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This change is in taxpayers' favour in principle. But it is expected to have no practical effect as it is in line with current practice.
Change 12: Carry back of terminal losses: clauses 89 and 90
This change makes it clear, in cases where a person makes a claim for terminal trade loss relief, that relief is to be used with other reliefs in a way that minimises the claimant's income tax liability.
The change also codifies current practice as regards the calculation of terminal loss relief under section 388(6) of ICTA.
Under section 388(1) of ICTA, a terminal loss is to be deducted from or set off against the profits charged to income tax for the year of assessment. It is not entirely clear what "charged" means in this context. For instance, whether it means income before or after the deduction of other reliefs. This change removes the concept of "charged" profits completely. So deductions for terminal trade loss relief will be made from profits in accordance with the rules set out in clause 25, that is in the manner that minimises the claimant's income tax liability.
The change also makes it clear that:
Change 13: Trading losses given against capital gains: effect of provisions restricting relief: clauses 95, 104, 107, 109, 110, 113, 115 and 725 and Schedule 2 Part 5 (reliefs for limited and non-active partners and for members of LLPs not to exceed contribution to the firm or LLP and members of LLPs and non-active partners: carry forward of losses)
This change provides that for limited partners etc:
The amount that may be treated as a capital loss
Section 72 of FA 1991 permits a trading loss to be treated as a capital loss to the extent that there is insufficient income against which to set off the trading loss in a claim under section 380 of ICTA.
Section 72 restricts the amount of a trading loss capable of being treated as a capital loss, to the:
amount ..which is available for relief under [section 380].
This means that any restriction set on relief under section 380 is also set on relief under section 72.
For an individual who is a limited partner at some time during a tax year section 117(1) of ICTA sets a restriction on the amount of a trading loss that can be set off under section 380 against the individual's income for a tax year.
The restriction is that the loss can only be set against:
Therefore, in the case of the individual who is a limited partner, the loss is "available for relief" under section 380 for the purpose only of being set against income of the trade concerned or otherwise up to L.
Applying this restriction to relief for the loss under section 72 results in that relief being subject to the overall limit of L as well.
The amount of any income from the trade concerned is ignored for this purpose. Any part of the loss that is outside L cannot be relieved under section 72, even if it could have been set against income from the trade but for some reason was not, eg, because other reliefs were set against the income. This approach is necessary to give full effect to the restriction that any part of the loss that is outside L can be used under section 380 only for the purpose of being set against income from the trade concerned.
It would be anomalous for section 72 to transform into a generally available capital loss any part of a trading loss which can only be set against income from the trade concerned.
The same considerations apply to section 72 in the case of restrictions on the use of trading losses under section 380 involving either members of limited liability partnerships (section 117 of ICTA as applied by section 118ZB of ICTA) or non-active partners (section 118ZE of ICTA).
They also apply in the case of the restrictions set by sections 118ZL(1) (partnerships exploiting films) and 391 (losses from trade etc carried on abroad) of ICTA on the use of losses under section 380. These sections provide that certain trading losses can only be set against specified income. That is, the losses are "available for relief" under section 380 for the purpose only of being set against the specified income. Giving full effect to these restrictions results in no relief being available under section 72 for losses covered by them.
Clauses 95(2), 104(3), 107(4), and 110(3) and 115(3) now set out expressly the interaction between these restrictions on trade loss relief and the treating of trading losses as capital losses. Clauses 109(1) and (3) and 113(1) and (4) and Schedule 2 Part 5 (members of LLPs and non-active partners: carry forward of losses) are consequential on the changes in clauses 107 and 110.
The reliefs to take into account in deciding how much of a trading loss can be used against other income
For an individual who is a limited partner at some time during a tax year, section 117(1) of ICTA sets a limit on the amount of a trading loss that can be used under section 380 or 381 of ICTA against income (other than from the trade concerned). The limit for the tax year has regard to other relief given to the individual under section 380 of 381 for losses from the trade (see section 117(1) and the definition of "aggregate amount" in section 117(2)).
If relief for a trading loss cannot be fully given in a claim under section 380 of ICTA, part of the trading loss may be relieved by treating it as a capital loss under section 72 of FA 1991.
