This snapshot, taken on
15/06/2011
, shows web content acquired for preservation by The National Archives. External links, forms and search may not work in archived websites and contact details are likely to be out of date.
 
 
The UK Government Web Archive does not use cookies but some may be left in your browser from archived websites.

Tax Bulletin 69

Contents

interpretations

miscellaneous

Self Assessment Returns

Three new measures to improve Self Assessment (SA) for taxpayers and agents are being taken forward.

1. Short Tax Return A new four page Short Tax Return (STR) for people with simple tax affairs has already been piloted with 50,000 taxpayers in 4 Area offices. Interim results of independent research with taxpayers and agents involved in the pilot has shown widespread and positive support for the STR and accompanying simplified guide.

In April 2004 we plan to introduce the form to more taxpayers over a wider area. Tax agents are therefore more likely to find some of their clients receive the STR. Our aim is to roll the STR out nationwide in April 2005.

As well as being shorter than the main return, the STR is also simpler. For example, there is no facility to include a self-calculation. Taxpayers are encouraged to file by 30 September so we can calculate their tax position for them and let them know how much to pay in good time for January. For those who want to make a rough calculation for their own purposes, a simple guide will be included in the2004 version.

To be able to use the STR, a person's affairs have to fit a tightly drawn set of criteria. People will therefore be selected automatically on the basis of the information from their previous year's return. However, returns filed close to the January filing date are less likely to be captured onto the Revenue's systems in time for a STR to be selected for the following year. In those cases people will receive a main tax return. Filing earlier in the year will ensure that the STR is sent to an eligible person the following year.

The STR has been designed so that the information provided on it can be captured automatically on to the Revenue's systems, using automated data capture technology. This will ensure the processing of these returns is more efficient and accurate. This places great importance on the use of the printed form we issue, to ensure the precise accuracy of print format and coloration. We therefore do not have plans to produce a substitute of the form for 2004. We appreciate that tax agents who use software may not wish to complete a STR manually and they can, of course, use their normal software to complete a main return or file on-line.

People qualifying for a STR will be those with simple affairs, for example some employees (other than company directors) with P11D benefits, self-employed with a turnover less than £15,000 (three line account cases), pensioners in receipt of state retirement pension, an occupational pension or a retirement annuity. In addition, they may have straightforward investment income, or a modest amount of income from property.

The STR will not be available from the IR website, Orderline, or local offices (except where the original is lost or destroyed).

Although the Revenue will issue STRs based on information from the preceding year's return, it remains the taxpayer's responsibility to check their eligibility to complete the form. Their circumstances may have changed during the year which might mean a STR is no longer appropriate. Details of eligibility are set out clearly at the front of the guide.

During this year's pilot we have also been testing 'telefiling', which allows people to file STR information over the telephone using a voice recognition system. Callers needing further advice during the process are connected to the Revenue helpline. Although the take-up is still fairly limited, those using the service have found it to be helpful. We therefore plan to continue the small pilot next year.

2. New Criteria for those who need to complete a Self Assessment tax return. Many people will no longer need to complete a SA return under new criteria to be published in April. With the help of Working Together colleagues and others we have concluded that there are certain groups of people, who currently receive returns, whose affairs can be adequately dealt with using the PAYE system. We have consulted widely on these proposals and the new rules will be introduced in April 2004. The new criteria will also be published on our website around the same time. Generally the types of people who will no longer need to complete a SA return are those with very straightforward affairs.

The changes mean:

  • higher rate employees with simple affairs will no longer automatically be sent a SA return;
  • the limit for claims to professional fees/expenses dealt with outside a SA return will rise to £2,500 (from the current limit of £500);
  • the investment income limit will rise to £10,000 (from the current limit of £8,500);
  • some relaxation to the rules for pensioners (where any further liability can be recovered through the PAYE coding).

After 6th April 2004 when a 2003/4 return is filed and captured onto our systems it will be automatically checked against the new rules. Where appropriate, the process will automatically:

  • Stop the issue of any further returns if the person no longer meets the new SA criteria.
  • Send a letter to the taxpayer and agent (where authority held) explaining the change in procedure and setting out the taxpayer's responsibilities.
  • Notify the PAYE coding record of any changes required for the following year.
  • Identify those cases where taxpayers need to return certain information (i.e. investment income) affecting their coding, on a Coding Review Form (the 'P810') which will be sent the following April.

The system will identify likely candidates, such as pensioners and individuals on low incomes, for a manual review. Because these cases are likely to be more involved, they will be checked by staff to see whether they meet the new criteria. If so, the record will be noted that a return need not be issued and a letter issued to the taxpayer (and agent).

Some taxpayers may prefer, for varying reasons, to continue to receive a SA return. As long as we are notified we can override the signals on the system and the taxpayer will continue to receive returns.

Keeping the taxpayer better informed of his or her tax situation is a key part of this initiative. The letters sent to people no longer receiving a return set out the circumstances in which they may need to request a return in the future. And, from next year, where employees become liable to higher rate tax, but do not meet the new criteria, we will send them a letter informing them what they are required to do if they have any additional liability. Furthermore, all taxpayers that are newly set up in SA will receive a letter explaining why they will be receiving a return and how to get help.

3. Minor queries Increased use of the telephone will help resolve problems that arise where staff have difficulty in understanding the customer's entries on the form. Up until now we have adhered closely to the amendment of a return either on the basis of an 'obvious error' or following an enquiry. But we have become increasingly aware of many situations where a simple conversation with the customer can resolve minor issues.

These issues include incorrect completion of the gross, net and tax boxes in respect of investment income, confusion over claims to married couple's allowance or the amount of the state pension, or a clear misunderstanding of the employment benefit figure provided by the employer.

The new way of handling 'minor queries' by telephone contact with the taxpayer or their agent has been successfully piloted for over a year. Staff, customers and agents have all welcomed the exercise, which helps to improve the accuracy of our processing and saves unnecessary correspondence. Following the success of the pilots we plan to roll this out nationally in April 2004, for the capture of the 2003/04 and subsequent tax returns.

Tips, Gratuities, Service Charges and Troncs: Income Tax, National Insurance contributions, National Minimum Wage issues and VAT

Sections 7 to 10 of leaflet E24 have been withdrawn. These will be replaced with revised guidance as soon as it is finalised. New guidance will also appear in the April 2006 issue of Tax Bulletin.

Feedback from employers and representations from industry bodies has identified a need for additional guidance for employers regarding tips, gratuities and service charges. This was felt to be particularly necessary in respect of National Insurance contributions because of the increasing incidence of payments made by means of credit or debit card or cheque.

A new booklet (E24) 'Tips, Gratuities, Service Charges and Troncs: A guide to Income Tax, National Insurance contributions, National Minimum Wage issues and VAT' (PDF 78K) will be published in February. The booklet will be distributed to employers through industry bodies and will be on the 2004 Employer's CD-ROM. It will also be on the employer's website from 2nd February 2004 at www.inlandrevenue.gov.uk/employers

The booklet does not signal any changes to PAYE, National Insurance, National Minimum Wage or VAT procedures or to our view of the legislation relating to tips, gratuities, service charges or troncs. Rather, its aim is to provide in one place, clearer and more detailed guidance to enable employers and troncmasters to deal with these areas correctly.

This article provides additional explanation on issues where there may have been a degree of uncertainty on the part of some employers and though not essential, we suggest it is read in conjunction with the booklet E24. In this guidance and the booklet, the word "tips" refers to payments of tips, gratuities and voluntary service charges.

Income Tax and troncs

Where there is a tronc the employer must (from 6 April 2004) notify the Inland Revenue of the name of a new troncmaster. The troncmaster is responsible for operating PAYE on all distributions from the tronc and is personally liable for tax which he/she fails to deduct (example 3 in the booklet refers).

If an employer, business partner or an official of the company, which operates the business, performs the role of troncmaster the tronc will not be accepted by the Inland Revenue as a tronc for PAYE purposes. Payments made from the tronc in this situation are considered to be made by the employer and must be taxed under the employer's PAYE scheme (example 4 refers).

Where there is a tronc with an independent troncmaster but the employer is involved in the distribution of monies from the tronc, the responsibility for PAYE rests with the employer.

Where an employer arranges for cash tips to be collected and distributed to staff by a trusted employee in accordance with a formula set by the employer, PAYE responsibility rests with the employer as the trusted employee is acting on the employer's behalf (example 5 refers).

National Insurance contributions

Tips passed to an employee by an employer are liable for both employer and employee National Insurance contributions.

Legislation at paragraph 5, Part 10 of Schedule 3 to the Social Security (Contributions) Regulations 2001 provides that any amount paid to an employee which is a gratuity or is in respect of a gratuity will be exempt from National Insurance contributions if it meets one of the following two conditions:

  • it is not paid, directly or indirectly, to the employee by the employer and does not comprise or represent monies previously paid to the employer by a customer;
  • it is not allocated, directly or indirectly, to the employee by the employer.

