Clause 710: Treatment of shares where annual acquisition limit

exceeded

1276.     This clause is based on paragraph 8 of Schedule 15B to ICTA and provides an ordering rule to determine which shares are treated as within the annual acquisition limit (referred to as "exempt shares") if that limit is exceeded in a tax year.

1277.     Subsection (2) provides the basic rule, that shares are treated as exempt shares if immediately after their acquisition the annual limit is not exceeded.

1278.     Subsection (4) deals with the situation where the limit is exceeded on a day in which shares of different descriptions are acquired. In that case the appropriate proportion of shares of each description are treated as exempt shares.

Clause 711: Identification of shares after disposals

1279.     This clause is based on paragraph 8 of Schedule 15B to ICTA and sets out the share identification rules for disposals of shares in a VCT.

1280.     The first rule (subsection (1)) provides the assumption that non-VCT shares are disposed of before VCT shares.

1281.     The second rule (subsection (2)) applies if the annual acquisition limit is exceeded and some shares are disposed of. Clearly an investor will want to know whether the shares falling within the annual acquisition limit are disposed of or whether the other shares (referred to as "excess shares") are disposed of. The clause sets out the assumptions to apply. Shares acquired on an earlier day are treated as disposed of before shares acquired on a later day (see subsection (3)); if the shares are acquired on the same day, excess shares are treated as disposed of first (see subsection (4)).

1282.     Subsection (5) is based on section 60 TCGA, incorporating the rule relating to acquisitions and disposals by a person's nominee, and acquisitions and disposals between a person and his nominee.

Clause 712: Identification of shares after reorganisations etc.

1283.     This clause deals with the identification of shares following a reorganisation etc, for example, where there has been a bonus issue of shares or where there has been an issue of shares falling within section 135 or 136 TCGA. It is based on paragraph 8(3) and (4) of Schedule 15B to ICTA and sets out three rules.

1284.     The first rule (subsection (2)), is that any "new shares" acquired as a result of the reorganisation etc. are treated as satisfying the conditions for exempt shares set out in clause 709(4) and, if relevant, clause 709 (6), if the "old shares" satisfied those conditions. Dividends paid in respect of the new shares therefore qualify for the income tax exemption under this Chapter.

1285.     The condition in clause 709(6) relates to shares acquired on or after 9 March 1999. If the "old shares" were acquired before 9 March 1999 the new shares do not need to satisfy the condition in clause 709(6). The source legislation refers only to the new shares being treated as satisfying the annual acquisition condition. The addition of the reference to the commercial reasons condition is a change to the law but not to policy. See Change 115 in Annex 1.

1286.     The second rule (subsection (3)) is that if only a proportion of the "old shares" met the condition about the annual acquisition limit or the commercial reasons test then only the corresponding proportion of the "new shares" are treated as doing so. It follows that the remainder of the new shares are treated as not doing so. So dividends paid in respect of those shares would not qualify for the income tax exemption under this Chapter.

1287.     The source legislation is silent as to whether "new shares" in excess of that corresponding proportion ("excess new shares") get another chance to qualify as exempt shares if any of the current year's annual acquisition limit remains available.

1288.     For example, in the tax year in which the "new shares" are issued (say with a value of £150,000 of which £100,000 qualify under the corresponding proportion rule) further shares are acquired to a value of say £100,000. The issue is whether the £50,000 new shares which did not qualify under the corresponding proportion rule can be treated as falling within the annual acquisition limit because £100,000 of the current year's annual acquisition limit remains available.

1289.     Paragraph 8(4)(a) of Schedule 15B to ICTA ensures that the excess new shares are disregarded in determining whether acquisitions, made during the same tax year as the excess new shares are issued, come within the annual acquisition limit. The position of the excess new shares is dealt with solely under paragraph 8(4)(b) of Schedule 15B to ICTA. That sets out the extent the new shares are to be treated as acquired within the permitted maximum by reference to the status of the shares from which they are derived, that is, the proportionate basis. If they do not qualify under that provision, they do not qualify at all.

1290.     It is not thought to be the intention of the legislation that excess new shares should have a second chance of being treated as falling within the permitted maximum. So subsection (3) provides explicitly that the remaining new shares are not treated as meeting the conditions to qualify for the income tax exemption. This is implied but not expressly stated in the current legislation.