The definition of "aggregate amount" in section 117(2) of ICTA refers to relief given under section 380 of ICTA but it does not expressly mention relief given under section 72 of FA 1991 (which as noted in the previous paragraph is given for amounts that would have been relieved under a section 380 claim if sufficient income had been available).
Practice has been to treat the definition's reference to amounts of relief given under section 380 of ICTA as encompassing relief given under section 72 of FA 1991.
Section 74 of FA 2005 seems to assume that this practice is correct (see, in particular, subsection (5) of that section).
Further, section 78 of FA 2005 amended the definition of "aggregate amount" so that the amount of any "reclaimed relief" is deducted as part of the process of arriving at the aggregate amount. Losses that have been claimed under section 72 of FA 1991 may contribute to the amount of any "reclaimed relief".
Again, this seems to assume that the practice referred to above is correct. It would be anomalous to deduct an amount X, computed with reference to section 72 of FA 1991, from an amount Y, computed entirely independently of section 72 of FA 1991.
The same considerations apply in the case of limits on the use of trading losses involving members of limited liability partnerships (section 117 of ICTA as applied by section 118ZB of ICTA) or non-active partners (section 118ZE of ICTA).
The practice of treating the reference to section 380 of ICTA in the definition of "the aggregate amount" as extending to section 72 of FA 1991 has been made explicit in clauses 104(5), 107(6), and 110(5) and in Schedule 2 Part 5 (reliefs for limited and non-active partners and for members of LLPs not to exceed contribution to the firm or LLP).
The conditions for recovery of excess relief
The conditions for excess relief to be reclaimed under section 74 of FA 2005 are set out in section 74(1). Section 74(1)(a) refers to relief being claimed in respect of a relevant loss under section 380 or 381 of ICTA. Section 74(1)(b) refers to any of that relief being claimed against income other than from the relevant trade.
In a tax year for which there is no income against which to offset a trading loss under section 380 of ICTA, relief may be given under section 72 of FA 1991 by treating the trading losses as capital losses (see Change 153 which makes explicit provision for such cases). In such a case it is arguable the condition in section 74(1)(b) of FA 2005 would not be met.
Such a case is unlikely to arise often in practice, if at all. And section 74 of FA 2005 clearly contemplates reclaiming relief that has been claimed under section 72 of FA 1991 (see section 74(4) and (5) and section 75 of FA 2005).
Clause 725(2) permits relief to be reclaimed even if the relief in respect of a relevant loss consists wholly of treating the trading loss as a capital loss.
This change is adverse to some taxpayers in principle. But it is expected to have no practical effect as it is in line with current practice.
Change 14: Post-cessation expenditure: meaning of qualifying event: definition of statutory insolvency arrangement: clause 98
This change replaces the term "relevant arrangement or compromise (within the meaning of section 74 of ICTA)" in section 109A(4) of ICTA with the term "statutory insolvency arrangement", which is defined in section 259 of ITTOIA.
Before the enactment of ITTOIA, a trading deduction for bad and doubtful debts was denied, for the purposes of both income tax and corporation tax, by section 74(1)(j) of ICTA, except in the circumstances covered in paragraph (j)(i) to (iii). Section 74(1)(j)(ii) of ICTA then allowed a deduction for a debt or part of a debt released as part of a relevant arrangement or compromise. Section 74(2) of ICTA defined this term.
Section 35 of ITTOIA introduced an income tax provision for bad and doubtful debts that uses a new term "statutory insolvency arrangement", defined in section 259 of ITTOIA. But the provision in section 109A of ICTA dealing with relief for post-cessation expenditure was not amended to incorporate the new term. This change corrects the position.
The effect of the change is, broadly, to allow claims for unpaid debts released under arrangements or compromises of a kind corresponding to those covered within the meaning of the former definition, but taking effect under or by virtue of the law of a country or territory outside the United Kingdom. This broadens the scope for taxpayers to make claims and is therefore taxpayer-favourable.
