Change 1: Income taxed as trade profits: omit the words "immediately derived from" in the identification of the foreign income to which the trade profit rules apply: clause 7

This change omits the words "immediately derived from" in the identification of the foreign income to which the trade profit rules apply.

Section 65(3) of ICTA deals with the calculation "under Case IV or V of Schedule D" of profits "immediately derived .. from the carrying on .. of any trade ..". Those words date from FA 1907.

For trading income generally, this Bill refers simply to the profits of a trade.

The change brings the rules for calculating all foreign trade profits (whether "immediately derived" or not) into line with the rules for calculating trade profits within Schedule D Case I. It is in line with the general approach of the source legislation in applying the same calculation rules to foreign and United Kingdom trades.

In the case of foreign trade profits that are not immediately derived from the carrying on of a trade, the income will be calculated in accordance with the trade profit rules, instead of being "computed on the full amount of the income arising" as in section 65(1) of ICTA. There is unlikely to be any practical difference.

If the foreign trade profits that are not immediately derived from the carrying on of a trade are profits of an overseas property business the profits will instead be charged as trade profits.

This change is adverse to some taxpayers and favourable to others in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 2: Profits of mines, quarries and other concerns: clause 12

This change identifies three consequences of the approach taken to the rewrite of section 55 of ICTA.

Section 55 of ICTA provides that profits arising out of land in the case of certain listed concerns shall be charged to tax under Schedule D Case I. The concerns listed include mines, quarries, railways and canals.

Section 55 of ICTA is rewritten as clause 12. It treats the profits and losses of the concern as if they were the profits or losses of a trade. This has three consequences.

(A) Section 55 of ICTA does not specify how the profits to be taxed under Schedule D Case I are to be calculated. Treating the profits and losses of the concern as if they were the profits or losses of a trade makes clear that the profits are calculated in the same way as trade profits. This means that the calculation rules in Part 2 of the Bill will apply. In particular the starting point for the calculation of the profits is generally accepted accounting practice.

(B) Section 55 of ICTA does not identify what profits are to be taxed for the tax year. In practice many taxpayers use the profits of the basis period. Treating the profits of the concern as if they were profits of a trade gives this practice statutory effect. A taxpayer who, under the current law, returns the profits of the tax year can retain this treatment by adopting a 5 April accounting date.

(C) Section 55 of ICTA refers only to profits. In practice loss relief is allowed for losses of concerns as if they were trade losses. Clause 12(1) gives that practice statutory effect by referring to both the profits and losses of the concern.

This change is adverse to some taxpayers and favourable to others in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 3: Caravan sites where trade carried on: clause 20

This change gives statutory effect to ESC B29 (caravan sites where there is both trading and letting income).

ESC B29 states:

Where the proprietor of a caravan site carries on material activities associated with the operation of that site which constitute trading, there may be included as receipts of that trade any site income from the letting of pitches for static or touring caravans, and any income from letting caravans where the letting does not of itself amount to a trade.

The concession was introduced in 1984 along with the legislation subsequently consolidated in sections 503 and 504 of ICTA under which the letting of furnished holiday accommodation which does not amount to a trade is treated as a trade for certain purposes.

ESC B29 puts operators of caravan sites which include an element of trading into the same position as persons running furnished holiday letting businesses. In practice there is an element of trade, such as the operation of a site shop or the provision of leisure facilities such as a caf,, included in the operation of most caravan sites.

This change gives taxpayers who meet the qualifying conditions a statutory right to treat receipts from letting caravans or pitches as receipts of the trade of operating a caravan site.

This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 4: Surplus business accommodation : clause 21

This change gives statutory effect to the Inland Revenue practice on receipts from surplus business accommodation known as Revenue Decision 9.

The case of Salisbury House Estate Ltd v Fry (1930), 15 TC 266 HL is authority for the proposition that the income tax Schedules are mutually exclusive so any amount received by a trader from the letting of premises surplus to the requirements of the trade should not be taken into account in calculating the profits of the trade but assessed separately to tax as income from property under Schedule A. Similarly, any outgoings in respect of the premises should be apportioned between the part which is let and the part used for the purposes of the trade.

In practice, the Inland Revenue does not object to a trader including receipts from letting surplus business accommodation in trade receipts provided certain conditions are met. This practice, published in the February 1994 edition of Tax Bulletin under the heading "Revenue Decisions - Schedule D Cases I and II - Letting Surplus Business Accommodation", is referred to in some in some reference books as Revenue Decision 9.

