House of Commons - Explanatory Note
Income Tax Bill - continued          House of Commons

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Change 1: Rates of tax: stock dividends and release of loans: clause 13

This change ensures that, in line with practice, income chargeable under Chapters 5 and 6 of Part 4 of ITTOIA which would otherwise be taxed at the higher rate is taxed at the dividend upper rate instead.

Section 1B of ICTA, as amended by paragraph 4 of Schedule 1 to ITTOIA, applies the dividend upper rate to an individual's income within Chapters 3 and 4 of Part 4 of ITTOIA (UK and foreign dividend income) that would otherwise have been taxed at the higher rate. It does not apply the dividend upper rate to income within Chapters 5 and 6 of Part 4 of ITTOIA (stock dividends from UK resident companies and release of loan to participator in close company). But the established practice in both cases has been to treat such income as if it fell within section 1B of ICTA.

This established practice has been recognised in the rewrite of section 1B of ICTA. Clause 13(2) applies the dividend upper rate instead of the higher rate to "dividend income". This term is defined in clause 19 to include income under Chapters 5 and 6 of Part 4 of ITTOIA. Accordingly, income within those Chapters will be taxed at the same rates as apply to ordinary dividends.

The amendment to section 1B of ICTA made by ITTOIA did not include references to Chapter 5 or 6 of Part 4 of ITTOIA because it was considered more appropriate to introduce such a change in the course of the rewrite of section 1B itself rather than as an amendment in ITTOIA.

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 2: Rates of tax: income of personal representative under section 466 of ITTOIA: clause 18

This change corrects an anomaly in relation to the rate of tax which applies when personal representatives are liable on gains charged under Chapter 9 of Part 4 of ITTOIA (gains from contracts for life insurance etc).

Chapter 9 provides for a charge where gains arise on certain insurance policies and contracts. The provisions setting out who is liable for tax in respect of the gain include section 465 (individuals) and section 466 (personal representatives) of ITTOIA. For liability under section 465, section 1A(2)(d) of ICTA ensures that a gain counts as savings income and benefits from the charge at the lower rate.

Where the gain arises in circumstances where personal representatives hold the rights in the policy or contract there are two possible outcomes.

The first, if the condition in section 466(2) of ITTOIA is not met, is that section 664(2)(e) of ITTOIA provides that the gain falls into the aggregate income of the estate. (The condition is that the circumstances are such that an individual liable under section 465 on the gain would not be entitled to the tax credit provided by section 530 of ITTOIA.). Section 680(4) of ITTOIA (income treated as bearing income tax) then treats this as income "bearing income tax at the lower rate".

In this case, the personal representatives are not chargeable under Chapter 6 of Part 5 of ITTOIA (beneficiaries' income from estates in administration) and, by virtue of section 698A of ICTA (taxation of income of beneficiaries at lower rate or at rates applicable to distribution income), the deemed income of the beneficiary is chargeable at the lower rate rather than the basic rate.

The second possible outcome, if the condition in section 466(2) of ITTOIA is met, is that the personal representatives are chargeable under section 466. The gain still falls into the aggregate income of the estate, but under section 664(2)(a) of ITTOIA rather than section 664(2)(e).

In this case, section 680(4) of ITTOIA does not apply and the normal rules that determine the rate of tax apply instead: the income does not fall within section 1A of ICTA, so the personal representatives are chargeable at the basic rate rather than the lower rate.

It was not intended that the basic rate should apply in these circumstances. The anomaly arose as a result of the amendment to section 1A of ICTA made by paragraph 1 of Schedule 35 to FA 2003. And in practice personal representatives have been given the benefit of the lower rate.

This change removes the anomaly: gains treated under section 466 of ITTOIA as income of personal representatives are included in the definition of savings income (see clause 18(4)).

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 3: Tax calculation: relief for deficiencies: amendment to section 539 of ITTOIA: clause 26 and Schedule 1 (section 539 of ITTOIA)

This change amends the way in which relief under section 539 of ITTOIA is given and introduces a formal claims requirement.

