Change 61: Non-UK resident companies: transactions through brokers: clause 1145

This change removes a difference between:

• the wording of one of the conditions which determines whether or not, in relation to transactions carried out by a non-UK resident company (otherwise than as a trustee) through a broker in the United Kingdom, the broker is the permanent establishment of the non-UK resident company and

• the wording of the parallel condition which determines whether, in relation to transactions carried out by any other non-UK resident through such a broker, the broker is the UK representative of the non-UK resident.

Prior to the enactment of section 148 of, and Schedule 26 to, FA 2003, sections 126 and 127 of FA 1995 applied to determine who was the UK representative of a non-UK resident (including a non-UK resident company) in respect of income or chargeable gains arising through a branch or agency in the United Kingdom. Section 127 of FA 1995 provides that certain branches or agents are not UK representatives in relation to income or chargeable gains arising from a transaction carried out through them, including, in particular, brokers who meet certain conditions in relation to the transaction.

Following the enactment of section 148 of, and Schedule 26 to, FA 2003, the provisions of FA 1995 only apply in relation to non-UK residents who are not companies and to non-UK resident companies in the capacity of trustee. The FA 2003 provisions determine whether or not a person is the permanent establishment of a company in another territory and, in the case of a permanent establishment in the United Kingdom, provide for the permanent establishment to be the UK representative of the non-UK resident company in relation to income or chargeable gains arising through the permanent establishment.

Under Schedule 23 to FA 1995, a branch or agency which is a UK representative is responsible for assessment and payment of the income tax and capital gains tax chargeable on the income and chargeable gains of the non-UK resident arising through the branch or agency. Under section 150 of FA 2003, a permanent establishment in the United Kingdom is responsible for assessment and payment of corporation tax on income or chargeable gains attributable to the permanent establishment.

Section 148(3) of FA 2003 provides that a company is not regarded as having a permanent establishment in a territory by reason of its carrying on business there through an agent of independent status acting in the ordinary course of the agent’s business. Schedule 26 to FA 2003 supplements that provision by, among other things, setting out the conditions under which transactions carried out through a broker in the United Kingdom are treated as carried out through an agent of independent status.

Paragraph 2 of Schedule 26 to FA 2003 provides for conditions that apply in determining whether a broker is a permanent establishment in respect of transactions carried out by a non-UK resident company through the broker in the United Kingdom. Under the FA 2003 legislation it was intended that these conditions would be the same as those that apply when determining, under section 127(2) of FA 1995, whether a broker is the UK representative of any other non-UK resident in relation to transactions carried out by that non-UK resident through the broker.

Section 127(2)(d) of FA 1995 contains the words “(apart from this paragraph)”. But those words are not included in the parallel condition in paragraph 2(2)(d) of Schedule 26 to FA 2003. No change was intended and that provision is in practice operated in the same way as section 127(2)(d) of FA 1995.

The effect of the additional words in section 127(2)(d) of FA 1995 is that the question whether the broker is to be regarded as the UK representative of the non-UK resident in relation to the income (or other amounts) in question is to be determined without reference to the condition in that paragraph. They are considered necessary to avoid the impasse that would otherwise arise in operating the condition in accordance with the following analysis:

• A transaction falls within section 127(2)(d) of FA 1995 only if there is no income or other amount chargeable to tax for the same tax year in relation to which the broker is the non-UK resident’s UK representative.

• If there is any other income or amounts deriving from another transaction carried out by the broker for the non-UK resident, section 127(1)(b) and (2) apply to determine whether the broker is the non-UK resident’s UK representative in relation to it.

• For the broker not to be the non-UK resident’s UK representative, the second transaction must fall within section 127(2).

• But absent the words “(apart from this paragraph)”, in applying the condition in section 127(2)(d) to the second transaction, the question whether the condition is met depends on whether it is met in relation to the first transaction.

This change removes the potential for such an impasse in the provisions for determining whether a broker in the United Kingdom is the permanent establishment of a non-UK resident company in relation to transactions carried out by the non-UK resident company through the broker. It does so by adding words equivalent to “(apart from this paragraph)” in clause 1145(6).

