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 135: Foreign income: special rules: relief for unremittable income and delayed remittances: conditions for granting relief: clauses 835 and 841

This change broadens one condition and removes another condition for claims for relief in respect of unremittable income under section 584 or 585 of ICTA.

Section 584 of ICTA provides for relief for taxpayers taxed on income arising outside the United Kingdom, where the income cannot be remitted to the United Kingdom and certain conditions are met. Section 584(1)(a) and (2)(b) of ICTA refer to income which cannot be remitted to the United Kingdom because of the laws of the overseas territory, any executive action of its government or the impossibility of the person obtaining foreign currency in the overseas territory "notwithstanding any reasonable endeavours on his part".

Section 585 of ICTA applies to taxpayers on the remittance basis (see section 65(4) of ICTA). It provides that relief from tax on income taxed under Schedule D Case IV or V may be claimed if the conditions set out in subsection (1)(a) to (c) are met.

• Subsection (1)(a) requires the taxpayer to have been unable to transfer the income to the United Kingdom.

• Subsection (1)(b) requires the inability to transfer to have been due to one of three reasons:

• the laws of the territory where the income arose;

• executive action of its government; or

• the impossibility of obtaining foreign currency in that territory.

Subsection (1)(c) requires the inability to transfer to have been not due to any want of "reasonable endeavours" on the part of the taxpayer.

(A) This concerns the condition contained in sections 584(1)(a) and 585(1)(b) of ICTA requiring an inability to transfer "due to..the impossibility of obtaining foreign currency" in the territory where the income arose. It could be argued that there cannot be an inability to transfer due to the impossibility of obtaining foreign currency in that territory if foreign currency is in fact obtainable there (regardless of whether it may be transferred to the United Kingdom).

Clauses 835(3)(c) and 841(3)(c) of the Bill remove the possibility of that narrow interpretation being taken. They require an inability to transfer because of the impossibility of obtaining in the territory currency "that could be transferred to the United Kingdom". The reference to that currency being foreign has been dropped as misleading: if local currency can be obtained that cannot be transferred to the United Kingdom, the case is likely to fall within clause 835(3)(a) or (b) or 841(3)(a) or (b), but there is no point in excluding it from paragraph (c).

(B) The condition contained in section 585(1)(c) of ICTA and the similar words about "reasonable endeavours" in section 584(2) of ICTA are not rewritten in the Bill. They are regarded as adding little to the requirements of sections 584(1)(a) and 585(1)(a) and (b) of ICTA. If, by reasonable endeavours, the taxpayer could transfer the income to the United Kingdom, the test in section 584(1)(a) of ICTA of his being prevented from transferring it and the similar tests in section 585(1)(a) of ICTA about being unable to transfer the income or remit the proceeds of transfer must not be met, and there would then be no inability to transfer because of local law, government action or the impossibility of obtaining foreign currency as required under section 585(1)(b) 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 136: Foreign income: special rules: delayed remittances: remittances in respect of which a claim may be made: clause 835

This change enables a claim for relief to be made in respect of some (as opposed to all) of a taxpayer's delayed remittances where the taxpayer is taxed on the remittance basis.

Relief is available under section 585 of ICTA to taxpayers who are taxed on the remittance basis for income which cannot be remitted to the United Kingdom, if the conditions in section 585(1) of ICTA are met.

Section 585 of ICTA does not expressly refer to the possibility that a claim for relief may be made in respect of some (as opposed to all) of the income from a source which meets those conditions. But in practice the Inland Revenue would allow such a partial claim.

Clause 835(1) of the Bill gives effect to this practice by providing that a claim may be made "in respect of any of the income which meets [the relevant conditions]" without requiring that the claim must be made in respect of all the income.

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 137: Foreign income: special rules: deductions: omission of requirement for income not to be received in the United Kingdom: clause 838

This change involves rewriting the part of section 65(1) of ICTA that permits deductions for expenses incurred outside the United Kingdom to be allowed in calculating the amount of foreign income chargeable to tax with the omission of the condition that the income in question must not be received in the United Kingdom.

Under section 65(1)(a) of ICTA certain deductions may be made from income within Schedule D Case IV and V that is taxed on the arising basis (with the exception of income arising from a trade carried on wholly abroad). The deductions are only permitted to be made where the income concerned is not received in the United Kingdom. (See the words preceding paragraph (a) of section 65(1) of ICTA.)

