Self Assessment:
Section 148 ICTA 1988:
Schedule 7 FA 1997 (Article no longer current)
Self Assessment:
Gilt Interest -- Quarterly Accounting (Article no longer current)
SP 4/85 -- Interest on Loans used to buy Land occupied for Partnership Business Purposes (Superseded by BIM45755 onwards)
Income into Capital (and Visa Versa) (No longer relevant)
Postponed Donations to Charities by Charity Owned Companies (Article no longer current)
UK/US Double Taxation Convention:
interpretations
Double Taxation Relief:
Accrual of Purchase Discount on Loans Repayable on Demand
Partnership Changes and the Herd Basis (Superseded by BIM55610)
miscellaneous
Capital Gains Tax:
Double Taxation Agreements:
Enterprise Investment Scheme (Article no longer current)
Self Assessment
Where appropriate, individuals certify their residence status and domicile as part of their SA return. This article explains how we intend to continue to give guidance and advice on residence status and domicile; the action we will take on receipt of completed forms P85, P86 and initial non-UK domicile claims; and when Section 9A Taxes Management Act (TMA) 1970 enquiries on residence status and domicile aspects may be made.
The SA tax return requires individuals to tell the Inland Revenue about their taxable income and capital gains. Because taxation of particular items of income or gains can depend on the individual's residence or domicile, people who regard themselves as not resident, not ordinarily resident or not domiciled in the UK will need to self-certify their status in their SA tax return. Where appropriate, individuals will need to complete the "NON-RESIDENCE ETC" pages NR1 and NR2 and submit these as part of their SA tax return.
"Notes on NON-RESIDENCE ETC" pages are available with the SA tax return. These notes are intended to help individuals to decide their residence status or domicile position. And they will help individuals to complete the "NON-RESIDENCE ETC" pages NR1 and NR2. These notes are particularly comprehensive and include, for example:
Because individuals will, in appropriate cases, self- certify their residence status on their SA return, there is no need for the Inland Revenue to give a prior 'ruling' on an individual's residence status. And so we have changed our procedures regarding such residence 'rulings'. We will continue to ask individuals for information about their residence or ordinary residence status. But neither tax offices nor Financial Intermediaries and Claims Office (FICO) intend to provide residence 'rulings' as we have done in the past.
Given that individuals will decide what they regard their residence status to be, we propose to end our existing practice of advising an individual in the fourth year of the consequences of continuing to make regular visits to the UK exceeding an average of 90 days per year.
Tax offices will continue to certify residence -- for example, certifying a formal claim form issued to the inindividual by the foreign tax authority -- to enable UK resident individuals to obtain relief from foreign tax under the terms of a Double Taxation Agreement.
We recognise that an individual may give us information about his/her residence position, for example on form P85 or form P86. We will use this information:
In these and similar situations, we will normally act on the basis of the information the individual provides and treat the residence position accordingly. Tax offices will be prepared to tell individuals how the residence position has been treated for coding or repayment purposes. We do not regard that as deciding the individual's residence status. In appropriate cases, we may make enquiries into an individual's residence status as part of an enquiry into the return once it has been received.
Initial non-domicile claims may be made on form DOM 1, form P86 or in the SA tax return. We will continue to deal with initial non-domicile claims which are made before we have received the return for the year in which the claim is made. And we will let claimants know how their claim to be non-domiciled in the UK has been treated. But we may ask questions to check the validity of the claim as part of a formal Schedule 1A TMA 1970 enquiry into the claim or as part of a Section 9A TMA 1970 enquiry into the SA tax return.
Code of Practice 10 -- "Information and advice" -- sets out the Revenue's position with regard to the provision of general information and assistance, and specific advice. There are a number of leaflets available on residence issues including, for example, booklet IR20 "Residents and Non-Residents," which explain the residence rules and their effect on an individual's liability. Individuals who would like further information or help in deciding their residence status can continue to contact FICO for guidance.
