Contaminated land

The change that additional relief is available only to companies liable to corporation tax also applies to the additional relief that is available under clause 1149 for expenditure on the remediation of contaminated land.

Paragraph 13 of Schedule 22 to FA 2001 provides that a company may deduct 150% of its qualifying land remediation expenditure from the profits of a Schedule A business or a trade carried on by the company. This paragraph does not limit the relief to corporation tax, but should only apply to corporation tax for the same reasons as those mentioned above for research and development. The change makes it clear that the additional relief applies only for corporation tax.

This change removes the possibility of entitlement to relief for companies subject to income tax.

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

Change 78: Additional relief for research and development: R&D threshold: clauses 1050, 1064, 1075 and 1097

This change makes a small adjustment to the calculation of the total qualifying R&D expenditure threshold where a company has an accounting period that is shorter than 12 months.

Schedule 20 to FA 2000 and Schedule 12 to FA 2002 provide relief for companies which have incurred qualifying expenditure on research and development. Schedule 13 to FA 2002 provides relief for companies which have incurred qualifying expenditure on vaccine-related research. These reliefs are rewritten in Chapters 2, 3, 4, 5 and 7 of Part 13 of this Bill.

The source legislation in paragraph 1(1) of Schedule 20 to FA 2000, paragraphs 1(1) and 7(1) of Schedule 12 to FA 2002 and paragraph 1(1) of Schedule 13 to FA 2002 states that a company is entitled to relief for an accounting period if the company’s qualifying expenditure for that period is not less than £10,000 or, if the accounting period is less than 12 months, such amount as bears to £10,000 the same proportion as the accounting period bears to 12 months. While the effect of the source legislation is generally understood, it is not explicit how it should be applied to particular circumstances. The legislation requires that the short accounting period be compared arithmetically to a 12 month period (the “normal” length of an accounting period). But not all 12 month periods are the same. What is the correct comparative period of 12 months? What should happen when that 12 month comparative period includes an extra day because it is a leap year?

In the cases affected by this change, the use of an arithmetical formula in which the denominator is based on a standardised number of days in a year removes any uncertainty in this regard. The number of days in the actual accounting period is divided by 365 to obtain the relevant proportion to apply to the threshold amount in order to find the adjusted threshold. So there is no need to consider which is the correct comparison period of 12 months when more than one such period could be appropriate.

In a leap year, the source legislation lowers by £27 the £10,000 threshold in clauses 1050, 1064, 1075 and 1097 of this Bill. Dividing by 365 in all cases, when 366 days might have been the appropriate number for substitution into the denominator, gives a slightly higher R&D threshold for the purposes of these clauses.

This change assists taxpayers because it provides certainty and clarity. But in limited circumstances it will raise slightly the qualification threshold, thereby denying relief where relief might otherwise have been available.

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

Change 79: Additional relief for research and development etc: meaning of “staffing costs”: clauses 1123 and 1170

This change relates to the rewrite of paragraph 5(1) of Schedule 20 to FA 2000 (relief for expenditure on research and development) and paragraph 5(1) of Schedule 22 to FA 2001 (relief for expenditure on contaminated land). The effect of the change is that the definitions of “staffing costs” in clauses 1123 and 1170 of this Bill apply to money earnings and reimbursed expenses. (Note that “employee costs”, which is the expression used in Schedule 22 to FA 2001, is rewritten in clause 1170 as “staffing costs” because the terms of the definition are identical to the terms used in defining “staffing costs” in clause 1123.)

Schedule 20 to FA 2000 allows a small or medium-sized enterprise to claim additional relief for qualifying expenditure on research and development that is related to its trade. “Staffing costs” (as defined in paragraph 5 of Schedule 20 to FA 2000) is one of the categories of qualifying expenditure. The same definition is applied in Schedules 12 and 13 to FA 2002.