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 15: Trading losses: restrictions: determination of contribution to the firm: clauses 104, 107, 110 and 113
This change streamlines the process of calculating an individual's contribution to the firm by specifying that it is to be determined at the end of a basis period rather than the end of a tax year.
Section 117 of ICTA specifies that the restriction on the amount of sideways relief which may be given to an individual for a loss sustained in a trade must not exceed the amount of the contribution (to the trade) at the "appropriate time". This time is defined (broadly) as the end of the tax year in which the loss is sustained or for which the loss is allowed.
The loss itself is of course calculated for the basis period for the tax year. And it is simpler for the contribution to be calculated on the same basis. Especially as the end of the basis period will correspond with the end of a period of account, so making it easier for the individual to determine the part of the contribution represented by (undrawn) profits. The end of a tax year may not so correspond, making it more difficult to determine profits, and perhaps requiring the individual to wait until the accounts for any overlapping period of account have been prepared.
This change is in principle and in practice adverse to some taxpayers and favourable to others. It also affects when tax is paid and administrative requirements. But the numbers affected are expected to be few and the amounts involved small.
Change 16: Trading losses: restrictions: contribution to the firm in place of contribution to the trade: clauses 104, 105, 106, 107, 108, 110, 111, 114, 725, 726, 727, 730, 733, 734, 735, 736, Schedule 2 Part 5 (restriction on reliefs for non-active partners: pre-10 February 2004 events and application of existing regulations under sections 114 and 735) and Schedule 2 Part 13 (individuals in partnership: recovery of excess relief and individuals claiming relief for film-related trading losses)
This change provides for certain restrictions (and related anti avoidance provisions) on the use of trade losses, incurred by individuals in a partnership, to operate by reference to the individual's contribution to the firm (rather than contribution to the trade, as in source legislation). It also deals with a number of consequential matters and clarifies a number of points about what is included in an individual's contribution.
Contribution to the firm
For individuals who are members of limited liability partnerships (LLPs), the source legislation restricts sideways or capital gains relief for trading losses by reference to the individual's contribution to the limited liability partnership (see section 118ZC(2) and (3) of ICTA).
By contrast, for individuals who are limited partners or non-active partners (who are not also members of LLPs), the source legislation restricts sideways or capital gains relief for trading losses by reference to the individual's contribution to the trade (see sections 117(3)(a) and 118ZG(2) and (3) of ICTA).
But partnership law is more likely to look at capital contributed to the partnership (referred to in the relevant clauses of the Bill as the firm), rather than to capital contributed to a trade that the partnership carries on. For instance, a person might become a limited partner in a partnership formed under the Limited Partnership Act 1907 (LPA). Under section 4(2) of the LPA the person, at the time of entering into the partnership, contributes a sum or sums as capital (or property valued at a stated amount). The LPA does not prevent further amounts being contributed at a later date. But the intention of the LPA is that the contribution is to the firm, not the trade. The firm uses the capital contributed to fund its various activities - be that one trade or more than one trade and any investments etc that the firm might hold. And the individual has limited liability for the debts and obligations of the firm, rather than just for the debts and obligations of any trade that the firm happens to carry on.
The Bill reflects this by providing that sideways or capital gains relief restrictions on trade losses (and related anti avoidance provisions) operate in relation to an individual's "contribution to the firm" rather than "contribution to the trade". This is, in principle, taxpayer-favourable as it may allow sideways relief or capital gains relief to be obtained by reference to a larger amount than would otherwise be the case. See clauses 104(4), 105(2), (4) and (6), 106(4), 110(4), 111(2) and (4) to (6), 725(3), (4), (7) and (8), 726(2) and (4), 727(4), 730(2) and (5) and 734(2), (3) and (8) and Schedule 2 Part 13 (individuals in partnership: recovery of excess relief and individuals claiming relief for film-related trading losses).
Firm carries on more than one trade
Some consequential changes have been made to cater for the possibility that a firm might carry on more than one trade.
