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Income Tax (Trading and Other Income) Bill


 

These Notes refer to the Income Tax (Trading and Other Income) Bill as introduced in the House of Commons on 30 November 2004 [Bill 9]

INCOME TAX (TRADING AND OTHER INCOME) BILL


explanatory notes — volume III (SCHEDULES)Schedule 1: Consequential amendments

Part 1: Income and Corporation Taxes Act 1988

Section 1A of ICTA

1.     Section 1A of ICTA is an income tax only provision. As this section is primarily concerned with rates of tax it is not rewritten.

2.     The repeal of Schedule F and Schedule D Cases III, IV, V and VI (for income tax purposes) means that it is now possible to restructure section 1A of ICTA to identify more clearly the types of income within the scope of the section. So, for example, instead of bringing in all income chargeable under Schedule D Case III, and then excluding certain items, it is now possible to focus directly on the income within section 1A of ICTA.

3.     As a result of the revised approach, section 1A(4)(b) of ICTA - dealing with estate income chargeable under section 695(4)(b) or 696(6) of ICTA - can be repealed. Similarly, it is not necessary to retain section 1A(7) of ICTA which effectively brings purchased life annuities within the scope of section 1A of ICTA - such purchased life annuities are now brought in by the consequential amendment to section 1A(2)(a) of ICTA.

Section 9 of ICTA

4.     This Bill deals in substance with income tax only. As a result the income tax and corporation tax codes will be separated to a much greater extent than in the source legislation.

5.     Corporation tax law, in statute, is made up of a combination of express corporation tax provisions and applied income tax principles, law and practice.

[Bill 9—EN] [III]     53/4

6.     The income tax principles, law and practice are applied by section 9 of ICTA .

7.     Section 9 of ICTA, so far as it operates on statutory provisions, operates in the source legislation on both income tax provisions that are rewritten in this Bill and income tax provisions that are not rewritten in this Bill (for example, parts of ITEPA). It also extends to case law and practice.

8.     The amendments to section 9 of ICTA maintain this approach in the context of the greater separation of the two codes. But section 9 of ICTA does not operate on the provisions in this Bill to convert them into provisions of the Corporation Tax Acts, see clause 881.

Section 18 of ICTA

9.     This paragraph amends section 18 of ICTA so that subsections (1) to (4) apply only for corporation tax purposes. The income tax aspects of this provision are rewritten as follows:

Cases I and II

The income charged under Schedule D Case I or II in the source legislation is rewritten for income tax purposes in Chapter 2 of Part 2 of this Bill.

Case III

10.     The income charged under Schedule D Case III in the source legislation is rewritten for income tax purposes in the following places in this Bill:

  • Part 4 - Chapter 2 (interest), Chapter 7 (purchased life annuity payments), Chapter 8 (deeply discounted securities), Chapter 10 (distributions from unauthorised unit trusts); and

  • Part 5 - Chapter 2 (receipts from intellectual property) - but royalties only, Chapter 4 (certain telecommunication rights: non-trading income) and Chapter 7 (annual payments not otherwise charged).

11.     The corporation tax version of Schedule D Case III in section 18(3A) of ICTA will continue to work for corporation tax.

Cases IV and V

12.     Except for foreign dividends, foreign income charged under these Cases in the source legislation has been integrated with the charge on equivalent types of UK income in this Bill for income tax purposes. Foreign dividends charged under Case V in the source legislation is rewritten for income tax purposes in Chapter 4 of Part 4 in this Bill. The Cases continue to operate as amended by section 18 (3A) to (3E) of ICTA for corporation tax purposes.

