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 110: Beneficiaries' income from estates in administration: requirement for apportionments where the parts of the residuary estate in which successive interests subsist do not wholly correspond: clause 676

This change introduces a requirement for just and reasonable apportionments to be made in cases involving successive interests in the residuary estate where the part of the residuary estate in which a succeeding interest subsists does not wholly correspond with the part in which the preceding interest subsisted.

The taxation of successive interests in the residue of an estate is dealt with in section 698 of ICTA. Section 701(11) of ICTA provides that where different parts of the estate are the subject of different residuary dispositions, Part 16 of ICTA has effect in relation to each of those parts with the substitution for references to the estate of references to that part of the estate. (This is rewritten as a general rule for the interpretation of Chapter 6 of Part 5 of this Bill in clause 649(4)). But there is no provision for situations where the residuary estate in which a later holder acquires an interest was not all subject to the interest held by a previous holder or is only a part of the residuary estate in which a previous holder held an interest.

Clause 676 provides that in such cases such apportionments as are just and reasonable are to be made.

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 111: Beneficiaries' income from estates in administration: omission of section 695(6) of ICTA: clause 678

This change relates to the omission of section 695(6) of ICTA, which requires that where relief is given to a person with a limited or discretionary interest in a foreign estate for United Kingdom income tax borne by the income of the estate, the person's total income should include an amount corresponding to the relief.

Section 695(5) of ICTA enables a beneficiary of a foreign estate who is entitled to a limited interest in the residue of the estate and is charged to tax for a tax year in respect of income from the estate to claim relief if any of the aggregate income of the estate has borne United Kingdom income tax. Section 698(3)(b) of ICTA applies this also to beneficiaries who are charged in respect of income paid from the estate under a discretion.

Section 695(6) of ICTA (which is also applied by section 698(3)(b) of ICTA) provides that where the relief is given "such part of the amount in respect of which [the beneficiary] has been charged to income tax as corresponds to the proportion mentioned in [section 697(5) of ICTA] shall, for the purposes of computing his total income, be deemed to represent income of such amount as would after deduction of income tax be equal to that part of the amount charged". (The proportion referred to is the proportion that the amount of the beneficiary's income that has borne United Kingdom income tax, less the tax, bears to the amount of the aggregate income of the estate, less United Kingdom income tax.) The meaning of this provision, which originated while surtax was still charged, is now obscure, and it is particularly difficult to see how it could operate in the context of Self Assessment. Consequently, in practice it tends to be ignored. Therefore it is not being rewritten in the Bill.

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 112: Exempt income: savings certificates: unauthorised purchases involving multiple certificates: clauses 692(2) and 693(5)

This change enables multiple savings certificates to be regarded as authorised in part where an unauthorised number of certificates has been purchased, and so confers exemption on the income from the part that is so regarded.

The Treasury limit the number of savings certificates of any particular issue that a person is permitted to purchase. The limits are stated in the prospectus for each issue.

The income from savings certificates is exempt from income tax under section 46 of ICTA. However, the exemption only applies to certificates purchased within the permitted limits. Section 46(3) of ICTA provides that the exemption does not apply to savings ".. certificates .. purchased .. in excess of the amount which a person is for the time being authorised to purchase ..". It is not entirely clear how this would work in the case of multiple certificates. (These are certificates which represent a number of individual unit certificates.)

For example, if the maximum number of certificates permitted is 100, X holds 80, and then purchases a multiple certificate of 50, section 46(3) of ICTA appears to prevent the exemption from applying to the second multiple certificate. However, in practice, the second certificate is treated as 50 individual certificates, so that 20 would be treated as authorised and 30 as unauthorised.

Clauses 692(2) and 693(5) reflect this practice by providing that certificates are authorised "so far as" their acquisition was not prohibited by regulations made by the Treasury limiting a person's holding or, in the case of Ulster Savings Certificates, such regulations made by the Department of Finance and Personnel.

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 113: Exempt income: Ulster Savings Certificates: clause 693

This change gives statutory effect to ESC A34 (certificates encashed after death of registered holder).

Income from Ulster Savings Certificates (USCs) is exempt from income tax if the conditions in section 46(3) and (4) of ICTA are met.