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 62: Meaning of permanent establishment: substitution of reference to income for reference to chargeable profits in paragraph 4(3) of Schedule 26 to FA 2003: clause 1148

This change substitutes a reference to a non-UK resident company’s income in clause 1148(3) for the reference to its chargeable profits in paragraph 4(3) of Schedule 26 to FA 2003.

This change is identical to the change made in rewriting paragraph 4(3) of Schedule 26 to FA 2003 in section 821(3) of ITA in relation to the limit on liability to income tax of non-UK resident companies under section 815 of that Act. See Change 121 in Annex 1 to the explanatory notes on ITA.

Paragraph 3 of Schedule 26 to FA 2003 sets out conditions relating to investment transactions carried out by a non-UK resident company (other than a company in the capacity of a trustee) through an investment manager in the United Kingdom. If the conditions in paragraph 3(2) are met, the investment manager is not a permanent establishment of the non-UK resident company in relation to the investment transactions. The non-UK resident company’s profit on those transactions will be chargeable not to corporation tax but to income tax and then only to the extent provided by section 815 of ITA.

Paragraph 4 of Schedule 26 to FA 2003 sets out the requirements of “the 20% rule” referred to in paragraph 3(2)(d) of that Schedule. This rule relates to the percentage of “relevant excluded income” in which the investment manager and connected persons may have a beneficial interest. It is equivalent to section 127(5) of FA 1995 which prior to FA 2003 applied to all non-UK residents but which since the enactment of section 148 of, and Schedule 26 to, FA 2003 only applies where the non-UK resident is not a company (other than a company in the capacity of a trustee).

The basis on which the legislation in FA 2003 was prepared was that it was not to affect the law under FA 1995, except so far as required to adopt the concept of permanent establishment in place of branch or agency in relation to non-UK resident companies (other than companies in the capacity of trustees).

It is clear from the reference in the definition of “relevant excluded income” in section 127(5) of FA 1995 to “such of the profits and gains of the non-resident..as..for the purposes of Chapter 1 of Part 14 of the ITA (limits on liability to income tax of non-UK residents) would fall (apart from the requirements of section 819 of that Act) to be treated as disregarded income (see section 813 of that Act)” that the defined term in FA 1995 is limited to income and does not include gains. This is reflected in section 821(2) of ITA.

The reference to “the aggregate of such of the chargeable profits of the company” in paragraph 4(3) of Schedule 26 to FA 2003 is, therefore, in practice read as referring to income only.

Accordingly, clause 1148(3) refers to “the total of the non-UK resident company’s income for the accounting periods” which derives from the relevant investment transactions.

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 63: Investment trusts: disposal of shares or securities from a holding: clause 1162

This change puts into legislation a well-known and established concession relating to the 15% holding limit condition.

Under section 842(1) of ICTA, the Commissioners of HMRC may approve a company as an investment trust only if it is shown to their satisfaction that the company meets certain conditions. One of these conditions is that no holding in a company (other than an investment trust or a company that would qualify as an investment trust if its shares were included in the official UK list) represents more than 15% of the investing company’s investments (“the 15% holding limit condition”).

Section 842(2), read with subsection (3)(b) of that section, provides for some exceptions. One of these is that if a holding in a company met the 15% holding limit condition when it was acquired or when it was last added to, it is treated as continuing to meet the condition until further shares or securities are acquired in that company.

In addition, where there is a disposal of shares or securities from a holding that exceeded the 15% holding limit and immediately after the disposal the holding represents 15% or less of the investing company’s investments, HMRC treats the holding as continuing to represent 15% or less by value of the investing company’s investments in later accounting periods until the holding is next enlarged.

This is set out in the HMRC Company Tax Manual as follows:

If a company has a holding which, at 6 April 1965 or at the date of acquisition, exceeded the percentage limits, it may dispose of part of the holding to bring the reduced holding within the 15 per cent limit. So long as no addition is made to the holding, approval should not be withdrawn for any subsequent accounting period solely because the reduced holding has appreciated relative to the other investments so that it exceeds 15 per cent of the company’s investments.

In clause 1162(4) and (5) this concession is worded:

(4) Subsection (5) applies if-

(a) a company disposes of shares or securities from a holding it has in a company,

(b) immediately before the disposal the holding represents more than 15% by value of the investing company’s investments, and

(c) immediately after the disposal the holding represents 15% or less by value of the investing company’s investments.