Section 539(1) of ITTOIA provides for relief for a deficiency to be given as a deduction from total income. But the mechanics of the relief as set out in section 539(3) to (5) show that it is intended to work as a computational adjustment to the amount of income tax payable. Accordingly, the relief is included with those that operate as tax reductions in clause 26 of the Bill, and section 539 of ITTOIA is itself amended to make the position clear.

Amended section 539 of ITTOIA adopts a step approach to the calculation of the reduction. Since the greatest reduction in tax is achieved by charging dividend income at the dividend ordinary rate instead of at the dividend upper rate (a reduction from 32.5% to 10%), Step 1 allocates the deficiency as far as possible to dividend income chargeable at the upper rate. On the same basis Step 2 deals with savings income charged at the higher rate (a reduction from 40% to 20%) and Step 3 with other income (a reduction from 40% to 22%).

The treatment set out above does not apply to certain life annuity contracts made in the accounting period of an insurance company or friendly society beginning before 1 January 1992. In such a case the provisions of paragraph 109 of Schedule 2 to ITTOIA apply to treat the deficiency as an income deduction. That paragraph is itself consequentially amended by this Bill to make the position clearer.

The opportunity has also been taken to introduce a claims requirement in line with other insurance related reliefs (see Change 83). In practice, box 12.9 of the Self Assessment return does require a claim to relief. The introduction of a formal claims requirement regularises this practice and provides a straightforward way of resolving disputes.

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 4: Tax calculation: order in which tax reductions are allowed: clauses 27 and 28

This change introduces the rule that where no priority is specified, tax reductions are allowed in the order that provides the greatest reduction in income tax liability for the year. In addition, the priority between two specific tax reductions is clarified.

In calculating liability to income tax, section 835(4) of ICTA provides that, subject to any express provisions, deductions from income are made in the order that produces the greatest reduction in tax. There is no corresponding provision regarding the order in which reductions that are given in terms of tax are allowed.

In many cases the order in which two or more tax reductions are made does not affect the liability, but in calculating the amount of some tax reductions it is necessary to establish which other reductions have already been taken into account. The new rule in clauses 27(2) and 28(2) mirrors the rule on deductions in providing that, subject to any express provisions, tax reductions are made in the order that produces the lowest income tax liability for the year.

Some of the rules on particular tax reductions do provide an order of priority in relation to some other tax reductions. For example, from sections 256(3), 347B(5B) and 353(1H) of ICTA it can be seen that a reduction under section 353 is allowed before a reduction under section 347B and that reliefs under Chapter 1 of Part 7 of ICTA (personal reliefs) come after the other two.

There are in fact two distinct personal reliefs that operate as tax reductions and in practice it will always be beneficial for relief under section 273 of ICTA to be deducted before married couple's allowance because the latter is transferable. Accordingly, in setting out in clause 27(5) those provisions that provide for a particular order, the reliefs under Chapter 1 of Part 7 have been separated with married couple's allowance to be given last.

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: References to "officer of Revenue and Customs": clauses 35, 36, 37, 38, 39, 45, 46, 47, 48, 49, 403, 459, 508, 538, 542, 551, 554, 557, 558, 561, 625, 628, 629, 630, 631, 636, 639, 640, 672, 676, 681, 684, 845, 848, 849, 864, 877 and 903, Schedule 1 (sections 256A and 256B of TCGA and section 102 of FA 2004) and Schedule 2 Part 14 (deduction by deposit-takers: discretionary or accumulation settlements)

This change replaces references to the "Board of Inland Revenue" (and one reference to the "Commissioners for Her Majesty's Revenue and Customs") in the source legislation with references to "an officer of Revenue and Customs".

References in the source legislation to the "Board of Inland Revenue" are treated by section 50(1) of CRCA as references to "the Commissioners for Her Majesty's Revenue and Customs". The rest of this note accordingly refers to the Commissioners for Her Majesty's Revenue and Customs (the Commissioners) rather than to the Board of Inland Revenue.

The provisions affected by this change will in future authorise or require things to be done by or in relation to an officer of Revenue and Customs rather than by or in relation to the Commissioners. This reflects the way in which HMRC is organised and operates in practice. Section 13 of CRCA allows nearly all functions conferred on the Commissioners to be exercised by any officer. All of the functions affected by this change, which are in the main concerned with administrative processes, are in fact exercised by officers of the Commissioners, and the Commissioners themselves are not personally involved in their exercise.