In some limited circumstances, FICO will give specific advice on an individual's residence status if asked to do so. In particular, FICO will be prepared to give specific residence advice on complicated issues. Answering the Yes/No questions in the "Notes on NON-RESIDENCE ETC" pages of the SA tax return will give the correct residence status in the vast majority of cases. But it was impossible to design these questions to deal with every single scenario. Bearing that in mind, individuals whose circumstances are especially complicated, and fall outside the scope of the guidance in the "Notes on NON-RESIDENCE ETC" pages, can ask FICO for specific residence advice. Details regarding the information individuals should supply when asking for such specific advice are set out on page 6 of Code of Practice 10.
Queries about residence status cannot of course be Section 9A TMA 1970 enquiries if they are made before the return is submitted. But if we have enquired into and agreed an individual's residence status after receipt of forms P85, P85(S) or P86 but before the SA tax return is submitted, in practice we would not normally take up the question again on receipt of the return.
With domicile it is likely that ticks in boxes 9.5 and 9.28 on the "NON-RESIDENCE ETC" pages of a return will prompt a review of an individual's domicile which may lead to the issue of a Section 9A TMA 1970 enquiry. And we may issue a form DOM 1 as part of a Section 9A TMA 1970 enquiry into the return. But where, for example, an individual:
we are unlikely to issue an enquiry into the domicile position.
A tick in box 9.29 of the "NON-RESIDENCE ETC" pages is also likely to prompt a review of an individual's domicile and the issue of a Section 9A TMA 1970 enquiry. At that stage we will review the individual's domicile from the date of any change in circumstances. In line with current practice, but depending on the circumstances of any particular case, we may only change the basis of assessment from 6 April following the date of change in domicile. Where it is difficult to pinpoint a precise date of change in domicile (and again depending on the circumstances of any particular case), the change to the basis of assessment may take effect from the 6 April following the date our enquiries are concluded.
If an individual completes and files the supplementary "NON-RESIDENCE ETC" pages fully disclosing all the relevant information with his or her tax return then, after the statutory period for enquiring into the return has expired, the Revenue would not be able to challenge the individual's residence status or domicile for the purposes of calculating the tax liabilities shown in that return. That is, unless we subsequently receive or find information enabling us to make a discovery on the grounds of inadequate disclosure or fraudulent or negligent conduct on the part of the individual.
Should you require any further information on the issues covered in this article, contact:
Financial Intermediaries and Claims Office (FICO)
Residence Advice and Liabilities
Unit 373, St John's House
Merton Road
Bootle
Merseyside L69 9BB
Telephone: 0151-472-6236 or 6258
This article gives information on the operation of the arrangements, which were announced in the Inland Revenue Press Release of 17 March 1997, for taxing continuing non-cash benefits -- such as a car or a beneficial loan -- provided as part of an employment termination settlement. That Press Release outlined an alternative to the strict approach for taxing such benefits.
The approach following the strict interpretation of Section 148 Income and Corporation Taxes Act (ICTA) 1988 requires taxpayers to provide in their self assessment for the year of termination, an estimate of the value of the right to receive continuing benefits. The value of this right is taxed in full for that year.
The strict approach can cause practical problems for both taxpayers and the Revenue, so an alternative, available at the taxpayer's option until the time allowed for making and amending a self assessment has elapsed, is being offered. This alternative values the benefits year by year only when received or enjoyed, with the value being calculated each year by reference to the provisions of Section 596B ICTA 1988 (which largely follow the 'cash equivalent' rules for employee benefits in Sections 154-168F ICTA 1988). That value is then taxed for the year of termination. Where the benefit is received in a year after termination, it is taxed under non-Self Assessment (SA) procedures.
The alternative approach is available for settlements where the employment is terminated in 1996-97 or 1997-98. It is anticipated that proposals to amend Section 148 to provide an appropriate legislative basis for terminations in subsequent years will be brought forward for consultation later this year.
Where taxpayers follow the strict method they should include in their SA return (or amended return) for the year of termination (1996-97 or 1997-98):
These amounts will be taken into account in the self assessment for all purposes, including the calculation of any payment on account that may be due in the year following termination. Once the self assessment is final no adjustment to the valuation of the right to benefits can be made, irrespective of the extent to which the expected benefits are in fact enjoyed in future years.