(5) For the purpose of determining whether the investing company meets condition E in accounting periods later than that in which the disposal was made, the holding is treated (if it does not already fall to be so treated under subsection (3)) as continuing to represent 15% or less by value of the investing company’s investments until the holding is next enlarged.

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

Change 64: Procedure for making orders and regulations: clause 1171

This change concerns the procedure for making regulations in connection with the construction industry scheme in Chapter 3 of Part 3 of FA 2004. In accordance with section 73A of FA 2004 the Treasury may by order designate an international organisation to be exempt from the obligation, as a contractor, to deduct tax from payments to sub-contractors.

There are three main parliamentary procedures for making orders, depending on the degree of scrutiny thought appropriate.

• No scrutiny: Sometimes Parliament may decide that it does not need any control over the exercise of a power.

• Negative resolution procedure: The order can become law without a debate or vote in Parliament. It can be opposed and may be rejected but not amended.

• Affirmative resolution procedure: The order is subject to affirmative resolution. It cannot come into effect until both Houses have approved a draft statutory instrument in a vote.

Most tax regulations are made under the negative resolution procedure. That is the general rule in:

• section 828 of ICTA;

• section 570B of CAA;

• section 717 of ITEPA;

• section 873 of ITTOIA; and

• section 1014 of ITA.

But there are exceptions in each Act for regulations that are routinely administrative, for which no Parliamentary scrutiny is considered necessary.

The power to designate an international organisation for the purpose of the construction industry scheme was in section 582A(1) of ICTA (applied by subsection (6) of that section). That power was excepted from the negative resolution procedure in section 828(3) of ICTA by subsection (4) of that section. So the power fell within the “no scrutiny” procedure.

ITA rewrote most of the rules about international organisations in section 979 of ITA. But that section does not apply to the construction industry scheme. Instead, ITA inserted section 73A of FA 2004. That section is an exception to the general rule in section 1014(4) of ITA that orders or regulations are to be made under the negative resolution procedure (see subsection (5)(a) of that section). So the power is within the “no scrutiny” procedure.

The difficulty is that the ITA rules apply only to powers “under the Income Tax Acts”. The deduction under section 61 of FA 2004 is “a sum equal to the relevant percentage of .. the payment”. On the face of it, that sum is neither income tax nor corporation tax, although it may be treated as either by section 62(2) or (3)(c) of FA 2004.

It is possible that, to the extent that section 61 of FA 2004 is part of the Corporation Tax Acts, there is no exception to the general rule in section 828(3) of ICTA that a power such as that in section 73A of FA 2004 is to be exercised by an instrument subject to the negative resolution procedure.

This change excludes the order-making power under section 73A of FA 2004 from the negative resolution procedure required under subsection (4) of clause 1171. The effect of the change is to restore the position to what it was before ITA and bring the income tax and corporation tax rules back into line.

This change has no implications for the amount of tax due, who pays it or when. It affects (in principle and in practice) only administrative matters.

Change 65: Corporation Tax Acts definitions: amendment of section 991 of ITA: Schedule 1

This change corrects an error in section 991 of ITA and brings the definition of “bank” in the Income Tax Acts and Corporation Tax Acts into line.

Section 840A of ICTA defines “bank” for the purposes of any provision of the Corporation Tax Acts that applies this definition. Prior to the amendment of this section by paragraph 226 of Schedule 1 to ITA, the section applied for both the Income Tax Acts and the Corporation Tax Acts.

Among the categories of body which make up the defined term in section 840A of ICTA is “a relevant international organisation which is designated as a bank for the purposes of that provision by an order made by the Treasury”. The “provision” referred to is the provision that applies the definition of “bank” in this section. An order made under this power may therefore affect some but not all of the provisions that apply the definition. While the only order made to date using this power (the European Investment Bank (Designated International Organisation) Order 1996 (SI 1996/1179), repealed by Schedule 3 to ITA) applied for the purposes of all such provisions, there may be circumstances in which it would be desirable to restrict the scope of the designation under such an order.

Section 991 of ITA expresses the power to designate an international organisation as a bank “for the purposes of this section”, that is, for the purposes of section 991 of ITA, rather than for the purposes of the provisions that apply the definition. It therefore omits the option to designate an international organisation as a bank for the purposes of some but not all provisions.

