Change 7: Trading and property income: relationship between rules prohibiting deductions and rules allowing deductions: clauses 51 and 214

This change resolves any conflict between the rules prohibiting a deduction in calculating trade profits and the rules allowing a deduction in calculating trade profits in favour of the rule allowing the deduction. But any conflict is unlikely.

The change brings the income tax and corporation tax codes back into line.

Parts 3 and 20 of this Bill set out a number of rules that restrict the deductions allowed in the calculation of trade profits. Each of these is a “prohibitive rule”.

Part 3 of this Bill also sets out a number of rules that allow deductions in the calculation of trade profits. Most of these rules are in Chapter 5 of Part 3 of this Bill. Each of these is a “permissive rule”.

In some cases the source legislation for a permissive rule overrides a specific prohibitive rule. In other cases the source legislation provides that a deduction is allowed “notwithstanding anything in section 74 [of ICTA]”. Such a form of words overrides all the restrictive rules in section 74 of ICTA. See, for example, section 82A of ICTA rewritten as clause 87. In other cases the source legislation says merely that a deduction is allowed.

Clause 51 makes clear that the permissive rule has priority over any prohibitive rule with the four exceptions set out in subsection (1)(b) of the clause.

In the case of car and motor cycle hire section 578A of ICTA makes clear that the provision restricts the amount of any deduction.

In the cases of unpaid remuneration and employee benefit contributions section 43 of FA 1989 and paragraph 1 of Schedule 24 to FA 2003 impose a timing rule that naturally overrides any permissive rule. And, in an instance where a conflict may arise, section 86 of ICTA (seconded employees) allows the deduction only “to the like extent” as if the employee had not been seconded.

In the case of crime-related expenditure the order of priority reflects the view that in enacting section 577A of ICTA Parliament intended that there should be no circumstances in which anyone should obtain a tax deduction by making a crime- related payment.

The order of priority given by clause 51 is relevant only if the expenditure is capable of falling within both a permissive rule and a prohibitive rule. This is most likely to happen in the case of the general restriction in clause 54. In these cases the source legislation leaves no uncertainty about the extent to which the prohibitive rule is overridden. The only area of uncertainty is where the restriction is imposed by a provision other than section 74 of ICTA. For example, the restriction that section 577 of ICTA imposes on business expenditure.

There is rarely scope for overlap between a specific permissive rule and a specific prohibitive rule. This is because the terms for either rule to apply are so closely defined. As a question of fact the expenditure will fall into one category or the other. But in the event of any overlap clause 51 changes the law by giving priority to the permissive rule.

For example, it is unlikely that expenditure that meets the conditions for section 83 of ICTA (patent fees etc) to apply would also be business expenditure disallowed by section 577 of ICTA. If it does the source legislation is silent on which rule takes priority. Clause 51 gives priority to the permissive rule.

Clause 214 applies the same order of priority to the profits of a property business.

If there is any doubt in the source legislation about which rule takes priority this change resolves the doubt in favour of the rule that allows the deduction.

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 8: Trading income: align rules for debts proving irrecoverable after trade deemed to have ceased with general rules for bad debts: clause 55 and Schedule 1

This change aligns the relief given for bad debts by section 89 of ICTA with the relief given by section 88D of ICTA.

Section 337(1) of ICTA sets out what happens if a company begins or ceases to carry on a trade or begins or ceases to be within the charge to corporation tax. Its trade profits are calculated as if the trade begins or ceases to be carried on.

Section 89 of ICTA provides relief for bad debts if there is an “event” within section 337(1) of ICTA or if there is a change in the persons carrying on the trade. It gives relief for bad debts which meet certain conditions. Since the trade carried on before the event or change is deemed to be different from the trade carried on after the event or change section 74(1)(e) of ICTA would otherwise prohibit a deduction for bad debts. The desired effect is to treat the trade as continuing as far as bad debts are concerned.

Although the aim of section 89 of ICTA is the same as that of section 88D of ICTA (that is, to give relief for bad trade debts), there are significant differences between the two sections and the nature of the relief given. Specifically:

• section 89 gives relief for debts which are irrecoverable, whereas section 88D gives relief for an impairment loss;

• section 89 requires proof that a debt is irrecoverable, whereas section 88D has no corresponding requirement; and

• section 88D refers to debts released as part of a “statutory insolvency arrangement”, whereas section 89 makes no mention of this.