It is thought that this rather curious condition was included as an attempt to put taxpayers who found themselves within the arising basis rather than the remittance basis (following the restrictions placed on the remittance basis in FA 1914) on a similar footing to those who could still take advantage of the remittance basis. In fact, no deductions are available to those taxed on the remittance basis (except in the case of trading income). Moreover, in practice, for taxpayers within the arising basis, the Inland Revenue make no distinction between income received and not received in the United Kingdom: deductions available under section 65(1)(a) of ICTA are given whether or not the income in question is received in the United Kingdom. (See Change 138 for further details about the nature of these deductions.)

In rewriting the circumstances in which these deductions are allowed, this restriction has been omitted. (It is necessary, however, and has been retained for the deduction allowed for annuities under section 65(1)(b) of ICTA which is rewritten in clause 839: see subsection (5)(a) of that clause.)

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 138: Foreign income: special rules: specifying deductions available: clause 838

This change concerns specifying the type of deductions available under section 65(1)(a) of ICTA for income within Schedule D Cases IV and V and extending the availability of these deductions to profits of foreign trades.

Section 65(1)(a) of ICTA allows certain deductions in computing the charge to income tax under Schedule D Cases IV and V where the income is taxed under the arising basis. Section 65(1)(a) of ICTA is drafted in very vague terms, referring to "the same deductions and allowances as if it [the income] had been so received [in the United Kingdom]". In this context, the word "received" is thought to be a reference to income taxed on the remittance basis.

In practice, the Inland Revenue treat these words as referring to expenses incurred in the "management and collection" of the income and the expenses allowed are confined to expenses incurred outside the United Kingdom. (See paragraph 1669 of the Inland Revenue's Inspector's Manual (IM 1669).) This interpretation is in accordance with the decision in Atkin v McDonald's Trustees (1894), 3 TC 306 (Court of Exchequer, Scotland, First Division) which involved income assessed on the remittance basis. In that case it was held that expenses incurred in the United Kingdom could not be deducted from the remitted income. So it follows that if deductions under section 65(1)(a) of ICTA are to mirror the position a taxpayer might find himself or herself in under the remittance basis, the section 65(1)(a) of ICTA expenses are confined to expenses incurred outside the United Kingdom.

Clause 838 uses the words "collection or payment" rather than "management and collection" because the use of the word "management" might imply that the costs of managing a portfolio of investments should be allowed, but that is not so. The deductions that are allowed are those solely concerned with the costs of handling the income. There is nothing in the legislation that confines those costs to costs involved in sending the money to the United Kingdom, so no such restriction has been imposed.

Section 65(3) of ICTA provides that section 65(1)(a) of ICTA does not apply to income arising from a trade, profession or vocation carried on wholly outside the United Kingdom ("a foreign trade"). But, in practice, the Inland Revenue treat section 65(1)(a) of ICTA as conferring a deduction for certain extra expenses of a foreign trade that result from the income arising outside the United Kingdom, although in fact it is unlikely that there are any expenses within section 65(1)(a) of ICTA that would not be allowable in arriving at the profits of a foreign trade. Such trades are thus treated in the same way as overseas property businesses, since section 65A(5) of ICTA does not disapply section 65(1)(a) of ICTA.

In rewriting section 65(1)(a) of ICTA, clause 838 does not exclude income from a foreign trade. So the costs attributable to the collection or payment of income from a foreign trade are deductible.

This change is adverse to some taxpayers and favourable to others in principle but in practice is expected to have only favourable effects and those small, and in few cases, because the incidence of these costs is rare.

Change 139: Pensions charged on the arising basis (sections 575, 613 and 635 of ITEPA): relief for arrears of foreign pensions: clause 840 and Part 11 of Schedule 2

This change gives statutory effect to ESC A55 (arrears of foreign pensions). In doing this the Bill makes a number of changes to the approach in the concession.

Sections 575, 613 and 635 of ITEPA determine the amount of taxable pension income for foreign pensions, foreign annuities and foreign voluntary annual payments respectively. The amount is found by applying the rules of Schedule D Case V. Section 65(1) of ICTA computes income under Schedule D Case V on the full amount of the income arising in the year of assessment (unless the remittance basis applies - see section 65(4) of ICTA). Section 68 of ICTA has provisions equivalent to section 65(1) of ICTA (but not to section 65(4) of ICTA), in respect of such income from the Republic of Ireland.