Case VI

13.     The provisions which are rewritten in this Bill for income tax purposes, and which charge income to income tax under Schedule D Case VI in the source legislation, have been replaced by individual charges on types of income. See the following Parts of this Bill:

  • Part 2 - Chapter 17 (adjustment income: trades, professions and vocations) and Chapter 18 (post-cessation receipts: trades, professions and vocations);

  • Part 3 - Chapter 7 (adjustment income: UK property businesses), Chapter 8 (rent receivable in connection with a UK section 12 concern), Chapter 9 (rent receivable for UK electric-line wayleaves) and Chapter 10 (post-cessation receipts);

  • Part 4 - Chapter 9 (gains from contracts for life insurance etc.), Chapter 11 (transactions in deposits) and Chapter 12 (disposals of futures and options involving guaranteed returns); and

  • Part 5 - clause 579 (royalties and other income from intellectual property), clause 583 (income from disposals of know-how), clause 587 (income from sales of patent rights), Chapter 3 (films and sound recordings: non-trade businesses), Chapter 4 (certain telecommunication rights: non-trading income), Chapter 5 (settlements: amounts treated as income of settlor), clause 682(3) (assessments, adjustments and claims after the administration period) and Chapter 8 (income not otherwise charged).

14.     Additionally, amendments have been made to all of the Schedule D Case VI provisions in ICTA and other enactments which are not being rewritten in this Bill but which apply for income tax purposes (see the table in Part 1 of section 836B of ICTA, inserted by this Schedule, referred to in the amendment in this Schedule for section 392 of ICTA). The amendments remove references to income tax being charged under Schedule D Case VI and create free standing income tax charges. The Schedule D Case VI references have been retained for corporation tax purposes.

15.     Some of the Schedule D Case VI provisions which are not rewritten in this Bill are of an administrative nature. These provisions typically withdraw reliefs and operate under the source legislation by way of an assessment under Schedule D Case VI (see particularly section 30(4) of TMA, sections 307(1), 384(8), 384A(6) and 703(3) of and paragraph 4(2) of Schedule 15B to ICTA and paragraph 27(2) of Schedule 16 to FA 2002). These provisions are rewritten as simple assessments. This is because the provisions that apply generally to income and amounts treated as income charged under Schedule D Case VI (sections 18, 59, 69 and 392 of ICTA) have no application to these provisions.

Section 20 of ICTA

16.     Section 20 of ICTA, Schedule F, is rewritten in Chapter 3 of Part 4 of this Bill (dividends etc. from UK resident companies etc.). It is repealed for all tax purposes.

Section 20(1) paragraph 1 of ICTA - the Schedule F charging provision

17.     Section 20(1) paragraph 1 of ICTA is an income tax only provision. It therefore applies directly to persons subject to income tax (unless they are dealers or certain individual members of Lloyd's in which case they are taxed under Schedule D Case I or II).

18.     As an income tax only provision, section 20(1) paragraph 1 of ICTA does not directly apply to persons subject to corporation tax. This is clear from the wording of section 20(1) paragraph 1 of ICTA itself but confirmation of this is also given by section 6 of ICTA.

19.     Therefore, section 20(1) paragraph 1 of ICTA could only apply to corporation tax indirectly, that is, via section 9 of ICTA.

20.     However, section 9 of ICTA is subject to exceptions. On one interpretation of the legislation section 208 of ICTA is one such exception.

21.     Applying this interpretation, where section 208 of ICTA applies section 9 of ICTA does not and so section 20(1) paragraph 1 of ICTA cannot apply.

22.     An alternative interpretation is that section 208 of ICTA is not an exception to section 9 of ICTA but an exemption from corporation tax on dividends charged under Schedule F.

23.     Applying this interpretation, section 9 of ICTA applies and so section 20(1) paragraph 1 of ICTA applies, but section 208 of ICTA prevents the dividend from being chargeable to corporation tax.

24.     On either interpretation, if section 208 of ICTA applies there is no liability under section 20(1) paragraph 1 of ICTA. Conversely, if section 208 of ICTA does not apply, there is.

25.     There are three exceptions to section 208 of ICTA. These are:

  • section 95(1A)(c) of ICTA (dealers);

  • section 219(4A) of FA 1994 (Lloyd's underwriters); and

  • section 434(1) of ICTA (franked investment income and life assurance profits).

26.     However, in each case Schedule F does not apply. Instead, dividends and other distributions are taxed under Schedule D Case I or Schedule D Case VI.

27.     There are therefore no instances where a body corporate acting in a beneficial capacity is chargeable to corporation tax under section 20(1) paragraph 1 of ICTA.

