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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 54: Property income: deduction of management expenses of owner of mineral rights: omission of condition that expenses are necessarily incurred: clause 272
This change concerns the omission of the requirement that the allowable expenses of managing mineral rights are incurred necessarily.
It brings the income tax and corporation tax codes back into line.
Section 121(3) of ICTA makes provision for expenses of management and supervision to be deducted from amounts chargeable to corporation tax in respect of mineral rents and royalties. The section requires that the expenses are disbursed wholly, exclusively and necessarily.
Section 121(3) of ICTA is rewritten as clause 272. That clause does not reproduce the condition that the expenses must be necessarily incurred. There is no evidence as to how this test is applied in practice but it is not obvious how it could be enforced. The extensive body of case law on the meaning of expenses being incurred necessarily applies to income formerly taxed under Schedule E (now taxed as employment income under ITEPA). That case law establishes that each and every holder of the office or employment would have to incur the expense.
That is not a test that could be sensibly applied to income taxed under Schedule D Case VI. It is not a test that could be sensibly applied to income taxed under Part 4 of this Bill. It is most unlikely that the necessarily restriction can be applied in practice and this clause recognises this by omitting necessarily.
This change removes a potential obstacle to a successful claim for relief.
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 55: Property income etc: priority of the charge on trade profits: the Crown Option: clauses 287 and 982 and Schedule 1
This change gives priority to the charge on trade profits if an item of income is both a trade receipt and potentially within the receipts of an overseas property business in Part 4 or within a charge to tax in Part 10 of this Bill.
In the source legislation taxable income is allocated to different Schedules. The charges under these Schedules are mutually exclusive.
In addition, a small number of charges (non-schedular charges) are imposed outside the schedular system.
The scope of Schedule D is set out in section 18 of ICTA. The effect of that section (and the relevant case law) is that Schedule D is the residual Schedule. If income meets the conditions to be taxed under Schedule D and the conditions to be taxed under ITEPA or another Schedule of ICTA it is taxed under the alternative and not under Schedule D.
But there is no order of priority between Cases I, III and V of Schedule D. In the event of income falling within more than one of those cases it has long been accepted that HMRC have the option to choose under which case the income should be taxed.
HMRCs guidelines for making the determination are published in paragraph 14035 of the Business Income Manual. The income is taxed under Schedule D Case I and not under Schedule D Case III or V.
This Bill deals with the Crown Option by providing for an order of priority between the Parts if income is capable of being taxed under more than one Part.
Clause 287 provides that if income is capable of being taxed under Part 4 of this Bill as profits of an overseas property business and under Chapter 2 of Part 3 of this Bill as trade profits it is taxed under Part 3. ICTA taxes the profits arising from an overseas property business under Schedule D Case V so clause 287 gives effect to the Crown Option for trades carried on wholly or partly in the United Kingdom (and to section 70A(1) of ICTA for trades carried on wholly abroad).
Clause 982(1) gives priority to Chapter 2 of Part 3 of this Bill if income falls within both Chapter 2 of Part 3 and Chapter 2, 5 or 6 of Part 10 of this Bill. This gives effect to the Crown Option for income within Part 10 of this Bill that is taxed in ICTA under Schedule D Cases III or V. It applies the same approach to trades carried on wholly abroad as is applied to trades carried on wholly or partly in the United Kingdom. This is consistent with the law (see sections 21A and 70A of ICTA) that the profits of both types of trade should be calculated on the same basis.
Chapters 7 (annual payments not otherwise charged) and 8 (income not otherwise charged) of Part 10 of this Bill include income charged under Schedule D Case III or V. But in both cases the income within these Chapters is income that cannot be taxed under another provision. So a specific rule ceding priority to Part 3 of this Bill is not needed.
Schedule 1 to this Bill repeals sections 12AE and 31(3) of TMA and paragraph 84 of Schedule 18 to FA 1998.
