Clause 11: Companies with more than one accounting date

73.     This clause allows a company carrying on more than one trade to nominate the accounting date which marks the end of the accounting period. It is based on section 12 of ICTA.

74.     The clause is most likely to apply to a non-UK resident company carrying on more than one trade in the United Kingdom through a permanent establishment. If a UK resident company carries on more than one trade it prepares a single set of accounts to cover all the company’s activities. A non-UK resident company may not be subject to these regulatory requirements. Without this clause an accounting period would end at each separate accounting date.

75.     The company is allowed to choose which accounting date is used for the purposes of the test in clause 10(1)(b). The company’s choice is subject to review by HMRC. In the source legislation this power is exercised by the Commissioners for HMRC. In practice it is exercised by an officer. Subsection (3) reflects that. See Change 1 in Annex 1.

76.     The source legislation does not provide for the situation where a company has one or more businesses in addition to its trades, or several businesses but no trade. The effect is that the company’s choice and the officer of Revenue and Customs’ discretion is limited to selection of an accounting date relating to one of the company’s trades. In other words, neither the company nor the officer can choose as the accounting period end date an accounting date of one of the company’s businesses which is not a trade.

Clause 12: Companies being wound up

77.     This clause identifies the beginning and end of an accounting period if a company is being wound up. It is based on section 12 of ICTA.

78.     Although the rules applying to companies in administration have been integrated into the general rules (see clause 10(1)(i) and (j)), the separate exposition of the rules applying to companies being wound up have been preserved. This is because the scheme of section 12(7) of ICTA is to provide for a self-contained set of rules about when an accounting period ends. It follows that the accounting period of a company being wound up does not end on the occurrence of any of the events listed in clause 10(1)(b) to (j). Accordingly, it is not appropriate to add the termination events listed in clause 12 to the list of termination events in clause 10(1).

79.     Subsection (5) is new. It makes provision for when a new accounting period of a company being wound up begins. Section 12(7) of ICTA provides for an accounting period to begin on the commencement of winding up, but does not provide for the commencement of any subsequent accounting period. The rule in section 12(2)(b) of ICTA, now clause 9(1)(b), continues to apply for that purpose. It is preferable to make separate provision for the commencement of a new accounting period after the end of 12 months, rather than rely on clause 9(1)(b) for this purpose.

80.     The reason for this is that the rule in clause 9(1)(b) is that a new accounting period only begins at the end of 12 months if the company is still within the charge to corporation tax. However, section 12(7) of ICTA does not make the company’s remaining within the charge to corporation tax a condition of a new accounting period starting on the company beginning to be wound up. Also, that provision states that “an accounting period shall not end otherwise than by the expiration of 12 months from its beginning”. Given that, section 12(2)(b) of ICTA must necessarily be modified in its application to companies being wound up.

Chapter 3: Company residence

Overview

81.     This Chapter gives the statutory rules for company residence outside double taxation conventions.

82.     The rules on company residence are both statutory and non-statutory. The oldest of the company residence rules (“central management and control”) is based on common law.

83.     The central management and control test is generally considered to be best expressed in De Beers Consolidated Mines v Howe (1905), 5 TC 198 HC. “A company resides, for the purposes of Income Tax, where its real business is carried on .. I regard that as the true rule; and the real business is carried on where the central management and control actually abides”. This has been endorsed by subsequent decisions and was described by Lord Radcliffe in Bullock v Unit Construction Company (1959), 38 TC 712 HL as being “as precise and unequivocal as a positive statutory injunction”.

84.     Residence may also be determined by the tie-breaker in a double taxation convention. When a company is resident in the territory of both parties a tie-breaker generally awards residence to the country where the effective management of the company is situated.

85.     The two main statutory rules are found in section 66 of FA 1988 and section 249 of FA 1994. These two tests are rewritten in this Chapter.

86.     Under section 66 of FA 1988 a company incorporated in the United Kingdom is, with some exceptions, regarded as resident here for all tax purposes. This overrides the rule in common law given above, although the common law test continues for companies outside section 66, that is to say companies which are not incorporated in the United Kingdom.