Section 20(1) paragraph 2 of ICTA - the income chargeable

28.     Section 20(1) paragraph 2 of ICTA determines the income chargeable and is expressed to apply for "all purposes of the Tax Acts". It therefore applies directly to a company subject to corporation tax unless there is an express provision to the contrary.

29.     Section 20(1) paragraph 2 of ICTA is expressly disapplied in the case of:

  • dealers;

  • Lloyd's underwriters; and

  • certain life assurance companies.

30.     Where section 20(1) paragraph 2 of ICTA might otherwise be relevant, that is, in order to establish that income is the aggregate of the dividend etc and the tax credit (for example, under section 13 of ICTA (small companies' relief), in connection with the surplus ACT rules etc), the relevant legislation uses the term "franked investment income". Franked investment income is defined in almost identical terms as section 20(1) paragraph 2 of ICTA.

31.     Section 20(1) paragraph 2 of ICTA therefore serves no practical purpose in a corporation tax context.

Section 20(2) of ICTA -priority provision

32.     Section 20(2) of ICTA applies to a distribution "which is chargeable under Schedule F". It does not therefore apply in a corporation tax context because section 20(1) paragraph 1 of ICTA does not apply.

Section 20(3) of ICTA - signpost

33.     In a corporation tax context, section 20(3) of ICTA introduces Part 6 of ICTA but this introduction is no longer required.

Replacement expressions for special tax rates

34.     The following replacement terms are used:

  • Schedule F ordinary rate becomes "dividend ordinary rate";

  • Schedule F upper rate becomes "dividend upper rate"; and

  • Schedule F trust rate becomes "dividend trust rate".

Section 60 of ICTA

35.     This paragraph omits section 60 of ICTA and the section is repealed by Schedule 3 of this Bill

36.     Section 60(4) of ICTA deals with the death of a taxpayer. It ensures that on the death of a person carrying on a trade the necessary cessation adjustments can be made, and the tax collected from the personal representatives.

37.     The rule in section 60(4) of ICTA dates from the time when adjustments on cessation could involve not only an adjustment for the year of death (the assessment for which might already have been made on a previous year basis) but also adjustments to the two previous years to increase the amount of the assessments to the profits of those years on a current year basis.

38.     Under Self Assessment any return of income for the year of death will naturally take account of the death. And there is no question of adjusting assessments for previous years on account of the death.

39.     The general rule in section 74 of TMA (that the personal representatives inherit the tax liabilities of the deceased) is enough. There is no need for the special rule in section 60(4) of ICTA for trade profits.

40.     See also the commentary on the repeal of section 113(6) of ICTA.

Section 71 of ICTA

41.     This paragraph omits section 71 of ICTA and that section is repealed in Schedule 3 to this Bill.

42.     Section 71 of ICTA applies to all the Cases of Schedule D when a preceding year basis of assessment applies. It provides that a person will remain chargeable in a year when no income from the relevant source arises. It is based on section 22 of FA 1928 which was enacted in response to the House of Lords decision in Whelan v Henning (1926), 10 TC 263 to the effect of "no income in year of assessment, no liability to tax".

43.     There is no longer a preceding year basis of assessment for any Schedule D Case. So the provision is redundant.

Section 74 of ICTA

44.     Section 74(1) of ICTA lists various items in respect of which no deduction is allowed in computing profits to be charged under Schedule D Case I or II.

45.     Section 74(1)(b) of ICTA prohibits deductions in respect of expenditure on "maintenance of the parties, their families or establishments, or any sums expended for any other domestic or private purposes distinct from the purposes of the trade, profession or vocation".

46.     Section 74(1)(b) of ICTA is not rewritten for income tax purposes because the deductions which it prohibits are covered by clause 34 which rewrites the general prohibition on deductions not "wholly and exclusively laid out for the purposes of the trade, profession or vocation" in section 74(1)(a) of ICTA. And because it applies only to individuals, there is no need to preserve section 74(1)(b) of ICTA. It is therefore omitted.

47.     Section 74(1)(h) of ICTA prohibits deductions for interest forgone on capital used in the trade or in improving the trade premises. It is unlikely that any accounts drawn up in accordance with generally accepted accounting practice would include a deduction for notional interest. Section 74(1)(h) of ICTA is not rewritten for income tax purposes as it is considered to be redundant.

