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 113: Limit on liability to income tax of non-UK resident companies: omission of disregard of any relief to which a company is entitled by virtue of arrangements having effect under section 788 of ICTA: clause 748

This change omits section 151(1)(a)(ii) of FA 2003.

Section 151(1) of FA 2003 provides that:

The income tax chargeable for a year of assessment on the total income of a company that is not resident in the United Kingdom is limited to the sum of the following amounts—

(a)     the amount of tax that, apart from this section, would be chargeable on that total income if—

(i)     the amount of that income were reduced by the amount of any income to which this section applies, and

(ii)     there were disregarded any relief to which that company is entitled by virtue of arrangements having effect under section 788 of the Taxes Act 1988 (double taxation relief), and

(b)     the amount of tax deducted from so much of any income to which this section applies as is income the tax on which is deducted at source.

Section 151 of FA 2003 replaced section 129 of FA 1995. There was no disregard in section 129 of FA 1995 similar to that in section 151(1)(a)(ii) of FA 2003. The replacement of section 129 of FA 1995 by section 151 of FA 2003 was not intended to make any change in the law except so far as a change was necessary following the change from "branch or agency" to "permanent establishment" introduced by section 148 of FA 2003.

It appears that section 151(1)(a)(ii) of FA 2003 was included by analogy with section 128(1)(a)(ii) of FA 1995. That sub-paragraph, however, only disregards reliefs under Chapter 1 of Part 7 of ICTA to which an individual is entitled, including any such reliefs to which an individual is entitled under that Chapter by virtue of a double taxation arrangement. The principal reliefs under that Chapter are personal allowance, blind person's allowance and married couple's allowance. The only other reliefs under that Chapter are life assurance premium relief and relief for payments securing annuities.

For an individual, only the personal and other reliefs mentioned above are disregarded in calculating the limit, not all reliefs to which the individual is entitled as a result of a double taxation arrangement.

For companies, the position should be the same. This means that there are no reliefs which should be disregarded, because a company is not entitled to any of those personal and other reliefs. If the reliefs to which the company was entitled as a result of a double taxation arrangement were disregarded, the limit on liability to income tax for the company could be higher, which could be to the company's disadvantage.

The provisions of sub-paragraph (ii) have, therefore, been omitted from the rewrite of section 151(1)(a) of FA 2003 in clause 748(4), on the basis that they are inappropriate.

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: Limit on liability to income tax of non-UK resident companies: substitution of references to income for references to chargeable profits in paragraph 4(3) and (5) of Schedule 26 to FA 2003: clauses 754 and 756

This change substitutes references to a non-UK resident company's income in clauses 754(3) and 756(2)(b) for the references to its chargeable profits in paragraph 4(3) and (5) of Schedule 26 to FA 2003. Paragraph 4 sets out the 20% rule applicable to investment managers.

The term "chargeable profits" is not defined for the purposes of Schedule 26 to FA 2003. Section 11(2) of ICTA defines the chargeable profits of a non-UK resident company as being the profits attributable to the company's permanent establishment in the United Kingdom and provides that such profits are chargeable to corporation tax. That definition, therefore, has no application in relation to the liability of a non-UK resident company to income tax in respect of income deriving from transactions carried out on behalf of the company by an investment manager who meets the independent investment manager conditions.

The basis on which the legislation in FA 2003 was prepared was that it was not to affect the law under FA 1995, except so far as required to adopt the concept of permanent establishment in place of branch or agency in relation to non-UK resident companies.

It is clear from the reference in the definition of "relevant excluded income" in section 127(5) of FA 1995 to "such of the profits and gains of the non-resident..as..for the purposes of section 128 below would fall (apart from the requirements of subsection (4) above) to be treated as excluded income" that the defined term in that Act is limited to income and does not include gains. This has been reflected in clauses 754(2) and 756(2)(a).

The references to "the aggregate of such of the chargeable profits of the company" in paragraph 4(3) of Schedule 26 to FA 2003 and to "so much of the chargeable profits of the non-resident company" in paragraph 4(5) of that Schedule are, therefore, in practice read as referring to income only.

