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Part 3: Trading income
Overview
147. This Part contains the rules relating to trading income. The Part charges:
- the profits of a trade (charged in the source legislation under Schedule D Case I or V); and
- post-cessation receipts (charged in the source legislation under Schedule D Case VI).
148. The structure of the Part is to:
- identify the income taxed as profits of a trade (Chapter 2);
- calculate the profits of the trade (Chapters 3 to 7);
- apply the rules for particular trades (Chapters 8 and 9);
- apply other rules affecting the calculation of profits of the trade (Chapters 10 to 14); and
- identify the other component of trading income - post-cessation receipts - (Chapter 15).
149. This Part is not an exhaustive statement of the rules for the calculation of trading income. Other regimes may affect that calculation. In particular, Parts 5 to 8 and 11 to 15 of this Bill contain rules that may affect trade profits.
150. References to “profits or gains” in the source legislation which relate only to income are rewritten in this Part omitting the reference to “gains”. This continues the tidying up of such references started in section 46(3) of, and Schedule 7 to, FA 1998.
Chapter 1: Introduction
Clause 34: Overview of Part
151. This clause provides an overview of this Part. It is new. The corresponding income tax rule is in section 3 of ITTOIA.
152. In contrast to section 3 of ITTOIA, this clause makes no reference to adjustment income. This is because for corporation tax purposes adjustments on a change of basis of accounting are brought into account in computing trading profits rather than being treated as a distinct category of income.
Chapter 2: Income taxed as trade profits
Overview
153. This Chapter explains what is taxed as profits of a trade. It identifies a number of activities and receipts and sets out how they are treated.
Clause 35: Charge to tax on trade profits
154. This clause applies the corporation tax charge on income to the profits of a trade. It is based on section 18 of ICTA. The corresponding rule for income tax is in section 5 of ITTOIA.
155. The clause does not rewrite the reference to “profession or vocation” in Schedule D Case II. See Change 2 in Annex 1.
156. Section 832(1) of ICTA provides that “trade” includes “every trade, manufacture, adventure or concern in the nature of trade”. This brings within the meaning of trade an isolated transaction (or a small number of transactions) which, while in the nature of trade, is not sufficiently extensive to amount to a trade.
Clause 36: Farming and market gardening
157. This clause has two functions. First, it treats all farming or market gardening carried on in the United Kingdom as a trade. Second, it treats all farming carried on in the United Kingdom by a particular person as a single trade. It is based on section 53 of ICTA. The rules for income tax are rewritten in section 9 of ITTOIA.
158. Subsection (1) deals with the first function. In most cases there will be no doubt that farming is a trade on first principles. Like clause 38 of this Bill this clause can trace its origins back to the time when there was a charge to income tax under Schedule B on the occupation of land. Farming was originally charged under Schedule B. The purpose of section 53 of ICTA and its predecessor provisions was to take the charge on farming out of Schedule B and into Schedule D. With the abolition of Schedule B that function is now spent.
159. But section 53 of ICTA does make clear that even uncommercial farming is treated as a trade. This clause preserves that effect.
160. Subsection (2) deals with the second function of the clause. It provides that all farming carried on by a company in the United Kingdom is treated as a single trade. It makes clear that farming carried on as part of another trade is not included in the single trade of farming.
161. The restriction of subsection (2) to farming in the United Kingdom is derived from the definition of “farming” in section 832(1) of ICTA.
162. Section 53(2) of ICTA uses the expression “particular company or partnership” to make clear that the single trade rule applies also to a firm. It follows that farming carried on by a company as a member of a firm is separate from any farming carried on by that company alone. This rule is dealt with in clause 1270 in Part 17 (Partnerships). The corresponding provision for income tax is section 859 of ITTOIA.
163. The definition of “farming” and “market gardening” is given in clause 1317 in Part 21 (Other general provisions). The corresponding provision for income tax is section 996 of ITA.
Clause 37: Commercial occupation of woodlands
164. This clause provides that the commercial occupation of woodlands is not treated as a trade for any corporation tax purpose. It is based on section 53 of ICTA and paragraph 3 of Schedule 6 to FA 1988. The corresponding rule for income tax is in section 11 of ITTOIA.