When a pension, annuity or voluntary annual payment (or an increase in such a pension etc) is granted retrospectively, arrears paid in respect of an earlier year or years arise for the purposes of sections 65(1) and 68 of ICTA in the year they become due rather than in an earlier year or years. The person receiving the arrears may be liable at a higher rate of tax in the year the income arises than the rate that would have applied had the arrears arisen in the earlier year.

Under ESC A55 the Inland Revenue recalculates the tax for the year in which the arrears arise for the purposes of section 65(1) of ICTA as if the arrears had arisen in the earlier year or years. If the recalculation is advantageous to the taxpayer, the tax charged is abated. The recalculation takes into account the 10% deduction under sections 65(2) or 68(5) of ICTA where appropriate. The abatement is applied without a claim.

Clause 840 of the Bill gives effect to the concession, but with some adaptations, taking the parallel relief for income charged under the remittance basis in clause 836 (relief for delayed remittances: back dated pensions) as its model. So, rather than the tax for the year in which the arrears arise being abated, the arrears are treated as income of each relevant earlier year. The tax charge for each earlier year will increase, but the reduction of the charge in the year in which the arrears otherwise arise will compensate (and normally exceed the aggregate of the increases). Clause 840(2) also requires a claim by the person liable for tax on the arrears, instead of action being initiated by the Inland Revenue. The administrative provisions of clause 837 (claims for relief on delayed remittances) are applied so as to cater for these factors in the change of approach. It provides a time limit for claims, machinery for adjusting tax for earlier years and administration of the relief when a claimant dies.

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

Change 140: Foreign income: special rules: unremittable income: time limit for claims for relief: clause 842(5)

This change alters the time limit for claims to relief in respect of unremittable income arising outside the United Kingdom so that the limit is tied to the tax year for which the income would otherwise be chargeable, rather than to the tax year in which the income arises.

Under section 584(6)(a) of ICTA a claim must be made "on or before the first anniversary of the 31 January next following the year of assessment in which the income arises". The year in which the income arises, however, might not be the year for which the income is chargeable, and the normal time limit for claims is by reference to the year for which the income is chargeable. So in such a case the limit under section 584(6)(a) of ICTA would differ from the normal time limit for claims.

In rewriting section 584(6)(a) of ICTA in clause 842(5), the time limit for claims has been expressed by reference to the tax year for which the income would be chargeable if no claim were made, so aligning the limit for this kind of claim with the normal time limits for claims.

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 141: Foreign income: special rules: unremittable income: withdrawal of relief: ECGD payments received: clause 843

This involves the withdrawal of relief in respect of unremittable income on the making of an Export Credit Guarantee Scheme payment in respect of the income.

Section 584 of ICTA provides a relief from income tax where a person's income arising outside the United Kingdom is charged on the basis of the income arising in the tax year, but cannot be transferred to the United Kingdom because of circumstances outside the person's control ("unremittable income"). Section 584(2) of ICTA provides that if such a person makes a claim in respect of overseas income which:

• is unremittable; and

• he or she will continue to be prevented from transferring to the United Kingdom, notwithstanding any reasonable endeavours on his or her part,

the amount of the income is to be left out of account in charging income from that source.

However, under section 584(2A) of ICTA if on any date "paragraph (a) or (b) of subsection (2) above ceases to apply" the income is treated as arising on the date of the change and is charged to tax for the tax year in which that date falls.

Section 584(5) of ICTA modifies the operation of the relief where a payment is made under the Export Credit Guarantee Scheme in respect of the unremittable income. Section 584(5) of ICTA provides that "..to the extent of the payment, the income shall be treated as income to which paragraphs (a) and (b) of subsection (2) above do not apply (and accordingly cannot cease to apply)". This makes it clear that no claim can be made, but not whether relief already given may be withdrawn or, if it may, whether the charge to withdraw the relief is to be made for the tax year in which the income first arose, or the year in which the ECGD payment is made.