Where cash instalments are received in years following the year of termination, taxpayers will be taxed (for the year of termination) as and when those payments are received. These payments should not be included in the self assessment for the year of termination or for the year of receipt but will need to be reported to the Revenue (see 'Payer reporting procedures' below).
If a taxpayer chooses the alternative basis, the SA return for the year of termination (1996-97 or 1997-98) should include:
These amounts will then be taken into account in the self assessment for the year of termination for all purposes, including the calculation of any payment on account that may be due in the tax year following termination.
Cash payments made in years after that of termination are dealt with in the same way as for the strict approach, which means that an assessment (or further assessment) outside the SA regime will be made for the year of termination. This assessment will also include the value of benefits received or enjoyed in that later year, calculated using the cash equivalent rules at 2 above relevant to that year.
Such assessments will be made and issued by the tax office. The self assessment will not be affected. If cash or benefits continue for several years, then several further assessments may be necessary.
As the Press Release indicated, if a benefit continues for a number of years it is possible that the tax charge under the alternative arrangements may exceed what would otherwise have been charged. It will be open to taxpayers who have opted for the alternative basis, but subsequently show that this is resulting in their paying more tax than they would have paid under the strict basis, to have the tax limited accordingly. Claims to this effect should be made within the normal appeal time limits -- which, in relation to amounts assessed under assessments (or further assessments) made by the tax office, will be within 30 days of the date of the assessment (or further assessment). Such claims will clearly involve the taxpayer in providing a valuation on the strict basis.
If the claim is accepted, the amount charged to tax will be restricted accordingly. Any tax that has been overpaid can be repaid.
Where the alternative option applies, and the benefit is a continuing beneficial loan which is a 'qualifying loan' under Section 160 (1C) ICTA 1988, so that interest relief was available during employment otherwise than by virtue of the loan having been used to purchase an asset for use in the employment, the individual will continue to be regarded as paying 'notional interest' (calculated under Section 160(1)) as well as any actual interest paid on the loan. This means that relief on the notional interest will continue to be available, for example under the mortgage interest relief provisions.
The tax on Section 148 assessments made on cash payments or benefits enjoyed in years after that of termination will be due 30 days from the issue of the notice of the assessment or further assessment. Interest will run from that date on any unpaid tax.
Any repayment supplement due in relation to tax paid on assessments made under Section 148 will be calculated from the date of payment of the tax.
Any balance of the exemption unused against earlier payments or benefits will be available against subsequent payments or benefits from the same termination settlement.
Where continuing cash payments, taxable under Section 148, are made for years after termination, the payer should deduct PAYE tax at the basic rate for the year of payment. This tax will be credited when making any non-SA assessment on the ex-employee and should be excluded from the self assessment calculations.
Paragraph 149 of the Employer's Further Guide to PAYE and NICs (Booklet CWG2 (1997)) advises employers to contact the tax office if they know that they will be providing anything other than cash to departing employees. PAYE may need to be operated in some circumstances, most commonly where the provisions of Section 203F-L ICTA 1988 apply, but in general there is no requirement on payers to deduct PAYE in respect of a continuing post-termination non-cash benefit. However, if payers and recipients are content, it may be convenient for payers to make such deduction if sufficient cash to account for PAYE on the value of such benefits -- as well as on the cash itself -- is being paid alongside the benefits.
There is a requirement under Section 148(7) for payers to notify the Revenue of payments made each year. In strictness this may place an obligation on the employer to make a further return for each year after the year of termination in which a cash payment is made; as regards benefits, the legal requirement is only to report, at termination, the expected benefit(s) payable.
In practice, however, for terminations in 1996-97 and 1997-98 (and apart from the end of year PAYE return of tax deducted from payments), the Revenue will not require payers to provide continuing details of cash payments made each year. But it would be helpful if payers could provide to the Revenue, once the termination settlement has been agreed, information about payments and benefits in the year of termination and of the planned payments and benefits to be provided for the future.
Illustration of alternative approach
On 6 July 1996 an employment is terminated and a Section 148 compensation settlement is made, consisting of a lump sum of £10,000, plus £15,000 a year cash instalments for five years, together with the continued use of a car whose annual benefit, valued under Section 157 ICTA 1988 rules, is £4,000.