1291.     The third rule (subsection (4)) provides that the new shares are ignored in determining whether other shares acquired in the same tax year qualify for the income tax exemption.

Chapter 6: Income from FOTRA securities

Overview

1292.     This Chapter provides for exemption from income tax in respect of United Kingdom government securities which are beneficially owned by persons who are not resident in the United Kingdom. Such securities are described as being "Free of Tax to Residents Abroad" or "FOTRA securities". The clauses are based on section 154 of FA 1996 and section 161 of FA 1998.

1293.     The beneficial owner of a FOTRA security may be entitled to an exemption from income tax in any of the following three situations:

• a person holding the security as an investment may be exempt from tax on the interest arising on the security;

• a dealer holding the security in circumstances where a profit on sale would be regarded as a trading receipt may be exempt from tax on the interest arising on the security; or

• a dealer holding the security in circumstances where a profit on sale would be regarded as a trading receipt may be exempt from tax on the profit arising from a purchase and sale of the security.

1294.     It is not intended to rewrite section 22(1) of F(No 2)A 1931, section 60(1) of FA 1940 or section 154(1) of FA 1996. These provisions all concern the Treasury's powers to issue securities. The first two provisions were left untouched in the 1952, 1970 and 1988 consolidations.

Clause 713: Introduction: securities free of tax to residents abroad ("FOTRA securities")

1295.     This clause sets out the scope of the Chapter. It is based on section 154(8) of FA 1996 and section 161 of FA 1998.

1296.     Subsection (2) sets out the three different classes of FOTRA securities. Each class of FOTRA security has its own distinct rules.

1297.     Subsection (3) to (6) define the term "the exemption condition" used in this Chapter. There are different definitions for each of the three classes of FOTRA securities in subsection (2).

Clause 714: Exemption of profits from FOTRA securities

1298.     This clause sets out the conditions that must all be met if the exemption is to apply. It is based on section 154 of FA 1996. As the exemption can apply, in certain circumstances, to trading income as well as to interest (see overview to this Chapter), the general word "profits" has been used in subsection (1) rather than a more limited word such as "interest".

1299.     Subsection (6) deals with two exceptions from the general exemption in subsection (1). These exceptions apply whatever the exemption condition relating to the FOTRA security provides.

Clause 715: Interest from FOTRA securities held on trust

1300.     This clause reflects an Inland Revenue practice to regard the interest from a FOTRA security held in trust as exempt (and the beneficial ownership test in the exemption condition as satisfied) where none of the beneficiaries of the trust is ordinarily resident in the United Kingdom at the time when the interest arises. See Change 116 in Annex 1. It is new. The clause refers to "interest" and not "profits" because this reflects the Inland Revenue practice. It is not likely that trading profits or any other kind of income (apart from interest) could arise in respect of FOTRA securities held in trust.

Clause 716: Restriction on deductions etc. relating to FOTRA securities

1301.     This clause prevents a deduction relating to a FOTRA security being taken into account for income tax purposes where the beneficial owner is exempt from tax. It is based on section 154(6) of FA 1996.

Chapter 7: Purchased life annuity payments

Overview

1302.     This Chapter rewrites the purchased life annuity provisions in sections 656 to 658 of ICTA.

1303.     Early case law established that the whole of an annuity payment received by an annuitant is chargeable to income tax (see, for example, the speech of the Lord President (Inglis) in Coltness Iron Co v Black (1881), 1 TC 287, 308, HL, which was cited with approval by Lord Wilberforce in CIR v Church Commissioners for England (1976), 50 TC 516, 566) HL. So there was a contrast between income tax law (where the whole of the payment is regarded as taxable income) and the commercial world (where a part of the payment is regarded as a return of capital).

1304.     In 1954 the Report of the Committee on the Taxation Treatment of Provisions for Retirement (Cmd. 9063) recommended changing the law so that only the income element in an annuity payment should be charged to income tax. Sections 27 and 28 of FA 1956 therefore provided for purchased life annuities to be regarded as containing both an income element (chargeable to income tax) and a capital element (not chargeable to income tax). The 1956 legislation, with subsequent amendments, appears in the source legislation as sections 656 to 658 of ICTA.

