This change is adverse to some taxpayers and favourable to others in principle and in practice. But the numbers affected and the amounts involved are likely to be small.

Change 24: Payments to Export Credits Guarantee Department: clause 91

This change allows payments to the Export Credits Guarantee Department ("ECGD") to be deducted in calculating the profits of a trade when the expense is payable rather than when it is paid.

Section 88 of ICTA allows a person carrying on a trade to deduct "sums paid" to the ECGD in calculating the profits of that trade.

Clause 91 follows accounting treatment in allowing traders to deduct a payment to the ECGD at the time it is payable.

This change will not alter the amount charged to tax. The most it will do is affect the timing of the tax liability. In a small minority of cases this could mean a different rate of tax being applied, according to individual circumstances. Any overall tax effect is likely to be negligible.

Change 25: Expenses connected with foreign trades: relax condition for family expenses: drop "functions" test: clause 92

This change allows a deduction for "family expenses" if the trader's absence from the United Kingdom is partly for the purposes of a trade that is not carried on wholly outside the United Kingdom. It also drops the requirement that the taxpayer performs functions of the trade at each end of the journey.

(A)     Sections 80 and 81 of ICTA allow a trading deduction for three sorts of expenses. Each has a condition related to the purpose of the trader's absence from the United Kingdom. The expenses are:

• travelling etc expenses of the trader between the United Kingdom and a foreign trade (section 80(3) of ICTA);

• travelling expenses of the trader between foreign trades (section 81(4) of ICTA); and

• travelling expenses of the trader's family (section 80(5) of ICTA).

There is no need to have three separate conditions for these expenses.

The single condition relating to the purpose of the trader's absence is in clause 92(1)(b). It applies to all the expenses with which the clause deals.

(B)     The condition relating to travel between foreign trades in section 81(4) of ICTA is relaxed so that an absence for the combined purposes of a foreign trade and a United Kingdom-based trade will qualify.

To qualify for relief for expenses of travel between foreign trades, a taxpayer's absence from the United Kingdom must be wholly and exclusively for the purposes of the foreign trades or for the purposes of the foreign trades and another trade (section 80(4) of ICTA). There are additional conditions in section 81(3) of ICTA that the taxpayer performs functions of a foreign trade at the point of departure and that the journey is for the purpose of performing functions of the trade at the destination.

The additional conditions probably add nothing to the basic condition in section 80(4) of ICTA. So the additional conditions are dropped.

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 26: Expenses connected with foreign trades: Irish trades: clause 92

This change allows a deduction for certain expenses incurred in connection with trades carried on wholly in Ireland whatever the basis adopted for the assessment of a taxpayer's other foreign income.

Section 80 of ICTA allows a deduction for the expenses that would otherwise be disallowed as not being incurred wholly and exclusively for the purposes of a trade assessable under Schedule D Case V. But it excludes an individual who satisfies the Board of Inland Revenue "as mentioned in section 65(4) [of ICTA]". That individual is assessable under Schedule D Case V on the basis of sums received in the United Kingdom (the "remittance basis").

The remittance basis does not apply to income arising in the Republic of Ireland (see section 68(1) of ICTA). So a person with other foreign income assessable on the remittance basis may have Irish income assessed on the basis of the income arising. In such a case there is no reason why the rules in section 80 of ICTA should not apply to the Irish income.

Subsection (2) of the clause makes it clear that the rules apply in calculating the profits of any trade that are not assessed on the remittance basis.

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 27: Assets of mutual concerns: exclude distributions of capital gains from the charge to tax: clause 104

This change defines the profits out of which a chargeable distribution is made so as to exclude distributions of chargeable gains.

Section 491(1) of ICTA excludes distributions of assets representing capital from the charge in subsection (3). Subsection (8) explains what is meant by such assets. It is generally understood that chargeable gains made by the concern do not represent capital as described in subsection (8). So distributions of such gains are within the charge in subsection (3).

Nevertheless, the Inland Revenue does not in practice seek to apply section 491 of ICTA to distributions of chargeable gains. The clause adopts a positive approach to defining the distributions to which the clause applies. The condition in clause 104(1)(d) refers to profits of the mutual business. Chargeable gains are not profits of the mutual business and so the clause reflects the current practice.

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 28: Sums recovered under insurance policies, etc: clause 106

This change gives statutory effect to the accountancy treatment for crediting a sum recovered under an insurance policy.