Example 6 of the new booklet shows how a payment of tips distributed to employees might fail to satisfy either of the conditions for exemption.

In that example the proprietor of a restaurant passes all tips paid by cheque and credit or debit card to his employees. Because the tips were included in cheque, credit or debit card payments made to the restaurateur it follows that they can never satisfy the first condition for exemption set out above, since that includes a requirement that the money must not have been paid to the employer by the customer.

The alternative condition will also not be satisfied because the restaurateur (the employer) has directly allocated the payments to the employees.

As neither of the conditions for exemption is satisfied the payments will all be liable for the payment of National Insurance contributions.

It might be useful here to make brief mention of the decision in the European Court of Human Rights in the case of Nerva and others v United Kingdom. The main finding in that case was that where a customer pays a tip by means of a credit card or cheque this constitutes a payment to the employer and he attains legal title to it. If he then pays it to his employees through the payroll it can be counted as remuneration paid by him for the purpose of complying with legislation relevant to the National Minimum Wage.

Legal advice secured following this decision confirmed that, where an employer pays a waiter a sum equivalent to the tips included in credit or debit card or cheque payments, then he is paying a sum "in respect of " a gratuity. Such payments therefore fall to be considered against the conditions in paragraph 5, Part 10 of Schedule 3 in the normal way.

The payments can never satisfy the first condition for exemption (contained in paragraph 5(2) of Part 10) although they may satisfy the alternative condition in paragraph 5(3). But that condition will not be satisfied if the employer decides how much is allocated as in example 6 outlined above. A similar outcome would arise if the employer were to try to satisfy his National Minimum Wage obligations by arranging things so that tips are used to top up the earnings to the level of the National Minimum Wage; or if he deducted charges imposed by the credit card company and therefore paid into the tronc less than the total amount of tips paid by credit or debit card and cheque. It is our view that in all these situations the employer is influencing or determining the amount to be allocated. The conditions for exemption will accordingly not be satisfied and National Insurance contributions will be due on all payments received by employees.

A payment made by an employer as part of a contractual arrangement or undertaking with an employee cannot be accepted as a tip and cannot therefore be disregarded for National Insurance contribution purposes.

A contractual payment includes any payment which:

  • forms part of the terms and conditions of the employment, or
  • is promised, guaranteed or underwritten by the employer even if the payment (or some part of it) is paid by a third party.

This is highlighted in the booklet by example 13. In that example, the employer agrees with his employees a minimum each will receive in tips from the tronc. If necessary he makes a payment into the tronc at the end of each week to make sure there is enough to meet the promised payments. All payments from the tronc are contractual because they are promised by the employer. They cannot satisfy the exemption at paragraph 5 of Part 10 of Schedule 3 because they are not payments of gratuities - they are promised/expected rather than being spontaneous and unexpected. National Insurance contributions are therefore due on all payments made by the tronc.

National Insurance contributions and troncs

A troncmaster is not required to pay National Insurance contributions on payments made from the tronc. Where payments from a tronc attract National Insurance contributions responsibility for calculating and paying the contributions due to the Inland Revenue rests with the employer because he is the secondary contributor as provided for by section 7 of the Social Security Contributions and Benefits Act 1992.

Payment of tips by a troncmaster will not attract National Insurance contributions where:

  • they are not distributing money that was originally paid to the employer and the employer does not pay the money directly or indirectly to their employees; or
  • the employer does not influence, directly or indirectly, the distribution of those tips.

Examples 9 to 14 of the booklet illustrate the Department's interpretation of the legislation by considering various scenarios. Some of these are covered here in a little more depth to aid your understanding of our position.

Example 9 A restaurateur passes all tips paid by cheque, credit or debit card to a troncmaster who has been elected by members of staff. The troncmaster is responsible for distributing tips to staff in accordance with an allocation framework determined by a staff committee. The employer has no control over the election of the troncmaster or the allocation arrangements.

No National Insurance contributions are due on the tips received by employees. The first condition for exemption is not satisfied because the payments were initially made to the employer. But the alternative condition is satisfied because the employer can in no way (directly or indirectly) be said to be allocating the tips because the allocation is totally independent of the employer and he has no involvement in it or influence over it.

Examples 11 and 12 These concern situations where we would hold that neither of the conditions for exemption is satisfied.

In example 11 the employer passes tips paid by cheque, credit or debit card to a troncmaster elected by the other staff but retains a portion of the tips to cover some of his expenses. The troncmaster distributes the tips passed to her and the distribution is in accordance with rules determined by a staff committee.

In example 12 the employer includes in the employment contract all of his employess a right to participate in the tronc.

The first condition for exemption is not satisfied in either example because we are concerned here with tips paid by cheque, credit or debit card and these are initially paid to the employer so can never satisfy this condition.

The second condition for exemption - that the employer does not allocate the payments, directly or indirectly - is also not satisfied in either scenario.

In example 11 this is because the employer has reduced the amount of tips available for distribution to staff from the tronc by retaining some tips to cover his costs. He has therefore been responsible (albeit indirectly) for the amounts disbursed to employees.

  • e.g. If tips totalling £100 are received and the tronc determines that it will allocate equal shares to all of the 10 staff then each employee would expect to get £10. If, however, the employer retains £10 this will impact on the distribution and mean that each employee will get only £9.

In such circumstances it is our view that the employer has indirectly allocated the tips and the condition for exemption is therefore not satisfied. National Insurance contributions will be due on all payments out of the tronc.

In example 12 the situation is different but the outcome is the same and National Insurance contributions will be payable on all payments out of the tronc. In that example the employer provides in each employee's contract a right to share in the tronc. The employer has accordingly indirectly impacted the allocation of tips because he has promised a share of tips to all employees. Even though he may not have specified any amounts, his actions will have an effect on the amount of tips each employee will receive because his actions mean every employee will get a share of the tips. Given a free hand the troncmaster/tronc committee might have decided that only some employees would participate in the tronc. In these circumstances it is our view that the employer has indirectly allocated the tips and the alternative condition for exemption is accordingly not satisfied.

Example 13 This example concerns a situation where an employer promises their employees - either orally or in a written contract - a minimum amount from the tronc. In such circumstances all payments out of the tronc are contractual payments. As stated above, contractual payments are not gratuities because they are in no way unexpected or spontaneous - rather, they are promised or guaranteed by the employer. They are therefore not covered by the exemption from National Insurance contributions provided for by paragraph 5 of Part 10 of Schedule 3 and National Insurance contributions will accordingly be due.

There is a flowchart on page 7 of the booklet, which provides a quick guide to how tips are dealt with for National Insurance contributions purposes.

National Minimum Wage

Only money that is paid by the employer through an employer's payroll counts for National Minimum Wage (NMW) purposes. Tips that are not paid through the employer's payroll, for example tips paid by a tronc, do not count for NMW purposes.

Increasingly, tips are paid by cheque or credit card and following the decision in Nerva, such payments will initially belong to the employer. However, if the employer gives them away, for example to a tronc, then if the troncmaster or a person other than the employer distributes them, they will not be included in the minimum wage calculation.

Examples 15 to 17 in the booklet illustrate how the NMW legislation operates in regard to tips. It also demonstrates in examples 15 and 16 that payments which do not count for NMW purposes (because they are not paid by the employer through the employer's payroll) may nonetheless attract National Insurance contributions. If an employer influences the allocation of the tronc then he will be liable to pay National Insurance contributions on the tronc payments.

In example 15, the employer combines tronc money with house pay to bring pay up to the NMW. But, as the NMW Regulations (Reg 31(1)(e)) only allow payments that have been paid by the employer through the employer's payroll to count as pay for NMW purposes, the employer will fail to meet the NMW criteria. And, having influenced the distribution of tips from the tronc, the employer will be liable for National Insurance contributions on all payments from the tronc.

In example 16 the facts are the same as in example 15 except that the troncmaster arranges for the employer to pay the tronc payments in with the employer's cheque. This may be done for convenience or to bring pay up to NMW levels. But although the pay cheque comes from the employer it does so after it has been through the tronc payroll. The employer is effectively acting as agent for the troncmaster. The tips have not been paid through the employer's payroll - they have already been allocated through the tronc payroll. The troncmaster will remain responsible for PAYE and the employer for operating National Insurance contributions.

Example 17 in the booklet illustrates the effect on the treatment of tips for NMW and National Insurance contributions purposes if the employer retains some of the cheque or credit card payments to meet his wages bill. Following the decision in Nerva, these monies belong to the employer and in the scenario described have been paid by him through his payroll. The payments will count as pay for NMW purposes and the employer will be liable for National Insurance contributions on these amounts. The employer has interfered with the amount of tips available for distribution by the tronc and has therefore indirectly effected the allocation of the tips. He will therefore be liable for National Insurance contributions on all payments made by the tronc.