1305.     Section 656(1) of ICTA provides:

.. a purchased life annuity shall, for the purposes of the provisions of the Tax Acts relating to tax on annuities and other annual payments, be treated as containing a capital element and, to the extent of that capital element, as not being an annual payment or in the nature of an annual payment; but the capital element in such an annuity shall be taken into account in computing profits or gains or losses for other purposes of the Tax Acts in any circumstances in which a lump sum payment would be taken into account.

1306.     The purpose of treating the annuity payment as containing a capital element and then treating that capital element as not being an annual payment, is to ensure the capital element is not charged to income tax. These propositions are rewritten as an exemption from income tax (see clause 717). Additionally, as the annuity payment is not treated as an annual payment or in the nature of an annual payment, that part of the payment is outside the scope of the deduction of tax at source rules (sections 348 and 349 of ICTA). This element of section 656(1) of ICTA is dealt with by the general disregard (see clause 783).

1307.     The purpose of the second limb of section 656(1) of ICTA is to ensure that a trader for whom the annuity would represent a trading receipt cannot exclude the capital element from the trader's Schedule D Case I tax computation. This is dealt with for traders liable to income tax by the combined effect of the priority rule for trading income (see clause 366(1) which gives Part 2 of this Bill charging priority over Part 4 of this Bill) and subsection (1) of clause 717. Clause 717(1) only exempts from income tax annuity payments charged to tax under Chapter 7 of Part 4 of this Bill. So if the annuity payments are not charged to tax under Chapter 7 of Part 4 they cannot benefit from the exemption in Chapter 7 of Part 6 of this Bill.

1308.     The annuity payments made under a purchased life annuity are generally regarded as investment income in the recipient's hands and are therefore charged to tax under Chapter 7 of Part 4 of this Bill. This Chapter deals with the exemption from income tax in respect of annuity payments charged under that Chapter. Annuities taxed under another part of the Bill such as Chapter 7 of Part 5, or under other legislation are outside the scope of this Chapter.

Clause 717: Exemption for part of purchased life annuity payments

1309.     This clause is based on section 656 of ICTA and sets out the extent of the exemption.

1310.     Subsection (1) sets out the exemption and makes it clear that an annuity payment is only exempt to the extent provided in section 719.

1311.     Subsection (2) makes it clear that not all annuity payments made under a purchased life annuity are exempt and signposts clause 718 which sets out the excluded annuities.

1312.     The Inland Revenue does not interpret "annual payment" in section 656(1) of ICTA as restricted to annual payments chargeable under Schedule D Case III. So the exemption is not dependent on the source of the annuity payment. Foreign annuity payments may therefore benefit from the exemption.

1313.     Subsection (3) indicates that a claim needs to be made for the exemption to apply but does not specify to whom that claim is made. Clause 878(4) draws attention to the rules in the TMA, which apply for the purposes of the Bill. Those rules require claims to be made to "an officer of the Board." See Change 149 in Annex 1.

1314.     The requirement for a claim is not in the source legislation but is in secondary legislation supporting sections 656 to 658 of ICTA (see regulation 4 of the Income Tax (Purchased Life Annuities) Regulations 1956 SI 1956/1230, as amended) ("the 1956 Regulations"). The claim provision has been promoted to primary legislation. That will change the status of the provision as it will no longer be possible to change it or revoke it through further regulations. See Change 117 of Annex 1.

Clause 718: Excluded annuities

1315.     This clause rewrites section 657(2) of ICTA, which sets out the annuities to which section 656 of ICTA does not apply. Not all of the annuities listed in section 657(2) of ICTA are specified. Some of the annuities referred to in section 657(2) of ICTA are excluded from the exemption in clause 717 by the combined effect of the priority provisions (see clause 366(3) which gives ITEPA charging priority over Part 4 of this Bill) and subsection (1) of clause 717. Clause 717(1) only exempts from income tax annuity payments charged to tax under Chapter 7 of Part 4 of this Bill. So if the annuity payments are not charged to tax under Chapter 7 of Part 4 of this Bill they cannot benefit from the exemption in this Chapter. It follows that the annuity payments made under the annuities set out in section 657(2) of ICTA which are not charged to tax under Chapter 7 of Part 4 of this Bill do not need to be mentioned. Clause 718 therefore lists only those annuity payments made under annuities excluded by section 657(2) of ICTA and charged to tax under Chapter 7 of Part 4 of this Bill.