In 1996-97 the ex-employee receives, for Section 148 purposes, the lump sum of £10,000, plus £15,000 cash and three quarters of one year's car benefit, that is, £3,000 (the one quarter of one year's car benefit up to termination -- £1,000 -- is taxed as an employee benefit under Section 157), a total of £28,000. This is fully covered by the £30,000 exemption.
In 1997-98 he receives £15,000 cash and a full year's car benefit -- assumed to remain at £4,000 in that year. A balance of £2,000 remains of the £30,000 exemption. So (assuming that personal allowances have been fully offset against other income) the amount of £17,000 (£15,000 + £4,000 - £2,000) will be charged by the Revenue making an assessment for 1996-97 at the taxpayer's appropriate tax rate for that year, taking into account any PAYE deducted from the further cash payment. The £17,000 is not included in and will not affect the 1996-97 or 1997-98 self assessments nor payments on account for 1997-98 or 1998-99.
In recent years, many companies have decided to pass cash back to their shareholders either by making purchases of their own shares or by paying special dividends. A purchase of own shares (other than by an open-ended investment company or authorised unit trust (whose units are treated as shares for certain purposes)) is, of course, a qualifying distribution to the extent that the amount paid out by the company exceeds the repayment of capital in respect of the shares concerned. Increasingly, those transactions were being undertaken in such a way that the company made the qualifying distribution wholly or mainly to persons entitled to payment of the tax credit, so the tax credits paid by the Exchequer were far larger than they would have been had all the company's shareholders been involved on a pro-rata basis. Parliament perceived this as abuse of the imputation system and decided to remove the payable tax credit from certain distributions.
This has been achieved by treating the distributions as foreign income dividends (FIDs) which, although they are qualifying distributions, do not carry payable tax credits. There is no motive or purpose test in the legislation. Any distribution is subject to the new treatment if it is within the scope of the legislation. The legislation is found at Schedule 7 Finance Act 1997. All references in this article are to Schedule 7 unless indicated otherwise. The article summarises the main points of the legislation, and then addresses some of the questions that have been raised. Most of the article is devoted to the scope of the legislation and various illustrative examples are given at the end.
The qualifying distributions made by UK resident companies which are reclassified as FIDs where the distribution is made on or after 8 October 1996 are:
although the application of the legislation is subject to a number of exceptions.
Questions have been raised about the scope of paragraph 1(3). The legislation is not as widely drawn as some commentators have suggested. It requires there to be arrangements made whereby a specified matter is made referable to a transaction in securities.
It is not enough that a specified matter can be related to a transaction in securities. For example, a company may issue ordinary shares -- the issuing of those shares is a transaction in securities. Without that share issue, dividends could never be paid out but that is not sufficient to bring the dividends within the scope of Schedule 7. The reason for that is that dividends might never be paid on the ordinary shares. There is no entitlement to a dividend of a particular amount at a particular time. Declaration and payment of dividends depend on the company having distributable reserves, and the directors deciding that the company should pay a dividend. It cannot be said that a specified matter has been made referable to the share issue.
The specified matters referred to in paragraph 1(3) are given at paragraph 1(4). Sub-paragraph (a) -- whether the distribution is made -- is mainly concerned with options. Sub- paragraph (b) -- the time when a distribution is made -- is concerned with, in particular, the shifting of the timing of dividends. It is not brought into play by reason only that a company has a dividend timetable for its ordinary shares, since no payment at a particular time is assured. Sub- paragraph (c) -- the form of a distribution -- is concerned with the FID/ordinary dividend divide. And sub-paragraph (d) -- the amount -- will normally be in point where the amount of a distribution is fixed in anticipation of a transaction in securities. However, this last matter is sufficiently wide to encompass a preference share dividend, since the amount of the dividend is to some extent made referable to the issue of the share. Because of that the paragraph 5 carve-out disapplies paragraph 1(3) in some circumstances.