Accordingly, clause 754(3) refers to "the total of the non-UK resident company's income for the accounting periods" which derives from the relevant investment transactions, and clause 756(2)(b) refers to "so much of the income of the non-UK resident company" deriving from the transaction.

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 115: Limit on liability to income tax of non-UK residents: inclusion of stock dividends from UK resident companies as an additional category of disregarded savings and investment income: clause 758

This change adds stock dividends chargeable to income tax under Chapter 5 of Part 4 of ITTOIA to the list of savings and investment income which is disregarded income under clause 746 or disregarded company income under clause 749.

As described in Change 1, 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 Chapter 5 of Part 4 of ITTOIA (stock dividends from UK resident companies). But the established practice 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) of this Bill applies the dividend upper rate instead of the higher rate to "dividend income". This term is defined in clause 19 to include income under Chapter 5 of Part 4 of ITTOIA. Accordingly, stock dividends from UK resident companies will be taxed at the same rates as apply to ordinary dividends.

In the light of this change, it is not appropriate that any distinction should continue to be made between the status as disregarded income or disregarded company income of dividends from UK resident companies chargeable under Chapter 3 of Part 4 of ITTOIA and stock dividends from such companies chargeable under Chapter 5 of that Part. Such stock dividends have, accordingly, been added in clause 758(1)(a).

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 116: Occasional residence abroad: omission of limitation to Commonwealth citizens and citizens of the Republic of Ireland: clause 762

This change extends the application of clause 762 to all individuals who are UK resident and ordinarily UK resident and leave the United Kingdom for the purpose only of occasional residence abroad.

Clause 762 is based on section 334 of ICTA, which applies only to Commonwealth citizens and citizens of the Republic of Ireland who are ordinarily UK resident.

The origin of the provisions in section 334 can be traced back to section X of the Statute of 1799 (39 George III c.13):

And be it further enacted that any subject of His Majesty whose ordinary residence shall have been in Great Britain and who shall have departed from Great Britain and gone into any parts beyond the seas for the purpose only of occasional residence at the time of the execution of this Act, shall be deemed, notwithstanding such temporary absence, a person chargeable in respect of his or her income as a person actually residing in Great Britain and shall be assessed and charged accordingly (in the manner hereinafter directed) upon the whole amount of his or her income whether the same shall arise from property in Great Britain or elsewhere, or from any profession, office, pension, stipend, employment, trade or vocation, in Great Britain or elsewhere

through section 39 of the Income Tax Act 1842:

And be it enacted that any subject of Her Majesty whose ordinary residence shall have been in Great Britain, and who shall have departed from Great Britain and gone into any Parts beyond the Seas, for the Purpose only of occasional Residence, at the Time of the Execution of this Act, shall be deemed, notwithstanding such temporary Absence, a Person chargeable to the Duties granted by this Act as a Person actually residing in Great Britain, and shall be assessed and charged accordingly (in manner hereinafter directed) upon the whole Amount of his Profits or Gains, whether the same shall arise from property in Great Britain or elsewhere, or from any allowance, annuity, or stipend, (save as herein is excepted,) or from any profession, employment, trade or vocation, in Great Britain or elsewhere

to its re-enactment, with no pre-consolidation amendments, in the first income tax consolidation Act, the Income Tax Act 1918, as rule 3 of the general rules applicable to Schedules A to E:

Every British subject whose ordinary residence has been in the United Kingdom shall be assessed and charged to tax, notwithstanding that at the time the assessment or charge is made he may have left the United Kingdom, if he has so left the United Kingdom for the purpose only of occasional residence abroad, and shall be charged as a person actually residing in the United Kingdom upon the whole amount of his profits or gains, whether they arise from property in the United Kingdom or elsewhere, or from any allowance, annuity, or stipend (save as herein is excepted), or from any trade, profession, employment, or vocation in the United Kingdom or elsewhere.

The reference to British subject has subsequently been amended to reflect the establishment of the Republic of Ireland as an independent Sovereign State and the creation of the Commonwealth. But, otherwise, the language of the provision has not changed in any material respect.