1316.     Additionally, section 657(2)(a) of ICTA is not rewritten. That section provides that section 656 does not apply to:

any annuity which would, apart from that section, be treated for the purposes of the provisions of the Tax Acts relating to tax on annuities and other annual payments as consisting to any extent in the payment or repayment of a capital sum.

1317.     Section 657(2)(a) appears to be designed to exclude "annuity" payments which, on the analysis in Perrin v Dickson (1924), 14 TC 608 CA, represent interest together with capital repayments. This case concerned a contract under which, in return for a series of annual premiums, an assurance society undertook to pay an "annuity" for seven years if a named individual should live that long. In the event of the individual's death the total amount of the premiums paid, without any interest, less any amount paid by way of "annuity", was to be repaid. The individual survived and it was held in the Court of Appeal that the payments received did not constitute an annuity for income tax purposes. Tax was chargeable only on so much of the payments as constituted interest on the original payments.

1318.     On a proper analysis, however, the payments are not really "annuity" at all, even if that is what they were called. And if contracts of the type considered in Perrin v Dickson do not give rise to annual payments it is difficult to see what purpose section 657(2)(a) of ICTA is intended to serve.

1319.     No true annuity which would need to be excluded in this way from the relief provided by section 656 has been discovered. Section 656(2)(a) of ICTA is otiose and has therefore been dropped.

Clause 719: Extent of exemption under section 717

1320.     This clause sets out the rules to work out the method of calculating the amount that is exempt from tax. The method varies according to the type of purchased life annuity involved. Sometimes a constant proportion of the annuity payment is exempt and sometimes a constant fixed sum is exempt.

1321.     By definition (see clause 423) the term of every purchased life annuity is dependent on the duration of a human life. The amount of the annuity payment may also be dependent on the duration of a human life. However, either might also be dependent on some other contingency.

1322.     Subsections (1) and (2) set the scene by explaining that the method of calculating the amount that is exempt is determined by two factors: the amount of the annuity payments and the term of the annuity.

1323.     The first step is to determine whether a constant proportion of each annuity payment is exempt or whether a constant sum is exempt. This depends on whether or not the amount of the annuity payments depends solely on the duration of a human life or lives (see subsection (2)(a)).

1324.     If the amount of the annuity payments does depend solely on the duration of a human life or lives, subsection (3) provides that a constant proportion of the annuity payment is exempt. This has been called the "exempt proportion".

1325.     If the amount of the annuity payments does not depend solely on the duration of a human life or lives (in other words the amount depends additionally on a non-life contingency) subsection (4) provides that a constant sum is exempt (assuming the period covered by each payment is the same). This has been called the "exempt sum".

1326.     Under the type of purchased life annuity covered by subsection (4) it is possible for the exempt sum to exceed the amount of a particular annuity payment. ESC A46 deals with this by allowing the excess of the exempt sum over the gross annuity payment to be carried forward and added to the exempt part of the next payment. Subsection (5) legislates ESC A46. See Change 119 in Annex 1. Special provision has also been included in Schedule 2 to deal with the carry forward of excess capital elements which accrued before 6 April 2005.

1327.     The next step is to work out the exempt proportion or the exempt sum. This depends on whether or not the term of the annuity depends solely on the duration of a human life or lives.

1328.     If the term of the annuity does depend solely on the duration of a human life or lives, subsection (7) points the way to the two provisions containing the formulae for calculating the exempt proportion or the exempt sum. Under virtually all purchased life annuities, the term of the annuity depends solely on the duration of a human life or lives.

1329.     But if the term of the annuity also depends on a non-life contingency, subsection (8) explains that the exempt proportion or the exempt sum is calculated on a just and reasonable basis. In making this calculation, account must also be taken of the additional contingencies and the relevant formula. Although the source legislation refers to a "just" basis of calculation, just and reasonable is used in subsection (8) in line with the approach which has been adopted throughout the Bill that all apportionments are on a just and reasonable basis. See Change 14 in Annex 1.