Section 74(1) of ICTA lists various items in respect of which no deduction is allowed in computing a trader's profits including:

(l) any sum recoverable under an insurance or contract of indemnity

A sum recovered under an insurance policy or contract of indemnity is a receipt and not therefore an item in respect of which a trader would expect to make a deduction in calculating his or her profits.

The courts have interpreted section 74(1)(l) of ICTA and the enactments from which it is derived as prohibiting the deduction of a loss or expense incurred by the trader to the extent that the loss or expense is recovered under an insurance policy or contract of indemnity (even where that recovery is on capital account). See, for example, Lawrence LJ's description of the meaning of the equivalent provision in the Income Tax Act 1918 ¹ on page 381 of Green v J Gliksten and Sons Ltd (1929), 14 TC 364 HL:

¹ Paragraph (k) of Rule 3 of the rules applicable to Cases I and II of Schedule D

in arriving at the balance of profits or gains there has to be no deduction in respect of a loss which is covered by insurance to the extent by which that loss is so recovered.

Clause 106 achieves the same effect as section 74(1)(l) of ICTA by bringing a capital amount recovered into account as a trade receipt rather than by prohibiting a deduction in respect of the loss or expense in respect of which it is recovered. This makes the proposition easier to understand without changing the law.

Section 74(1)(l) of ICTA requires a deduction in respect of a loss or expense to be reduced by the amount of any insurance recovery. But where the loss and the recovery fall in different periods the accountancy treatment is to deduct the loss or expense in the year in which it is incurred and to credit the recovery in the accounting period in which it arises.

In practice, the Inland Revenue allows traders to follow the accounting treatment in crediting the recovery. This informal concession is set out in paragraphs 40130 and 40755 of the Inland Revenue Business Income Manual. Clause 106 gives the concession statutory effect.

This change will not alter the amount charged to tax. The most it will do is affect the timing of that tax liability. In a small minority of cases this could mean a different rate of tax being applied, according to individual circumstances. Any overall tax effect is likely to be negligible.

Change 29: Gifts of trading stock: drop the need for the gift to be plant and machinery in the hands of the educational establishment: clause 108

This change removes the requirement that a gift to an educational establishment should qualify as plant and machinery in the hands of the educational establishment.

Section 84(1) of ICTA gives relief for the gift of an article that "qualifies as plant or machinery". Subsection (2) sets out what those words mean. The similar relief for gifts of trading stock to charities does not have the same condition. So there is no need for the gift to qualify as plant or machinery in the hands of an educational establishment.

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 30: Gifts of trading stock: gifts "for the purpose of" a charity etc: clause 108

This change brings the wording of the relief for a gift to a charity, a registered club or one of the special bodies listed in clause 108(5) of into line with that for a gift to an educational establishment.

Section 84 of ICTA allows relief for a gift of an article "for the purposes of a designated educational establishment". Those words ensure that the relief is available even if the gift is made to a person (such as a local education authority) who becomes the legal owner of the article so that it can be used in a school. In many cases the gift is not "to" the school.

Section 83A of ICTA allows similar relief for a gift "to" a charity. The clause allows relief for a gift "for the purposes of" a charity, a registered club or one of the listed bodies.

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 31: Gifts of trading stock: drop the need for a claim: clause 108

This change removes the requirement that a taxpayer should make a claim for relief on a gift to an educational establishment.

Section 84(3) of ICTA provides that the relief does not apply unless "the donor makes a claim". The general approach of this Bill is not to require a claim for a trading deduction. In this case, the relief takes the form of removing the obligation to include a trade receipt. But the same principle applies here.

The similar relief for gifts to charities in section 83A of ICTA does not require a claim. So this change makes the two reliefs consistent.

The provisions that govern claims are not the same as the provisions that govern returns. But in practice the change from making a claim to allowing the relief will have only the following consequences, which both relate to the time available for "claiming" the relief.

First, 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.

Second, error or mistake relief claims under section 33 of TMA will be possible if too much tax is paid as a result of omitting to include the relief in the tax return. Claims under section 33 of TMA must be made within five years of 31 January following the tax year to which the return relates.

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 32: Herd basis rules: meaning of "substantial part of herd": clause 113(6) and clause 120(7)

This change gives statutory effect to the practice of treating 20% of the herd as substantial.