In his judgment in Reed (HM Inspector of Taxes) v Clark, (1985), 58 TC 528 Ch D, Nicholls J reviews the history of this provision (then section 49 of ICTA 1970) and the cases in which it is considered. He observes (at page 550 B):

Despite the long history of the statutory provision now reproduced as s 49, the researches of very experienced Counsel have not revealed any reported decision in which a claim to tax has succeeded only by virtue of that provision. But in several cases the provision has been commented upon..

Nicholls J refers to the judgments in Levene v CIR (1927), 13 TC 486 HL at all its stages. The judgment of Viscount Cave LC in that case in the House of Lords contains the following passage (at page 505):

My Lords, the word "reside" is a familiar English word and is defined in the Oxford English Dictionary as meaning "to dwell permanently or for a considerable time, to have one's settled or usual abode, to live in or at a particular place". No doubt this definition must for present purposes be taken subject to any modification which may result from the terms of the Income Tax Act and Schedules; but, subject to that observation, it may be accepted as an accurate indication of the meaning of the word "reside". In most cases there is no difficulty in determining where a man has his settled or usual abode, and if that is ascertained he is not the less resident there because from time to time he leaves it for the purpose of business or pleasure.

The cases also make clear that residence in this context denotes, to paraphrase the words of Rowlatt J at first instance in Levene (at page 492), a quality attributable to the individual which makes the individual describable as resident with reference to a place.

In Reed v Clark the issue in relation to section 49 of ICTA 1970 was whether, it having been found by the Commissioners that Mr Clark was resident in the USA for the tax year 1978-79, his residence was only occasional. The decision of the Commissioners that it was not and that Mr Clark was both resident and ordinarily resident in the USA for that year was upheld by Nicholls J.

Although historically the provisions in section 334 of ICTA have been limited to British subjects and their current manifestations, Commonwealth citizens and citizens of the Republic of Ireland, the observations of Viscount Cave LC in Levene quoted above are applicable to any individual who has his or her settled or usual abode in the United Kingdom. Such a settled or usual abode will in virtually every case lead to the result that an individual is ordinarily UK resident for income tax purposes.

In accordance with the judgment of Viscount Cave LC, occasional residence abroad by such an individual who is not a Commonwealth citizen or a citizen of the Republic of Ireland equally will not displace the quality of the individual's residence as being in the United Kingdom. In practice, the same tests are applied in determining whether any individual, whether or not a Commonwealth citizen or a citizen of the republic of Ireland, has ceased to be UK resident upon leaving the United Kingdom. This change makes this explicit.

In rewriting this provision, it has also been made explicit that it only applies if the individual is UK resident, as well as ordinarily UK resident, at the time the individual leaves the United Kingdom. There has never been any doubt that the provision only applies if the individual is both UK resident and ordinarily UK resident at that time.

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 117: Individuals in the United Kingdom for temporary purpose: substitution of 183 days for six months: clauses 764 and 765

This change replaces references to six months with references to 183 days in clauses 764(1) and 765(1) which deal with the residence status of individuals who are in the United Kingdom for some temporary purpose only.

Clause 764(1) is based on section 336(1) of ICTA which provides that:

A person shall not be charged to income tax under a charge to which subsection (1A) applies as a person residing in the United Kingdom, in respect of profits or gains received in respect of possessions or securities out of the United Kingdom, if—

(a)     he is in the United Kingdom for some temporary purpose only and not with any view or intent of establishing his residence there, and

(b)     he has not actually resided in the United Kingdom at one time or several times for a period equal in the whole to six months in any year of assessment, but if any such person resides in the United Kingdom for such a period he shall be so chargeable for that year.

Clause 765(1) is based on section 336(2) of ICTA, which provides that:

For the purposes of determining taxable earnings from an employment under Chapters 4 and 5 of Part 2 of the Income Tax (Earnings and Pensions) Act 2003 (employment income: charge to tax), a person who is in the United Kingdom for some temporary purpose only and not with the intention of establishing his residence there shall not be treated as resident in the United Kingdom if he has not in the aggregate spent at least six months in the United Kingdom in the year of assessment, but shall be treated as resident there if he has.

Section 336(1) and (2) of ICTA both depend upon the question whether the period or periods during which the person has been actually residing in the United Kingdom, or which the person has spent there, amount in total to six months. But the number of days in a consecutive period of six months may vary between 181 and 184. In the majority of cases, the period is of 183 days or less.