The conditions in Revenue Decision 9 are:

• the accommodation is temporarily surplus to the current requirements of the trade;

• part of the accommodation is used for trade purposes;

• the rental income is comparatively small; and

• the rent is in respect of the letting of surplus business accommodation only - not surplus land.

In legislating the conditions in Revenue Decision 9, clause 21 sets out rules for determining whether accommodation is temporarily surplus to requirements. These are:

• that the accommodation must have been used for the purposes of the trade within the last three years (or acquired within that period);

• that the accommodation must be let for a term of not more than three years; and

• that the trader must intend to use the accommodation for trade purposes at a later date.

This gives taxpayers increased certainty as to whether the condition is met.

This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 5: Rents in respect of wayleaves where associated with a trade: clauses 22 and 344

This change shifts the charge on rents from certain wayleaves associated with a trade from Schedule D Case V and Case VI to a charge on trade profits.

Section 120 of ICTA makes provision about rent payable in respect of "any easement enjoyed in the United Kingdom in connection with any electric, telegraphic or telephonic wire or cable" other than an easement of a kind mentioned in section 119(1) of ICTA. Section 119 of ICTA applies to certain easements which are or might be used or enjoyed in connection with any of the concerns listed in section 55 of ICTA. Those concerns include mines, quarries, certain industrial concerns, canals, docks, markets, bridges, ferries, and railways. "Rent" and "easement" both have wide meanings for this purpose (see section 119(3) of ICTA).

Section 120(1) of ICTA provides for the rent from electric-line easements to be charged under Schedule D unless other income from the land to which the easement relates is charged under Schedule A. In that case the rent is charged to tax under Schedule A, section 120(1A) of ICTA.

Section 120(1) of ICTA does not specify under which Case of Schedule D the rent is to be charged. In practice, where the easement relates to land on which a person carries on a trade, the rent is charged under Case I of Schedule D and, in other cases, under Case VI. In the absence of section 120 of ICTA the rent would be charged to tax under Schedule A. Section 120 of ICTA does not apply to rent from easements relating to land outside the United Kingdom, which is charged to tax under Schedule D Case V.

Section 120(1) of ICTA as it applies to trades is rewritten in clause 22. Under clause 22:

• the word "easement" is rewritten as "wayleave". The rest of this note refers to wayleaves;

• rents from wayleaves related to land associated with a trade will be charged to income tax under Part 2 of the Bill (as profits of the trade) if the taxpayer so chooses and has no other income from the land in question; and

• all other rents from wayleaves will be charged to income tax under Part 3 of the Bill (property income).

This enacts the existing non-statutory practice for easements to which section 120 of ICTA applies which are associated with a trade but represents a change both in practice and in the law as respects:

• wayleaves other than those connected with "electric, telegraphic or telephonic wire or cable";

• wayleaves relating to land outside the United Kingdom; and

• wayleaves of a kind mentioned in section 119(1) of ICTA.

Clause 22 applies the same treatment to land occupied for the purposes of a profession or vocation. It also makes clear that any expenses incurred in respect of the wayleave can also be allowed as deductions in calculating the profits.

Section 119(1) of ICTA is rewritten as Chapter 8 of Part 3 to this Bill. Under the current law rent in respect of a wayleave that meets the conditions in both sections 119(1) and 120(1) of ICTA is taxed under section 119 of ICTA. Clause 262(2) reverses that order of priority. This is necessary to allow the taxpayer to have such rent taxed as the profits of a trade. It will not prevent a claim for relief under clause 340 as rent for an electric-line wayleave would not qualify for such relief.

All rents that are in practice currently charged to tax under Schedule D Case VI by virtue of section 120(1) of ICTA will be charged under clause 344 (charge to tax on rent receivable for a UK electric-line wayleave).

This change is in taxpayers' favour in principle and may benefit some in practice. But the numbers affected and the amounts involved are likely to be small.

Change 6: Relationship between rules prohibiting deductions and rules allowing deductions: clauses 31 and 274

This change resolves any conflict between the rules prohibiting a deduction in calculating trade profits and the rules allowing a deduction in calculating trade profits in favour of the rule allowing the deduction. But any conflict is unlikely.

Part 2 of this Bill sets out a number of rules that restrict the deductions allowed in the calculation of trade profits. Each of these is a "prohibitive rule". Clauses 34 and 35 are prohibitive rules of general application. The other restrictions apply in more closely defined circumstances.

Part 2 of this Bill also sets out a number of rules that allow deductions in the calculation of trade profits. Most of these rules are in Chapter 5 of Part 2 of the Bill. Each of these is a "permissive rule".