A number of clauses in the herd basis rules refer to "a substantial part of the herd" or "a substantial difference":

• clause 118(1)(b) (sale of animals from the herd);

• clause 119(1) (sale of whole or substantial part of herd);

• clause 120(7) (acquisition of new herd begun within 5 years of sale);

• clause 122(1)(a) (replacement of part sold within 5 years of sale); and

• clause 126(1)(a) (slaughter under disease control order).

What constitutes a substantial part of the herd or a substantial difference is primarily a question of fact. But this Chapter gives statutory effect to a long-standing practice set out in paragraph 55525 of the Inland Revenue's Business Income Manual. This provides that 20% of the herd will be regarded as substantial. This does not, however, prevent a smaller percentage from being regarded as substantial.

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 33: Herd basis rules: sale of whole or substantial part of herd: clauses 119, 120 and 122

This change merges the rules in paragraph 3(7) to (9) of Schedule 5 to ICTA.

Paragraphs 3(7) to (9) of Schedule 5 to ICTA set out the rules relating to the sale of all or most of a herd within 12 months.

Paragraph 3(7) of Schedule 5 to ICTA applies when a herd is sold as a whole and then replaced. Paragraph 3(8) of Schedule 5 to ICTA deals with cases where the whole of a herd is sold "in circumstances in which sub-paragraph (7) above does not apply". Or when a substantial part of a herd is sold. Paragraph 3(9) of Schedule 5 to ICTA sets out rules for the circumstances where paragraph 3(8) but not 3(7) of Schedule 5 to ICTA is relevant, provided that replacement begins to take place within five years.

ICTA does not make clear how quickly a herd must be replaced in order for paragraph 3(7) - rather than paragraph 3(8) of Schedule 5 to ICTA - to apply. This Chapter merges these rules.

There are three practical differences between the application of the rules in paragraph 3(7) and those in paragraph 3(8) and 3(9) of Schedule 5 to ICTA.

First, paragraph 3(8) of Schedule 5 to ICTA directs that neither the profit nor the loss on the sale is to be taken into account. So, in effect, the farmer may obtain a tax-free gain on any profit from the sale. By contrast paragraph 3(7) of Schedule 5 to ICTA does not say how to deal with the proceeds of sale before it is known how many of the old herd will be replaced.

Second, if the farmer subsequently acquires a new production herd (which must be treated as a replacement herd) or animals to replace the part of the herd sold, paragraph 3(9) of Schedule 5 to ICTA recovers any tax-free gain made on the sale of the old animals. To achieve this the proceeds of the sale of each animal are brought into account at the time the replacement animal is acquired. By contrast paragraph 3(7) of Schedule 5 to ICTA contains no timing rule.

Third, in providing for the sale proceeds to be brought into account, paragraph 3(9) of Schedule 5 to ICTA allows the trading receipt to be reduced if the replacement animal is of worse quality than the old animal (on an enforced sale). Paragraph 3(7) of Schedule 5 to ICTA, however, does not permit such a reduction to be made.

Merging these rules removes these differences. It gives a common set of rules where a whole herd is sold, whether at once or over a period of up to a year. These are the rules set out in paragraphs 3(8) and (9) of Schedule 5 to ICTA.

Clause 119 begins the process of merger by providing that in all cases where a herd or a substantial part of a herd is sold within a year the profit or loss which arises from that sale is not to be taken into account. That rule is then made subject to the rules which follow in clause 120 and clause 122 which concern the acquisition of a new herd or replacement of a substantial part of a herd respectively.

It is possible that merging the rules may disadvantage the farmer who sells only a substantial part of the herd and replaces the part sold with a smaller number of animals. In this case clause 120(4) taxes the profit on the difference if the difference is not substantial. That subsection is based on paragraph 3(11) of Schedule 5 to ICTA. It is arguable that the rule in paragraph 3(11) of Schedule 5 to ICTA applies only to the sale of the whole herd. But unless the rule in paragraph 3(11) of Schedule 5 to ICTA is applied to all cases where a herd is sold within a year it would be difficult, if not impossible, to merge the rules in paragraph 3(7) and (9) of Schedule 5 to ICTA. This is because it would be necessary to distinguish the two circumstances in which a herd may be sold.

This change is adverse to some taxpayers and favourable to others in principle and in practice. But the numbers affected and the amounts involved are likely to be small.

Change 34: Herd basis elections: time limit for making election: clause 124

This change relates to the time limit for making a herd basis election under paragraph 2 of Schedule 5 to ICTA.