There is a flowchart on page 8 of the booklet, which shows how tips are dealt with for NMW purposes.

Employers: Online Filing And Electronic Payment

Tax Bulletin 68 gave details about online filing of employers' End of Year returns and electronic payment. Read on for more.

Online filing: sending the whole return

Online filing does not alter the current rules (Regulation 43 SI1993/No. 744) which spell out when an employer must complete an End of Year return and what should be sent.

A return (a P35 and at least one P14) is due when a P11 is maintained for at least one employee. A complete online return must consist of the P35 and P14s.

The new online filing rules only apply to the P35 and P14s, although employers can send and receive other forms and returns online, including the P11D, P11D(b) and the P38A. Employers who are contractors must carry on sending the Construction Industry Scheme CIS36 return as they do now.

Sending a return in parts

Not all employers will want to file the P35 and P14s as a single return. For instance, an agent may deal with the P14s and the employer does the P35. Or the agent may only deal with a particular group of employees.

From April 2005 (the 2004-05 return), employers will be able to send their online returns to us in parts from more than one source. We will hold on to each part until we have the whole return (checking that it meets our Quality Standard).

A return filed in parts can be made up of information sent to us on online, paper or magnetic media. Employers need to establish what information is being sent to us, and by whom, and make sure that each part carries the right details. All parts of the return must be sent online to avoid online filing penalties (see below) or to qualify for the early online filing incentives. See Inland Revenue Notes for Payroll Software Developers, Series 10, Number 15 (September 2003) for more (www.inlandrevenue.gov.uk/comp/index.htm) .

Nil returns

Employers do not have to send a P35 where there are no P14s, just because one was sent to them. They can let us know by 'phone or letter, or by sending in the blank P35 with a note saying that no return is necessary. There is not an online facility for employers to tell us that they are not sending a return.

Sometimes an employer must file a nil return, for example, when all of an employer's employees are paid above the National Insurance Lower Earnings Limit but below the Earnings Threshold. P14s should be filled-in, even though no National Insurance contributions are deducted.

Amendments to returns

There has been no change in the Regulations that say that employers must make one complete return of everything that is required by the law, by the filing date. If they do not, they will face failure penalties under Sec. 98A(2) TMA 1970. And an incorrect return may mean a penalty under Sec. 98A(4) TMA 1970.

If an employer needs to send us any corrections to a return, the new P14s must only include details of the corrected items and the amount of the change. They must not be a replacement of the whole P14. For example an increase in the pay figure of £500 should be shown as +500. From April 2005, employers will be able to send us corrected details online.

Making sure returns meet the Quality Standard

All returns filed online from 2004/05 must meet our Quality Standard. If they do not, they will be rejected. The Standard sets out the minimum standard of accuracy for returns filed online. See Inland Revenue Notes for Payroll Software Developers, Series 10, Number 14 (July 2003) for more (www.inlandrevenue.gov.uk/comp/index.htm) .

Magnetic Media

Returns or any part of a return made by magnetic media - including floppy disc, CD-ROM and any other media written to the requirements of the Technical Guide, Submitting Year End Returns on Magnetic Media (CA51/52) - are not online returns. Employers can use magnetic media to send information where the return is made in parts and will be subjected to all the validation requirements set out in the CA51/52. But using magnetic media for any part of a return may mean the employer will face a penalty because magnetic media is not online.

CA51/52 is at: www.inlandrevenue.gov.uk/ebu/ebu_paye_ts.htm.

Penalties

Under Regulation 46ZG S.I. 2003 No. 2494, employers must file their whole return online or face a penalty of up to £3,000 for sending a return or part of a return on paper or magnetic media. Employers will find that they still face a penalty even if they try to put things right by filing the return forms again online because the first item, or part of it, was not made in the right way.

The Regulation 46ZG penalty for not filing online applies regardless of when the return is made. What matters is that the whole return - whenever it is sent in - must be sent online and of the required quality. Existing penalty laws, in Sec. 98A(2)(a) and (b) TMA 1970, still apply where a complete return - transmitted by whatever medium - is not made by 19 May.

The £825 tax-free payment

Small employers (fewer than 50 employees) who file their returns online from 2004/05 or any later year up to 2008/09 will qualify for early online filing tax-free payments (referred to in legislation as "incentive" payments). Small employers filing online from 2004/05 to 2008/09 will get the maximum £825.

The tax-free incentive payments for small employers will be credited to their PAYE accounting record in the current year, even if an agent or payroll bureau files online on their behalf. For instance, an employer will be credited with £250 for 2005-06 where the 2004-05 return is filed online. We will not be making payments to agents.

Employers can choose to reduce a later amount due by the tax-free payment, or claim a repayment from their tax office.

Accounting for the tax-free payments

The tax-free incentive payments will need to be shown in the accounts, for example as "other operating income". As the incentive payments are not taxable, tax computations should show profit reduced by the incentive included in the accounts.

Electronic Payment

In the April 2003 Budget, the Chancellor announced that large employers (those with 250 or more employees) must pay their monthly In Year PAYE, NICs deductions from payments to subcontractors and student loans repayments electronically in full and on time from deduction year 2004/05 onwards. If the employer does not do so, he or she will incur a surcharge.

We wrote to employers last November to tell them that our records showed that they were large. We will be writing to these employers again in the near future to give them more information about the new legislation.

For electronic payments, the payment date is extended from the 19th to the 22nd of the month. To take advantage of this new date, employers must arrange to make payment in sufficient time to be sure that we receive cleared funds by that date (payment reaches our bank account by 22nd). We must receive the cleared payment by the previous Friday where the 22nd falls at a weekend or bank holiday.

For more about the new dates for payment and paying electronically:

  • go to www.inlandrevenue.gov.uk/howtopay/paye.htm
  • see Do It Online: Your Guide to Filing PAYE Returns and Paying Electronically
  • call Accounting & Payments Service Cumbernauld (01236 783717), or Shipley (01274 539328). Lines are open 8am to 5pm.

interpretations

Businesses, Individuals and the Settlements Legislation - Part II

Introduction

In Tax Bulletin 64 we provided some information and examples on the settlements legislation in Part XV of Income and Corporation Taxes Acts (ICTA) 1988. Publication of that article was welcomed but many people have asked us for some further information on examples 3, 4 and 5. These were cases where the settlements legislation applied to small companies and partnerships. We have also been asked for guidance on completing a SA return where the settlements legislation applies.

As with the original article in Tax Bulletin 64, this article sets out the Inland Revenue's view of the way the legislation applies. That view is not accepted by many accountants and tax practitioners.

Unless otherwise stated all references are to ICTA 1988 in this article.

The existing guidance on the settlements legislation is found in the Inland Revenue's Trusts, Settlements and Estates Manual which is available on our website at "www.ir.gov.uk/manuals/tsemmanual/". That manual will be updated to incorporate this further information shortly.

General

The feedback we have received on the Tax Bulletin 64 article was that the examples were particularly helpful so below we have provided some more examples. However there are some general principles that might also be of use.

Shares

Much of the feedback we have received on the Tax Bulletin 64 article concerned ordinary shares and the rights that they carry. Whilst the rights and obligations associated with a share are relevant they are only part of the issue. We have not suggested that, for the legislation to apply, an ordinary share itself must be wholly or substantially a right to income. We look at the whole arrangement, as the legislation requires. The relevant questions are: What has been invested? What assets, trade, profession have been placed in the company and by whom? Who does what to earn the income of the company? Is the remuneration paid at a commercial rate for the job? Is someone getting a disproportionate return on the capital they have invested because of their relationship with the settlor? All these issues must be considered and if the shares are being used as a vehicle for diverting income then the legislation may apply.

It has also been argued that as the shares in Young v Pearce [1996] STC 743, were preference shares, ordinary shares cannot also be caught by the settlements legislation. We do not accept that. The Young v Pearce case was determined on the facts in that case and the question whether the settlements legislation can apply to situations involving ordinary shares was not considered.

Partnerships

We have also received feedback on the application of the legislation to partnerships where some argue that the unlimited liability of the partners means the settlements legislation cannot apply. We do not accept that. It is important, in relation to partnerships, to look at the whole arrangement to see whether someone is getting a disproportionate return on their contribution because they are related to, or friends with, the settlor. If they are then the legislation applies even if a partnership is being used.

Family company/partnerships.

We have been asked to reconsider the application of the settlements legislation to family/company arrangements as it has been suggested these involve special factors. We consider this is a misunderstanding of the settlements legislation which was enacted specifically to prevent individuals avoiding tax by diverting income to a family member or friend. An outright gift of money is a bounteous act but does not create a settlement. But an arrangement for one spouse to receive the other's income via dividends is caught by the settlements legislation. There is a substantial body of case law on "bounty" and the suggestion that the rules should be applied differently in a family situation is not consistent with that case law.