Where the source legislation provides for a claim or election to be made to the Commissioners, this Bill does not expressly state to whom such a claim or election is to be made. Where a return has been issued, section 42(2) of TMA requires the claim to be made in the return if possible and the return must be made to the officer who issued it. Similarly, where the claim is made outside a return, paragraph 2(1) of Schedule 1A to TMA requires the claim to be made to an officer.

Where a claim was formerly to the Commissioners, this change has a further consequence. Under section 46C of TMA (claims in a return) and paragraph 10 of Schedule 1A to TMA (claims outside a return), appeals concerning such claims are to the Special Commissioners. This contrasts with the rules in sections 31B to 31D of TMA under which, in most cases, a taxpayer may appeal to the General Commissioners or elect under section 31D to appeal to the Special Commissioners. The abolition of the requirement that a claim must be made to the Commissioners means that the rules in sections 31B to 31D will generally apply to appeals affected by this change. But in a few cases, especially where the issue is likely to be complex, appeals remain reserved to the Special Commissioners.

This Bill also removes any unnecessary references to any claim or election being in a form specified by the Commissioners. In relation to a claim or election in a return section 113 of TMA provides that the return shall be in such form as the Commissioners prescribe. Paragraph 2(3) of Schedule 1A to TMA makes parallel provision in relation to claims and elections made outside returns.

Section 113 of and Schedule 1A to TMA do not apply to the form of certificates, notices etc. Where the source legislation provides that the Commissioners determine the form of such documents, this Bill retains that approach, even though section 13 of CRCA means the work can be, and is, done by officers in practice. This is in order to indicate that such material is prescribed for HMRC as a whole.

Each provision affected by the conversion or omission of references to the Commissioners will be identified in the Table of Origins by a cross-reference to this change.

In ITEPA and ITTOIA references to "an inspector" in the source legislation which were converted to "the Inland Revenue" (meaning any officer) were also identified as a change. But references to an inspector are treated by section 50(2) of CRCA as references to an officer of Revenue and Customs. It follows that it is no longer appropriate to identify the conversion of such references as a change.

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 6: Blind person's allowance: enactment of ESC A86: clause 38

This change gives statutory effect to ESC A86.

For claimants in England and Wales, the blindness condition for entitlement to blind person's allowance under section 265 of ICTA is met where the claimant is on a register compiled by a local authority under section 29 of the National Assistance Act 1948.

ESC A86 states that:

    When a person becomes entitled to the blind person's allowance by being included on a register compiled under the National Assistance Act 1948 s 29, then he or she shall (subject to the normal time limits for claims) also be given the blind person's allowance for the previous year if, at the end of that previous year, he or she had already obtained the evidence of blindness (such as an ophthalmologist's certificate) upon which the registration was subsequently based.

To get the benefit of the concession, the individual must make a claim for the tax year preceding the year of registration. This requirement is preserved, so that a person who qualifies for relief under clause 38(4) must make a claim for the tax year preceding the tax year in which he or she is first registered.

Clause 38(4) gives effect to this 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 7: Personal reliefs: transfers between spouses or civil partners: clauses 39, 47, 48, 49, 51, 52 and 53, Schedule 1 (sections 257BA, 257BB and 265 of ICTA) and Schedule 2 Part 4 (personal reliefs)

This change removes the ability of spouses or civil partners to transfer blind person's allowance or married couple's allowance between them, in certain circumstances in which one or both of them is non-UK resident.

For those who are entitled to blind person's allowance or married couple's allowance immediately before the Bill comes into force, the change does not have effect until the start of the 2009-10 tax year.

Section 278 of ICTA provides that the various personal reliefs provided for by Chapter 1 of Part 7 of ICTA are not available to individuals who are non-UK resident unless they fall within one of the categories in section 278(2)(a) to (e).