In some cases the source legislation for a permissive rule overrides a specific prohibitive rule. See, for example, section 112 of FA 1989 rewritten as clause 82 which overrides section 74(1)(a) and (b) of ICTA. In other cases the source legislation provides that a deduction is allowed "notwithstanding anything in section 74 [of ICTA]". Such a form of words overrides all the restrictive rules in section 74 of ICTA. See, for example, section 82A of ICTA rewritten as clause 88. In other cases the source legislation says merely that a deduction is allowed. See, for example, section 77 of ICTA (incidental costs of loan finance) rewritten as clause 59.

If the source legislation makes clear that a permissive rule overrides a specific prohibitive rule that limitation is included in the rewrite of the permissive rule. See, for example, clause 82 (personal security expenses). In other cases clause 32 makes clear that the permissive rule has priority over any prohibitive rule with two exceptions. The exceptions are the restriction on crime-related expenditure and the restriction on the costs of hiring a car or motor cycle.

In the case of crime-related expenditure the order of priority reflects the view that in enacting section 577A of ICTA Parliament intended that there should be no circumstances in which anyone should obtain a tax deduction by making a crime related payment.

In the case of car and motor cycle hire section 578A of ICTA makes clear that the provision restricts the amount of any deduction.

The order of priority given by clause 32 will be relevant only if the expenditure is capable of falling within both a permissive rule and a prohibitive rule. This is most likely to happen in the case of one or both of the general restrictions in clauses 34 and 35. In these cases the source legislation leaves no uncertainty about the extent to which the prohibitive rule is overridden. The only area of uncertainty is where the restriction is imposed by a provision other than section 74 of ICTA. For example, the restriction that section 577 of ICTA imposes on business expenditure.

It is unlikely there is scope for overlap between a specific permissive rule and a specific prohibitive rule. This is because the terms for either rule to apply are so closely defined. As a question of fact the expenditure will fall into one category or the other. But in event of any overlap clause 32 changes the law by giving priority to the permissive rule.

For example, it is unlikely that expenditure that meets the conditions for section 83 of ICTA (patent fees etc) to apply would also be business expenditure disallowed by section 577 of ICTA. If it does the source legislation is silent on which rule takes priority. Clause 32 gives priority to the permissive rule.

Clause 274 applies the same order of priority to the profits of a property business.

This change is in taxpayers' favour in principle and may benefit some in practice. But the numbers affected and the amounts involved are likely to be small.

Change 7: Align rules for debts proving irrecoverable after trade deemed to have ceased with general rules for bad and doubtful debts: clause 35

This change aligns the relief given for bad debts by section 89 of ICTA 1988 with the relief given by section 74(1)(j) of ICTA.

Section 113(1) of ICTA provides that where there is a complete change in the persons carrying on a trade the trade is deemed to cease and recommence. (Before Self Assessment the trade was also deemed to cease and recommence on a partial partnership change, unless the partners elected otherwise.)

Section 89 of ICTA provides relief for bad debts where there has been a change in the persons carrying on the trade and the trade is deemed to cease under section 113 of ICTA. It gives relief for bad debts which meet certain conditions and which are assigned to the successor to the trade. Since the trade carried on prior to the change is deemed to be different from the trade carried on after the change section 74(1)(e) of ICTA would otherwise prohibit a deduction for bad debts. The desired effect is to treat the trade as continuing as far as bad debts are concerned.

Although the aim of section 89 of ICTA is the same as that of section 74(1)(j) of ICTA (that is, to give relief for bad trade debts), there are significant differences between the two sections and the nature of the relief given. Specifically:

• section 89 gives relief for debts which are "irrecoverable", whereas section 74(1)(j) gives relief for debts which are bad or doubtful;

• the requirement for proof that a debt is bad or doubtful in section 74(1)(j) was removed by FA 1996 to assist in the introduction of Self Assessment; section 89 still has this;

• relief in section 89 is specifically related to the period in which the debt becomes in whole or in part irrecoverable; section 74 is silent on this;

• section 74(1)(j) refers to debts released as part of a "relevant arrangement or compromise"; section 89 makes no mention of this; and

• section 89 does not make specific reference to the bankruptcy or insolvency of debtors; this is referred to in section 74(1)(j)(iii).

This Bill does not rewrite section 89 of ICTA. Section 89 of ICTA is not needed because the approach adopted in the Bill is to focus on the person carrying on the trade rather than the trade. The effect is to extend the more generous provisions of section 74(1)(j) of ICTA to debts within section 89 of ICTA. This simplifies the law by bringing the bad debt relief provisions for income tax payers into one clause.

This change is in taxpayers' favour in principle and may in practice benefit some. But the numbers affected and the amounts involved are likely to be small.