In relation to contaminated land, Schedule 22 to FA 2001 allows a company to claim additional relief for qualifying expenditure on the remediation of contaminated land used for the purposes of a trade or UK property business. “Employee costs” (as defined in paragraph 5 of Schedule 22) is one of the categories of qualifying expenditure.

When these Schedules were introduced, paragraph 5(1)(a) of each Schedule defined staffing costs and employee costs respectively as:

the emoluments paid by the company to directors or employees of the company, including all salaries, wages, perquisites and profits whatsoever other than benefits in kind.

This language drew on the definition of “emoluments” in section 131 of ICTA. The only difference is that section 131 of ICTA omitted the words “other than benefits in kind”. Section 131 of ICTA identified the emoluments on which an employee was charged to income tax under the former head of charge, Schedule E.

Schedule E was rewritten in ITEPA. The charge on emoluments became part of the charge on employment income. The word “emoluments” is outdated and was replaced in ITEPA by “earnings”. The charge on employment income is made up of a number of different elements and the meaning of “earnings” in ITEPA goes wider than the definition of “emoluments” in section 131 of ICTA.

References to emoluments in legislation not being rewritten in ITEPA were amended by that Act so as to align them with the new definition of earnings. This included the references in paragraph 5(1)(a) of Schedule 20 to FA 2000 and paragraph 5(1)(a) of Schedule 22 to FA 2001. Paragraphs 245 and 258 of Schedule 6 to ITEPA substituted the following:

(a) The earnings paid by the company to directors or employees of the company

Paragraphs 245 and 258 of Schedule 6 to ITEPA also inserted the following definition of “earnings”:

earnings or amounts treated as earnings which constitute employment income (see section 7(2)(a) or (b) of the Income Tax (Earnings and Pensions) Act 2003)

There were two problems with this amendment.

First, it was unnecessary. The definition in section 131 of ICTA applied in determining the tax charge on the employee receiving the payment. It identified an amount that constituted income in the hands of the employee. Over the years it has been the subject of a significant amount of judicial comment, particularly the meaning of “perquisites and profits whatsoever”.

The definitions in paragraph 5(1)(a) of Schedule 20 to FA 2000, and paragraph 5(1)(a) of Schedule 22 to FA 2001, apply to determine the amount of an expense in the hands of the company. Although the language is the same, the definitions were independent of the definition in section 131 of ICTA because that definition was from the standpoint of the employee. None of the supporting structure of Schedule E that influenced the interpretation of the definition applies to Schedule 20 to FA 2000 or Schedule 22 to FA 2001. There was no need to change the definition in Schedule 20 and Schedule 22 to mirror the rewrite of Schedule E.

Second, inadvertently it expanded the definition so that it included benefits in kind. These came in through the reference to amounts treated as earnings in section 7(2)(b) of ITEPA. The definition of those amounts in section 7(5)(b) of ITEPA includes payments under the benefits code.

This error was corrected in paragraph 7 of Schedule 17 to FA 2004. That Schedule made a number of minor amendments to, or connected with, ITEPA. The aim of the Schedule was to restore the pre-ITEPA position with minimal differences. It did this in paragraph 5(1) of Schedule 20 to FA 2000 and paragraph 5(1) of Schedule 22 to FA 2001 by reinstating the original definition.

The difficulty with the original definition is partly that words such as “emoluments” and “perquisites” are outdated and partly that aspects of the definition are not clear. It is not certain that terms defined to regulate the income tax position of an employee have or should have the same meaning where the same term is used to regulate the corporation tax position of an employer company. In particular it is not clear what the phrase “profits whatsoever” means when looked at from the position of the employer making the payment. It is not possible to pay an amount of profit. Profit is a concept that applies to the person who receives the payment.

The reference to emoluments in paragraph 5(1)(a) of Schedule 20 to FA 2000 is rewritten in clause 1123. The reference to emoluments in paragraph 5(1)(a) of Schedule 22 to FA 2001 is rewritten in clause 1170. The exclusion by the source legislation of benefits in kind limits the meaning to amounts paid in money.