Goodwill

It has been suggested that we have ignored the value of goodwill in a company in determining whether a gift of shares is substantially a right to income. We agree that goodwill can be a valuable asset of a business and each case will depend on its particular facts. In the typical service company scenario to which the settlements legislation may apply, goodwill is personal to the individual who earns the income for the company and does not attach to the company itself. In such circumstances goodwill would not be an asset for distribution in the winding up of the company and it will not enhance the value of the shares.

Spouses

There has been some misunderstanding about how the legislation applies when spouses are involved. We have not suggested that a "non fee-earning" spouse makes no contribution to a business. The question, in the context of the settlements legislation, is "What contribution does that spouse make and how commercial is the reward for it?" The settlements legislation applies not only where there is a benefit to the settlor's spouse but also where the settlor retains an interest in the settlement whoever the beneficiary may be. In a service company it is usually the person with the specialist knowledge who retains the interest because s/he controls the source of income.

The whole arrangement

It is essential to look at the whole arrangement when considering whether the settlements legislation applies. Sometimes the whole arrangement will not be clear until sometime after the company, for example, is set up. So we might need to wait until dividends or remuneration are paid before we can say the legislation applies.

What is a disproportionate return on capital?

We have said that one of the factors we look at when deciding whether or not the settlements legislation applies is whether someone is receiving a disproportionate return on capital invested. In deciding what is disproportionate we look at the return on the actual capital invested and also any risks. So, for example, someone who invests £1 in an ordinary share and gets £35,000 a year in dividends is getting a disproportionate return on the capital. If that £1 had been invested in the stock market or a bank the return would have been much less. On the other hand if an individual is admitted to a partnership they may take on considerable personal financial risk, and the partnership share of the profits might be a fair return for that risk (see example 14 below).

What is an uncommercial salary?

Likewise we have said we look at individuals drawing an uncommercial salary. In deciding what is uncommercial we look at the going rate for the job and also an individual's previous earnings. So if an IT consultant was earning £80,000 a year when employed by a plc and she then sets up her own IT consulting company and earns fees of £120,000 a year with expenses of £20,000 we would expect to see her drawing a salary of around £80,000. If instead her total salary is only £40,000 with £40,000 going to a non-working spouse then that is uncommercial.

Similarly if one spouse undertakes an average of 8 hours secretarial work a week for a company, and the going rate for a secretary in that area is £6 an hour (£2,496 per year), then we would consider it uncommercial if the spouse was in fact receiving £5,000 a year from the company.

Deciding on what is and is not a commercial salary is not an exact science. It is impossible to give definitive guidance as each case depends on the facts. When in doubt it is useful to consider whether an individual employed at arms length would have accepted the same salary if their friend / relative was not also benefiting from the arrangement.

Completing the SA return

As section 660C(1) & (1A) sets out, income to which the settlements legislation applies is taxable either at Schedule F rates where it is dividends and dividend type income or under Schedule D Case VI for all other income.

When an individual completes a SA return and has to include income caught by the settlements legislation that income needs to go on the "Trusts etc." pages (page T1) under "Income from Trusts and Settlements", unless it is foreign income which should be returned on the foreign pages (Box 6.2 on FI for foreign dividends and box 6.4 on F2 for other foreign income). For UK source income the boxes to use on page T1 will depend on the type of income:

  • For dividends and other Schedule F type income use boxes 7.10, 7.11 and 7.12.
  • For all other income (taxed under Schedule D Case VI) use boxes 7.4, 7.5 and 7.6. Where the income is not taxed in the recipient's hands then box 7.5 should be left blank.

We would also suggest individuals include suitable explanations in the "Additional Information" box. For example an individual receiving a dividend might not be required to include that dividend on the SA return as another person is taxable under the settlements legislation. If they both include a brief explanation about this it helps prevent unnecessary enquiries. (The figures in the returns will not necessarily agree with other information we might hold - for example from the company accounts.)

Previous examples in Tax Bulletin 64

In Tax Bulletin 64 we provided fifteen examples of where the settlements legislation did and did not apply. We have been asked to make clear for those examples how the income should be returned on the individuals' SA returns. The fifteen examples are therefore reproduced below with an additional section explaining how SA returns should be completed.

Example 1 - Issued shares with restricted rights. An engineering company has 100 ordinary £1 shares. Mr A and Mr B own 50 ordinary shares each. They create a new class of B shares which carry no voting rights and no assets in a winding up. They then issue 50 B shares to each of their wives. Dividends voted on those B shares would be treated as the income of Mr A and Mr B rather than their wives as the B dividends are from shares that are wholly or substantially a right to income and so not exempted from section 660A by section 660A(6). (This example is based on the High Court case of "Young v Pearce; Young V Scrutton [1996] STC 743").

Completing the SA return

Any dividends paid to Mrs A on the B shares are treated as Mr A's income under the settlements legislation and so he should return those dividends at boxes 7.10 to 7.12 on page T1 of his SA return and include a brief note in the "Additional Information" box.

Mrs A should not include any of the dividends received on the B shares on her SA return, if she gets one, but a brief note in the "Additional Information" box would be helpful.

The situation is the same for Mr and Mrs B.

Example 2 - Gifted shares with restricted rights. Mr C is the sole director and owns all the 1000 ordinary £1 shares in C Limited. His aunt, Mrs D, has always been very kind to him and he wants to thank her for this. He subscribes, at par, for 100 B shares, with no voting rights and restricted rights to capital of £10 per share in the event of winding up. He gifts the shares to Mrs D. Mr C then declares a dividend of £100 per share with Mrs D receiving dividends of £10,000.

This is a bounteous arrangement and we would apply the settlements legislation to the dividends. The property giving rise to the dividends cannot be looked at too narrowly as the shares alone. The wider arrangement must be considered. Because he is in effective control of the company Mr C retains an interest in the underlying property as he could simply pay all future income arising to himself as director's salary or as dividends on the ordinary shares.

Completing the SA return

All of Mrs D's dividends of £10,000 are treated as Mr C's income under the settlements legislation. He should return that £10,000 at boxes 7.10 to 7.12 on page T1 of his SA return and include a brief note in the "Additional Information" box. His own dividends should be returned in the normal way.

Mrs D should not include any of the £10,000 of dividends on her SA return, if she gets one, but a brief note in the "Additional Information" box would be helpful.

Example 3 - Subscribed shares. E Ltd was incorporated in October 1997 to provide the services of Mr E as an IT consultant to a number of clients working in the pharmaceutical industry. The company's share capital is £2 consisting of 2 £1 shares. Mr E is the sole director of the company, and his wife Mrs E is company secretary but takes no other active part in the company. From the beginning each subscribed for one share. The company has no significant capital assets. The figures for the first year's trading are: -

  • Turnover 100,000 Expenses 5,000 Salary (Mr E) 10,000 Salary (Mrs E) 5,000 Dividends 70,000

In this case Mrs E receives a salary for her duties as company secretary, but the whole arrangement whereby Mrs E invests £1 and in return gets a dividend of £35,000 is bounteous. There is nothing to suggest that the dividend is a commercial return on her investment. As there is no significant capital in the company, what has passed from Mr E to Mrs E is substantially a right to income and the whole of the dividend is taxed on Mr E.

In reaching this conclusion, the legislation allows us to look at the whole arrangement. It is the work that Mr E carries out which creates the company's profits which in turn enable the dividends to be paid. Mrs E's investment of £1 does not enable the company to make profits and the company itself has minimal capital value. In accepting a salary below the market rate from the company, and thereby allowing some of the income earned to pass to Mrs E as a dividend, Mr E has entered into a bounteous arrangement to divert income to his spouse with the aim of avoiding tax.

Completing the SA return

Mrs E has received a salary of £5,000 which is a commercial salary for the work she does. All of Mrs E's dividends of £35,000 are treated as Mr E's income under the settlements legislation. He should return that £35,000 at boxes 7.10 to 7.12 on page T1 of his SA return and include a brief note in the "Additional Information" box. His own dividends should be returned in the normal way.

Mrs E should not include any of the £35,000 of dividends on her SA return, if she gets one, but a brief note in the "Additional Information" box would be helpful. She should include the £5,000 salary on her return.

Example 4 - Subscribed shares with little capital value then gifted As in example 3 but in October 1997 Mr E was not married and subscribed for both £1 shares himself. Mr E's solicitor was acting as company secretary. A year later he got married and gave his wife one of his shares in the company. At this point Mrs E took over the role of company secretary. In the following year Mrs E receives a wage of £5,000 and the company pays a dividend of £35,000 per share.