The entitlement to relief of non-UK residents who fall within the categories in section 278(2)(b) to (e) is dealt with in the Bill, by virtue of clause 56(3). The entitlement of non-UK residents who fall only within section 278(2)(a) (which concerns Commonwealth citizens and EEA nationals) continues to be dealt with in Chapter 1 of Part 7 of ICTA.

In the case of blind person's allowance and married couple's allowance, there is provision in Chapter 1 of Part 7 of ICTA for the transfer of part of the allowance between spouses and civil partners in certain circumstances.

It will continue to be possible for these allowances to be transferred between spouses or civil partners, if both individuals qualify under clause 56 or both qualify under section 278(2)(a). But it will no longer be possible for these allowances to be transferred from one spouse or civil partner to the other if one of them qualifies under clause 56 and the other qualifies under section 278(2)(a).

This change is necessary to ensure that the provisions of the Bill are fully compatible with the provisions of the Human Rights Act 1998. See the overview commentary on Part 3 of the Bill and the explanation concerning the European Convention on Human Rights towards the end of the Explanatory Notes.

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

Change 8: Married couple's allowance: calculation of income threshold: clause 58 and Schedule 1 (section 256A of ICTA)

This change corrects an omission in the amendments made by the Tax and Civil Partnership Regulations 2005 (SI 2005/3229).

Paragraph 52 of the Regulations inserted section 257AB of ICTA, which applies to marriages and civil partnerships entered into on or after 5 December 2005. Section 257A of ICTA continues to apply where the marriage took place before that date, unless an election is made for the new rules to apply.

The two provisions are intended to operate in the same way except that under the new provision it is the higher income spouse or civil partner rather than the husband who is entitled to claim. Both provisions apply only where at least one party to the marriage or civil partnership was born before 6 April 1935.

The amount of the married couple's allowance is reduced from its maximum level when the claimant's income exceeds a certain threshold. In this Bill that threshold is called "adjusted net income" and is defined in clause 58. A corresponding provision is inserted into ICTA by Schedule 1 to this Bill to cater for claimants under that Act.

In calculating the claimant's income for this purpose, section 835(5) of ICTA provides that deductions under Chapter 1 of Part 7 of ICTA are not to be taken into for the purposes of section 257A(5). Section 835(5) should have been amended so that it applied also for the purposes of section 257AB(4), to keep the rules for the two provisions in step, but this was overlooked. This change corrects this, so that clause 58 and section 256A of ICTA apply in the calculation of married couple's allowance for all marriages and civil partnerships whenever they were entered into.

It may be noted that corresponding changes were made to other legislation by adding references to section 257AB(4) to existing references to section 257A(5). Regulation 104 inserted such a reference in section 25(9A) FA 1990 and Regulation 177 inserted such a reference in section 192(5) FA 2004. This reinforces the view that there was never any intention to have any difference in treatment as regards the measure of income between the two married couple's allowance provisions.

The change is taxpayer-adverse in that when calculating whether the taper applies to reduce entitlement to married couple's allowance under section 257AB, it is required that income is determined before the deduction of personal allowance (and if appropriate blind person's allowance and certain life insurance related reliefs). But making this change will bring the law into line with what it was understood was being achieved when the Tax and Civil Partnership Regulations were made.

The change applies only to couples where the rules relating to marriages or civil partnerships entered into after 5 December 2005 apply, where one individual was born before 6 April 1935, and where the claimant's income is in the range of income to which the tapering rules in clause 46(4) apply. The number of people potentially affected is considered likely to be small, as is the tax effect in any individual case.

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

Change 9: Trading losses: trades carried on "on a commercial basis": basis periods: clauses 66 and 74 and Schedule 2 Part 5 (trade loss relief against general income and early trade losses relief)

This change amends the rule about when a trade must be carried on "on a commercial basis", if certain restrictions on loss relief are not to apply, so that it operates by reference to basis periods rather than years of assessment.

The source legislation is set out in terms of a requirement for the trade to be carried on "on a commercial basis throughout the year of assessment". And if there is a change in the basis on which it is carried on during the year, it is to be treated as being carried on throughout the year as it is carried on by the end of the year. But this does not fit well with the fact that profits and losses are determined by reference to basis periods.