87.     Section 249 of FA 1994 treats a company resident in the United Kingdom under the common law test or section 66 of FA 1998 as being non-UK resident if the tie-breaker in the double taxation treaty between the United Kingdom and that other territory would make the company resident outside the United Kingdom.

88.     Both these statutory rules apply for the purposes of the Taxes Acts as defined in section 118 of TMA (see section 66(1) and 66A(2) of FA 1988 and section 249(1) of FA 1994). This Bill rewrites the rules for the purposes of the Corporation Tax Acts only. Because the Corporation Tax Acts are defined more narrowly (Schedule 1 to the Interpretation Act 1978) than the Taxes Acts, Schedule 1 to this Bill inserts new sections into TMA, TCGA and ITA to apply the rules given in this Chapter to those Acts.

Clause 13: Overview of Chapter

89.     This clause sets out which residence rules are dealt with in this Chapter. It is new.

90.     Although this Chapter does not legislate the common law test on residence (see above), subsection (3) makes clear that clause 15 applies where a company has been resident in the United Kingdom under that test.

Clause 14: Companies incorporated in the United Kingdom

91.     This clause provides that a company incorporated in the United Kingdom is resident here for corporation tax purposes and, under clause 5, is within the charge to corporation tax on all its income and chargeable gains. It is based on section 66(1) of FA 1988.

92.     Subsection (2) makes it clear that a company which is resident in the United Kingdom under subsection (1) is not resident in any other territory.

93.     Although section 66 of FA 1988 and section 249 of FA 1994 refer to a company being “regarded as” resident it is not considered necessary to adopt that or similar wording. A company is simply resident somewhere.

Clause 15: Continuation of residence established under common law

94.     This clause gives rules on residence for companies which are not incorporated in the United Kingdom. Companies which were UK resident immediately before they ceased business or came under the control of a foreign liquidator continue to be treated as UK resident. The clause is based on section 66(2) of FA 1988.

95.     This clause clarifies that the provision applies only to companies which are not incorporated in the United Kingdom. That is less clear in the source legislation. Any United Kingdom incorporated company which ceases business or is being wound up outside the United Kingdom is already UK resident under the rule in the previous clause.

96.     The purpose of the rule in this clause is to provide that a company which is resident in the United Kingdom through central management and control (see above) remains resident here. Such a company could otherwise become non-UK resident if central management and control left the United Kingdom.

97.     Section 66(4) of FA 1998 gives effect to Schedule 7 to that Act, the commencement and transitional provisions. Paragraphs of that Schedule which are not spent are rewritten in Schedule 2 (transitionals and savings) to this Bill.

Clause 16: SEs which transfer registered office to the United Kingdom

98.     This clause provides that once an SE (“Societas Europaea” - see clause 1319) has transferred its registered office to the United Kingdom it becomes and remains resident there, notwithstanding its residence elsewhere under overseas law or the subsequent transfer of its office abroad. The clause is based on section 66A of FA 1988.

99.     This clause applies only to SEs which transfer their registered office to the United Kingdom since SEs that are formed here are resident in the United Kingdom in any event under clause 14.

100.     Once the registered office is moved to the United Kingdom the SE is effectively treated as if it were incorporated there. It cannot cease to be resident at any time simply by transferring its registered office.

Clause 17: SCEs which transfer registered office to the United Kingdom

101.     This clause provides the same rule for SCEs (European Cooperative Societies - see clause 1319) that clause 16 provides for SEs. It is based on section 66A of FA 1988.

Clause 18: Companies treated as non-UK resident under double taxation arrangements

102.     Under this clause a company which is resident in the United Kingdom, but treated under a double taxation convention as resident in a territory outside the United Kingdom, is resident outside the United Kingdom for corporation tax purposes. The clause is based on section 249 of FA 1994.