Under section 46(3) of ICTA the exemption does not apply to certificates purchased in excess of the maximum number prescribed by the Department of Finance and Personnel in Northern Ireland. Under section 46(4) of ICTA the holder must be resident and ordinarily resident in Northern Ireland:

• either when the certificates are repaid; or

• where the holder purchased the certificates, at the time of purchase.

So, if the holder did not purchase the certificates, but, say, inherited them, the exemption would apply only if the holder satisfied the residence condition at the time of repayment.

ESC A34 therefore extends the exemption so if the deceased holder of the USCs was resident and domiciled in Northern Ireland at the time the certificates were purchased, but the personal representative, or the beneficiary who inherited the USCs was not, the exemption is still available. It provides-

Accumulated interest on Ulster savings certificates held by persons resident and domiciled in Northern Ireland is exempt from income tax (TA 1988 s 46). Where repayment is made after the death of the holder, exemption is allowed if the deceased was resident and domiciled in Northern Ireland at the time of purchase.

Until 1981, the residence condition for the exemption was that the holder had to be "resident and domiciled" in Northern Ireland (see section 96 of ICTA 1970), although in practice this was interpreted as "resident and ordinarily resident". The wording of the legislation was amended by section 34 of FA 1981 to bring it in line with the practice. The ESC was introduced in 1958 and has not been amended, so it is still phrased in terms of the pre-1981 legislation, although, in practice, it is now operated in line with the post-1981 wording, so that the reference in the ESC to "domiciled" is read as "ordinarily resident".

Clause 693(4) gives statutory effect to the concession.

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 114: Individual investment plans: non-resident insurance companies: clauses 697 and 698(6)

This change extends the provisions in section 333A of ICTA to cover non-resident insurance companies and omits section 333B(4) of ICTA (so far as income tax is concerned).

Sections 333 to 333B of ICTA contain powers for the Treasury to make regulations providing for the income of individuals from investments held in certain types of investment plan to be exempt from income tax. Section 333A of ICTA provides that the regulations may include certain requirements to be fulfilled by a "European institution" or a "relevant authorised person" if it is to be a "plan manager".

Section 333B(4) of ICTA provides for regulations to be made about non-resident insurance companies appointing United Kingdom tax representatives. So far as income tax is concerned, this provision does much the same for non-resident insurance companies as section 333A of ICTA does for European institutions. This duplication is unnecessary: it was never intended that non-resident insurance companies should be subject to substantially different requirements from European institutions. Indeed, some non-resident insurance companies may be European institutions, which increases the scope for confusion.

So, in rewriting these provisions, section 333A of ICTA has been extended to cover non-resident insurance companies and section 333B(4) of ICTA has been omitted, so far as income tax is concerned. Clause 697(2)(c) provides that "foreign institution" includes "..an insurance company which is non-UK resident".

This has four effects.

• The provisions rewritten from section 333A of ICTA will apply only to non-resident insurance companies which are plan managers, whereas section 333B(4) of ICTA applies for all non-resident insurance companies.

• The more specific language of section 333A of ICTA is substituted for the general formula in section 333B(4)(a) of ICTA, see clauses 697 and 698.

• The scope of the provision is restricted to the "prescribed duties" (rewritten as "specified" duties, see clause 697(1)) referred to in section 333A(2), (3) and (4), whereas section 333B(4) of ICTA applies to any duties.

• The powers which may be conferred and the liabilities which may be imposed are restricted to those covered by section 333A(10) of ICTA, rather than those covered by section 333B(4)(b) of ICTA (see clause 698(6)).

This change has no implications for the amount of tax paid, who pays it or when.

Change 115: Exemptions: venture capital trust dividends: conditions for shares where share reorganisations have occurred: clause 712

This change treats shares acquired as a result of a company reorganisation as satisfying the condition requiring them to have been acquired for genuine commercial reasons.

In order to qualify for the income tax exemption for distributions from venture capital trusts ("VCTs") the shares in respect of which the distributions are made must satisfy certain conditions. The conditions are set out in paragraph 7(3) of Schedule 15B to ICTA. These include that:

• the shares were acquired "for bona fide commercial purposes and not as part of a scheme or arrangement the main purpose of which, or one of the main purposes of which, is the avoidance of tax" (paragraph 7(3) (a)(ia)); and

• they are not "shares acquired in excess of the permitted maximum for any year of assessment" (paragraph 7(3)(a)(ii)).