The clauses now state that the trade is commercial if it is carried on a commercial basis "throughout the basis period for the tax year" or, if there is a change during the basis period, "by the end of the basis period".

As a result of looking to basis periods, it is no longer necessary for these clauses to cater for the possibility of the trade only being carried on for part of a tax year (since a trade cannot, by definition, be carried on for less than a complete basis period).

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 10: Trading losses: trade leasing allowance given to individuals: alignment of individual's time commitment with period during which trade carried on: clause 75 and Schedule 2 Part 5 (sideways relief: trade leasing allowances given to individuals)

This change eliminates an inconsistency that arose following the change from preceding year basis to current year basis of assessment introduced by FA 1994.

A mismatch exists between the requirement that, to benefit from a trade leasing allowance, an individual must carry on the trade giving rise to the trade leasing allowance throughout one defined period and that during a different defined period substantially all of the individual's time must be devoted to carrying on the trade.

For example, the accounts of the trade could show a loss for the year from 1 July 2003 to 30 June 2004. So the basis period would cover the same period. But the individual must carry on the trade for a continuous period of at least six months in the tax year ending 5 April 2005 and substantially the whole of the individual's time throughout the year ending 5 April 2005 must be given to carrying on the trade.

The mismatch between these periods arose when individuals became taxable on a current year rather than preceding year basis. This change, introduced by FA 1994, also resulted in losses being determined for a tax year by reference to a basis period ending in that tax year, rather than the losses being those arising in the tax year itself.

Section 384(6) to (8) of ICTA deal with the restriction of set-off of leasing allowances against the general income of an individual. It addressed a concern that an individual could obtain an advantage by entering into a leasing activity in partnership simply to benefit from capital allowances, but not actually participate in the business, and then leave the partnership once the allowances had become available. The provision was designed to distinguish, in a broad way, between those activities, which were not commercially motivated, and those that were. It did this by looking at the taxpayer's degree of personal involvement in the leasing activities.

The provision was originally enacted as section 70 of FA 1980. The use of capital allowances on assets provided for leasing in the course of a trade was restricted such that the allowances could not be used to establish a loss available for set-off against general income unless, in accordance with section 70(1):

(a) the trade is carried on by him for a continuous period of at least six months in, or beginning or ending in, the year of loss as defined in that section; and

(b) he devotes substantially the whole of his time to carrying it on throughout that year or if it is set up or permanently discontinued (or both) in that year, for a continuous period of at least six months beginning or ending in that year.

The definition of "year of loss" was "any year of assessment" in respect of which a loss was sustained in any trade. Accordingly losses were looked at on a fiscal year basis, that is by looking at the loss actually sustained in the year from 6 April to the following 5 April. And the time commitment test was looked at for the same period.

But, when the preceding year basis of assessment was abolished by Chapter 4 of Part 4 of FA 1994, the "year of loss" provisions were amended by section 209(3) of that Act so that losses are computed for the same period as profits, in other words they are measured by reference to a basis period ending in a year of assessment. But the time commitment test was not updated. So an individual sufficiently involved in the business during a basis period, but not sufficiently involved during a year of assessment, will fail to meet the time commitment test. Equally, the reverse circumstances could occur.

Accordingly the drafting complexities and illogicality of looking at different periods for determining whether a loss relief should be available have been eliminated by aligning the periods. Both conditions should be satisfied by reference to the basis period rather than the tax year.

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 11: Carry-forward of trading losses: business transferred to a company: deletion of rule specifying order in which loss is to be set off against sources of income: clause 86

This change removes the rule in section 386(2) of ICTA.

Section 386 of ICTA, which is rewritten in clause 86, is concerned with the case where an individual has accumulated losses from a trade which is incorporated, and where the individual later receives income from the company concerned. It makes provision for such losses to be set against such income.

Section 386(2) of ICTA specifies that losses should be set off against the income in a particular order, namely income that is taxed by assessment and then other income.

The rule dates from section 29 of FA 1927, at which time earned and unearned income were taxed at different rates. It does not fit with self-assessment and has no practical effect, since HMRC practice is to allow the taxpayer to make the set-off in the order that provides maximum benefit.

 
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Prepared: 8 December 2006