103.     Section 250 of FA 1994 is spent. It is repealed by this Bill.

Chapter 4: Non-UK resident companies: chargeable profits

Overview

104.     This Chapter sets out which profits of a non-UK resident company are liable to corporation tax. It is based on sections 11 and 11AA of, and Schedule A1 to, ICTA.

105.     The Schedules themselves contain rules on territorial scope. Section 18(1)(a)(i) and (ii) of ICTA brings within the charge to tax under Schedule D annual profits or gains accruing to a UK resident from (a) any kind of property whatever wherever situated and (b) from any trade wherever carried on. Section 18(1)(a)(iii) brings within the same charge to tax annual profits or gains accruing to a non-UK resident from any property in the United Kingdom or from any trade or profession exercised there. Section 18 of ICTA is not itself a charge but a method of computing and marshalling under a Schedule income that is charged to tax under section 6 of ICTA.

106.     Section 9 and section 18(4A) of ICTA apply section 18(1) (Schedule D) of ICTA for corporation tax purposes. But section 11 of ICTA sets out another rule on the scope of the corporation tax charge on a non-UK resident company.

107.     The scope of Schedule D in section 18 of ICTA is narrower than the charge in section 11 of ICTA. Under section 18 non-UK residents are only liable to tax in respect of annual profits or gains from property in the United Kingdom or from trades exercised there. Under section 11 a non-UK resident company is chargeable to corporation tax on all profits wherever arising that are attributable to its permanent establishment in the United Kingdom and on income from property or rights held by or for the permanent establishment through which it trades. There is no requirement that that property should be in the United Kingdom.

108.     The seventh edition (1999) of Taxation of Companies and Company Reconstructions by Bramwell et al (footnote to page 421) says of section 11(2):

These words appear to be rather wider than the income tax “profits or gains arising from any trade exercised within the United Kingdom”. It is possible that the corporation tax charge on trading profits extends beyond the income tax charge, perhaps, for example, in the area of overseas activities connected with a United Kingdom branch.

109.     Section 70(3) of ICTA enables a non-UK resident company to be charged to corporation tax under Schedule D Case V.

110.     Prior to the removal of Case IV for corporation tax purposes in FA 1996, section 70(3) of ICTA extended Schedule D Cases IV and V to non-UK residents. (The replacement of “Case IV” by “Case III” as a consequential amendment in FA 1996 made little sense since section 18(3A) of ICTA already brought income arising outside the United Kingdom into Schedule D Case III for corporation tax purposes.)

111.     The FA 1965 Notes on Clauses for the section on which section 70(3) of ICTA is based read:

(This clause) provides machinery for charging any overseas income attributable to the branch in the United Kingdom of a non-resident company trading here through the branch. Such a branch may have funds which are recognisably attributable to branch operations but deposited abroad and earning interest whilst still held to the branch’s account. The machinery selected is that of Cases IV and V (which applies to overseas income of residents of the United Kingdom).

112.     Section 70(3) of ICTA would seem to confirm that non-UK resident companies can be charged on income arising outside the United Kingdom and thus confirm the wider scope and precedence of section 11 of ICTA over section 18(1)(a)(iii) of ICTA (see above).

113.     Section 18(1)(a)(iii) of ICTA is therefore redundant for corporation tax purposes because it adds nothing to section 8 of ICTA, which deals with the scope of corporation tax generally, and section 11 of ICTA.

114.     Section 70(3) is not rewritten. The section adds nothing to the basic position of a non-UK resident company under clauses 5(3) and (4) and 19. Moreover the parenthetical words in section 70(3) (“but without prejudice to any provision of the Tax Acts especially exempting non-residents from tax on any particular description of income”) apply on first principles to income falling within the definition of “chargeable profits”.

115.     A reordering of the clauses on permanent establishments in this Chapter is intended to clarify the relationship between the various provisions. First comes the charge on the profits attributable to the permanent establishment followed by an introductory clause explaining how the clauses are set out and how they apply.

116.     This is followed by the clauses on the separate enterprise principle. Those that apply this principle specifically to banks are at the end of this group of clauses. The special rules on deductions then appear at the end of the Chapter.