The approach adopted in this Bill is to focus on the company carrying on the trade rather than on the trade. So it does not matter whether the debt was created when another taxpayer was carrying on the trade and this Bill repeals section 89 of ICTA without rewriting it (see Schedule 1). The change extends the more generous provisions of section 88D of ICTA to debts within section 89 of ICTA. This simplifies the law by bringing the bad debt relief provisions for companies into one clause.

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

Change 9: Trading income: car hire: release of debt after debtor has ceased trading: clause 56

This change reduces the amount charged as a post-cessation receipt when a debt relating to the hire of a car with a new retail value of more than £12,000 is released after the debtor has ceased trading.

It brings the income tax and corporation tax codes back into line.

Section 578A of ICTA restricts the amount which a company carrying on a trade can deduct in respect of the cost of hiring a car or motor cycle with a retail value, when new, of more than £12,000. The restriction takes the form of a reduction calculated by reference to the difference between the £12,000 limit and the retail price.

Section 578A(4) of ICTA provides that where there is a rebate of a hire charge, or a debt to which section 94 of ICTA applies is released, the amount brought into account in respect of the rebate or release is reduced in the same proportion as that in which the trading deduction was restricted.

Section 578A(4) of ICTA deals only with a continuing trade. This change extends the same treatment to debts wholly or partly released after the debtor has ceased to trade and taxed as post-cessation receipts under clause 193 of this Bill.

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 10: Trading income etc: car hire: hire agreements without option to purchase: clauses 57 and 1251 and Schedule 1

This change extends the definition of “qualifying hire car” for the purpose of restricting the amount allowed as a deduction for the cost of hiring a car to include cars hired under a hire-purchase agreement where there is no option to purchase.

The change brings the income tax and corporation tax codes back into line. It also applies to management expenses.

Section 578A of ICTA restricts the amount which a company can deduct in respect of the cost of hiring a car or motor cycle with a retail value, when new, of more than £12,000. Section 578A of ICTA does not apply to a car or motor cycle which is a “qualifying hire car” as defined in section 578B(2) of ICTA.

Section 578B(2) of ICTA defines a “qualifying hire car” as a car which is:

(a) .. hired under a hire-purchase agreement .. under which there is an option to purchase exercisable on the payment of a sum equal to not more than 1 per cent. of the retail price .. when new, or

(b) .. a qualifying hire car for the purposes of Part 2 of the Capital Allowances Act (under section 82 ..)

The definition of “qualifying hire car” in section 578B(2) of ICTA does not extend to cars hired under a hire-purchase agreement where there is no option to purchase. In practice, HMRC do not apply the restriction in section 578A of ICTA on the amount of deduction to cars hired under such agreements. This clause legislates that practice by including cars hired under a hire-purchase agreement where there is no option to purchase in the definition of hire car in subsection (2)(a) of the clause. So the hirer gets a deduction for the full amount of the hiring costs.

This change applies also to the corresponding rule for expenses of insurance companies in section 76ZN of ICTA (inserted by Schedule 1 to this Bill).

This change is in taxpayers’ favour in principle. But it is expected to have no practical effect as it is in line with generally accepted practice.

Change 11: Trading income: lease premiums etc: deduction for tenant under taxed lease if land is outside the United Kingdom: clauses 62 and 66

This change makes relief available for tenants under taxed leases of land used in connection with a trade, where the land is outside the United Kingdom.

It brings the income tax and corporation tax codes back into line.

Section 87(2) of ICTA provides in certain cases for a trading deduction to be given to a tenant under a lease, if previously an “amount chargeable” had arisen in relation to the lease concerned.

Section 87(1) of ICTA defines “amount chargeable” to include:

(a) any amount [that] falls to be treated as a receipt of a Schedule A business by virtue of section 34 or 35, ..

(c) any amount [that] falls to be treated as a receipt of a UK property business by virtue of any of sections 277 to 282 of ITTOIA 2005..

Section 70A(5) of ICTA provides that:

The income from an overseas property business shall be computed for the purposes of Case V of Schedule D in accordance with the rules applicable to the computation of the profits of a Schedule A business.