48.     Section 74(1)(k) of ICTA prohibits deductions for "any average loss beyond the actual amount of loss after adjustment". This rule applies to the practice in shipping and aviation trades of sharing between all parties with a financial interest in a vessel and its cargo the financial loss incurred where part of a vessel or its cargo is lost or damaged in an attempt to save the vessel, the crew and passengers or the rest of the cargo. The term "average loss" is applied to the share of the loss allocated to each party. The amount of the average loss "after adjustment" may not be known for some years after the actual loss has occurred.

49.     Section 74(1)(k) of ICTA is not rewritten for income tax purposes. This allows the tax treatment of the average loss to follow the generally accepted accountancy practice in such cases. This is to make a provision in the year of loss and to review that provision in subsequent years.

50.     Section 74(1)(m) of ICTA prevents a deduction for any annuity and other annual payment "payable out of the profits". Because the rule applies only to amounts payable "out of the profits", it has no application to the calculation of those profits. The rule is not rewritten for income tax purposes.

51.     Section 74(1)(o) of ICTA prevents a deduction in calculating trade profits for any interest that has qualified for Mortgage Interest Relief At Source. When MIRAS was available for mortgage interest generally this rule against double deductions served an important function. Since 1999 MIRAS has been available only on loans to buy a life annuity and secured on the private residence of a person aged 65 years or over. The relief is given only to loans in existence on 9 March 1999 or replacement loans.

52.     It is very unlikely that any interest would satisfy the conditions to qualify both for MIRAS and as a deduction in calculating trade profits. For this reason this Bill does not rewrite section 74(1)(o) of ICTA.

Section 82 of ICTA

53.     There are two reasons for repealing this section:

  • the section no longer achieves its original purpose; and

  • the section is, in part, out of step with modern tax principles.

54.     Section 82 of ICTA is a complex provision which prevents a deduction in computing trade profits for payments of annual interest to a non UK resident except in two circumstances.

55.     The first is when the payer has made the payment as required by section 349(2) of ICTA under deduction of tax and has accounted to the Inland Revenue for the tax: section 82(1)(a) of ICTA. (This is interpreted to include payments within section 349(2) of ICTA made gross solely because of a double taxation agreement.)

56.     The second is when the interest is not within section 349(2) of ICTA but is paid by a UK resident trader under a liability incurred exclusively for the purposes of the trade. The interest has to be payable and paid outside the United Kingdom and either incurred for the purposes of activities outside the United Kingdom or paid in foreign currency: section 82(1)(b) of ICTA.

57.     Section 82 of ICTA originates from FA 1949. At the time it was introduced annual interest was not a permitted trading deduction: relief was obtained by the payer deducting income tax before paying the interest. But in certain circumstances, notably where the source of the interest was outside the United Kingdom, the payer could not legally deduct tax and could therefore get no effective relief for the interest. So what is now section 82(1)(b) of ICTA was introduced to give relief by allowing the gross payment as a Schedule D Case I or II deduction.

58.     FA 1969 ended deduction of tax at source from most interest paid and with it the general relief for interest paid that the deduction at source system gave. New rules were introduced which gave relief for interest only on loans for particular purposes, mainly the purchase or improvement of land. Where, however, the interest was for a trading purpose it could be deducted in computing trading profits.

59.     The FA 1969 reforms preserved deduction of tax at source for payments of annual interest only in a limited number of circumstances and the tax deducted had to be paid over to the Inland Revenue (rather than be retained by the payer). One such circumstance was when it was paid to a person whose usual place of abode was outside the United Kingdom. It was recognised that what is now section 82(1)(b) of ICTA could no longer operate as an exception to the former general rule against allowing interest as a deduction in computing trading profits: that rule had gone. But it was preserved in a form which allowed a deduction only when its original conditions were satisfied. In addition, what is now section 82(1)(a) of ICTA was grafted onto it as new legislation to take account of the new deduction at source rule.