165. Subsection (3) makes clear that when this clause is read together with related clauses any profits and losses arising from the commercial occupation of woodlands are wholly outside the corporation tax code.
166. This clause prevents any charge to tax as trading income and denies any claim for relief for a trade loss. Clause 208(b) of this Bill performs a similar function in relation to property income. Clause 980 prevents there being any charge to tax under Chapter 8 of Part 10 (income not otherwise charged). The corresponding rule for income tax is in section 768 of ITTOIA.
Clause 38: Commercial occupation of land other than woodlands
167. This clause deals with the commercial occupation of land for purposes other than farming or woodlands. It is based on section 53 of ICTA. The corresponding rule for income tax is in section 10 of ITTOIA.
168. The clause treats the commercial occupation of land in the United Kingdom as the carrying on of a trade. It provides certainty of treatment if land is occupied on a commercial basis in circumstances that do not amount to the carrying on of a trade on first principles.
169. The origins of section 53 of ICTA go back to the time when there was a charge to income tax under Schedule B on the occupation of land. The purpose of the Schedule B charge was to tax the profit that an occupier of the land could earn from the land itself, for example, by farming it. The tax was charged whether or not the occupier actually exploited the land.
170. The Schedule B charge was calculated by reference to the annual value of the land. This amount could be considerably less than the amount of profit an occupier could in fact derive from the land. For this reason the basis of charge was switched from Schedule B to Schedule D Case I if the land was farmed or otherwise managed on a commercial basis.
171. The last remnant of Schedule B was repealed by FA 1988. Schedule 6 to FA 1988 exempted any profits and losses from the occupation of commercial woodlands from corporation tax.
172. The provisions of section 53 of ICTA relating to farming are rewritten as clause 36 of this Bill. The provisions relating to the occupation of commercial woodlands are rewritten as clause 37 of this Bill.
Clause 39: Profits of mines, quarries and other concerns
173. This clause treats the profits and losses of certain concerns as if they were the profits and losses of a trade. It is based on section 55 of ICTA. The corresponding rule for income tax is in section 12 of ITTOIA.
174. The feature that most of these concerns have in common is that they exploit land for its natural resources. The clause applies only if the activity carried on by the concern does not amount to a trade on first principles. If the activity is a trade on first principles the profits and losses will be taxed in accordance with clause 35 of this Bill.
175. The clause does not deem the concern to be carrying on a trade. The company will not qualify for roll-over relief under section 152 of TCGA on any chargeable gain. That section requires the taxpayer to be carrying on a trade as defined in section 158(2) of TCGA. If the concern is operated by a company not resident in the United Kingdom that company does not become liable to corporation tax through the application of clause 5(2). Clause 5(2) requires a trade to be carried on in the United Kingdom.
176. Subsections (1) and (2) provide that the profits and losses of the concern are calculated and charged to tax as if the concern were a trade. The source legislation was not explicit in this regard. See Part A of Change 3 in Annex 1. This change reproduces Change 2 in ITTOIA and so brings the income tax and corporation tax codes back into line.
177. Subsection (3) provides that the normal loss rules apply. See Part B of Change 3 in Annex 1.
178. Subsection (4) lists the concerns to which the clause applies. It updates the reference to “fishings” to “rights of fishing”.
179. Subsection (5) makes clear that clause 38 of this Bill has priority over clause 39. This is because clause 38 treats the activity as if it were a trade. This contrasts with the approach of this clause, which is to treat the profits and losses as trade profits and losses. Clause 38 may be more beneficial for the company. For example, the activity would qualify as a trade for chargeable gains purposes. See section 158(2) of TCGA.
Clause 40: Credit unions
180. This clause ensures that most credit unions are not treated as carrying on a trade for tax purposes. It is based on section 487 of ICTA.
181. Credit unions are profit-sharing financial co-operatives, owned and managed by their own members, which offer a convenient way of saving and loans to their members.
182. The members make regular savings, as little or as much as they wish. These savings then form a common pool of money from which loans are made to members. When members have been saving for a certain period of time (usually about 12 weeks) they can apply for a loan from the pool. Interest on the loan is charged at about 1% per month on the monthly reducing balance.