This lack of clarity appears to be an unintentional result of amendments made by paragraph 33 of Schedule 20 to FA 1996, which substituted the present subsections (2) and (2A) of section 584 of ICTA for the original subsection (2) and amended subsection (5) in consequence. Those amendments, which were part of the changes made to facilitate Self Assessment for income tax, built on the changes already made by F(No 2)A 1987 for the introduction of "Pay and File" for corporation tax. Before the FA 1996 changes section 584(2) of ICTA was much longer and provided not only that account would not be taken of the income to the extent that the claimant showed "to the satisfaction of the Board that conditions [corresponding to those in paragraphs (a) and (b) in the present subsection (2)]" were satisfied with respect to it, but also that "on the Board ceasing to be satisfied that those conditions are satisfied" such assessments etc were to be made as were necessary to take account of the income and of any tax payable in the overseas territory in respect of it "according to their value at the date when in the opinion of the Board those conditions cease to be satisfied with respect to it".

The original section 584(5) of ICTA provided that to the extent of the Export Credit Guarantee Scheme payment the income should be treated as income "with respect to which the conditions mentioned in subsection (2) above are not satisfied (and accordingly cannot cease to be satisfied)". So it plainly had the effect that not only could no claim be made, but the Board would be bound to be satisfied that the income had ceased to be unremittable - or perhaps had never been unremittable - and so it could be assessed. It was never very clear what date was to be used for the value of the income and the foreign tax. But presumably the only date that could be used was the date when the Board had to cease to be satisfied, that is the date of the payment.

There is no good reason for the treatment of income which is no longer unremittable to vary according to whether circumstances have changed or an ECGD payment has been made. So this apparent change in the effect of section 584(5) of ICTA appears to have been completely unintentional. In practice, the income is taxed in the tax year in which the ECGD payment is made. Therefore clause 843(4) and (5), which rewrite section 584(5) of ICTA, provide for the income to be taxed in that tax year, and accordingly for the income and any tax payable in respect of it in the place where it arises to be taken into account for income tax purposes at that date.

This change is adverse to some taxpayers in principle. But it is in line with the original legislation before amendment and with the intention of the amended legislation. And it is expected to have no practical effect as it is in line with current practice.Change 142: Relevant foreign income: unremittable income: appeals to the Special Commissioners: Chapter 4 of Part 8 and Part 11 of Schedule 2

This change involves the omission from the Bill of any provision rewriting the requirement under section 584(9) of ICTA that appeals concerning questions about relief for unremittable income should be heard by the Special Commissioners.

Section 584(9) of ICTA provides that appeals involving any question as to the operation of that section (relief for unremittable overseas income) must be made to the Special Commissioners and not to the General Commissioners. This is a departure from the normal rules in sections 31B to 31D of TMA under which in most cases a taxpayer may have an appeal heard by the General Commissioners or make an election under section 31D of TMA for the appeal to be heard by the Special Commissioners.

The Bill does not include any requirement about appeals involving any question as to the operation of Chapter 4 of Part 8 of the Bill, which rewrites section 584 of ICTA. So the normal rules in sections 31B to 31D of TMA will apply to such appeals without restriction.

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 143: Partnerships: allocation of firm's profits between partners: clause 850

This change legislates the practice in paragraph 72245 of the Inland Revenue's Business Income Manual.

Section 111(3) of ICTA provides that a partner's share of the profits or losses of a trade carried on in partnership is to be determined "according to the interests of the partners". It offers no guidance on how this is to be done.

Some partnership agreements provide for an initial allocation of profits (often in the form of a salary or interest on capital) to some partners before the balance is allocated on the basis of a percentage share in the profits.

For instance, three partners may agree to allocate profits of 250,000 as follows:

But, if the profits were only 90,000, the position would be:

Section 111(3) of ICTA deals in this case with an allocation of the trade profits. So the answer for partner C cannot be a loss. The Inland Revenue practice, supported by decisions by the Special Commissioners, is to re-allocate C's "loss" to the other partners, so that in the example both A and B are allocated 45,000 of the trade profits. C's share is nil.

A similar position can arise if the result for the firm is a loss. A share of that loss under section 111(3) of ICTA cannot be a profit.

Subsections (2) and (3) of the clause sets out how a profit is to be allocated between partners, so that no partner's share is a loss. Subsections (4) and (5) set out the corresponding rule for the case where the overall result is a loss.