Since the capital value of the company is insignificant the gift of the share from Mr E to his wife is not exempt from section 660A by virtue of section 660A(6) as the shares are "wholly or substantially a right to income". Accordingly the settlements legislation applies in relation to Mrs E's £35,000 dividend payment and the income would be treated as Mr E's for tax purposes.

Completing the SA return

As in example 3 all of Mrs E's dividends of £35,000 are treated as Mr E's income under the settlements legislation. He should return that £35,000 on page T1 his SA return at boxes 7.10 to 7.12 and include a brief note in the "Additional Information" box. His own dividends should be returned in the normal way.

Again Mrs E should not include any of the £35,000 of dividends on her SA return, if she gets one, but a brief note in the "Additional Information" box would be helpful. She should include the £5,000 salary on her return.

Example 5 - Partnerships Mr F and Mr G are in partnership as second hand car dealers. They do not have any premises but buy and sell cars through auctions and the classified adverts of local papers. The partnership's only assets are some office equipment worth less than £1,000 and they usually have a couple of cars in stock at any one time. They are successful and the profits of £80,000 a year are split equally between them. They decide to admit their wives to the partnership and amend the partnership agreement in order to split profits equally four ways. Mrs F and Mrs G do no work in the partnership and the partnership has no employees.

This is a bounteous arrangement transferring income from one spouse to the other. The settlements legislation will apply and Mr F and Mr G continue to be taxable on half the profits each.

Completing the SA return

Mr F and Mr G are taxable on half the partnership profits each. So each should include £40,000 on their SA return. The £20,000 not caught by the settlements legislation is returned as partnership profits in the normal way. The £20,000 caught by the settlements legislation goes on page T1 in boxes 7.4 and 7.6. A note explaining this should be included in the "Additional Information" box.

Mrs F and Mrs G should not include the £20,000 from the partnership on their SA returns. However they should each include in the "Additional Information" box a note explaining that although they received £20,000 of profits from the partnership this is taxable on their husbands under the settlements legislation and has therefore been excluded from their individual return.

The partnership return should show overall partnership profits of £80,000. The partnership allocation should show £20,000 to Mr F, £20,000 to Mr G, £20,000 to Mrs F and £20,000 to Mrs G. The partners should add a note to the "Additional Information" box explaining that the £20,000 attributable to Mrs F and the £20,000 attributable to Mrs G are taxable on Mr F and Mr G respectively under the settlements legislation and are being returned on Mr F and Mr G's individual SA returns.

Example 6 - Dividend Waivers Where a company with few shareholders declares a final dividend when one or more of the shareholders has waived their right to a dividend in circumstances where other shareholders may benefit, it is possible the settlements legislation could apply.

For example Mrs H owns 80 ordinary shares in H Limited. Mr H owns 20 shares. In 2000 the company made a profit of £25,000. Mrs H waived her right to any dividend. The company then declared a dividend of £1,000 per share, and Mr H, who had no other income, received a dividend of £20,000.

We would apply the settlements legislation in these circumstances. Clearly a dividend of this amount could not have been paid from the company's profits on all the shares, so the waiver arrangement enhanced the dividend paid to Mr H. £16,000 of the dividend paid to Mr H is attributed to Mrs H under section 660A because the waiver was a bounteous arrangement.

Completing the SA return

£16,000 of Mr H's dividends of £20,000 are treated as Mrs H's income under the settlements legislation. Mrs H should return that £16,000 at boxes 7.10 to 7.12 on page T1 of her SA return and include a brief note in the "Additional Information" box.

Mr H should include only £4,000 of the £20,000 dividends on his SA return in the normal way and add a note to the "Additional Information" box explaining why only £4,000 is being returned even though £20,000 was received.

Example 7 - Dividends on certain shares As in example 6, but in this case Mrs I owns A shares and Mr I owns B shares. Both A and B shares rank equally. Again profits of £25,000 are made and a dividend of £20,000 is voted on the B shares while no dividend is voted on the A shares.

Clearly by not voting dividends on the A shares (which rank equally with the B shares) this is a bounteous arrangement as the dividend paid on the B shares could only be paid if no dividend was declared in respect of the A shares. £16,000 of the dividend paid to Mr I is attributed to Mrs I under section 660A because the decision to vote dividends only on certain shares was a bounteous arrangement.

Completing the SA return

£16,000 of Mr I's dividends of £20,000 are treated as Mrs I's income under the settlements legislation. Mrs I should return that £16,000 at boxes 7.10 to 7.12 on page T1 of her SA return and include a brief note in the "Additional Information" box.

Mr I should include only £4,000 of the £20,000 dividends on his SA return in the normal way and add a note to the "Additional Information" box explaining why only £4,000 is being returned even though £20,000 was received.

Example 8 - Children - gift of shares from parent Mr J owns all 100 issued £1 shares in J Limited. Mr J is the sole company director and is the person responsible for making all the company's profits because of his knowledge, expertise and hard work. Mr J gives each of his four children 10 shares. Dividends are paid.

Section 660B applies and attributes the dividends paid to the children to Mr J for tax purposes. This is because Mr J has paid the income to his unmarried minor children.

Completing the SA return

Any dividends paid to his four children are treated as Mr J's income under the settlements legislation. He should return those dividends at boxes 7.10 to 7.12 on page T1 of his SA return and include a brief note in the "Additional Information" box. His own dividends should be returned in the normal way.

The four children do not need to return the dividends or inform the Inland Revenue they have received them. If they do receive a SA return, a note should be included in the "Additional Information" box explaining that although they received dividends during the year these have not been returned as they are taxable as Mr J's income under the settlements legislation.

Example 9 - Children - gift of shares other than from parent As in example 8, but the 40 shares held by the children were originally owned by their grandmother who had subscribed for them at par when the company was set up but shortly afterwards had gifted them to her grandchildren.

Section 660B applies and attributes the dividends received by the children to Mr J for tax purposes. Since Mr J is the person responsible for making the company's profits and decides on the level of dividends paid, it is Mr J who is the settlor rather than the children's grandmother.

The legislation could apply in a similar way if the children had subscribed for the shares themselves with money received from a third party or even from bank accounts in their own names.

Completing the SA return

Any dividends paid to his four children are treated as Mr J's income under the settlements legislation. He should return those dividends at boxes 7.10 to 7.12 on page T1 of his SA return and include a brief note in the "Additional Information" box. His own dividends should be returned in the normal way.

The four children do not need to return the dividends or inform the Inland Revenue they have received them. If they do receive a SA return then a note should be included in the "Additional Information" box explaining that although they received dividends during the year these have not been returned as they are taxable as Mr J's income under the settlements legislation.

Example 10 - An outright gift to a spouse Mrs L owns 10,000 ordinary shares in a FTSE 100 company. Those shares are worth £40,000. Mrs L gives those shares to her husband. Mr L is now entitled to all the dividends from the shares and can sell the shares if he wants and keep the proceeds. This is an outright gift of shares that are not wholly, or substantially, a right to income since they have a capital value and can be traded, so the settlements legislation does not apply.

Completing the SA return

As the settlements legislation does not apply all income should go in the normal boxes on the SA return.

Example 11 - Subscribed shares Mr M is the sole director and owns all the 100 ordinary shares in M Limited, a small manufacturing company. The company employs 10 people and owns a small factory, a high street shop, tools fixtures and fittings and 3 delivery vehicles. Mr M draws a salary of £30,000 each year and receives dividends of £20,000. Mr M then gifts 50 shares to his wife who plays no part in the business. Mr and Mrs M then each receive dividends of £10,000.

We would not seek to apply the settlements legislation to the dividends received by Mrs M. This is because the outright gift of the shares cannot be regarded as wholly or substantially a right to income. The shares have capital rights and the company has substantial assets so on the winding up or sale of the business the shares would have more than an insubstantial value.

Completing the SA return

As the settlements legislation does not apply all income should go in the normal boxes on the SA return.

Example 12 - Subscribed shares Mr N wants to set up in business as a bookseller. He needs at least £100,000 to buy premises, equipment and stock. He sets up a company and he and Mrs N each subscribe for 40,000 ordinary £1 shares at par and the company borrows £20,000 from the bank. Mr N draws a salary which after four years is £40,000. Mrs N does not work for the company. Company profits are used to repay debt and expand the business. The business does well and after 6 years the profits are sufficient to pay a dividend of £10,000.

We would not seek to apply to apply the settlements legislation to the dividend of £5,000 received by Mrs N. There is no bounty as Mr N draws a commercial salary for his efforts and the dividend is a commercial return on the initial investment which was vital at the commencement of the business and contained a clear element of risk.

Completing the SA return

As the settlements legislation does not apply all income should go in the normal boxes on the SA return.