The first of those conditions was added by section 70 of FA 1999, and only has effect for shares acquired after 8 March 1999.

Paragraph 8(3) and (4) of Schedule 15B to ICTA apply where shares in VCTs are acquired in circumstances in which they are required by TCGA to be treated as the same assets as other shares. This covers the situation where there has been a reorganisation, for example, a bonus issue of shares or an issue of shares falling within sections 135 and 136 of TCGA. Under paragraph 8(3) and (4) of Schedule 15B to ICTA new shares acquired as a result of the reorganisation etc. are treated as being acquired within the permitted maximum i.e. as meeting the condition in paragraph 7(3)(a)(ii) of Schedule 15B to ICTA if the old shares were within the permitted maximum. However, no reference is made to the first of the conditions mentioned above i.e. the bona fide commercial purposes test.

For the issue of new shares to fall within sections 135 and 136 of TCGA, section 137(1) of TCGA must be satisfied. Section 137(1) of TCGA will only be satisfied if the share reorganisation was effected for bona fide commercial reasons and not as part of a scheme or arrangement the main purpose (or one of the main purposes) of which is the avoidance of tax liability. So, in practice, the Inland Revenue treat such new shares as having been acquired for bona fide commercial purposes as so meeting both conditions mentioned above.

Clause 712 applies the same rules about new shares meeting the genuine commercial purposes condition as are applied about the permitted maximum condition.

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 116: Interest from FOTRA securities held on trust: clause 715

This change gives statutory effect to a practice relating to interest arising from FOTRA securities held on trust.

FOTRA exemptions apply where gilt-edged securities are in the beneficial ownership of persons who are not ordinarily resident in the United Kingdom. The source legislation, principally section 154 of FA 1996, is rewritten in Chapter 6 of Part 6 of the Bill. The beneficial ownership test lies within the definition of "FOTRA security": as it is part of the exemption condition of the securities. (See, in particular, section 22 of F(No 2)A 1931).

Although in the case of bare trusts and trusts with an interest in possession, it is fairly clear where the beneficial ownership lies, in the case of discretionary or accumulation trusts it can be difficult to apply the beneficial ownership test. In some types of trust the beneficial ownership of an asset is, in effect, in suspense. In others, while it may be clear where the beneficial ownership lies, it may belong to a different person from the person entitled to the income.

In practice, where interest from FOTRA securities held in trust arises to trustees and none of the beneficiaries of the trust is ordinarily resident in the United Kingdom, the beneficial ownership test is regarded as met whatever kind of trust is involved and no account is taken of whether the trustees themselves are resident or ordinarily resident. So if all the potential beneficiaries of a discretionary or accumulation trust (that is, those who have the right, at the discretion of the trustees, to benefit from the trust income or accumulated income) are not ordinarily resident in the United Kingdom, the FOTRA beneficial ownership test is treated as having been met.

Clause 715 gives effect to this practice. So, for the purposes of determining whether interest arising from a FOTRA security held in trust is exempt from income tax under clause 714, it is to be assumed that the security is in the beneficial ownership of a person who is not ordinarily resident if none of the beneficiaries of the trust is resident when the interest arises. (See clause 715(1) and (2)). Clause 715(3) defines "beneficiaries of the trust" widely so as to cover all potential income beneficiaries of discretionary and accumulation trusts. Clause 715(4) brings in beneficiaries receiving accumulated income.

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 117: Exempt income: purchased life annuity payments: claim for exemption of capital element of purchased life annuity: clause 717(3)

This change relates to the rewriting in the Bill (and so as primary legislation) of the requirement in regulation 4 of the Income Tax (Purchased Life Annuities) Regulations 1956 SI 1956/1230 for a claim to be made to obtain the benefit of section 656(1) of ICTA.

Case law has established that the whole of an annuity payment received by an annuitant is chargeable to income tax. (See, for example, the judgment of the Lord President (Inglis) in Coltness Iron Co v Black (1881), 1 TC 287 CS, which was cited with approval by Lord Wilberforce in CIR v Church Commissioners for England (1976), 50 TC 516 HL ².) However, section 656(1) of ICTA provides for a part of an annuity payment made under a purchased life annuity to be treated as capital (the "capital element"). The effect is that, so far as it consists of the capital element, the annuity payment is exempt from income tax.