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

Change 144: Partnerships: carrying on by partner of notional business: clause 854

This change makes clear how the basis period rules apply to a non-trade business carried on in partnership.

If a person carries on a business (but not a trade) in partnership, section 111(10) of ICTA provides that subsections (1) to (3) of that section apply as they apply to a trade carried on in partnership. But those subsections do not import the special basis period rules in sections 60 to 63A of ICTA. So the income of the firm is assessed on the basis of the income arising or profits accruing in the tax year.

The position changes if the firm also carries on a trade. Then each partner's share of the trading profits is assessed, in accordance with the rules in sections 60 to 63A of ICTA, on the profits of basis periods which may differ from tax years. A consequence of that treatment is that section 111(7) and (8) of ICTA apply to the non-trading income of the firm. So the non-trading income may also be assessed on the income of basis periods which differ from tax years.

There is a potential problem if a non-trading firm starts to trade. Section 111(8)(b) of ICTA seems to require the basis periods for the non-trading income to be re-determined for all years since the partner joined the firm. That would pose considerable practical difficulties in the absence of rules about how to make the adjustments to assessments for earlier years.

Subsection (2)(b) of the clause makes it clear that the partner's "notional business" (comprising a share of the non-trading income) does not start until the firm starts to trade: there is no question of looking back to the time when the partner joined the firm.

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

Change 145: Partnerships: resident partners and double taxation agreements: clause 858

This change enacts the Inland Revenue practice of giving a narrow interpretation to the word "affect" in section 112(4) of ICTA.

The business profits article of the United Kingdom/Jersey double taxation agreement exempts the profits of a Jersey firm from United Kingdom tax. In the case of Padmore v CIR (1989), 62 TC 352 CA ³, the Court of Appeal decided that the exemption covered the share of the profits arising to a United Kingdom resident partner. The rules in section 112(4) and (5) of ICTA were enacted in 1987 to remove the exemption.

³ STC 493

It was intended, in the case of income tax, that the 1987 legislation should do no more than remove the exemption claimed in the Padmore case. The words used in section 112(4) of ICTA are "shall not affect any liability to tax". On the face of it, these words could deny the partner any relief, including tax credit relief, under a double taxation treaty.

Subsection (2) of the clause makes it clear that it is only the partner's chargeability to tax that is preserved, overriding any provision to the contrary in a double taxation treaty. No other effect of the treaty is overridden.

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

Change 146: Exception of certain business gifts from the disallowance of expenditure on business entertainment and gifts in calculating the profits of non-trade and non-property businesses: clause 867

This change extends an exception made in calculating profits, in the case of a business which is a trade or property business, to non-trade and non-property businesses.

Section 577 of ICTA (business entertaining expenses) prohibits the deduction of business entertaining expenditure in calculating profits chargeable to tax under Schedule D (section 18 of ICTA). Profits chargeable to tax under Schedule D include not only profits of a trade, profession or vocation, whether chargeable under Case I or II or Case V of that Schedule, but profits chargeable under other Cases of that Schedule. Section 21A(2) of ICTA applies section 577 of ICTA to the computation of income under Schedule A (section 15 of ICTA).

Section 577(8) of ICTA extends the restriction of deductible expenses under that section to the provision of gifts.

There are a number of exceptions from the restriction under section 577(1) or (8) to ICTA. Subsection (9) makes an exception for gifts to "expenditure incurred in making a gift to a body of persons or trust established for charitable purposes only" and two named bodies are treated as such a body of persons for this purpose. This exception was inserted by section 54 of FA 1980 in the predecessor of section 577 of ICTA, to give statutory form to an extra-statutory concession for donations by businesses to local charities. The scope of the former concession was broadened by the inserted exception, but the exception was restricted to "computing profits under Case I and II of Schedule D".

The exception provided by section 577(9) of ICTA does not therefore apply to business other than trades, professions and vocations or property businesses.

Section 577 of ICTA is rewritten, in respect of such trades and property businesses, in clauses 45 to 47 in Part 2 of this Bill. This clause borrows from those clauses to provide the extension of the rules, including exceptions, to non-trade businesses and non-property businesses.

It was not Inland Revenue policy, despite the drafting used in section 577(9) of ICTA, to make a distinction in the application of the exception between trades and property businesses and other businesses. This clause extends the benefit of the exception in principle to those other businesses.