Example 13 - A partnership Mr and Mrs O and their friend Mr P have a business idea. They want to open a Cycle Repair Shop. Mrs O does not want to work but agrees to invest in the business without taking an active part, that is to say she is a sleeping partner. Each partner invests £10,000 and the £30,000 is used to lease a shop, buy equipment and stock and keep the business going until trade builds up. Under the partnership agreement Mr O and Mr P receive £500 a week with all the remaining profits split three ways between the partners.

The business is a huge success and makes large profits and continues to grow. Within five years Mrs O is receiving £50,000 a year as her share of the partnership profits. Although Mrs O does not work in the business, and her initial investment has turned out to be very successful, the settlements legislation would not apply to treat her share of the partnership profits as Mr O's. Mrs O's original investment was vital to get the business started and she risked losing it if the business failed.

Completing the SA return

As the settlements legislation does not apply all income should go in the normal boxes on the SA return.

Example 14 - A partnership Mr P is a self-employed engineer engaged on specialist work for a number of clients in the construction industry. Mr P employs his wife, who plays an active part in the business including ordering and collecting specialist parts. Mrs P is paid a salary of £20,000. The profits of the business are £40,000. Mrs P owns a substantial property inherited from her mother.

Because of a number of claims made against Mr P, his insurers want to raise premiums by £20,000. He doesn't think he can afford this so his insurers agree to not increase the premiums if Mr P agrees to pay the first £25,000 of any claim. Mr P and Mrs P enter into an equal partnership. Accordingly Mrs P no longer draws a salary but is entitled to a share of the profits as well as being exposed to the liabilities of the partnership. The property she owns is therefore potentially at risk.

Mrs P's share of the profits is £30,000. Mrs P therefore has extra overall income of £10,000 because she has taken on the risk of the partnership liabilities including that associated with the £25,000 excess on the insurance policy. There is therefore no bounty and the settlements legislation would not apply.

Completing the SA return

As the settlements legislation does not apply all income should go in the normal boxes on the SA return.

Example 15 - Gift of shares other than from parent In 1960 Mr & Mrs Q and Mr & Mrs R set up a small family cleaning company. In total there were, and still are, 100 £1 ordinary shares in the business. Initially Mr Q and Mr R each subscribed at par for 40 shares and Mrs Q and Mrs R each subscribed at par for 10 shares.

When Mr & Mrs Q died they each left their shares in the company (50 in total) to their daughter, Miss Q. When Mr R also died he left his 40 shares in the company to his daughter Mrs S. Miss Q and Mrs S are both directors of the company and carry out its day to day running. The current turnover of the company is approximately £1,000,000 per year and its capital value is over £250,000. Miss Q and Mrs S each receive a salary of £60,000 per year. Each year a dividend of £500 per share is paid.

Mrs R has retained her original 10 shares in the company since 1960. Without discussing the matter in advance with either Miss Q or Mrs S, Mrs R decides to give her shares to her five year old granddaughter who is also Mrs S's daughter. Mrs R makes the gift on her granddaughter's next birthday.

The settlements legislation would not apply to this case since Mrs R retains no interest in the shares which she gives to her granddaughter and is therefore not a settlor within the meaning of section 660G. Nor is Mrs R's decision to gift the shares to her granddaughter part of a wider arrangement with Mrs S to settle income on the child.

Completing the SA return

As the settlements legislation does not apply all income should go in the normal boxes on the SA return.

Additional examples involving a company

Examples 3, 4 & 5 plus examples 11, 12 & 13 explained circumstances in which the settlements legislation did and did not apply to some company and partnership situations. We have been asked to provide further examples like these, which are below. These examples also have guidance on completing the SA return:

Example 16 - Subscribed shares T Ltd was incorporated in October 1997 to provide a consultancy service to the health sector. Mr T is an IT specialist with a number of years experience in the health sector and Mrs T is an ex-nurse who specialises in producing computer based learning materials for hospitals. The company's share capital is £10,000 consisting of 10,000 £1 shares. Mr and Mrs T are both full time working directors of the company. From the beginning each subscribed for 5,000 shares. The first year's accounts show that each director received remuneration of £30,000 and that profits available for distribution were £50,000. £30,000 profits are retained in the company to build up the business. A dividend of £2 per share is declared and paid - each shareholder receiving £10,000.There is no bounty here and no arrangement to which the settlement legislation can apply.

Completing the SA return

As the settlements legislation does not apply all remuneration and dividends should go in the normal boxes on the SA return.

Example 17 - Subscribed shares Mr U is a self-employed IT consultant. He reads an advert on a specialist website and as a result he decides to offer his services through a "composite" company set up by another company specialising in taxation services. Under an agreement he will subscribe for a special class of share (a £1 "U" share) which has rights to all his earnings less a "commission" paid to the organisers. When the agreement is sent to him for signature there is a box to tick if he wants a share issued to anyone else. He ticks the box and asks for an additional share to be issued to Mrs U. Apart from subscribing £1 for the share, Mrs U takes no part in the business. During year one his efforts contribute income of £68,000 to the company. The company retains sufficient to cover expenses and tax and the balance remaining of £54,000 is paid to Mr and Mrs U as dividends who each receive £27,000.

This is a bounteous transaction caught by the settlements legislation. In reaching this conclusion it is necessary to look at the whole arrangement. The substance of what has happened is that part of Mr U's earnings have been paid to Mrs U.

Completing the SA return

Mr U should return his own dividend income of £30,000 (£27,000 + tax credit of £3,000) on his SA return in the normal way. He should include his wife's £30,000 on page T1 of his return at boxes 7.10, 7.11 and 7.12 and include a brief note in the "Additional Information" box.

Mrs U should not include any of the £30,000 of dividends on her SA return, if she gets one, but a brief note in the "Additional Information" box would be helpful.

Example 18 - Gifted Shares Mrs V carries on a trade as a designer through a company V Ltd. She is the sole director and sole shareholder of 100 £1 shares subscribed for at par on the company's formation. The company's accountant acts as company secretary. The company has insignificant capital. In a typical year the company's gross income is in the region of £60,000 p.a. After expenses (including Director's remuneration of £25,000) and providing for tax, the profits available for distribution are £24,000. Dividends of £20,000 are paid to Mrs V. In the following year Mr V, who worked for another company, is made redundant and loses his source of income. Mrs V gifts half her shares to Mr V. Mr V carries out some part-time secretarial work for the company for which he is paid £5,000 p.a. At the end of the year gross income is £65,000, Mrs V votes herself £10,000 remuneration and after other expenses and tax the balance of £40,000 is paid out as dividends - each spouse receiving £20,000.This is a bounteous arrangement, whereby Mrs V has transferred part of her income to her spouse, and it is caught by the settlements legislation. In reaching this conclusion it is necessary to look at the whole arrangement. What has happened is that part of Mrs V's earnings have been paid to Mr V. Two of the key elements in the arrangement are that the expertise and earning capacity of Mrs V have been provided to the company at undervalue and Mr V is paid a market rate for his work.

Completing the SA return

Mrs V should include her husband's dividend income of £20,000 on page T1 of her SA Return at boxes 7.10, 7.11 and 7.12 and include a brief note in the "Additional Information" box. Her own dividend income of £20,000 goes on the main return in the normal way and her £10,000 of remuneration goes on the Employment pages.

Mr V should include the £5,000 of remuneration in his SA return, if he gets one, in the normal way but should not include the £20,000 of dividends. A brief note in the "Additional Information" box explaining why the £20,000 of dividends received are not on the return would be helpful.

Example 19 - Gifted Shares The facts are as above but Mrs V continued to pay herself a commercial rate of remuneration of £25,000 leaving only £20,000 to be distributed to the two shareholders. The gift of shares is a bounteous transaction which diverts £10,000 of income to Mr V and in the absence of any capital in the company those shares represent substantially a right to income. So the exemption in section 660A(6) for gifts between spouses does not apply and the dividends are assessable on Mrs V.

Completing the SA return

Mrs V should include her husband's dividend income of £10,000 on page T1 of her SA Return at boxes 7.10, 7.11 and 7.12 and include a brief note in the "Additional Information" box. Her own dividend income of £10,000 goes on the main return in the normal way and the £25,000 of remuneration goes on the Employment pages.

Mr V should include the £5,000 of remuneration in his SA return, if he gets one, in the normal way but should not include the £10,000 of dividends. A brief note in the "Additional Information" box explaining why the £10,000 of dividends received are not on the return would be helpful.

Example 20 - Gifted Shares Mr W & Mr X are founder shareholders and directors of a successful hardware shop run through a company called DIY Ltd. The company was set up to acquire the partnership trade carried on by the two shareholders. At the time there was a single shop, the trade plus assets were worth about £50,000 which were transferred to the company and the company issued 10,000 £1 shares to the partners in return. Over the years the company has grown. It now owns a chain of 8 DIY stores. Some premises are owned and others rented. The company owns a number of delivery vans and employs 50 staff. The shares have increased in value from £5 per share to £75 per share. Mr W and Mr X respectively gift some of their shares to their wives. Mrs W & Mrs X are given 2000 shares each. Dividends are paid on all shares.Although this is a bounteous transaction it is an outright gift that is not substantially a right to income, because the company has significant capital assets, and is therefore excluded from the definition of settlement by section 660A(6).