183. There are other rules about credit unions:
- in Part 5 (loan relationships);
184. Subsection (1) is the rule that the usual activities of a credit union are not to be treated as a trade. The rule applies only in the calculation of the credit union’s income. So, if the carrying on of a trade is relevant for some other purpose (for instance, the taxation of chargeable gains), and the credit union is in fact carrying on a trade, the position is not disturbed by this rule.
Clause 41: Effect of company starting or ceasing to be within charge to corporation tax
185. This clause treats a company as starting or ceasing to carry on a trade in particular circumstances. It is based on section 337 of ICTA. The corresponding rule for income tax is in section 18 of ITTOIA.
186. Section 337 of ICTA requires the company’s trade or property business income to be calculated as though it had started or ceased to carry on a trade or a property business in two cases. Clause 41 deals with trades and clause 289 with property businesses.
187. The first trade case is when the company begins or ceases to carry on the trade (section 337(1)(a) of ICTA). Then its profits from that trade are calculated as though the trade had, at that time, begun or ceased. It is not necessary to rewrite this case. It is dealt with automatically in the rewritten rules because they are “person-based” and do not assume that a particular trade can continue independently of the person actually carrying it on.
188. The second case involves movement by the company into or out of the corporation tax regime (section 337(1)(b) of ICTA). Non-UK resident companies are within the charge to corporation tax only if they are trading, are trading in the United Kingdom, and through a permanent establishment in the United Kingdom. Then they are chargeable to corporation tax on all the profits attributable to that permanent establishment. First meeting or ceasing to meet those conditions can result in a change of taxing regime from income tax to corporation tax or vice versa.
189. Clause 41 says what happens when a company enters or leaves the corporation tax regime in respect of the trade: then its trade profits are calculated as though it had started or ceased to carry on the trade. The corresponding income tax rule in section 18 of ITTOIA is a complementary, mirror-image rule which applies when the company enters or leaves the income tax regime in respect of the trade.
Clause 42: Tied premises
190. This clause treats rent received by a company carrying on a trade, for premises let to persons to whom the company supplies goods sold or used on those premises, as a receipt of the trade rather than a receipt of a property business. It is based on section 98 of ICTA. The corresponding rule for income tax is in section 19 of ITTOIA.
191. Section 98 of ICTA is expressed in general terms. But it most commonly applies to rent received by a brewing company which lets premises to tied tenants.
Clause 43: Caravan sites where trade carried on
192. This clause allows a company which carries on a trade associated with the operation of a caravan site to include in the receipts of that trade income from letting pitches or caravans where the letting does not itself constitute a trade. It is based on ESC C36. The corresponding rule for income tax is in section 20 of ITTOIA. See Change 4 in Annex 1.
193. See clause 1314 and Change 96 in Annex 1 for the definition of “caravan”.
Clause 44: Surplus business accommodation
194. This clause allows income from letting surplus business accommodation to be treated as a trade receipt instead of as rent. It is based on the practice known as “Revenue Decision 9” set out in the HMRC publication Tax Bulletin of 15 February 1994. The corresponding rule for income tax is in section 21 of ITTOIA. See Change 5 in Annex 1.
Clause 45: Payments for wayleaves
195. This clause applies if a trader receives rent from a wayleave granted in respect of land on which a trade is carried on. It is based on section 120 of ICTA. The corresponding rule for income tax is in section 22 of ITTOIA.
196. Rent received in respect of a wayleave is normally taxed as property income either by Chapter 2 of Part 4 of this Bill (property businesses) or by clause 277 (charge to tax on rent receivable for a UK electric-line wayleave). But if the rent is received in respect of land on which a trader carries on a trade and the trader receives no other rent in respect of the same land the rent, and any associated expenses, can be included in the calculation of the trade profits. See Change 6 in Annex 1. This change enacts a non-statutory practice, and also makes changes to both practice and the law. It reproduces Change 5 in ITTOIA and so brings the income and corporation tax codes back into line.