If a firm carries on only one trade, the restriction of sideways or capital gains relief for trade losses by reference to the contribution to the firm means that the individual can get such relief for losses up to the amount at risk, and no more. But if the firm carries on more than one trade, restricting sideways or capital gains relief for trade losses in each trade by reference to the contribution to the firm might result in the individual getting such relief for more than the amount at risk. Clearly the source legislation does not allow this in the case of limited partners and non-active partners (who are not also members of LLPs) as it restricts sideways or capital gains relief for trade losses by reference to the amount of capital contributed to each trade.
So in the case of limited partners and non-active partners (who are not also members of LLPs) the Bill restricts the total sideways or capital gains relief available in respect of losses from all trades carried on by the firm to the amount that the individual has at risk.
As noted earlier, for LLPs a member's contribution is already in terms of the contribution to the LLP. But the source legislation does not explicitly deal with the possibility that an LLP might carry on more than one trade. Therefore to ensure that a consistent policy is applied throughout the clauses (ie the relief available is restricted to the amount at risk), the restriction mentioned in the preceding paragraph has been explicitly applied in relation to members of LLPs as well. This is in principle taxpayer-adverse in the case of members of LLPs. See clauses 104(7), 105(10), 107(8), 110(7), 111(10), 725(6), 727(6), 733(9) and (10) and 736(4) and Schedule 2 Part 5 (restriction on relief for non-active partners: pre-10 February 2004 events).
Powers to make regulation in relation to contributions and regulations already made
In the case of firms (not LLPs) the powers, in section 118ZN of ICTA and section 122A of FA 2004, are to make provisions excluding amounts from an individual's contribution to the trade. Consequent on the move to "contribution to the firm", this Bill provides powers that operate in relation to an individual's contribution to the firm.
The Bill also treats regulations made under the powers in section 118ZN of ICTA and section 122A of FA 2004 as having been made, with suitable modifications, under corresponding powers in this Act. See clauses 114(1), 735(2), Schedule 2 Part 5 (application of existing regulations under sections 114 and 735) and Schedule 2 Part 13 (individuals claiming for film-related trading losses).
Contribution to an LLP
The source legislation provides that the contribution to an LLP is the greater of the amount which the individual has contributed to it as capital (so far as it is not recoverable) and the amount of the individual's liability on a winding up (see section 118ZC(2) of ICTA).
But the total amount the individual has at risk in an LLP is, in principle, the sum of what has been contributed as capital to the LLP and the additional amount that the individual could be called on to meet in a winding up of the LLP.
The Bill provides that an individual's contribution to a LLP takes account of the total amount at risk, namely any amounts contributed as capital to the LLP and any further amounts for which the individual is liable on a winding up. See clause 108(7).
Profits or losses in accordance with generally accepted accounting practice
The Bill provides explicitly, where source legislation does not, instances where a reference to profits or losses means amounts calculated in accordance with generally accepted accounting practice. See clauses 105, 108(4) and 111(9).
The Bill also explicitly provides that capitalised undrawn profits are included in an individual's contribution. See clauses 105(3), 108(3), 111(3) and 734(4) and (5).
Contributions to a firm trading profits not drawn
The Bill also provides that an individual's share of trading profits, taken into account in determining the individual's contribution to the firm, is calculated by looking at periods where such profits were made, and ignoring trading losses in other periods. The source legislation does not contain an equivalent provision. The effect is broadly to determine an individual's share of undrawn trading profits as the amount that the individual would have received if such profits had been distributed fully on a period by period basis. See clauses 105(8) and 111(8).
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 17: Trading losses: restrictions: withdrawal of capital ignored where amounts charged to tax as profits of a trade: clauses 105 and 108
This change brings the position of limited partners and active members of limited liability partnerships (LLPs) into line with that of non-active partners in relation to the treatment of amounts of capital withdrawn in the context of determining an individual's contribution to the firm.
It is possible that amounts of capital withdrawn may be regarded for tax purposes as profits charged to tax as profits of a trade. In these circumstances it is inequitable to restrict loss relief by reference to those amounts. Indeed section 118ZG(5) of ICTA (as inserted by section 124 of FA 2004) operates in relation to non-active partners to ensure that such amounts are not taken into account to restrict loss relief.
This change extends that rule to limited partners and members of LLPs generally.