Completing the SA return

As the settlements legislation does not apply all income should go in the normal boxes on the SA return.

Further examples involving a partnership

Example 21 Mr Y, an architect, commences business as a sole trader. The business is successful and a few years later annual profits are in the region of £80,000. The business has insignificant capital and there are no employees. The business is transferred to a new partnership of Mr & Mrs Y. A deed is created under which profits are to be shared equally. Mrs Y subscribes no new capital and carries out no work whatsoever for the partnership. Profits for the year are £80,000 and £40,000 belong to Mrs Y. This is a bounteous arrangement transferring income from one spouse to another. The settlements legislation will apply and Mrs Y's share of the profits will continue to be assessed on Mr Y.

Completing the SA return

Mr Y should include Mrs Y's partnership income of £40,000 on page T1 of his SA Return at boxes 7.4 and 7.6. His own share of £40,000 is returned as partnership profits in the normal way. A note explaining this should be included in the "Additional Information" box.

Mrs Y should not include the £40,000 from the partnership on her SA return. However she should include in the "Additional Information" box a note explaining that although she received £40,000 of profits from the partnership this is taxable on Mr Y under the settlements legislation and has therefore been excluded from her individual return.

When completing the partnership return this needs to show overall partnership profits of £80,000. The partnership allocation should show £40,000 to Mr Y and £40,000 to Mrs Y. The partners should add a note to the "Additional Information" box explaining that the £40,000 attributable to Mrs Y is taxable on Mr Y under the settlements legislation and is being returned on Mr Y's individual SA return.

Example 22 Mr Alpha and Mr Beta are in partnership as second hand car dealers. They own the freehold premises through which the partnership trades (valued at £200,000) and routinely carry a stock of 50 used cars. The business is successful and has established goodwill in the locality as a reliable trader. It employs a number of salesmen and office staff. Profits of £100,000 a year are split equally between the partners. They decide to admit their wives to the partnership and amend the partnership agreement in order to split profits and capital equally four ways. Mrs Alpha and Mrs Beta do no work in the partnership. Although this is a bounteous transaction it is an outright gift that is not substantially a right to income and is excluded from the definition of settlement by section 660A(6).

Completing the SA return

As the settlements legislation does not apply all income should go in the normal boxes on the SA return.

Summary

Whether or not the settlements legislation applies to an arrangement depends on the particular facts of the case. It is necessary to look at the arrangement as a whole. If there is a bounteous arrangement which effectively transfers income earned by one person to another resulting in a reduction in overall tax liability the arrangement will be liable to challenge under the settlements legislation.

When considering whether or not the settlements legislation applies it is worth remembering that Parliament introduced the settlements legislation to prevent individuals transferring their income to a relative or friend in order to avoid tax. It therefore follows that a simple test to indicate whether or not the legislation might apply is to consider whether the same arrangements would have been made with a third party at arms length.

If you have any comments on this article and the issues raised you can contact the Editor of Tax Bulletin at the Inland Revenue (Somerset House, Strand, London WC2R 1LB).

Licences and other rights to use telecommunications cable systems

In Tax Bulletin 50 we set out our views on a number of issues on the interpretation of Schedule 23 to the Finance Act 2000. The Schedule is about the tax treatment of certain licences granted under the Wireless Telegraphy Act 1949 and more generally to 'indefeasible rights' (IRUs) to use telecommunications cable systems.

One issue concerned the head of charge where the holder of the licence or IRU did not exploit the asset in the course of a trade. We said we would expect the income stream to be a source within Case VI of Schedule D if it is not within Case I. We did not think the receipts from exploitation of the asset would be chargeable under Case III.

For companies within the charge to corporation tax in respect of these licences and rights the rules in FA 2000 are superceded by those in Schedule 29 to Finance Act 2002. This change takes effect for accounting periods ending on or after 1st April 2002. In applying the rules in Schedule 29 to these periods sums brought into account earlier under the FA 2000 rules are treated as if they had been brought into account under Schedule 29 itself.

Unlike the FA 2000 legislation, Schedule 29 provides specifically that sums relating to assets within its scope which are held for the purposes of (broadly) non-trading activities are to be brought into account under Case VI.

We now think that the expectation we expressed in our earlier Tax Bulletin article that Case VI would be the appropriate head of charge for non-trading assets within Schedule 23 is misleading. We consider that it is quite possible on the facts of a particular case that Case III would be the appropriate head of charge. That is where the royalties received from the licensing of the rights within Schedule 23 have a UK source and take the form of 'pure income profit'. Royalties, other than those arising in the course of a trade, may fall into this category where for example the licensing agreement under which they are paid does not impose any further obligation on the licensor to provide related services.

Where royalties fall within Case III in the hands of the recipient, Schedule 23 does not in strictness permit sums written off the related licence or rights in a company's accounts (on an impairment review or by way of amortisation under Finance Reporting Standard 10) to be deducted in computing the sum chargeable to tax. This is because the Schedule merely deems the sums written off to be on revenue account, which is insufficient to override the prohibition on deductions in computing Case III income in section 64 of the Taxes Act 1988.

We do not of course propose to apply our corrected view of the law retrospectively. This means that where the recipient of royalties is a company within the charge to corporation tax in respect of the relevant licence or rights our change of view will have no practical consequences. Accounting periods to which the rules in Schedule 23 applied will have ended at the latest on 31st March 2002.

The rules in Schedule 23 will continue to apply to a recipient of these royalties who is within the charge to income tax. In such cases we do not propose to apply the change of view to royalties arising under an agreement entered into by the payer and recipient prior to 20 February 2004 But our revised view will apply to royalties payable under other agreements.

miscellaneous

Revenue Prosecutions

Hamdi & Mohsen Bichara

Brothers Hamdi and Mohsen Bichara both pleaded guilty and were sentenced to four years in prison at Liverpool Crown Court recently. The charges related to the defrauding both the Inland Revenue and Customs and Excise. The loss to the Revenue is in excess of £785,000 and the loss of VAT to Customs more than £443,000.

The Bichara brothers are directors of a company, Fiestatime Ltd, which operates a busy and successful restaurant known as Uncle Sam's Bistro from Renshaw Street in central Liverpool. They have owned the restaurant since the late 80's. The fraud had been ongoing since 1995 culminating in a raid by Customs and Excise on the restaurant premises and the Bichara's homes in February 2001.

The Bichara brothers were both interviewed under caution by officers from the Inland Revenue Special Compliance Office, Manchester, they admitted to failing to declare the correct receipts for the restaurant for a number of years. Following extensive further investigations by Revenue and Customs officers, it was established that the fraud was carried out by manipulating the tills within the restaurant to the extent that takings of £3.2 million were not recorded. These sums were used to pay tax-free wages to restaurant staff.

An Inland Revenue spokesman commented,

"The outcome of this case is an extremely good example of the investigation work undertaken between the Inland Revenue and Customs and Excise. The Inland Revenue is committed to uncovering fraud against the department. Others contemplating committing similar offences should be aware that they could face prosecution and should expect to be sentenced if found guilty. Additionally the Inland Revenue will seek to recover the money taken from the public purse."

The charges were two counts of common cheat. No awards for costs were made as this will be dealt with at a confiscation hearing at a later date.

Nicola Jane Hodgson

28- year-old Miss Nicola Jane Hodgson, of 21 Harwood Lane, Great Harwood, appeared before Hyndburn Magistrates Court recently, to answer two charges of false accounting (contrary to Section 17 (1)(a) Theft Act, 1968) and two charges of fraud (contrary to Section 35 (1) Tax Credits Act 2002).

Matters arose from both Working Families Tax Credit and Working Tax Credit / Child Tax Credit applications by Hodgson, which were made falsely. On the applications Hodgson provided a false address, failed to include details of her savings, omitted details of her partner and his employment, and falsely claimed for childcare costs.

Her partner is a self employed childminder working from the family home as ABC childminding, which is one of the childminders she falsely claimed to be using.

The tax credit lost in this case is £6369.19.

Hodgson pleaded guilty to all four charges. She was fined £300 on each charge (£1,200 total fine) and ordered to pay £250 costs.

Hodgson has also paid back the full amount of the tax credit falsely claimed, £6369.19 to the Inland Revenue.

Graham Madeley, John Soars and Mark Scarrett.

The Managing Director of a Midlands based agricultural construction company has been forced to pay an estimated £1.2 million after guilty to lying to the Inland Revenue.