In principle, this change is favourable to some taxpayers and adverse to others because it allocates income to a specific head of charge. That head of charge may produce a different amount of income to be brought into charge or may facilitate the claiming or relieving of losses or other reliefs that are not available under the other charge. The rules applicable to income within Part 3 are generally regarded as more flexible and favourable than those applying to the heads of charge which would have applied but for this change.
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 generally accepted practice.
Change 56: Loan relationships: references to connections between a company and another person to be rewritten as applying to connections between two companies: clauses 348, 361, 468, 469 and 470.
This change rewrites references to a company connected with a person so as to refer to a connection between two companies.
Section 87 of FA 1996 provides for the amortised cost basis to be used when bringing into account credits and debits on loan relationships when there is a connection between the creditor company and a person standing in the position of the debtor or between a debtor company and a person standing in the position of a creditor.
Section 87(3) explains what is meant by a connection between a company and another person for the purposes of section 87. The definition is only in terms of the person being a second company. This was not always the case. Section 87(3)(c) originally included the case of a participator of the debtor or creditor company or an associate of the participator until that paragraph was repealed by FA 2002. The definition of participator in section 417 of ICTA can include an individual.
The most likely interpretation is therefore that person in section 87(1) and (3) of FA 1996 means company. Section 87 is rewritten accordingly. The far less likely interpretation is that section 87(3) only provides the definition where the other person is a company and that it is up to the courts to interpret what is meant by connection in section 87(1) where the person is an individual. Section 839 of ICTA, which provides a definition of connected persons including connected persons who are not companies, only applies where the section itself is applied (see section 839(1)). It is not applied by section 87 of FA 1996 although it is so applied elsewhere in the loan relationship provisions.
Section 88 of FA 1996 provides exceptions to the connection provision in section 87 of FA 1996.
Section 88(1) provides that a connection between a creditor company and the person standing in the position of debtor in the exempt circumstances set out in section 88 is disregarded for the connection provisions of section 87. Although section 88(5) provides a refinement of that rule for the debtor company if the person standing in the position of a debtor is also a company, it is not clear how the person in subsection (1) who is the debtor could be other than a company, since section 87, as explained above, now only provides connection rules between companies. Section 88(1) and (5) is therefore rewritten as applying to debtor companies only.
Section 88(2) excludes cases where, broadly, loan relationships are treated as trading assets. But paragraphs (e) and (f) of that subsection do not allow the exclusion where the asset representing the loan relationship has, under certain conditions, been in the beneficial ownership of connected persons.
Section 88(4)(b) explains what is meant by a connected person having the beneficial ownership of assets by applying the meaning of a connection given by section 87 of FA 1996. Connected person here is therefore also rewritten as referring to a connected company.
Paragraph 4A of Schedule 9 to FA 1996
Paragraph 4A of Schedule 9 to FA 1996 provides for the deemed release of a loan (and hence a charge on the debtor company) where the creditor company acquires the loan from a second person for an amount less than the carrying value in the accounts of the debtor company. Under sub-paragraph (2)(d) this provision does not apply where there is a connection between the new creditor company and the person from whom it acquired that debt. Sub-paragraph (8) provides the meaning for the purposes of the paragraph of connection between a company and another person. In both instances the other person is a company.
It seems probable therefore that person in paragraph 4A(2)(d) refers to a company only. Indeed, the effect of paragraph 4A is that no charge arises from a released debt where a loan is passed between group companies.
The far less likely interpretation is that paragraph 4A(8) of Schedule 9 to FA 1996 only provides the definition where the other person is a company and that it is up to the courts to interpret what is meant by connection in paragraph 4A(2)(d) where the person is an individual. Paragraph 4A(2)(d) is therefore rewritten as being only of relevance where the person is a company.
If the courts decided that connected persons in sections 87 and 88 of FA 1996 included individuals the rewrite of those sections would extend the circumstances where the amortised cost basis was compulsory. This could be favourable or unfavourable to the taxpayer depending on the effects of applying that particular basis of accounting. If it were held that person in paragraph 4A of Schedule 9 to FA 1996 included an individual this would reduce the circumstances when there was a deemed release by the creditor company of its rights under the loan relationship which one would expect to be taxpayer favourable.