An election must normally be made within a specified period, based on when the farmer first keeps a production herd of the particular class. The ordinary rule for farmers except those trading in partnership is set out in paragraph 2(3)(a) of Schedule 5 to ICTA. This provides that the election must be made "not later than twelve months from the 31st January next following the qualifying year of assessment". The qualifying year of assessment is then defined in paragraph 2(6) of Schedule 5 to ICTA as "the first year of assessment after the commencement year for which the amount of profits or losses .. is computed for tax purposes by reference to the facts of a period during the whole or part of which [the farmer] kept such a herd".

For firms the position is slightly different. Paragraph 2(3)(b) of Schedule 5 to ICTA states that they must make an election "not later than twelve months from the 31st January next following the year of assessment in which the qualifying period of account ends". This means that, provided a partnership's first period of account extends into the second tax year, it will get longer to make an election.

Clause 124 merges the two rules. This change of approach simplifies the law by having a common rule for all farmers. It sets the time limit for all farmers in the same way as for a firm, by referring to the period of account in which the herd is first kept. In most cases, this rule gives the same time limit as that in paragraph 2(3)(a) of Schedule 5 to ICTA. But it may also benefit some taxpayers by giving them longer to make the election if the first period of account in which they keep the production herd extends into a second tax year.

Example 1

A farmer starts to keep a herd of a particular class on 1 March 2006. The accounts of the farming trade are made up to 31 December annually:

• The ICTA rule: The first (basis) period in which the farmer keeps the herd is the year ended 31 December 2006. So the "qualifying year of assessment" is 2006-07 and the time limit is 31 January 2009.

• The rule in clause 124: The "relevant period of account" is the year ended 31 December 2006. That ends in 2006-07. So the time limit is 12 months from 31 January 2008, that is 31 January 2009.

But, if the farmer has a period of account longer than 12 months and first keeps the herd early in the period, the time limit may change.

Example 2

A farmer starts to keep a herd of a particular class on 1 March 2006. This is in a period of account that runs from 1 January 2006 to 30 June 2007. The basis period for 2006-07 is the year ended 30 June 2006 (see clause 214(4)). The basis period for 2007-08 is the year ended 30 June 2007, the new accounting date:

• The ICTA rule: The first (basis) period in which the farmer keeps the herd is the year ended 30 June 2006. So the "qualifying year of assessment" is 2006-07 and the time limit is 31 January 2009.

• The rule in clause 124: The "relevant period of account" is the 18 months ended 30 June 2007. That ends in 2007-08. So the time limit is 12 months from 31 January 2009, that is 31 January 2010.

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

Change 35: Herd basis elections: date from which effective: clause 124(7)

This change relates to the date from which a herd basis election is effective.

For farmers, except those trading in partnership, the current legislation in paragraph 2(4)(a) of Schedule 5 to ICTA refers to the election having effect for the qualifying year of assessment and all subsequent periods. For partnerships the rule in paragraph 2(4)(b) of Schedule 5 to ICTA is slightly different. The election has effect for the qualifying period of account.

As explained in Change 34 this Bill merges the rules for making herd basis elections. This means that for all farmers the election will take effect by reference to periods of account.

This is a minor change in the law if "period" in the definition of "qualifying year of assessment" in paragraph 2(6) of Schedule 5 to ICTA means basis period not period of account. But in practice it is interpreted as meaning period of account.

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

Change 36: Herd basis elections: 5 year gap in which no production herd kept: clause 125

This change gives statutory effect to the practice in paragraph 55630 of the Inland Revenue's Business Income Manual (BIM 55630).

Paragraph 4 of Schedule 5 to ICTA provides a special rule for herd basis elections where there is a gap of at least five years when the farmer does not keep a production herd of a particular class. The farmer is treated as never having kept such a production herd at all.

This approach sits oddly with the rule in paragraph 2(4) of Schedule 5 to ICTA that a herd basis election is irrevocable. It is not clear which rule has priority.

The Inland Revenue's practice, set out in BIM 55630, is to allow the farmer to decide whether or not he or she wants the herd basis rules to continue to apply. This is achieved by ignoring the previous election for the purposes of allowing the farmer to make a fresh election: farmers can either make a fresh election or do nothing. Clause 125 gives this practice statutory effect.

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

Change 37: Herd basis elections: slaughter under disease control order: clause 126

This change relates to the time limit for making a herd basis election under paragraph 6 of Schedule 5 to ICTA if the whole or a substantial part of a production herd is slaughtered under a disease control order.