Accordingly, to ensure fairness between all persons affected by these provisions and to cater for broken periods, references to six months in these provisions are in practice treated as references to 183 days. This practice is published in HMRC booklet IR20: Residents and non-residents: Liability to tax in the UK.

Clauses 764(1) and 765(1), therefore, refer to 183 days in place of six months.

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 118: Jointly held property and earned income: clause 769 and Schedule 1 (section 189 of FA 2004)

This change concerns the "earned income" exception from the rule which allocates income arising on property held jointly by a married couple, or members of a civil partnership, who live together, equally between the individuals concerned.

The change is that the joint property rule is rewritten in direct terms without reference to earned income, and the earned income exception is replaced with one for all partnership income, which has broadly the same effect. It also makes a related change to the definition of "relevant UK earnings" in section 189 of FA 2004.

Section 282A(1) of ICTA provides a rule that income arising to married couples and civil partners from jointly held property is allocated equally (the 50:50 rule). The rule is subject to a number of exceptions, including section 282A(4)(a). That subsection excludes all earned income from the rule. Earned income is defined by section 833(4) to (6) of ICTA.

This joint property rule is the only place in the Income Tax Acts where the concept of earned income is used directly. This note considers each type of earned income in turn and sets out whether it can arise on jointly held property.

The first case dealt with in section 833(4) of ICTA is employment, pension and social security income and property income attached to an employment. Such income cannot arise jointly.

The second case in section 833(4) is income arising from a trade, profession or vocation. Clearly, such income can arise jointly, ie where the business is carried on in partnership. Such income is specifically excluded from the 50:50 rule by direct reference to partnerships - see Exception C. Because all income subject to the partnership rules in Part 9 of ITTOIA is excluded it is not necessary to reproduce the special rule in section 282A(4)(b) to ensure that the income of sleeping partners is also excluded.

Section 833(5) to (5E) of ICTA contains complex rules to determine whether income arising from patents and know-how is earned or unearned. Such income can arise jointly. The clause does not reproduce any of these rules and all such income (unless it is partnership income) will as a result fall within the 50:50 rule.

So where income was previously "earned" the 50:50 rule will apply in cases where it did not apply before. But, couples will have the option of electing for allocation to follow beneficial entitlement (provided their shares in the asset match their shares in the income), which gives couples an alternative basis on which to allocate income that may work to their advantage.

The other types of income to be considered are those that are treated as earned under specific provisions:

• Adjustment income within section 232 of ITTOIA. This income can arise jointly where it is partnership income. It is now excluded from the 50:50 rule through the exclusion for partnership income.

• Post-cessation receipts within section 256 of ITTOIA. The source of such receipts is considered to be the trade, profession or vocation, and that no longer exists. It follows that the income does not arise from jointly held property and so is not within section 282A of ICTA.

• Furnished holiday lettings businesses within Chapter 6 of Part 3 of ITTOIA. This is specifically excluded by Exception D.

• Sale of income derived from personal activities within section 775 of ICTA. This cannot arise jointly.

• Profits from a Lloyd's underwriting business. Section 171 FA 1993 provides that all income arising to a member from a Lloyd's underwriting business is treated as arising from a trade. This might include income from jointly held property, such as that held in an ancillary trust fund. Such income is treated as earned under section 180 FA 1993. In order to ensure that the 50:50 rule does not apply, section 180(1)(b) is amended by Schedule 1 to specifically disapply clause 769.

In summary, the exclusion for income subject to the partnership rules corresponds closely to the exclusion in the source legislation for earned income. The only type of income that will become subject to the 50:50 rule is income from patents and know-how that was previously classified as earned under the rules in section 833(5) to (5E) of ICTA. And this should generally work to the taxpayers' advantage.

The repeal of section 833(5) to (5E) of ICTA also requires a change to the definition of "relevant UK earnings" in section 189(2)(c) of FA 2004. In essence, patent income arising to an individual who devised an invention counts as relevant UK earnings, but this is subject to exceptions in section 833(5C) and (5E) of ICTA. The amendment made to section 189 by Schedule 1 to this Bill does not incorporate those exceptions, so that a wider range of patent income now qualifies as "relevant UK earnings". This works to the taxpayer's advantage.