Change 8: Unpaid remuneration of employees: payment made after return submitted but within 9 months of the end of the period of account: clauses 37 and 865

This change drops the requirement to make a claim for a deduction for remuneration paid after the return is submitted but within nine months of the end of the period of account in which it is charged.

Section 43(5) of FA 1989 deals with profit calculations made within nine months of the end of the period of account. Paragraph (a) requires the assumption that any remuneration unpaid at the time of the calculation will not be paid by the end of that nine month period. That means the proposed remuneration cannot be deducted in making the calculation. Paragraph (b) provides an adjustment procedure that applies when the remuneration is paid after the calculation is made but before the end of the nine month period. If a claim is made within two years of the end of the period of account the calculation may be adjusted.

This change brings the adjustment procedure into line with the normal Self Assessment rules and deals with the adjustment as an amendment to a return. Section 9ZA(2) of TMA sets a time limit for making such amendments. That is twelve months from the filing date for the relevant return.

The provisions that govern claims are not the same as the provisions that govern returns. But in practice, the only consequences of the change from claim to deduction relate to the time available for "claiming" the deduction.

The absolute time limit for making a claim is replaced by a time limit that may vary according to the particular circumstances. That may be because the return is issued late or because the taxpayer makes a late return. Accordingly, the Inland Revenue is no longer able to refuse a claim because it is late by reference to an absolute time limit: returns time limits and sanctions will apply and they depend on the date the return was issued and submitted.

This change is in taxpayers' favour in principle and may benefit some taxpayers in practice. But the numbers affected and the practical effects are likely to be small.

Change 9: Exceptions to the rule restricting deductions for business gifts: clause 47

This change provides for the monetary limit on the cost of gifts excluded from the general rule prohibiting deduction for expenses incurred in providing gifts in clause 45 to be increased by Treasury order.

Clause 47(3) is based on section 577(8)(b) of ICTA. The £50 limit in section 577(8)(b) of ICTA (previously £10) was inserted with effect from 2001-02 by section 73 of FA 2001 in line with an increase in the corresponding VAT provision made by Treasury order.

Section 577(8)(b) of ICTA was rewritten as it applied to employees in section 358(3)(b) of ITEPA. Section 716(2) of ITEPA provides that the Treasury may by order increase, or further increase, the sum specified in various provisions in ITEPA including section 358(3)(b) of ITEPA. Incorporating a similar provision in clause 47 allows the limit to be increased in line with the corresponding limits in ITEPA and in the VAT provisions by Treasury order rather than by primary legislation.

This change has no implications for the amount of tax paid, who pays it or when. It affects (in principle but not in practice) only administrative matters.

Change 10: Car hire: release of debt after debtor has ceased trading: clause 48

This change reduces the amount charged as a post-cessation receipt when a debt relating to the hire of a car with a new retail value of more than £12,000 is released after the debtor has ceased trading.

Section 578A of ICTA restricts the amount which a person carrying on a trade can deduct in respect of the cost of hiring a car with a retail value, when new, of more than £12,000. The restriction takes the form of a reduction calculated by reference to the difference between the £12,000 ceiling and the retail price.

Section 578A(3) of ICTA provides that where there is a rebate of a hire charge, or a debt to which section 94 of ICTA applies is released, the amount brought into account in respect of the rebate or release is reduced in the same proportion as that in which the trading deduction was restricted.

Section 578A(4) of ICTA deals only with a continuing trade. This change extends the same treatment to debts wholly or partly released after the debtor has ceased to trade and taxed as post-cessation receipts under section 103(4) of ICTA.

This change is in taxpayers' favour in principle and may benefit some in practice. But the numbers affected and the amounts involved are likely to be small.

Change 11: Car hire: hire agreements without option to purchase: clause 49

This change extends the definition of "qualifying hire car" for the purpose of the restriction on the amount allowed as a deduction for the cost of hiring a car to include cars hired under a hire purchase agreement where there is no option to purchase.

Section 578A of ICTA restricts the amount which a person carrying on a trade can deduct in respect of the cost of hiring a car with a retail value, when new, of more than £12,000. Section 578A of ICTA does not apply to a car which is a "qualifying hire car" as defined in section 578B(2) of ICTA.

Section 578B(2) of ICTA defines a "qualifying hire car" as a car which is:

(a).. hired under a hire-purchase agreement .. under which there is an option to purchase exercisable on the payment of a sum equal to not more than 1 per cent. of the retail price of the car when new, or

(b).. a qualifying hire car for the purposes of Part 2 of the Capital Allowances Act (under section 82)..