Both clauses 1123 and 1170 rewrite the reference to emoluments in two parts:

• earnings paid in money (subsection (2)); and

• reimbursed expenses (subsection (3)).

“Earnings” is not defined so it has its ordinary meaning. It covers salaries, wages, commissions, bonuses and tips. It covers such payments whether paid regularly or otherwise. This covers part of the rewrite of “perquisites and profits whatsoever”.

“Reimbursed expenses” covers the balance of the rewrite of “perquisites and profits whatsoever”. It applies to cash reimbursements of expenses but not to expenses reimbursed in a non-cash form such as car and fuel benefits. This follows from the exclusion by the source legislation of benefits in kind.

In clauses 1123(2) and (3) and 1170(2) and (3), the phrase “because of .. employment” is used instead of the ITEPA phrase “by reason of employment”. The intended effect is that interpretations developed in relation to ITEPA, which might not be appropriate in this corporation tax context, cannot simply be read across into this definition. The phrase takes its ordinary meaning. There must be a relevant payment, and on ordinary principles, that payment must have been made because of the fact of employment of that director or employee.

The requirement that the expenses are paid by the director or employee comes because paragraph 5(1)(a) of Schedule 20 to FA 2000 and paragraph 5(1)(a) of Schedule 22 to FA 2001 apply to “profits whatsoever”. There is no profit to the director or employee unless he or she has incurred a personal liability that is then relieved by the company. So it would not apply to expenditure incurred by the director or employee using a company credit card (a card linked to the company’s bank account) because the cost is borne by the company (the company is liable), not the director or employee.

This change modernises the language of the law without changing the meaning of the law. This change also clarifies the law on the basis of generally accepted practice. To that extent this change removes in principle the right of a taxpayer to assert that the generally accepted practice is unlawful.

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

Change 80: Expenses of management: credit unions: clause 1218

This change makes clear that a credit union cannot be the subject of a charge to tax on a FISMA repayment or an industrial development grant under Part 16 of this Bill.

Section 487(4) of ICTA provides that a credit union is not a company with investment business for the purpose of section 75 of ICTA. As a result, such a company cannot have expenses of management deducted under section 75. And it follows that there can be no charge on a “reversal amount” under section 75B of ICTA.

But the charge under section 76B of ICTA on a repayment under FISMA is not dependent on there having been a previous deduction under section 75. It is arguable that the rule in section 487(4) of ICTA is not wide enough to remove the possibility of a charge under section 76B.

In the unlikely event that a credit union receives an industrial development grant it is similarly arguable that section 487(4) of ICTA does not remove the charge under section 93(1) of ICTA.

Clause 1218(2) of this Bill takes credit unions completely outside the rules in Part 16. So there can be no charge under the rules in Chapter 5 of that Part.

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 81: Expenses of management: clause 1221

This change clarifies the relationship between:

• the rules in section 75(4) of ICTA that an expense must be in respect of the company’s investment business and not for an unallowable purpose; and

• other rules that expenses are to be treated as expenses of management.

In the case of expenses that are to be treated as expenses of management, there is a distinction between:

• rules that simply treat expenditure as an expense of management; and

• rules that go to on to say that expenditure is, as a result, deductible under section 75.

The rules in the first category leave the expenditure to meet the tests in section 75(4) of ICTA. Clause 1221 of this Bill preserves this position for rules such as that in clause 1244 of this Bill (rewriting section 79 of ICTA).

The rules in the second category apparently override the rules in section 75(4) of ICTA. Clause 1221(2) and (3) of this Bill make this clear.

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 82: Expenses of management: cessation of business: clauses 1240 and 1242 and Schedule 1

This change clarifies the deduction timing rule in cases where an investment business ceases.