An election must normally be made within a specified time based on when the farmer first keeps a production herd. Paragraph 6(1) of Schedule 5 to ICTA modifies the ordinary time limit for making a herd basis election if the whole or a substantial part of a production herd is slaughtered under a disease control order.

For farmers except those trading in partnership paragraph 6(2)(a) of Schedule 5 to ICTA provides the election must be made "not later than twelve months from the 31st January next following the qualifying year of assessment". That year is then defined by paragraph 6(4) of Schedule 5 to ICTA as the first year of assessment for which the amount of the profits or losses of the trade are calculated "by reference to the facts of a period in which the compensation is relevant".

For firms the position is slightly different. Paragraph 6(2)(b) of Schedule 5 to ICTA provides the election must be made "not later than twelve months from the 31st January next following the year of assessment in which the qualifying period of account ends". Paragraph 6(4) of Schedule 5 to ICTA defines the "qualifying period of account" as "the first period of account in which the compensation is relevant".

Paragraph 6(5) of Schedule 5 to ICTA provides that compensation is deemed to be relevant in any period if is "taken into account as a trading receipt in computing the profits or losses of that or an earlier period".

Clause 126 merges the two rules. This change of approach simplifies the law by having a common rule for all farmers. It sets the time limit for all farmers in the same way as for a firm by reference to first period of account in which the compensation is relevant. In most cases this rule gives the same time limit as that in paragraph 6(2)(a) of Schedule 5 to ICTA. But it may benefit some taxpayers by giving them longer to make the election if the compensation is received in a period of account that is longer than 12 months.

This change is in line with the approach adopted for the rewrite of the ordinary time limits in paragraph 2 of Schedule 5 to ICTA. Clause 124 has a single rule for elections by all farmers. See Change 34.

Example

The accounts of an established farming business are made up for the period 1 January 2005 to 30 June 2006. No herd basis election is in place. In September 2005 compensation is received for a production herd slaughtered under a disease control order.

Unless the farmer is trading in partnership the time limit for making an election is 31 January 2008. The qualifying year of assessment is the tax year 2005-06. The 31 January next following this year is 31 January 2007. The election must be made within 12 months of that date.

If the farmer is a firm the time limit for making the election is 31 January 2009. The qualifying period of account ends on 30 June 2006. This ends in the tax year 2006-07. The 31 January next following this year is 31 January 2008. The election must be made within 12 months of that date.

In principle and in practice this change may benefit some taxpayers by giving them longer to make the election. But it has no implications for the amount of income liable to tax or who is liable for tax on it.

Change 38: Tax treatment of sound recordings: clauses 130, 132 and 135

This change gives statutory effect to ESC B54 (tax relief on films, tapes and discs).

ESC B54 states:

Notwithstanding section 113(2) of Finance Act 2000, master audiotapes or discs shall be deemed to be included in the definitions in section 68(2) of the Capital Allowances Act 1990. This ensures that treatment of the expenditure on production of master audio tapes or discs will continue to be treated as expenditure of a revenue nature.

Clause 130 and clauses 132 to 135 rewrite sections 40A to 40D of F(No 2)A 1992. Sections 40A to 40D of F(No 2)A 1992 contain rules for the tax treatment of films other than films that are "qualifying films" as defined in section 43 of F(No 2)A 1992. These rules were previously in section 68 of the Capital Allowances Act 1990 and were inserted in F(No 2)A 1992 when the Capital Allowances Act 1990 was repealed by CAA.

Before FA 2000, section 68(2)(c) of the Capital Allowances Act 1990 defined "disc" for the purposes of section 68 of that Act as "an original master film disc or original master audio disc". Section 113(2) of FA 2000 substituted a new definition of "film, tape or disc" (by reference to the definition of "film" in section 43 of F(No 2)A 1992).

Because the definitions in section 43 of F(No 2)A 1992 apply only to films - not to master audiotapes or discs - the effect of section 113(2) of FA 2000 is to exclude expenditure on master audiotapes or discs from relief under section 68 of the Capital Allowances Act 1990. This is not what was intended. So ESC B54 restores the position before section 113(2) of FA 2000.

Clauses 130, 132 and 135 incorporate ESC B54 by referring to "sound recordings" in clauses 130(1)(a),(2),(3) and (4), clause 132(1) and clause 135(1).