The definition of "qualifying hire car" in section 578B(2) of ICTA does not extend to cars hired under a hire purchase agreement where there is no option to purchase. In practice, the Inland Revenue does not apply the restriction in section 578A of ICTA to cars hired under such agreements. This clause legislates that practice by including cars hired under a hire-purchase agreement where there is no option to purchase in the definition of hire car in subsection (2)(a).

This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.

Change 12: Trade profits: exclusion of double relief for interest: final variation of claim: clause 52

This change makes clear when a claim under section 353 of ICTA is finally determined for the purposes of rewriting section 368(4) of ICTA.

Section 353 of ICTA provides for interest to be claimed as a relief. In limited circumstances that relief may also qualify as a deduction in calculating trade profits. Section 368(4) of ICTA provides that a trade deduction is not allowed if relief has been given under section 353 of ICTA.

Section 368(4) of ICTA is subject to section 368(6) of ICTA. That subsection provides that the references to relief given or a deduction allowed refer to relief given or a deduction allowed on a claim or in an assessment that has been finally determined.

The term "finally determined" does not fit well with Self Assessment. Clause 52(2) makes clear that it means when the claim can no longer be varied. This wording is based on section 43C(4) of TMA.

This change has no implications for the amount of tax paid, who pays it or when. It affects (in principle but not in practice) only administrative matters.

Change 13: Deduction for tenant under taxed lease if land is outside the United Kingdom: clauses 60 and 64

This change makes the relief available to tenants under taxed leases of land in the United Kingdom used in connection with a trade, profession or vocation available where the land is outside the United Kingdom.

Section 34 of ICTA provides that if a premium is, or certain other amounts are, payable in respect of a lease, the landlord is treated as receiving an amount by way of rent. If the premium or other amount is due to a person other than the landlord, generally that person is treated as receiving income in consequence of entering a transaction within Schedule A. Section 35 of ICTA treats a person who assigns at a profit a lease which has been granted at an undervalue as receiving income in consequence of entering into a transaction within Schedule A.

Section 65A(5) of ICTA provides that:

the income from an overseas property business shall be computed for the purposes of Case V of Schedule D in accordance with the rules applicable to the computation of the profits of a Schedule A business.

So if the lease is of land outside the United Kingdom, sections 34 and 35 of ICTA apply by virtue of section 65A(5) of ICTA. The amount which would be treated as income of a Schedule A business in the case of land in the United Kingdom is treated instead as income of an overseas property business.

Section 87(1) and (2) of ICTA provides that if land in relation to which an "amount chargeable" arose is occupied or otherwise used for the purposes of the tenant's trade, profession or vocation, the tenant is treated in computing his or her profits as paying rent in respect of the land.

Section 87(1) of ICTA defines "the amount chargeable" as:

(a) any amount [that] falls to be treated as a receipt of a Schedule A business by virtue of section 34 or 35, or

(b) any amount [that] would fall to be so treated but for the operation of section 37(2) or (3).

Section 87(1) and (2) of ICTA is rewritten in clauses 60 and 61. The "amount chargeable" on the landlord is referred to in those clauses as the "taxed receipt".

Section 65A(5) of ICTA provides that income from an overseas property business is computed for the purposes of Schedule D Case V in accordance with the rules applicable to the calculation of the profits of a Schedule A business. But section 65A of ICTA does not deem Schedule D Case V income to be income of a Schedule A business. So a receipt which falls to be taxed under Schedule D Case V by virtue of section 34 or 35 of ICTA as applied by section 65A of ICTA is not an amount which falls to be treated as "a receipt of a Schedule A business" and is not therefore within section 87(1) of ICTA.

This means that if a tenant occupies land outside the United Kingdom under a lease in respect of which the landlord has been taxed under Schedule D Case V by virtue of section 34 or 35 of ICTA as applied by section 65A(5) of ICTA, the tenant is not entitled to relief in circumstances in which he or she would have been entitled to relief under section 87(2) of ICTA if the land had been in the United Kingdom.

Clause 60 applies to land wherever it is situated and to taxed receipts brought into account in calculating the profits of an overseas property business as well as a UK property business. Clause 64 limits the expenses a tenant is treated as incurring under clause 61 where there is a reduction under Chapter 4 of Part 3 of this Bill in a receipt of an overseas property business as well as where there is a reduction in a receipt of a UK property business.

This change will result in a tenant receiving relief by reference to a taxed receipt in respect of land outside the United Kingdom in circumstances where there is currently no entitlement to relief. But this may, in certain circumstances, reduce the amount of relief subsequently available by reference to the taxed receipt under Chapter 4 of Part 3 of the Bill.