So if the lease is of land outside the United Kingdom, sections 34 and 35 of ICTA may apply to a landlord/assignor by virtue of section 70A(5) of ICTA. The amount given by section 34 or 35 of ICTA in cases where the land is outside the United Kingdom is treated as a receipt of an overseas property business.

But section 70A(5) of ICTA does not deem an overseas property business receipt to be a receipt of a Schedule A business. So a company occupying land outside the United Kingdom under a lease in respect of which the landlord has been treated as receiving an overseas property business receipt is not entitled to relief, under section 87(2) of ICTA (see the italicised words in the above extract from section 87(1) of ICTA), in circumstances in which it would have been entitled to relief if the land had been in the United Kingdom.

Similarly a company which occupies land outside the United Kingdom under a lease in respect of which the landlord has been treated as receiving an overseas property business receipt under sections 277 to 282 of ITTOIA is not entitled to relief in circumstances in which it would have been entitled to relief if the land had been in the United Kingdom. That is because section 87(1)(c) of ICTA refers to amounts which are treated as receipts of a UK property business under sections 277 to 282 of ITTOIA.

Clause 62(1) provides for a tenant to be treated as incurring expenses by reference to a taxed receipt under clause 63 regardless of where the land in question is situated. Clause 66(1) restricts, regardless of where the land in question is situated, the expenses that clause 65 (land not occupied by tenant but employed for purposes of tenant’s trade) treats a tenant as incurring under clause 63 where there is a reduction under the additional calculation rule by reference to that taxed receipt. The same changes were made for income tax in sections 60 and 64 of ITTOIA (see Change 13 of Annex 1 to ITTOIA).

This change will result in a company receiving relief under clause 63 where there is currently no entitlement to relief.

Section 295 of ITTOIA (as amended by Schedule 1 of this Bill) and clause 235 place a cap on the total amount of relief that can be obtained by reference to a taxed receipt. This means that widening entitlement to relief under clause 63 may, in certain circumstances, reduce the amount of relief subsequently available to other persons under Chapter 4 of Part 3 of ITTOIA or under Chapter 4 of Part 4 of this Bill.

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

Change 12: Requiring an apportionment to be just and reasonable: clauses 63, 67, 78, 229, 234, 255, 1185, 1194 and 1241 and Schedule 1

This change requires certain apportionments that are not required to be made on a just and reasonable basis in the source legislation to be made on that basis.

It brings the income tax and corporation tax codes back into line. It also applies to management expenses.

Apportionments are sometimes to be made on a specified basis, such as time apportionment. But often they are left to be made according to what is reasonable in the particular circumstances. This change is concerned with such apportionments.

In some cases where there is an apportionment under legislation rewritten in this Bill, the apportionment is required by the source legislation to be made on a just and reasonable basis. In other cases, it is required to be made only on a just basis or only on a reasonable basis, or there are no requirements. It is now the practice to require an apportionment to be just and reasonable. There is no reason why an apportionment should not be on a just and reasonable basis. And it is desirable that all apportionments of this nature should be made on the same basis.

Accordingly, where an apportionment under legislation rewritten in this Bill is not required to be made on a just and reasonable basis, the rewritten provision requires the apportionment to be made on a just and reasonable basis. The changes are as follows:

• section 30(2)(a) of ICTA (apportionment of deemed payment in respect of expenditure on sea walls, as may be just) (see clause 255(2));

• section 37(3) of ICTA (apportionment of appropriate fraction of the amount chargeable on the superior interest attributable to a part of premises required to be just) (see clause 229(3));

• section 37(6) of ICTA (amount chargeable on the superior interest to be proportionately adjusted between parts of premises; no explicit requirements as to the basis on which the adjustment is to be made) (see clause 234(7));

• section 87(3) of ICTA (apportionment of deemed rent attributable to part of land not occupied for the purposes of a trade, profession or vocation required to be just) (see clause 63(5));

• section 87(5) of ICTA, which applies section 37(6) of ICTA (amount chargeable on the superior interest to be proportionately adjusted between parts of premises; no explicit requirements as to the basis on which the adjustment is to be made) (see clause 67(6));

• section 579(5) of ICTA (apportionment of a redundancy payment where the employee is employed in different capacities; no requirements as to the basis on which the apportionment is to be made) (see clauses 78(2) and 1241(2));

• section 35(2) of FA 2006 (apportionment of expenditure as between UK expenditure and non-UK expenditure, for purposes of film production provisions, required to be fair and reasonable) (see clause 1185(2)); and

• paragraph 8 of Schedule 4 to FA 2006 (estimates for purposes of film production company provisions required to be fair and reasonable) (see clause 1194).