² STC 339

To obtain the benefit of section 656(1) of ICTA, an annuitant has to make a claim under regulation 4 of the Income Tax (Purchased Life Annuities) Regulations 1956 SI 1956/1230. Section 658(4) of ICTA provides that the regulations may "make provision for the time limit for making any claim for relief from or repayment of tax". But that is the only specific reference to a claim in the primary legislation. So that it is clear to a reader of the exemption that it is subject to a claim, the implied requirement for a claim in regulation 4 is rewritten in clause 717(3). Accordingly, the power in section 658(3) of ICTA to make regulations about this is not rewritten. As a result, the requirement for a claim cannot be revoked or amended by regulations.

This change has no implications for the amount of tax due, who pays it or when. It affects (in principle and in practice) only administrative matters.

Change 118: Exempt income: purchased life annuity payments: method of calculating exempt part of purchased life annuity: clause 719

This change alters the method of calculating the exempt part of an annuity payment where both the term of the annuity and the amount of the annuity payment depend on some contingency other than the duration of human life, and gives statutory effect to ESC A46.

Section 656(1) of ICTA provides for a part of an annuity payment made under a purchased life annuity to be treated as capital (the "capital element"). The effect is that, so far as it consists of the capital element, the annuity payment is exempt from income tax.

The way in which that exempt part is calculated varies according to the type of annuity involved, but the legislation is very jumbled and does not distinguish the different types very clearly.

By definition (see section 657(1) of ICTA) the term of a purchased life annuity is always dependent on the duration of a human life. The amount of the annuity payment might also be dependent on the duration of a human life. And the term or the amount (or both) might also be dependent on some other contingency (a "non-life contingency").

There are two basic approaches to the calculation of how much of any annuity payment is exempt. Which approach applies is, in general, determined by whether or not the amount of the annuity payment depends on some non-life contingency. Where the amount does depend on a non-life contingency, a constant sum is exempt (assuming the period covered by each payment is the same). (See section 656(2) of ICTA.) But where the amount of the payment does not depend on a non-life contingency, a constant proportion of each payment is exempt. (See section 656(3)(a) to (c) of ICTA.)

Where not only the amount of the annuity payment but also 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 part of each payment to be computed as a constant proportion. "[T]hat proportion shall be such as may be just, having regard to subsection (2) above and to the contingencies affecting the annuity."

As section 656(2) of ICTA recognises, actuarial techniques do not provide any mechanism for calculating the (exempt) capital element as a constant proportion of an annuity where the amount of the annuity is dependent on a non-life contingency. So the calculation envisaged by section 656(3)(b) and (e) of ICTA is not possible. Actuarial techniques do, however, provide a route to calculating a capital element as a constant monetary sum. It is possible, therefore, where both the amount and the term depend on a non-life contingency, to calculate the (exempt) capital element as a constant monetary sum (rather than as a constant proportion). Accordingly, clause 719(4) provides for the constant sum method to apply in this case.

If the exempt capital element is so calculated, it is then possible for the amount of the exempt part to exceed the amount of a particular annuity payment. (See Change 119 in Annex 1.) To cover that situation the carry forward of excess exempt amounts allowed by ESC A46 has been extended to annuities of this sort. The result is that the excess may be carried forward and added to the exempt part of the next payment. (See clause 719(5).)

This change is adverse to some taxpayers and favourable to others in principle. If the amount of the annuity payment increases at a rate greater than that assumed for the purpose of calculating the capital element, the constant proportion approach favours the taxpayer. If the rate of increase falls below that predicted, the constant sum approach is to the taxpayer's advantage. In practice, it is expected to have no effect because this type of annuity has not been met in practice and remains no more than a hypothetical possibility.

Change 119: Exempt income: purchased life annuity payments: carry forward of excess exempt capital element in purchased life annuity payment: clause 719 and Schedule 2

This change gives statutory effect to ESC A46.

Section 656(1) of ICTA provides for a part of an annuity payment made under a purchased life annuity to be treated as capital (the "capital element"). The effect is that, so far as it consists of the capital element, the annuity payment is exempt from income tax.

The way in which that exempt part is calculated varies according to the type of annuity involved, but the legislation is very jumbled and does not distinguish the different types very clearly.