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 119: Deduction of tax: deposit-takers and building societies: enactment of regulations: clauses 785, 786, 804, 805, 879, 880, Schedule 1 (section 17 of TMA and Schedule 2 to FA 2005) and Schedule 2 Part 14 (deduction by deposit-takers: discretionary or accumulation settlements)

Introduction

This change enacts some provisions of the Income Tax (Building Societies) (Dividends and Interest) Regulations 1990 (SI 1990/2231) (the building society regulations) and certain provisions in other regulations and orders. The main purpose of the change is to secure a common basis for the split between the primary and secondary legislation about the deduction of sums representing income tax by deposit-takers and by building societies.

Position under the source legislation

The main source provisions for the deposit-taker regime, such as the main definitions, details of the categories of payment from which a sum representing income tax is or is not to be deducted and provisions about declarations of non-UK residence, are set out in sections 480A to 482 of ICTA. These sections are supported by the Income Tax (Deposit-takers) (Interest Payments) Regulations 1990 (SI 1990/2232). This split between primary and secondary legislation is in keeping with the approach to the divide between primary and secondary legislation generally.

But, for historical reasons, not least in relation to the creation and later abolition of composite rate tax, all of the provisions for building societies are regulations - in particular the building society regulations made under section 477A of ICTA.

The following regulations and orders also apply in relation to the deduction regimes:

• The Income Tax (Building Societies) (Audit Powers) Regulations 1992 (SI 1992/10) and the Income Tax (Deposit-takers) (Audit Powers) Regulations 1992 (SI 1992/12) about audit powers for the two regimes;

• The Income Tax (Deposit-takers) (Non-residents) Regulations 1992 (SI 1992/14) about declarations and certificates for non-residents;

• The Income Tax (Interest Payments) (Information Powers) Regulations 1992 (SI 1992/15) about the provision of information by building societies and deposit-takers;

• The Income Tax (Prescribed Deposit-takers) Order 1992 (SI 1992/3234) which treats firms with EEA passport rights as deposit-takers;

• The Deposit-takers (Interest Payments) (Discretionary or Accumulation Trusts) Regulations 1995 (SI 1995/1370); and

• The Income Tax (Prescribed Deposit-takers) Order 2002 (SI 2002/1968), which treats certain dealers in financial instruments as deposit-takers.

Revised approach

The enactment of the following regulations will ensure that the provisions relating to building societies will be divided between primary and secondary legislation in the same way as for deposit-takers. To achieve this:

• parts of regulations 2, 3, 4 and 11 of the building society regulations are included in Chapter 2 of Part 14 of this Bill;

• regulation 10 of the building society regulations is included in Chapter 15 of Part 14 of this Bill; and

• regulation 12(1) of the building society regulations is incorporated into section 17 of TMA (see Schedule 1 to this Bill).

As a number of the building society regulations are enacted, the wide powers provided in section 477A(1) of ICTA are replaced with specific regulation and order making powers in line with the deposit-taker regime.

This makes it explicit that the two regimes run in parallel (differing only where necessary to reflect the particular status of building societies). It will also facilitate the making of any future changes, because any such changes to those building society rules now in primary legislation would be made in a Finance Act (rather than by regulation) alongside parallel changes made to the rules for deposit-takers. Equally, it will no longer be possible to amend those rules by regulations.

This approach is also a prerequisite for Change 120, under which the main provisions of the two regimes are aligned and combined.

In addition the following provisions in regulations are also included in the Bill:

• (in clause 786) provisions about EEA firms (SI 1992/3234) and dealers in financial instruments (SI 2002/1968);

• (in clause 782(4) and Schedule 1 Part 2 (new paragraph 11 of Schedule 2 to FA 2005)) the provisions about "relevant arrangements" in regulation 2(4) and (5) of the building society regulations (SI 1990/2231); and

• (in Schedule 2 Part 14 (deduction by deposit-takers: discretionary or accumulation settlements)) the provisions about deposits made by the trustees of discretionary or accumulation settlements before 6 April 1995 (SI 1995/1370).