60.     The current position is that what started life as a permissive provision, allowing relief as a trading deduction in circumstances where none would otherwise have been available, has become a restrictive one. It restricts relief where, on general principles, it would otherwise be due: interest paid gross would normally have to satisfy only the "wholly and exclusively" test in section 74(1)(a) of ICTA to be deductible. The linking of a right to deduction as a trading expense with the obligation to deduct tax on payment does not reflect modern principles of determining deductibility of trade expenses.

61.     The section no longer fulfils any practical purpose and is therefore redundant.

Section 86 of ICTA

62.     This section allows a person carrying on a trade to deduct the cost of an employee who is seconded to a charity or educational establishment in calculating the profits of the trade.

63.     Section 86(5) of ICTA lists educational establishments in Scotland for the purposes of relief under section 86 of ICTA. Section 86(5)(d) of ICTA refers to "a self-governing school within the meaning of the Self-Governing Schools etc (Scotland) Act 1989"

64.     Section 86(5)(d) of ICTA is not rewritten for income tax purposes because such schools were abolished on 1 April 2003. But there is a transitional rule in Part 3 of Schedule 2 to this Bill to deal with the case of a secondment being relevant to a period of account ending on or after 6 April 2005.

Section 89 of ICTA

65.     Section 89 of ICTA is not rewritten for income tax purposes. See the commentary on clause 35 and Change 7 in Annex 1.

Section 92 of ICTA

66.     Section 92 of ICTA applies to regional development grants under Part 2 of the Industrial Development Act 1982. The Industrial Development Act 1982 was repealed by the Statute Law (Repeals) Act 2004 with effect from 22 July 2004. No applications under Part 2 of the 1982 Act could be made after 31 March 1988 and there are no payments outstanding in respect of grants made before that date. So section 92 of ICTA is not rewritten for income tax purposes.

Section 113 of ICTA

67.     This paragraph omits section 113 of ICTA and the section is repealed in Schedule 3 to this Bill.

68.     Section 113(1) of ICTA applies to trade profits. But it is extended to property businesses by section 21B of ICTA. It ensures that a trade is treated as ceasing when there is a change in the persons carrying it on. The need for the rule arises from the fact that some rules in ICTA are expressed in terms of the commencement and cessation of a trade, rather than the position of the person carrying it on.

69.     The rewritten basis period rules in Chapter 15 of Part 2 of this Bill are expressed in terms of the person carrying on the trade. Other rules that depend on the commencement or cessation of a trade are also rewritten in terms of the person carrying on the trade.

70.     So there is no need for a special rule deeming there to be a cessation where the trade is carried on by a successor.

71.     In many cases, a rule in ICTA is explicit that a change in the persons carrying on a trade to which section 113(1) of ICTA applies is to be treated as a cessation for the purposes of the rule: for instance, the post-cessation receipts rules in sections 103 to 109A of ICTA (see section 110(2)(a) of ICTA).

72.     In other cases there is no explicit indication that section 113(1) of ICTA applies to treat the trade as ceasing. In each of the following clauses the rewritten rule makes it clear that the trade is not treated as ceasing unless there is a complete change in the persons carrying it on. This retains the effect of section 113(1) of ICTA as limited by section 113(2):

  • Clause 77: Payments in respect of employment wholly in employer's trade;

  • Clause 79: Additional payments;

  • Clause 173: Valuation of trading stock on cessation; and

  • Clause 182: Valuation of work in progress on cessation.

73.     Section 113(6) of ICTA deals with the death of a taxpayer. It ensures that on the death of a person carrying on a trade the necessary cessation adjustments can be made and the tax collected from the personal representatives.

74.     The rule in the subsection dates from the time when adjustments on cessation could involve not only an adjustment for the year of death (the assessment for which might already have been made on a previous year basis) but also adjustments to the two previous years to increase the amount of the assessments to the profits of those years on a current year basis.

75.     Under Self Assessment any return of income for the year of death will naturally take account of the death. And there is no question of adjusting assessments for previous years on account of the death.

76.     The general rule in section 74 of TMA (that the personal representatives inherit the tax liabilities of the deceased) is enough. There is no need for the special rule in section 113(6) of ICTA for trade profits (or property income, to which it is applied by section 21B of ICTA).

77.     See also the commentary on the repeal of section 60(4) of ICTA.

 
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