197. Subsection (4) defines “rent”. Section 120 of ICTA uses the definition of “rent” in section 119(3) of ICTA (rent etc. payable in connection with mines, quarries and similar concerns). Section 119 of ICTA is rewritten in Chapter 7 of Part 4 of this Bill. The definition of rent in that Chapter and in this clause must be the same. See the commentary on clause 271 of this Bill for a fuller description of the rewrite of the word “rent” in Chapter 7 of Part 4 of this Bill.
198. Subsection (5) defines “wayleave”. Section 120 of ICTA uses the word “easement” as defined in section 119(3) of ICTA to describe the nature of the right for which the rent is paid. This clause uses “wayleave” as that is how most of the payments covered by this clause are usually described in practice. The definition of “easement” in section 119(3) of ICTA gives that word a meaning that is much wider than its usual legal meaning. See the comments of Uthwatt J at pages 329 and 330 of Mosley v George Wimpey & Co Ltd (1945), 27 TC 314 CA.
199. The definition of “wayleave” preserves the generality of the words in section 119(3) of ICTA and includes a reference to the Scottish equivalent, “servitude”.
200. The definition has no territorial limitation. So the clause covers services other than UK electric-line wayleaves.
201. The clause does not rewrite the reference to “profession or vocation” in Schedule D Case II. See Change 2 in Annex 1.
Chapter 3: Trade profits: basic rules
Clause 46: Generally accepted accounting practice
202. This clause sets out the starting point for the calculation of trade profits. It is based on section 42 of FA 1998. The corresponding rule for income tax is in section 25 of ITTOIA.
203. Subsection (1) is the general rule that requires profits to be calculated “in accordance with generally accepted accounting practice”, an expression defined in section 50 of FA 2004. In particular, such practice generally requires account to be taken of debtors and creditors and of the value of stock. The general rule is subject to any special rule of law whether expressed in statute or explained by the courts.
204. The relevant statutory laws are mainly those that are rewritten in this Part. But there are also provisions not included in Part 3 of this Bill which may affect the calculation of profits: for example, the pension contributions deductions provisions in FA 2004 and some anti-avoidance provisions in ICTA that apply to all income types.
205. Subsection (2) makes clear that subsection (1) does not bring with it any of the other accounting requirements, such as a formal audit.
206. Subsection (3) sets out exceptions to the general rule in subsection (1). Lloyd’s underwriters have their own special rules (mostly in Chapter 3 of Part 2 of FA 1993); there are special rules for insurance companies (mostly in Chapter 1 of Part 12 of ICTA and Chapter 1 of Part 2 of FA 1989); and tonnage tax companies (see Schedule 22 to FA 2000) are subject to “special rules” for the calculation of profits.
Clause 47: Losses calculated on same basis as profits
207. This clause ensures that profits and losses are calculated on a consistent basis. It is based on section 46 of FA 1998. The corresponding rule for income tax is in section 26 of ITTOIA.
Clause 48: Receipts and expenses
208. This clause is based on section 46 of FA 1998. The corresponding rule for income tax is in section 27 of ITTOIA.
Clause 49: Items treated as receipts and expenses
209. This clause signposts rules affecting trade profits that are elsewhere in the Corporation Tax Acts. It is new. The corresponding rule for income tax is in section 28 of ITTOIA.
210. In particular the CAA rules override the rules against the inclusion of capital items in clauses 53 and 93 of this Bill.
Clause 50: Animals kept for trade purposes
211. This clause contains the basic rule for the corporation tax treatment of animals. It is based on paragraphs 1, 7 and 9 of Schedule 5 to ICTA. The corresponding rule for income tax is in section 30 of ITTOIA. The animals are treated as trading stock unless a herd basis election is made under Chapter 8 of this Part.
Clause 51: Relationship between rules prohibiting and allowing deductions
212. This clause makes clear the interaction between those provisions that allow a deduction and those provisions that prohibit a deduction. It is new. See Change 7 in Annex 1. The corresponding rule for income tax is in section 31 of ICTA.
213. The general principle is that a rule allowing a deduction takes priority over a rule prohibiting a deduction. But this is subject to a number of exceptions.
Clause 52: Apportionment etc of profits and losses to accounting period
214. This clause provides for apportionment of profits and losses when a company’s period of account does not coincide with an accounting period. It is based on section 72 of ICTA. That section is rewritten for income tax purposes in sections 203 and 871 of ITTOIA.