Clause 1120 rewrites section 840A of ICTA but includes that option in its expression of the power as it applies to the Corporation Tax Acts (see subsection (5)). Schedule 1 to the Bill therefore amends section 991 of ITA to restore the option in the income tax definition and to keep the income tax and corporation tax codes in line.

This change has the potential to limit when an international organisation is treated as a bank for the purposes of some provisions of the Income Tax Acts. Whether that leads to an increase or decrease of tax (or whether there is any effect) depends on the affected provision and the circumstances of the affected taxpayer.

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 66: Company distributions: demergers: Schedule 2

This change disapplies paragraph 8(1) of Schedule 2 in respect of the repeal by this Bill of regulations that amend the source legislation for clause 1081(1). As a result, clause 1081(1) applies to the whole of the first accounting period of a company to which this Bill has effect.

Section 213 of ICTA provides that certain distributions made in the course of a demerger are excluded from references to “distribution” in the Corporation Tax Acts (see the definition of that term in section 832(1) of ICTA). The Corporation Tax (Implementation of the Mergers Directive) Regulations 2009 (SI 2009/2797) amended section 213(4) of ICTA, substituting the words “resident in a member State” for the words “UK resident” in setting out a condition applying to companies relevant to the demerger. The regulations ensure that the United Kingdom is, in respect of distributions in a demerger, fully compliant with its obligations under Directive 90/434/EEC of the European Council and of the Council of 26 October 2005 on cross-border mergers of limited liability companies. The effect of the amendment is to increase the number of cases in which distributions in the course of a demerger are exempt distributions (and are therefore taken out of the charge to income tax or corporation tax on income). Clause 1081(1) rewrites section 213(4) of ICTA as so amended, and accordingly provides that one condition for exemption under the provisions about exempt distributions is that “each relevant company must be resident in a member State at the time of the distribution”.

The regulations came into force on 11 November 2009 and have effect in relation to distributions falling within section 213(3) of ICTA made on or after that date. The Bill repeals the regulations in full. Paragraph 8(1) of Schedule 2 preserves the remaining force of a transitional or saving provision associated with a provision rewritten by the Bill notwithstanding the repeal by the Bill of that transitional or saving provision. Without the change made by this paragraph, the application of the amendment made by the regulations for distributions made on or after 11 November 2009 would continue to have effect for some companies in respect of the first accounting period to which this Bill applies.

The Bill comes into force on 1 April 2010 and has effect for corporation tax purposes for accounting periods ending on or after that day. It therefore applies to accounting periods beginning as early as 2 April 2009. Because of the change made by this paragraph, the law as restated in clause 1081(1) applies to any distribution made in that first accounting period. There is therefore no question of having to apply different rules (that is, those in this Bill and those as they existed in ICTA before the regulations had effect) to the same accounting period. This change ensures, having regard to the need for a statement of compatibility under section 19 of the Human Rights Act 1998, that the law to be enacted in the Bill is also compliant with the United Kingdom’s obligations under Directive 90/434/EEC of the European Council and of the Council of 26 October 2005 on cross-border mergers of limited liability companies.

The change may further increase the number of cases in which distributions in the course of a demerger are exempt distributions. That will reduce the incidence of the charge to income tax or corporation tax on income for those who benefit from the change.

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.

ANNEX 2: EXTRA-STATUTORY CONCESSIONS, CASE LAW, AND LIST OF REDUNDANT MATERIAL NOT REWRITTEN

This Annex is in three parts:

• Table 1: a list of ESCs and Statements of Practice that are rewritten in this draft Bill;

• Table 2: a list of Changes which involve enacting case law principles; and

• Table 3: a list of provisions that are redundant in whole or in part and are omitted by this draft Bill.

TABLE 1

The following ESCs and Statement of Practice are rewritten in this draft Bill.

TABLE 2

The following table sets out a change in the law which involves giving statutory effect to principles derived, wholly or mainly, from case law.

TABLE 3

The omission of provisions which are redundant in whole or in part is an integral part of the rewrite process. In some cases provisions have become redundant with the passage of time; in others they have become unnecessary as a result of the approach taken to the rewriting of related provisions.

For ease of reference, those omissions worthy of specific explanation are listed in the table below. The table also sets out where those explanations can be found.