This change is in principle adverse to some taxpayers and favourable to others. But it is expected to have no practical effect as it is in line with current practice.
Change 57: Loan relationships etc: amortised cost basis and connected companies: fair value to apply in the case of reset bonds and shares with guaranteed returns: clauses 349 and 534
This change gives precedence to fair value accounting where a reset bond or a share which is an interest-like investment would normally attract the amortised cost basis of accounting as a result of the connected companies provisions.
Section 87(2) of FA 1996 requires debits and credits on a loan relationship to be accounted for on an amortised costs basis where there is a connection between the creditor and debtor company. This is rewritten in clause 349.
Sections 88A(4) of FA 1996 requires debits and credits on a loan relationship where the rate of interest is reset to be determined on the basis of fair value accounting (rewritten in clause 454). Sections 91A(3) and 91B(3) of FA 1996 (rewritten in clause 534) also require credits to be determined on the basis of fair value accounting where shares with interest-like returns are treated as loan relationships.
This change gives precedence to the fair value basis where a conflict between the two methods of accounting arises, the more specific rule taking precedence over the more general rule.
The tax effect will depend on the circumstances of the taxpayer and the effects of fair value accounting on the loan relationship or deemed loan relationship.
This change is in principle adverse to some taxpayers and favourable to others. But it is expected to have no practical effect as it is in line with generally accepted practice.
Change 58: Loan relationships: deficits on loan relationships referable to basic life assurance and general annuity business: change in basic rule so that deficit set off against income and gains of deficit period instead of being carried forward: clause 388
This changes the default rule for setting off deficits on loan relationships referable to basic life assurance and general annuity business so that such deficits are set off against income and gains of the deficit period instead of being carried forward and treated as expenses in later accounting periods.
Under paragraph 4(4) of Schedule 11 to FA 1996, if a claim is not made under either paragraph 4(2) to set off the deficit against income and gains in the deficit period, or paragraph 4(3) to carry the deficit back and set it off against eligible profits in earlier accounting periods, then the deficit is carried forward to the next accounting period. No claim is required to carry the deficit forward.
This change secures that no claim is required to set off the deficit against income and gains within the deficit period. If a deficit remains after setting off the deficit against eligible income in the deficit period, the excess is carried forward without a claim unless a claim is made to carry it back. (A claim is still required if the company wants to carry the deficit back to earlier accounting periods.)
This change will not alter the amount charged to tax. The most it will do is affect the timing of the tax liability. In a small minority of cases this could mean a different rate of tax being applied, according to individual circumstances. Any overall tax effect is likely to be negligible.
Change 59: Loan relationships: funding bonds: charge to tax as interest: clauses 299 and 413
This change replaces a theoretical but unlikely charge to tax under Schedule D Case VI with a charge under the loan relationships legislation where funding bonds are issued and it is impractical to retain any bonds on account of income tax.
This change reproduces Change 82 in ITTOIA and so brings the income tax and corporation tax codes back into line.
Section 582(1) of ICTA generally treats the issue of funding bonds as a payment of interest and they are taxed accordingly. But there is one situation where funding bonds are charged to tax under Schedule D Case VI, rather than as interest. Section 582(2)(b) and (2A) of ICTA provides that where it is impracticable to retain bonds the recipient is instead chargeable to tax under Schedule D Case VI.
It would, however, be extremely unusual for a Case VI charge to arise on a company. Under section 930(1), 933 and 934 of ITA a company or authority is not obliged to deduct tax where the company beneficially entitled to the income is resident in the United Kingdom or, if not resident, the payment is within the charge to corporation tax under section 11 of ICTA. The only likely instance of a Case VI charge arising on a company liable to corporation tax (and hence the loan relationships regime) under section 582 is where tax is deductible on interest because it is paid other than by a company or authority. The only obvious example is a payment of a United Kingdom public revenue dividend under section 892 of ITA and public revenue dividends are unlikely to give rise to funding bonds.
Section 582(3A) of ICTA provides that the provisions of section 582 override the provisions of Chapter 2 of Part 4 of FA 1996 and thus the rules in section 582 apply where that treatment differs from treatment under the loan relationships regime.