117.     Much of the terminology employed in sections 11 and 11AA of, and Schedule A1 to, ICTA is shared in common with the Model Tax Treaty and Commentary of the Organisation for Economic Cooperation and Development (OECD). Indeed the legislation is intended to reflect to a considerable degree the Model Treaty and Commentary. This terminology is retained so that the relationship between the two is not lost.

Clause 19: Chargeable profits

118.     This clause sets out what profits of the non-UK resident company are charged to tax. It is based on sections 11(1) to (2A) and 11AA(1) of ICTA.

119.     Subsection (2) provides that income and chargeable gains form part of the non-UK resident company’s chargeable profits only if they are of a type specified in subsection (3) and are attributable to the company’s permanent establishment. This is a rather different approach to that in section 11(2A) of ICTA but, read with section 11AA(1) of ICTA, it seems that section 11(2A) of ICTA is merely identifying the types of income and gains that are capable of being attributed to the permanent establishment and not giving the amount of those income and gains.

120.     Subsection (3)(c) brings into the chargeable profits of a company chargeable gains falling within section 10B of TCGA. The chargeable gains falling within that section are those accruing to a company on the disposal of assets situated in the United Kingdom. Such gains are relevant in this context if the assets in question are connected with the trade carried on by the company through the permanent establishment or are for use by or for the purposes of the establishment.

121.     “Permanent establishment” is defined in section 148 of FA 2003 and appears in Schedule 4 (index of defined expressions).

122.     Neither the words “subject to any exceptions provided for by the Corporation Tax Acts” nor the second sentence of section 11(2) of ICTA are rewritten as they are considered unnecessary.

Clause 20: Profits attributable to permanent establishment: introduction

123.     This clause describes how the clauses that follow are set out and how they apply. It is based on section 11AA(1) of ICTA.

Clause 21: The separate enterprise principle

124.     This clause sets out the basic rule of the separate enterprise principle. It is based on section 11AA(2) and (3) of, and paragraph 1(2) of Schedule A1 to, ICTA.

125.     The terms “distinct and separate enterprise” and “credit rating” in this clause are unique to section 11AA of ICTA. The former term is taken from Article 7 of the Model Treaty and the latter from the commentary on that article. The meaning of the former is well understood from its use in double taxation conventions while the latter takes its normal commercial meaning, a meaning that is well established through credit ratings given by agencies such as Moody’s or Standard and Poor.

Clause 22: Transactions treated as being on arm’s length terms

126.     This clause provides the rule for dealing with transactions between the permanent establishment and the rest of the non-UK resident company. It is based on paragraph 2 of Schedule A1 to ICTA.

Clause 23: Provision of goods or services for permanent establishment

127.     This clause sets out the rule for goods and services provided by the non-UK resident company to the permanent establishment. It is based on paragraph 6(1) to (3) of Schedule A1 to ICTA.

128.     Although this clause deals with both a deduction (expense) - see subsection (3) - and the separate enterprise principle, it is grouped with other clauses dealing with the separate enterprise principle as that is the main rule here and to separate these elements would be unhelpful.

Clause 24: Application to insurance companies

129.     This clause provides the power for the making of regulations in respect of the application of clause 21 to insurance companies. It is based on section 11AA(5) of ICTA.

Clause 25: Non-UK resident banks: introduction

130.     This clause introduces clauses 26 to 28 which contain particular provisions applying the separate enterprise principle to banks. It is based on paragraph 7(1) and (2) of Schedule A1 to ICTA.

131.     While these provisions are an application of the separate enterprise principle with particular relevance to banks, the principles behind them are applicable to companies other than banks and subsection (2) clarifies this point.

Clause 26: Transfer of financial assets

132.     This clause applies the separate enterprise principle to loans or financial assets transferred between the permanent establishment and any other part of the company. It is based on paragraphs 7(1) and 8(1) and (2) of Schedule A1 to ICTA.