This change applies also to the corresponding rule for expenses of insurance companies in section 76ZH of ICTA (inserted by Schedule 1 to this Bill).

It is difficult to identify even a theoretical difference between a just and reasonable apportionment and an apportionment on another basis. But this change is presented on the basis that there may be such a difference.

This change makes minor amendments to a number of existing rules, but is expected to have no practical effect as it is in line with generally accepted practice.

Change 13: Trading and property income: lease premiums etc: restrictions on expenses under clauses 63 and 232 in respect of taxed receipt: clauses 66, 67, 233 and 234

This change clarifies how expenses that a tenant is treated under section 37(4) of ICTA (property business) or section 87(2) of ICTA (trade) as incurring by reference to a taxed receipt are affected in certain cases. Those cases are where there is a reduction, under section 37(2) of ICTA (later chargeable amount) or under section 288 of ITTOIA (additional calculation rule), by reference to that taxed receipt.

It brings the income tax and corporation tax codes back into line.

Section 37(4) of ICTA provides:

Subject to subsection (5) below, a company which is for the time being entitled to the head lease shall be treated for the purpose, in computing the profits of a Schedule A business, of making deductions in respect of the disbursements and expenses of that business as paying rent for those premises (in addition to any actual rent), becoming due from day to day, during any part of the period in respect of which the amount chargeable on the superior interest arose for which the company was entitled to the head lease, and, in all, bearing to that amount the same proportion as that part of the period bears to the whole.

Section 37(5) of ICTA modifies section 37(4) of ICTA if the reduced amount of a later chargeable amount has been calculated under section 37(2) of ICTA by reference to the amount chargeable on the superior interest (“ACSI”). Section 37(5) of ICTA provides:

Where subsection (2) above applies, subsection (4) above shall apply for the period in respect of which the later chargeable amount arose only if the appropriate fraction of the amount chargeable on the superior interest exceeds the later chargeable amount, and shall then apply as if the amount chargeable on the superior interest were reduced in the proportion which that excess bears to that appropriate fraction.

The appropriate fraction is defined in section 37(7) of ICTA.

The general principle behind section 37(5) of ICTA is that, if part of ACSI has been used under section 37(2) of ICTA to reduce a later chargeable amount, only the balance of the ACSI should be available under section 37(4) of ICTA. This is achieved by reducing the amount of rent that the tenant is treated, in relation to the ACSI, as paying under section 37(4) of ICTA for the period in respect of which the later chargeable amount arose. And if (in the calculation under section 37(2) of ICTA) the appropriate fraction of the ACSI was fully used to reduce the later chargeable amount, no rent is treated as incurred under section 37(4) of ICTA for the period in respect of which the later chargeable amount arises.

The same general principle applies under section 37A of ICTA where part of ACSI has been used under section 288 of ITTOIA (additional calculation rule). The appropriate fraction is defined in section 37A(6) and (7) of ICTA.

Section 87(5) of ICTA applies section 37(5) of ICTA (part of ACSI used under section 37(2) of ICTA) if a tenant under a taxed lease is treated as paying rent under section 87(2) of ICTA in circumstances in which section 87(4) of ICTA applies.

Section 87A of ICTA applies section 37A of ICTA (part of ACSI used under section 288 of ITTOIA) if a tenant under a taxed lease is treated as paying rent under section 87(2) of ICTA in circumstances in which section 87(4) of ICTA applies.

The following explanation is in terms of sections 37 and 87 of ICTA but is equally applicable to sections 37A and 87A of ICTA.

Later chargeable amount reduced by more than one ACSI

It is possible that:

• the reduced amount, under section 37(2) of ICTA, of a later chargeable amount is nil, and

• the reduced amount of nil has been calculated by reference to more than one ACSI, but

• the appropriate fraction of each ACSI does not exceed the later chargeable amount.