As section 582(1) of ICTA treats funding bonds as a payment of interest for all purposes of the Corporation Taxes Acts, applying a different charge under Schedule D Case VI in just one situation has no particular logic and adds an unnecessary complication. As explained above, a Case VI charge is extremely unlikely to arise in the first place. So the separate Case VI charge is not reproduced. Clause 413(2) ensures that all issues of funding bonds are charged to tax as interest, irrespective of the circumstances in which they are issued.
Loss relief against this income for losses previously arising under Schedule D Case VI has not been preserved given the unlikelihood of a Case VI charge. The exemption from tax for income charged under Schedule D Case III and which is applied for charitable purposes (section 505(1)(c)(ii) of ICTA) applies as a result of this change.
A tax disadvantage would arise if the taxpaying company had what would have been in the source legislation a Schedule D Case VI loss to bring forward or carry sideways and which could not be otherwise relieved. But since the likelihood of the Case VI charge arising under section 582 is so remote this can be virtually discounted.
A tax advantage could arise in the case of a charity where income, previously charged under Schedule D Case VI in the source legislation and therefore excluded from exemption, is not under the rewritten provision so excluded. But the likelihood of this occurring is equally remote. A tax advantage might also arise in that non-trading deficits on a loan relationship are available for set off against income within the rewritten provision and which was previously charged under Case VI income and against which such deficits could not be set.
This change is in principle adverse to some taxpayers and favourable to others. But it is expected to have no practical effect as it is in line with current practice.
Change 60: Relationships treated as loan relationships etc: meaning of offshore funds for qualifying investments test: clauses 489 and 587
This change clarifies the meaning of offshore fund in paragraphs 4 and 8 of Schedule 10 to FA 1996 for the purposes of the non-qualifying investments test (known as the qualifying investments test in Part 6 of this Bill (relationships treated as loan relationships etc)).
Paragraph 4 of Schedule 10 to FA 1996 provides for a companys relevant interests in an offshore fund to be treated as a right under a creditor relationship where the fund fails to satisfy the non-qualifying investments test: broadly where more than 60% of the holdings of the fund by value represent investments that would be loan relationships if held directly by the company.
Offshore fund is not directly defined for the purposes of paragraph 4 of Schedule 10 to FA 1996, but the meaning of relevant interest in an offshore fund for the purposes of paragraph 4 is given by paragraph 7 of the same Schedule. It is defined as a material interest in an offshore fund for the purposes of Chapter 5 of Part 17 of ICTA or an interest which would be such an interest on the assumption that the unit trust schemes and arrangements referred to in section 756A(1)(b) and (c) of ICTA were not limited to collective investment schemes. Section 756A(1) of ICTA (which is subject to sections 756B and 756C of that Act), gives the meaning of offshore fund for the purposes of Chapter 5 of Part 17 of ICTA and requires that offshore funds should be collective investment schemes. But the definition of relevant interest in an offshore fund in paragraph 7 extends that meaning.
The non-qualifying investments test referred to in paragraph 4(1) is in paragraph 8 of Schedule 10 to FA 1996. Paragraph 8(7F) requires offshore fund, for the purpose of the test, to have the same meaning as in Chapter 5 of Part 17 of ICTA, but it does not mention the assumption in paragraph 7(1)(b) of Schedule 10 that unit trust schemes and arrangements referred to in section 756A(1)(b) and (c) of ICTA need not be limited to collective investment schemes. So it is unclear if that extension to non-collective investment schemes applies.
The definition in paragraph 8(7F) applies to offshore funds held by the investing company, that is, the same offshore fund and the same company as are referred to in paragraph 4(1) (to which the definition in paragraph 7 refers) since the definition in paragraph 8(7F) also applies for the interpretation of assets of an offshore fund. That expression occurs in paragraph 8(5)(b), which in turn gives the meaning of investments of an offshore fund for the purposes of paragraph 8(1) (investments of the .. fund). This is the same offshore fund referred to in paragraph 4(1).