133.     Each of the clauses applying the separate enterprise principle to banks contains the phrase “in accordance with the separate enterprise principle” to clarify that the provisions given are all within the general principle in clause 21 and not expressing new principles.

134.     Subsections (3) and (4) retain the term “valid commercial reasons” in paragraph 8(2) of Schedule A1 to ICTA notwithstanding that the usual phrase adopted in rewrite Bills is either “commercial reason” or “genuine commercial reason”. This is because “valid commercial reason” is the term used in the Commentary (paragraph 15.2) to Article 7(2) of the treaty.

135.     Subsection (4) also contains the term “tax advantage”. The term is undefined (as in the source legislation) although its use elsewhere in the Taxes Acts refers to the definition in section 709 of ICTA. The absence of a definition in paragraph 8(2) of Schedule A1 is intentional. It was considered that any attempt to define all possible and future forms of tax advantage in this context would have added complexity for no good purpose.

Clause 27: Loans: attribution of financial assets and profits arising

136.     This clause explains how a financial asset (eg a loan) made by the non-UK resident company and the profits arising from it should be attributed (whether to the permanent establishment or another part of the company). It is based on paragraphs 7(1) and 9(1) and (3) to (5) of Schedule A1 to ICTA. An example would be where a permanent establishment in the United Kingdom obtains new business and passes that business back to the overseas part of the company. Resulting loans, derivatives etc can be attributed to the permanent establishment under this clause notwithstanding that they have been issued by an overseas office.

Clause 28: Borrowing: permanent establishment acting as agent or intermediary

137.     This clause applies the separate enterprise principle where a permanent establishment of a non-UK resident bank acts as an agent or intermediary in borrowing funds for another part of the company. It is based on paragraphs 7(1) and 10(1) and (2) of Schedule A1 to ICTA.

Clause 29: Allowable deductions

138.     This clause brings together some general rules on deductions allowable in arriving at the profits of a permanent establishment. It is based on section 11AA(4) of, and paragraph 3(1) and (2) of Schedule A1 to, ICTA.

139.     “Executive and general administrative expenses” in subsection (2) are not defined. The term is borrowed from Article 7(3) of the OECD Model Treaty. The Commentary on the Model Treaty does not define the term further but “executive expenses” would seem to cover the expenses of higher management of the permanent establishment.

Clause 30: Restriction on deductions: costs

140.     This clause is the first of three clauses which restrict deductions in arriving at the attributable profits of a permanent establishment. It provides that no deduction for costs should exceed what would be payable under the separate enterprise principle. It is based on section 11AA(3) of ICTA.

Clause 31: Restriction on deductions: payments in respect of intangible assets

141.     This clause disallows a deduction for inter-company payments for the use of intangibles where the intangible assets are held by the company. The reasoning here is that it is difficult to allocate ownership of intangibles to any one part of a company as if it were an independent enterprise. The clause is based on paragraph 4(1) to (3) of Schedule A1 to ICTA.

Clause 32: Restriction on deductions: interest or other financing costs

142.     This clause applies the same principle as the previous clause but to interest payments. An exception is, however, made for companies dealing in loans, debts commodities and futures. It is based on paragraph 5(1) to (3) of Schedule A1 to ICTA.

Chapter 5: Supplementary

Clause 33: Trade includes office

143.     This clause provides that trade includes an office in Part 2 of the Bill, subject to context. It is based on section 6(4) of ICTA which applies the definition of “trade” in paragraph (b) of that subsection to various provisions of ICTA, except in so far as the context otherwise requires.

144.     The reference to “carrying on a trade” in paragraph (b) is new. It reflects one of the usages of “trade” in Part 2.

145.     The interpretation does not refer to employment or vocation. The treatment of vocations is discussed in Change 2 in Annex 1. A company does not hold an employment but it is not uncommon for a company to hold an office such as that of company secretary and the charge to corporation tax on income from an office is set out in clause 969.

146.     Clause 969 applies the charge to corporation tax on income under clause 2 to income from the holding of an office.