In these circumstances, section 37(5) of ICTA prevents any relief under section 37(4) of ICTA for the period in respect of which the later chargeable amount arose.

But it is more consistent with the principle behind section 37(5) of ICTA that if the total of the appropriate fractions of the ACSI involved exceeds the later chargeable amount, rent equal to that excess should be treated as paid for the period in respect of which the later chargeable amount arose. Otherwise, that excess will not be available to provide relief under section 37(4) of ICTA. It will be lost, unless it can be used in the calculation of a reduced amount for a different later chargeable amount.

To deal with such a case, clause 233(3) uses the test that the “daily amount” of the taxed receipt must exceed the “daily reduction” of the lease premium receipt. Then clause 233(6) (by reference to clause 230(6)) limits the “daily reduction” of the lease premium receipt to the reduction that is attributable to the taxed receipt in question. The same change was made for income tax in section 293 of ITTOIA (see Change 15(A) of Annex 1 to ITTOIA).

Overlap in periods for which more than one later chargeable amount is reduced by one ACSI

It is also possible that the reduced amount of more than one later chargeable amount has been calculated under section 37(2) of ICTA by reference to an ACSI and that the amount of each of the later chargeable amounts has been reduced to nil. In these circumstances, section 37(4) and (5) of ICTA work satisfactorily if there is no overlap between the periods in respect of which each of the later chargeable amounts arose. But it is not at all clear how section 37(4) and (5) of ICTA are intended to operate if there is such an overlap.

If there is an overlap between the periods in respect of which each of the later chargeable amounts arose, it is reasonable that section 37(5) of ICTA should apply so that the total of the reductions in all later chargeable amounts by reference to the ACSI should be taken into account in determining how much, if any, rent should be treated as paid under section 37(4) of ICTA.

To deal with such a case, clause 233(2) and (5) make explicit provision if there is an overlap in the periods for which more than one lease premium receipt is reduced under clause 228 or under section 288 of ITTOIA by reference to a taxed receipt. The same change was made for income tax in section 293 of ITTOIA (see Change 15(A) of Annex 1 to ITTOIA).

Without these changes, clause 233 would produce the same result as section 37(5) of ICTA if there is one taxed receipt and one lease premium receipt. These changes make clause 233 work if:

• a lease premium receipt is reduced by reference to more than one taxed receipt; or

• a taxed receipt reduces more than one lease premium receipt and there is an overlap in the periods in relation to which those lease premium receipts arise.

Clause 66(2), (5) and (6) is based on that part of section 87(5) of ICTA that applies section 37(5) of ICTA. It includes similar changes to those in clause 233. The same change was made for income tax in section 64 of ITTOIA (see Change 15(A) of Annex 1 to ITTOIA).

Later chargeable amounts arise in relation to different parts of the premises covered by the head lease

Section 37(6) of ICTA provides for the application of section 37(4) and (5) of ICTA if the later chargeable amount is in respect of a lease of only part of the premises subject to the head lease.

Section 37(6) of ICTA does not deal with the possibility that:

• more than one lease of part of the premises is granted out of the head lease;

• later chargeable amounts in respect of each such lease are reduced under section 37(3) of ICTA by reference to ACSI; and

• there is an overlap in the receipt periods of those later chargeable amounts.

This possibility is dealt with in clause 234(5). The same change was made for income tax in section 294 of ITTOIA (see Change 15(B) of Annex 1 to ITTOIA).

Clause 67 is based on that part of section 87(5) of ICTA that applies section 37(6) of ICTA. Clause 67(4) includes a similar change to that in clause 234. The same change was made for income tax in section 65 of ITTOIA (see Change 15(B) of Annex 1 to ITTOIA).

Section 295 of ITTOIA (as amended by Schedule 1 of this Bill) and clause 235 place a cap on the total amount of relief that can be obtained by reference to a taxed receipt. So if, as a result of this change, the relief to which a company is entitled is increased or decreased, this may affect the amount of relief subsequently available to other persons under Chapter 4 of Part 3 of ITTOIA or under Chapter 4 of Part 4 of this Bill.