Before FA 2004 a company claiming management expenses had to be one “whose business consists wholly or mainly in the making of investments” (part of the definition of “investment company” in section 130 of ICTA, used in section 75(1) of ICTA). So it was likely that when the business ceased to be carried on there would be an end of an accounting period in accordance with section 12(3)(e) of ICTA.

The timing rules in sections 90(1)(ii) and 579(3A) of ICTA make the payments referable to the “accounting period ending on the last day on which the .. business was carried on”. If an accounting period ends on that day, the rule is straightforward.

Since FA 2004 management expenses are available to a company with investment business. Such a company may carry on other activities, such as a trade. So it is not necessarily the case that the cessation of the investment business triggers the end of an accounting period.

These clauses cater for the possibility that an accounting period does not end with the cessation of the investment business: they refer to the accounting period in which the investment business ceases. If an accounting period does in fact end with the cessation of the investment business, there is no change in the law.

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

This change will not alter the amount charged to tax. The most it will do is affect the timing of that 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 83: Car or motor cycle hire: clause 1251 and Schedule 1

This change clarifies the operation of section 578A of ICTA in three areas.

Corporation tax: expenses of management

Two rules, which partly overlap, restrict the amount that can be charged to tax when the amount of a deduction for management expenses has been reduced under section 578A(3) of ICTA and a credit reversing the expenses is later brought into account.

If there is a rebate or release of a debt, the “reversal amount” within section 75B(3) of ICTA is “so much of the debit as represents the expenses of management”. The amount which “represents the expenses of management” is restricted under section 578A(3) of ICTA. So the amount treated as the “reversal amount” under section 75B(3) cannot exceed that restricted amount (£75 in the example below).

Section 578A(4) seems to duplicate this restriction. It also imposes a stronger restriction in a case where a rebate represents only part of the original deduction (see below). But in the context of management expenses, section 578A(4) applies only in relation to rebates, not releases of debts.

It is not entirely clear how section 578A(4) of ICTA should be reconciled with the competing rule given by section 75B of ICTA.

Clause 1251(4) of this Bill makes clear that the restriction is the same as the one made under clause 1251(2). The clause also makes clear what happens if the rebate or release of a debt represents only part of the original deduction.

Example

It is clear that the charge on the rebate should be restricted by 25% to 45.

It is similarly uncertain how section 578A of ICTA interacts with section 76 of ICTA (expenses of insurance companies). In section 76ZN of ICTA (inserted by Schedule 1 of this Bill) subsection (3)(a)(ii) caters for the possibility that the release of a debt for car hire may be a “reversal” within section 76(7) of ICTA. In that case, this rule ensures that the reversal is restricted by the appropriate fraction.

Income tax: receipt of a “rebate”

Section 578A(4) of ICTA applies if there is:

• a rebate; or

• a release of a debt,

in connection with an expense that has been restricted under the section. Clause 56(4) of this Bill rewrites the rule for corporation tax. But section 48(4) of ITTOIA seems to apply only to the release of a debt: although the introductory words of subsection (4) refer to a rebate, the main part of the rule refers only to debts released. Schedule 1 to this Bill amends section 48(4) of ITTOIA so that it applies also to rebates (which are brought into account as a receipt of the trade without a special rule).

Income tax: “corresponding provisions”

Section 578A of ICTA applies to:

• a trading deduction;

• a management expense; and

• an expense of an insurance company.

A rebate or release of a debt is restricted under subsection (4) however the original deduction was given. Clauses 56(3) and (5) and 1251(3) and (5) of this Bill make this clear by referring to a “corresponding provision”. But section 48(4) of ITTOIA deals only with the case where the original deduction (as a trading expense) was restricted under that section. Schedule 1 of this Bill amends section 48(3) of ITTOIA, and introduces a new subsection (4A), so that it applies also to deductions previously given as a management expense or as an expense of an insurance company.

Summary

The corporation tax change merely clarifies the law. The income tax changes restrict a charge to tax in cases where ITTOIA may not give the restriction.