Paragraph 7(1)(b) and (2) of Schedule 10 provides that for the purposes of paragraph 4 of Schedule 10 an interest is a relevant interest in an offshore fund (and therefore falls within paragraph 4(1)(a)) if it would be a material interest in an offshore fund assuming the arrangements in section 756A(1)(b) and (c) of ICTA were not limited to collective investment schemes. Therefore it appears that the clear legislative intent is that such interests are subject to paragraph 4 if the fund fails to satisfy the non-qualifying investments test in paragraph 4(1)(b), so that the debits and credits brought into account for the purposes of corporation tax as respects the companys interest in the fund are determined on the basis of fair value accounting.
If, when FA 2004 added paragraph 8(7F) to Schedule 10, the intention had been that the narrow definition in paragraph 8(7F) was to apply without the extension implied by paragraph 7(1)(b) and (2) and so that extension was to be ineffective, FA 2004 would have repealed paragraph 7(1)(b) and (2), and there would have been mention of this intention in the commentary to the Finance Bill 2004. So it appears that the better interpretation is that the wider definition of an offshore fund given by the application of the assumption in paragraph 7(2) was meant to apply throughout and therefore it is applied by clause 489 for the whole of Chapter 3 of Part 6 of this Bill and the definition of assets of an offshore fund in clause 493 is glossed accordingly.
Clause 587 in Part 7 of this Bill (derivative contracts) refers also to a holding that is a material interest in an offshore fund and applies the meaning of that phrase in clause 489. This change therefore applies also for the purposes of that clause.
This is a minor change in the law as it will prevent the taxpayer from arguing the contrary view that the assumption in paragraph 7(2) does not apply.
Adopting the wider definition of what is an offshore fund potentially brings more investments within the possibility of being qualifying investments and therefore makes it more probable that holdings in the unit trust or offshore fund with the investments are subject to the loan relationship provisions. Whether being subject to the loan relationship provisions is adverse or beneficial depends on the circumstances of the taxpayer.
This change is in principle adverse to some taxpayers and favourable to others. But it is in line with the original legislation before amendment and with the intention of the amended legislation.
Change 61: Relationships treated as loan relationships etc: power to change investments that are qualifying investments: clause 497
This change extends the power in paragraph 8(8) of Schedule 10 to FA 1996 for the Treasury to amend paragraph 8 of that Schedule to extend or restrict the investments of a unit trust scheme or offshore fund that are qualifying investments, so that it also covers investments of open-ended investment companies (OEICs).
Paragraph 4 of Schedule 10 to FA 1996 treats a companys holdings in unit trust schemes or offshore funds as rights under a loan relationship of the company if the schemes or funds fail the test set out in paragraph 8 of that Schedule. The test is failed when the market value of the schemes or funds qualifying investments exceeds 60% of the market value of all its investments. Paragraphs 4 and 8 of Schedule 10 are modified by regulation 95 of the Authorised Investment Funds (Tax) Regulations 2006 (SI 2006/964) so that they apply similarly to holdings in OEICs.
However, paragraph 8(8) of Schedule 10 gives power for paragraph 8 to be amended by order so as to extend or restrict the investments only of unit trust schemes or offshore funds that are qualifying investments and not those of OEICs. A similar effect might be achieved using the regulation-making power in section 17(3) of F(No.2)A 2005 to modify paragraph 8 in relation to OEICs.
Chapter 3 of Part 6 of this Bill rewrites Schedule 10, incorporating the modifications relating to OEICs. In rewriting paragraph 8(8) in clause 497 of this Bill, the opportunity has been taken to extend the power in that paragraph to cover investments of OEICs, as well as unit trust funds and offshore funds, so that a single instrument can be used to extend or restrict the qualifying investments of all three investment vehicles.
Extending or restricting the investments of OEICs that are qualifying investments could be beneficial or adverse to a company with holdings in OEICs. But since the same effect could be obtained by making regulations under section 17(3) of F(No 2)A 2005, the change does not extend the overall scope of the Treasurys powers.
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