: payments in respect of limited interests followed by absolute interests

1126.     This clause covers the position where the absolute interest holder is entitled to receive payments in respect of a preceding limited interest which has ceased otherwise than on death. It is based on section 698(1A) and (1B) of ICTA.

1127.     Subsection (2) deals with such payments while the absolute interest holder still has the absolute interest. It provides that a payment made to the absolute interest holder in respect of the limited interest is treated as paid in respect of the absolute interest (and not the limited interest). Thus, such payments may form part of the basic amount of estate income in tax years before the final tax year.

1128.     Subsection (3) deals with the position where the holder's absolute interest has itself ceased (but the administration period continues). The approach here is to treat any such sum paid in these circumstances as a payment in respect of the earlier limited interest. The result is that such payments are treated as estate income under the limited interests provisions. But subsection (6) provides that the payments are treated as paid or payable in respect of the absolute interest for the purposes of clause 668 (reduction in share of residuary income of estate).

1129.     The taxation of successive interests in the residue of an estate is dealt with in section 698(1A) to (2) of ICTA. Section 698(1B) of ICTA deals with the case where there were successive interests in an estate which ceased otherwise than on death and the earliest or one of the earlier interests was a limited interest (see section 698(1A) of ICTA).

1130.     Section 698(1B)(a) of ICTA provides that Part 16 of ICTA applies as if all the interests were the same interest ("the deemed single interest"), so that none of them are to be treated as having ceased on being succeeded by any of the others. Section 698(1B)(b) of ICTA then determines who had the deemed single interest. It is either the person in respect of whose interest or previous interest the payment was made (section 698(1B)(b)(i) of ICTA) or a person who has or had an interest and is entitled to receive the payment (section 698(1B)(b)(ii) of ICTA). So a beneficiary who does not give up his or her entitlement to income which is unpaid at the time the interest ceases is taxable on the payment, rather than the person holding the successive interest at the time when the payment is made. However section 698(1B)(b) of ICTA is made subject to section 698(1B)(c) of ICTA. Section 698(1B)(c)(i) of ICTA provides that so far as a later interest is an absolute interest, it is to be treated as having always existed and the earlier interest or interests as having never existed for the purposes of the provisions dealing with absolute interests in section 696(3A) to (5A) of ICTA.

1131.     In rare circumstances the later absolute interest may itself have ceased at the time the payment is made. For example, A has a limited interest which is succeeded by absolute interests held first by B and then by C, and a payment is received by B in respect of A's earlier limited interest after B's own interest has ceased but before the end of the administration period. As a result of section 698(1B)(b)(ii) of ICTA, Part 16 applies to the payment as if B had the deemed single interest. So section 696(3) of ICTA deems the sum to be paid to B as income in the year in which it is actually paid. That is a tax year in which C had the absolute interest. Under section 698(1B)(c)(i) of ICTA for the purposes of section 696(3A) to (5) of ICTA, Part 16 is to apply as if the later interest of C had always existed and the earlier interests had never existed. Section 698(1B)(c)(ii) and (iii) of ICTA then provides that sums paid as income in respect of the earlier interests are deemed to be sums paid in respect of the later interest of C.

1132.     The relationship between these particular provisions where the later interest has itself ceased at the time the payment is made but the administration period continues is difficult to work out. It would seem that the payment in the above example should be taxed on B because of section 696(3) of ICTA. The payment is then brought into account when the payments made in respect of C's interest are compared to his aggregated income entitlement (in making the final year calculation under section 696(5) of ICTA in respect of C's interest to determine whether any amount should be treated as having been paid to C immediately before the end of the administration period). So although section 698(1A) and (1B) of ICTA operate in a very convoluted way in the above circumstances, the end result appears to be that B, the person with the absolute interest who receives the payment, is taxed on it, but it does not affect B's aggregated income entitlement.

1133.     In order to spell out in the legislation how a payment made in these circumstances should be treated, clause 673(3) and (4) provide that where such a payment is made, this Chapter applies as if the earlier limited interest had continued to subsist while the later absolute interest subsisted and had been held by the holder of the later absolute interest. The result is that payments to that holder are treated as estate income under the provisions about limited interests.

1134.     Sums to which that holder is entitled that remain payable at the end of the administration period are treated in the same way. They will be basic amounts arising from the limited interest in the tax year in which the absolute interest ceases and dealt with by clauses 654 and 661. The effect of this on later absolute interests is then determined by the successive absolute interests provisions in clause 671. Under subsection (6) of clause 673, however, these sums are to be treated as paid or payable in respect of the absolute interest for the purposes of the provisions about the reduction in shares of residuary income under clause 668.