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 18: Employment losses: claims for set-off of losses made by an office holder against general income: clause 128
This change extends the scope of the relief for employment losses to include office holders as well as employees.
Section 380 of ICTA provides for losses sustained by a person in any trade, profession, vocation or employment to be set off against that person's general income. It makes no mention of losses sustained by an office holder, but in practice HMRC accept a claim for the set-off of such a loss.
An employment loss might arise if an employee is remunerated (in whole or in part) by way of a share in the profit or loss of his employer, or if the employee is entitled to capital allowances that exceed earnings.
In the former case, HMRC accept that a loss can arise if an employee is obliged, under the terms of his employment, to make a payment to his employer that exceeds his income. For example, someone paid commission on sales might be obliged to guarantee his employer against bad debts and the guarantee payment could exceed the commission in any given year.
The reason for employment being included in section 380 of ICTA appears to have been that certain employments (which included certain offices), like trades, were originally taxed under Schedule D, so the loss provisions which applied to trades applied to those employments (and offices). Almost all employments were taxed under Schedule E following the transfer from Schedule D to Schedule E brought about by section 18 of FA 1922, but the inclusion of the word "employment" in the loss provision was never amended.
In fact, HMRC took the view as long ago as 1925 that the transfer of offices and employments to Schedule E should not deprive the taxpayer of any benefits enjoyed under Schedule D. Accordingly, and despite the wording of section 380(1) of ICTA, loss relief is in practice available to office holders as well as to employees.
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 19: Employment losses: disapplication of restriction of set-off of capital allowances against general income: clause 128
This change disapplies a potential restriction on the ability of an employee to set off part of a loss attributable to first-year allowances. The restriction was designed to apply to trades rather than employments and is extremely unlikely to apply to employments.
Section 384A of ICTA is an anti-avoidance section dealing with the restriction in certain circumstances of the ability of an individual to set off part of a loss attributable to first-year allowances against general income. It was designed to counter contrived arrangements under which higher rate taxpayers were able to reduce their tax liabilities by entering into partnerships with a corporate member.
The provision was originally enacted as section 41 of FA 1976. The particular scheme that the provision was designed to counter operated as follows. An individual or individuals liable to income tax at the higher rates would enter into a partnership, which would include a corporate member. The partnership would acquire machinery or plant, which was then leased out. The partnership would be entitled to first-year allowances, which would be shared between the individual members for offset against general income taxable at high rates. But income received from the leasing activity would be allocated to the corporate member and be taxed at the much lower corporate rate. Therefore an advantage was obtained because of the mismatch between the rates at which income was taxed and first-year allowances were relieved.
The provision was drafted to counter not only this scheme but also other possible arrangements. Section 41(1) of FA 1976 (which gave rise to section 384A(2) of ICTA, rewritten in clause 77) fulfilled the function of dealing with the identified scheme, while section 41(2) of FA 1976 (which gave rise to section 384A(4) of ICTA, rewritten in clause 78) was designed as a blanket provision to counter future schemes. It operated by denying loss relief if an individual entered into a scheme with the sole or main benefit of obtaining a reduction in tax by way of first-year allowances made in connection with the transfer of a trade or an asset in certain circumstances.
It is clear that what is now section 384(4) of ICTA was drafted to catch schemes or arrangements involving transfers of trades or assets being made to create artificial benefits to traders. But one part of it, section 41(2)(a)(ii) of FA 1976 (now section 384A(4)(b) of ICTA), could also potentially catch a transfer of an asset by an employee. But this is simply because the loss provisions apply across trades, professions, vocations and employments.
The ability of an employee to acquire an asset qualifying as machinery or plant in respect of which first-year allowances are available is limited, given the wholly, exclusively and necessarily rule that ensures that only assets necessary for carrying out the duties of the employment can qualify. There is, therefore, very little potential for an employee to enter into a scheme for the reduction of a liability to tax by acquiring an asset which enables a claim for first-year allowances (which can be set-off against employment income) to create a loss.
So, in the context of rewriting the loss provisions for employments separately from those for trades, professions and vocations, this provision has not been rewritten for the purposes of the employment loss provisions.
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