By definition (see section 657(1) of ICTA) the term of a purchased life annuity is always dependent on the duration of a human life. The amount of the annuity payment might also be dependent on the duration of a human life. And the term or the amount (or both) might also be dependent on some other contingency (a "non-life contingency").

There are two basic approaches to the calculation of how much of any annuity payment is exempt. Which approach applies is, in general, determined by whether or not the amount of the annuity payment depends on some non-life contingency. Where the amount does depend on a non-life contingency a constant sum is exempt (assuming the period covered by each payment is the same). (See section 656(2) of ICTA.) But where the amount of the payment does not depend on a non-life contingency a constant proportion of each payment is exempt. (See section 656(3)(a) to (c) of ICTA.)

An example of an annuity where the amount depends on a non-life contingency 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 gross annuity may fall short of the amount of the constant 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.

ESC A46 deals with the situation where the amount of the annuity payment is less than the amount computed as exempt under the constant sum method in section 656(2) of ICTA. It allows any excess of the exempt amount over the gross annuity to be carried forward and increase the exempt part of the next payment. Clause 719(5) gives statutory effect to the concession and Part 9 of Schedule 2 to this Bill enables such excesses that were not absorbed by annuity payments made before tax year 2004-05 because they were too small, to be carried forward by increasing the exempt amount of the first payment made after 5 April 2005.

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 120: Exempt income: purchased life annuity payments: determining the age of the person during whose life a purchased life annuity is payable: clauses 720(4) and 721(4)

This change alters in certain circumstances the age to be taken for the person during whose life a purchased life annuity is payable for the purposes of calculating the amount of the annuity that is exempt.

Section 656(1) of ICTA provides for a part of an annuity payment made under a purchased life annuity to be treated as capital (the "capital element"). The effect is that, so far as it consists of the capital element, the annuity payment is exempt from income tax.

The way in which that exempt part is calculated varies according to the type of annuity involved, but the legislation is very jumbled and does not distinguish the different types very clearly.

By definition (see section 657(1) of ICTA) the term of a purchased life annuity is always dependent on the duration of a human life. The amount of the annuity payment might also be dependent on the duration of a human life. And the term or the amount (or both) might also be dependent on some other contingency (a "non-life contingency").

There are two basic approaches to the calculation of how much of any annuity payment is exempt. Which approach applies is, in general, determined by whether or not the amount of the annuity payment depends on some non-life contingency. Where the amount does depend on a non-life contingency, a constant sum is exempt (assuming the period covered by each payment is the same). (See section 656(2) of ICTA.) This is determined by reference to the purchase price of the annuity and its expected term. Under section 656(2)(a)(ii) of ICTA the term is determined as at the date when the first annuity payment begins to accrue "by reference to prescribed tables of mortality".

But where the amount of the payment does not depend on a non-life contingency a constant proportion of each payment is exempt. (See section 656(3)(a) to (c) of ICTA.) Under section 656(4)(c) of ICTA the proportion used is the proportion that the total amount or value of the consideration for the grant of the annuity bears to the actuarial value of the annuity. That is determined as at the date on which the first payment begins to accrue "by reference to the prescribed tables of mortality".

Section 656(7) of ICTA provides that in using the prescribed tables of mortality to determine the expected term of an annuity or the actuarial value of the annuity payments

the age, as at the date when the first of the annuity payments begins to accrue, of a person during whose life the annuity is payable shall be taken to be the number of years of his age at his last birthday preceding that date.

So the age of the person during whose life the annuity is payable is determined by reference to his or her last birthday before the date of the calculation. Accordingly, where the calculation is to be made on the individual's actual birthday, it is still his or her age on his or her previous birthday that is taken even though he or she is, in any ordinary sense, a full year older.

Actuarial practice recognises the annuitant's age in years and fractions of years. For simplicity of calculation the purchased life annuity legislation only recognises full years, but it is not consistent with actuarial practice that it should attribute to an individual an age that he or she attained a year and a day previously. Inland Revenue practice follows actuarial practice in this respect, and so bases the calculation on the age attained on the date of the calculation if that date is the individual's birthday. Under both approaches for calculating how much of any annuity payment is exempt, the constant sum approach and the constant proportion approach, this practice produces a higher figure for the exempt element than the legislation. Clauses 720(4)(b) and 721(4)(c) rewrite this practice.