215. This clause does not carry over the rewrite change in sections 203(4) and 871(5) of ITTOIA whereby apportionment is permitted by a measure of time other than the days permitted by section 72(2) of ICTA. HMRC has a long-established view that days cannot be split into accounting periods. That helps prevent exploitation of the wider range of reliefs available in the rather different context of corporation tax.
Chapter 4: Trade profits: rules restricting deductions
Overview
216. This Chapter contains provisions prohibiting various deductions in calculating the profits of a trade or restricting the extent to which such deductions can be made.
Clause 53: Capital expenditure
217. This clause prohibits deductions for capital expenditure and is based on section 74(1)(f) of ICTA. The corresponding rule for income tax is in section 33 of ITTOIA.
218. It is a long-established and generally accepted principle that capital items are ignored in calculating the profits of a trade and the question whether a sum is income or capital is ultimately a question of law, not accountancy. For judicial authority for this proposition, see, for example the words of Brightman J on page 173 of ECC Quarries Ltd v Watkis (1975), 51 TC 153 ChD 1:
..unchallenged evidence, or a finding, that a sum falls to be treated as capital or income on principles of correct accountancy practice is not decisive of the question whether in law the expenditure is of a capital or an income nature.
219. A sum which is of a capital nature may however be allowed as a deduction in calculating the profits of a trade because of a statutory exception to the general rule on the deduction of such items in this clause. See, for example, clause 89 (expenses connected with patents).
220. In the absence of general agreement on what constitutes capital expenditure “items of a capital nature” is not defined.
221. Section 74(1)(g) of ICTA is redundant as the deduction of capital employed in the improvement of premises is covered by the general prohibition on the deduction of “items of a capital nature”. So this Bill repeals section 74(1)(g) of ICTA without rewriting it.
Clause 54: Expenses not wholly and exclusively for trade and unconnected losses
222. This clause contains rules for the deduction of expenses and losses in calculating the profits of a trade. It is based on section 74(1)(a) (expenses) and (e) (losses) of ICTA. The corresponding rules for income tax are in section 34 of ITTOIA.
223. Section 74(1)(a) of ICTA provides that in calculating the profits of a trade no deduction is allowed for expenditure which is not incurred “wholly and exclusively” for the purposes of that trade. This could be construed to mean that if expenditure is incurred partly for trade purposes and partly for some other purposes, no part of that expenditure can be deducted in arriving at the trade profits.
224. But section 74(1)(c) of ICTA, which prohibits any deduction in respect of the rent of premises used for residential or “domestic” purposes, provides for the apportionment of rent paid for premises used partly as residential accommodation and partly for the purposes of a trade. And in practice a deduction is allowed for any expenditure which can be apportioned between trade and non-trade expenditure - for example, expenditure on a car used partly for trade and partly for private purposes.
225. There is judicial support for allowing a deduction where expenditure incurred for more than one purpose can reasonably be apportioned between expenditure incurred for the purpose of the trade and non-trade expenditure. See, for example, Lochgelly Iron and Coal Company Ltd v Crawford (1913), 6 TC 267 CS, in which a deduction was allowed for part of a subscription to a trade association and Copeman v William Flood & Sons Ltd (1941), 24 TC 53 KB, in which the High Court remitted the case to the Commissioners to find as a fact whether the remuneration paid to certain directors who were also shareholders in the family company was wholly and exclusively expended for the purpose of the Company’s trade, and if not, how much of the remuneration was so expended.
226. Conversely, the courts have held that if it is not possible to identify any part of the expenditure that is incurred wholly and exclusively for the purposes of the trade, no apportionment is possible. See, for example, Mallalieu v Drummond (1983), 57 TC 330 HL 2 in which no deduction was allowable for clothing worn for warmth and decency as well as being required by the taxpayer’s profession.
227. So subsection (2) of this clause provides for the deduction of any part or proportion of expenses incurred partly for the purposes of the trade and partly for some other purpose that can be identified as incurred wholly and exclusively for the purposes of the trade. Rent on dual purpose accommodation can be apportioned under subsection (2) of this clause. So this Bill repeals section 74(1)(c) of ICTA without rewriting it.
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