62 year old Graham Madeley, Managing Director of Scalford Construction Company of Scalford near Melton Mowbray, was ordered to pay a £625,00 confiscation order, a £200,000 fine and nearly £92,000 towards prosecution costs by a judge at Leicester Crown Court. The court also ordered Mr Madeley to pay up to a maximum of £300,000 of the defence costs.

The court heard that Madeley had used company money to renovate and run the stately home he and his family live in-Leesthorpe Hall, a country house with stables set in nineteen acres between Melton Mowbray and Oakham. In doing so he had taken steps to ensure that the invoices provided by his suppliers gave false or misleading descriptions of the work carried out at the house. Two accountants, John Soars and Mark Scarrett, of the accountancy firm Newby Castleman aided him by submitting false accounts to the local tax office. During the course of an investigation Madeley and Soars lied to the Inland Revenue to try and hide the benefits Madeley should have paid tax on. Scarrett drew up false documents to help conceal the fact that the Inland Revenue had been lied to.

Despite initially being settled locally and after the receipt of new information, the case was taken up by the Nottingham branch of the Inland Revenue's Special Compliance Office. Their subsequent investigation discovered that more than £580,000 was spent on work at Leesthorpe Hall or otherwise benefited Mr Madeley and his family. Only £150,000 of this was declared to the Inland Revenue. In addition another £200,000 in other benefits such as gardeners and cleaners at Leesthorpe Hall and benefits arising from the use of company cars were omitted or understated.

The £625,000 confiscation order must be made within 2 months or Madeley will face 3 years imprisonment in default. He has 90 days to pay the £200,000 fine or face two years imprisonment in default.

Mark Scarrett received a 240 hour community order after pleading guilty to charges of false accounting.

John Soars, a senior partner with Newby Castleman also pleaded guilty to false accounting. In his case sentencing has been adjourned until 20th February 2004, pending an assessment of his assets.

The estimated £1.2 million is far in excess of the tax bill Madeley would have been expected to pay (£281,000). Because the diverted moneys were invested in the property much of the sum to be confiscated was calculated as a proportion of the increase in the value of the property. This exceeded the actual amount spent.

Mark Michael Brown

Mark Brown, a self employed taxi driver of Westbrook Terrace, Darlington who failed to tell the Inland Revenue of his business was handed a 12 month Conditional Discharge from Bishop Auckland Magistrates Court in County Durham recently after pleading guilty to the offence.

The amount of duty he fraudulently evaded was £2428.99, the Inland Revenue is taking civil action to recover this plus interest.

In addition to his taxi driving, Brown who is in full time employment was also claiming Working Families Tax Credit.

Brown is the first person in England to be successfully prosecuted under Section 144 of the FA 2000- Fraudulent Evasion Of Income Tax.

In March 2000, a report was compiled by Lord Grabiner QC. Grabiner made recommendations in his review of the "informal economy", all of which were accepted by Government. Grabiner saw the need for far higher numbers of prosecutions of people who operate in the informal economy. This would be achieved by bringing prosecutions before the court as quickly as the interests of justice would allow.

The report led to a new statutory offence of fraudulent evasion of income tax - Section 144 FA2000.

Cesar Augusto Rodriquez

Having previously been found guilty of Cheating the Public Purse, 48-year-old Salsa Dance teacher, Cesar Augusto Rodriquez was sentenced to 9 months imprisonment at Manchester Crown Court recently.

Sentencing had been adjourned to allow time for an investigation by the Department of Work and Pensions (DWP) to be concluded.

In sentencing, His Honour Judge Ensor commented that he considered tax evasion to be very serious and his leniency in sentencing was due to Rodriquez's medical condition.

Rodriquez made his benefit claim using a council property address. He had a tenancy agreement for the flat with Bolton Metro from whom he also claimed housing benefit, and this claim continued even though he married in 2000 and went to live with his wife Alison at 9 Ashdene Road, Withington.

Since 1996 Rodriquez had been working as a Salsa dance teacher, giving twice weekly lessons at the Copacabana Club, Dale Street, Manchester. He advertised on an Internet web site, displaying photos of himself dancing with clients.

Rodriquez did not tell the Inland Revenue about the income received from these lessons. He had also, since 1985, been fraudulently claiming incapacity benefit from the DWP by failing to advise them that he was self-employed as a dance teacher.

The tax loss is estimated at £24,300.

Rodriquez was arrested and his property searched by Greater Manchester Police and he was interviewed by officers of the Inland Revenue's Special Compliance Office.

Linda Davies

A 41-year-old single mother, Linda Davies of 7 Buttermere Drive, Oswaldtwistle, Accrington, who works for the Department of Work and Pensions, was sentenced at Hyndburn Magistrates Court, Accrington, after pleading guilty to four counts of false accounting.

The Magistrates ordered her to pay £5000 in compensation, £250 costs and also gave her a 12 months conditional discharge.

Davies was arrested by Lancashire Police and interviewed under caution by officers of the Inland Revenue Special Compliance Office in October 2003, on suspicion of false accounting Contrary to Section 17 (1)(a) of the Theft Act 1968.

It was alleged that between 13 July 2000 and 8 January 2002 Davies submitted four claims to Working Families Tax Credit (WFTC) and omitted to include savings in excess of £8000 on her applications.

One of the qualifying conditions for claiming WFTC is that you must not have savings in excess of £8000.

Investigations into Davies's four WFTC applications revealed that she did in fact have savings in excess of £8000, and was therefore not entitled to £5738.20 tax credits she received.

This case was investigated by Inland Revenue Special Compliance Office, Manchester.

Watir Ullah

A 41-year-old father of six, Mr Watir Ullah of Good Shepherd Close, Rochdale, was sentenced at Rochdale Magistrates Court recently. He received 120 hours community punishment and was ordered to repay five thousand pounds.

Mr Ullah was arrested by Rochdale CID and interviewed under caution by officers of the Inland Revenue Special Compliance Office, Manchester in February last year, on suspicion of making a false claim to Working Families Tax Credit (WFTC).

Investigation revealed that Ullah had been previously employed as a waiter at the Alishaan Restaurant, in Radcliffe, Manchester, but was not working there when he made his WFTC claim. In order to obtain the maximum award Ullah falsified supporting documents stating he was working 30 hours a week, and forged his previous employer's signature.

One of the qualifying conditions of claiming WFTC is that the claimant must be in paid employment for at least 16 hours per week.

Mr Ullah's actions enabled him to obtain WFTC of £5211.70 to which he was not entitled.

Inland Revenue Statements of Practice and Extra-Statutory Concessions issued between 1 December 2003 to 31 January 2004

Extra Statutory Concessions

There have been no Extra Statutory Concessions for this period

Statements of Practice

There have been no Statements of Practice for this period

You can get copies of SPs and ESCs by telephoning 020 7438 4266.

Content

The content of Tax Bulletin gives the views of our technical specialists on particular issues. The information published is reported because it may be of interest to tax practitioners. Publication will be six times a year, and include a cumulative index issued on an annual basis.

  • You can expect that interpretations of the law contained in the Bulletin will normally be applied in relevant cases, but this is subject to a number of qualifications.
  • Particular cases may turn on their own facts, or context, and because every possible situation cannot be covered, there may be circumstances in which the interpretation given here will not apply.
  • There may also be circumstances in which the Board would find it necessary to argue for a different interpretation in appeal proceedings.
  • The Bulletin does not replace formal Statements of Practice.
  • The Board's view of the law may change in the future. Readers will be notified of any changes in future editions.

Nothing in this Bulletin affects a taxpayer's right of appeal on any point.

Letters on any article appearing in Tax Bulletin should be sent to the Editor, Mr Shell Makwana, Room G7, New Wing, Somerset House, Strand, London, WC2R 1LB or e-mail Shell.Makwana@ir.gsi.gov.uk. We are sorry though that neither he nor our contributors will normally be able to enter into correspondence about Tax Bulletin or its contents.

Subscription

The subscription for 2004 is £22. If you would like to subscribe to Tax Bulletin please send your name and address together with your cheque to Inland Revenue, Finance Division, Barrington Road, Worthing, West Sussex BN12 4XH. Cheques should be crossed and made payable to "Inland Revenue".

If you would like information regarding Tax Bulletin subscription or distribution please contact Mrs Sylvia Brown,

Room G7, New Wing, Somerset House, Strand, London, WC2R 1LB. Telephone: 020 7438 6373. For more general information regarding Tax Bulletin, please contact Mrs Jayne Harler, Assistant Editor, on 020 7438 7842 or at the address provided above.

Copyright

Tax Bulletin is covered by Crown Copyright. There is no objection to firms copying the Bulletin for their own use. Anyone wishing to republish Tax Bulletin or extracts more widely should write for permission to Miss Glenda Bishop, Room G12, New Wing, Somerset House, Strand, London,