1330.     If both the amount of the annuity payment and the term of the annuity (in addition to depending on the duration of human life) depends on a non-life contingency, section 656(3)(b) and (e) of ICTA provide for the exempt capital element of each payment to be computed as a constant proportion. But, as section 656(2) of ICTA recognises, actuarial techniques do not provide any mechanism for calculating the (exempt) capital element as a constant proportion if the amount of the annuity payment is dependent on a non-life contingency. So clause 719(4) provides for the exempt sum method to apply in this case. See Change 118 in Annex 1. And, as it will be possible for the exempt sum to exceed the annuity payment, ESC A46 has been extended so that it too applies. See Change 119 in Annex 1.

Clause 720: Exempt proportion: term dependent solely on duration of life

1331.     This clause sets out the formula for calculating the exempt proportion of an annuity payment for the most common type of annuity, that is, an annuity whose term and the amount of the annuity payments, depend solely on the duration of a human life or lives.

1332.     Under this type of annuity the amount of the annuity payment may change, but only in a pre-determined way. For example, the amount may increase by a fixed percentage at set intervals or, if written on two lives, may reduce on the first death. The method of calculation calculates the exempt part as a constant proportion of each annuity payment and thus caters for increases and decreases in the amount of the annuity payments.

1333.     The source legislation does not set out how the actuarial value is to be calculated. However, the source legislation ensures a consistent approach is adopted by setting out when the value is to be calculated (see section 656(4)(c) of ICTA rewritten as subsection (3)) and requiring (see section 656(4)(c) and (7)(b) of ICTA rewritten as subsection (4)) that:

• the same tables of mortality are always used (the tables prescribed by the regulations are those comprised in Table A8 set out in Appendix A on pages 113 to 115 of the booklet entitled "Continuous Mortality Investigation Reports Number 10" published by the Institute of Actuaries and the Faculty of Actuaries in 1990 (regulation 6 of the 1956 Regulations));

• the age of the person during whose life the annuity is payable is taken as a whole number of years; and

• no discount is given in arriving at the present value of a future payment.

1334.     Subsection (4)(b) reflects Inland Revenue practice (which follows actuarial practice). See Change 120 in Annex 1.

Clause 721: Exempt sum: term dependent solely on duration of life

1335.     This clause sets out the formula for calculating the exempt sum where:

• the term of the annuity does not depend on any contingency other than the duration of a human life or lives; but

• the amount of the annuity payments does depend on some contingency other than the duration of a human life or lives.

1336.     Under this type of annuity the amount of the annuity payment may change in an unpredictable way. As changes in the amount of the annuity payments are unpredictable, any actuarial valuation of them would be virtually impossible. So the exempt part of each annuity payment is calculated as a constant sum.

1337.     An example of an annuity of this type is an index linked annuity where the amount of the annuity fluctuates with movements in the Retail Prices Index. Initially the return under this type of annuity is low and the annuity payments may fall short of the amount of the exempt sum. With inflation the amount of the annuity payments is likely to rise and in due course to overtake the amount of the exempt sum.

1338.     The term of the annuity can only be predicted by an actuarial calculation. Again a consistent approach to that calculation is ensured by subsections (3) and (4) (see further the commentary on clause 720(3) and (4)).

Clause 722: Consideration for the grant of annuities

1339.     This clause contains rules to deal with the case where the purchase of the annuity is part of a composite transaction. It is based on section 656(4) of ICTA.

1340.     For example, capital protected annuities, which provide for the return on death of the purchase consideration less the annuity payments made to date, could be regarded as a composite of an annuity and a life insurance. However, under subsection (2) the consideration given for a capital protected annuity is treated as given for the annuity alone.

1341.     Subsections (3) and (4) provide for the consideration to be apportioned on a just and reasonable basis. Although the source legislation refers to apportionment on a "just" basis, just and reasonable is used in subsections (3) and (4) in line with the approach which has been adopted throughout the Bill that all apportionments are on a just and reasonable basis. See Change 14 in Annex 1