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 84: Partnerships: reinstatement of section 111(10) of ICTA: clause 1258

This change makes clear that the rule in clause 1258 of this Bill (that a firm is not a separate entity for tax purposes) applies to a firm carrying on any business, whether or not that business is a trade.

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

Section 111(1) of ICTA provides that a partnership is not to be treated as an entity separate and distinct from the partners. The subsection refers to a trade or profession carried on in partnership.

Before section 111 was amended by ITTOIA subsection (1) applied to all businesses, not just trades and professions. The extension to all businesses was lost when subsection (10) was repealed by ITTOIA.

But sections 114 and 115 of ICTA set out the rules for calculating the profits of a firm. Those sections apply to all businesses, not just trades and professions. So it is doubtful whether the absence of the rule in section 111(10) has any consequences.

The broadening of the rule brings more companies into it. Whether this is favourable or adverse to those companies depends on the particular circumstances.

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 85: Distributions and partnerships: Schedule 1

This change makes it clear that section 114(1)(a) of ICTA does not apply to payments received by companies carrying on a business in partnership.

Section 114(1) of ICTA requires that the profits of a trade etc carried on in partnership should be calculated as if the trade etc were carried on by a company (the “deemed company” in clause 1261). In calculating those profits, section 114(1)(a) provides that “references to distributions shall not apply”.

It is clear from the context that this rule applies to payments made by the firm. So there is no question of a payment of, say, interest being treated as a distribution by the firm under section 209 of ICTA and being disallowed in calculating the firm’s profit.

There is a theoretical possibility that the rule in section 114(1)(a) of ICTA also applies to payments to the firm. In that case, the rule in section 208 of ICTA (which removes distributions by a United Kingdom resident company from the charge to corporation tax) would not apply and the distributions received would be a receipt of the firm’s trade etc.

This is not how the rule is interpreted in practice. So clause 1260(2) deals only with payments by the firm. But there is an indication in the Real Estate Investment Trust rules that section 114(1)(a) of ICTA does apply to payments to a firm: section 121(4) of FA 2006 provides that section 114(1)(a) of ICTA “does not disapply subsection (1)”. That subsection charges some distributions to tax as if they were receipts of a property business. HMRC’s view is that section 121(4) of FA 2006 is unnecessary because section 114(1)(a) of ICTA does not in any case affect section 121(1) of FA 2006.

Schedule 1 to this Bill repeals section 121(4) of FA 2006.

Treating section 114(1)(a) of ICTA as applying to payments received by a firm would increase the tax liabilities of its partners. So the removal of the possibility of that treatment reduces those liabilities.

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 86: Partnerships: allocation of firm’s profits between partners: clauses 1263 and 1264

This change legislates the practice in paragraph 72245 of the HMRC Business Income Manual.

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

Section 114(2) of ICTA provides that a partner’s share of the profits or losses of a trade carried on in partnership is to be determined “according to the interests of the partners”. It offers no guidance on how this is to be done.

Some partnership agreements provide for an initial allocation of profits (often in the form of a salary or interest on capital) to some partners before the balance is allocated on the basis of a percentage share in the profits.

For instance, three partners may agree to allocate profits of 250,000 as follows:

But, if the profits were only 90,000, the position would be:

Section 114(2) of ICTA deals in this case with an allocation of the trade profits. So the answer for partner C cannot be a loss. HMRC practice, supported by decisions by the Special Commissioners, is to re-allocate C’s “loss” to the other partners, so that in the example both A and B are allocated 45,000 of the trade profits. C’s share is nil.

A similar position can arise if the result for the firm is a loss. A share of that loss under section 114(2) of ICTA cannot be a profit.

Clause 1263 of this Bill sets out how a profit is to be allocated between partners, so that no partner’s share is a loss. Clause 1264 of this Bill sets out the corresponding rule for the case where the overall result is a loss.

Whether the new statutory rules for apportioning profits result in an adverse or favourable result for particular partners depends upon the particular circumstances.