As indicated above, a specified matter has to be made referable to a transaction in securities before paragraph 1(3) can apply. There has to be a defined link between the transaction in securities and the specified matter. A mere economic link or coincidence of timing is insufficient to trigger the legislation. Thus the funds for a dividend may come from the sale of a company, but that of itself is not sufficient to bring paragraph 1(3) into play. Paragraph 1(3) can, however, apply in such circumstances if arrangements are made whereby the dividend is made referable to the sale.
"Transaction in securities" has the same meaning as in Chapter 1 of Part XVII of Income and Corporation Taxes Act (ICTA) 1988 and, in the Revenue's view, includes a dividend. Whether the link between a qualifying distribution and another dividend is sufficient to bring Schedule 7 into play will depend on whether there are or have been arrangements by virtue of which any one or more of the specified matters is or was made referable to that dividend. This can only be decided having regard to all the circumstances. The mere fact that the arrangements provide for two dividends of the same amount conceivably payable at the same time is not on its own sufficient to establish that one has been made referable to the other.
Shareholders who receive distributions which are not treated as FIDs under Schedule 7 may be within the scope of the legislation on transactions in securities at Chapter 1, Part XVII (Sections 703-9) where the shares on which the dividend is paid have been acquired in anticipation of the payment of that dividend.
(Examples illustrating the scope of the statute are included at the end of this article.)
A qualifying distribution within the scope of Schedule 7 is treated as a FID for almost all tax purposes (paragraph 2(1) and (3)). Thus, when a distribution is treated as a FID under the new rules, that deemed FID is capable of being matched with distributable foreign profits to achieve a repayment of Advanced Corporation Tax (ACT) under the FID scheme.
An election under the existing FID legislation for a dividend to be a FID cannot be made in respect of a qualifying distribution which is a deemed FID under Schedule 7 (paragraph 2(2)). The reason for this is that the treatment of the two types of distribution in the hands of dealers is different.
Apart from certain exceptions, where distributions within paragraph 1(2) (purchase of own shares etc.) arise to trustees on or after 5 December 1996, paragraph 3 has the effect of taxing those distributions at the rate applicable to trusts, currently 34 per cent. The exceptions apply for trusts which are unit trust schemes within the meaning of Section 469 ICTA 1988, charitable trusts, pension trusts and settlor interested trusts.
Paragraph 12 makes consequential amendments to Section 686 ICTA 1988 to ensure that the way in which relief is given for trust management expenses does not change following the introduction of paragraph 3.
A stock dividend scheme, under which a company provides shareholders with the option of cash or shares, constitutes arrangements whereby the cash dividend is made referable to a transaction in securities. Paragraph 4(1) provides a carve out so that such cash dividends are not recharacterised as FIDs.
A preference share carries a predetermined right to a dividend. If a company declares a dividend, the amount payable on preference shares will normally be within the scope of paragraph 1(3) by virtue of the terms of issue of the share. Paragraph 5(1) provides that a dividend on a fixed rate preference share is not within paragraph 1(3) simply because of the terms of issue of the share. Paragraph 5(2) extends the meaning of fixed-rate preference share, which is otherwise borrowed from Section 95 ICTA 1988, to dividends fixed by reference to a standard published rate of interest.
A company may decide to pay a dividend to its shareholders prior to a sale by them of shares in the company. Paragraph 6 provides a carve out for such dividends. In order to qualify under the carve out the dividend must be paid within 14 days of the sale. It is only relevant where the dividend has been made referable to the transaction in securities. Where that is not the case, for instance where a dividend is paid before contract but there are genuine uncertainties as to completion, then Schedule 7 may not be in point at all.
A manufactured dividend arises where, under a contract or other arrangements for the transfer of UK shares, one of the parties pays to the other an amount representative of a dividend on the shares. Where a manufactured dividend is paid by a UK company, it is treated as if it were a dividend of the paying company. Where it is paid by a person other than a UK company, it is treated as if it were a dividend on the shares transferred.
As such a transfer is a transaction within paragraph 1(3) Schedule 7, all manufactured dividends potentially fall within the scope of that schedule. Paragraph 7(1) prevents this and ensures only manufactured dividends in respect of dividends that are themselves within Schedule 7 are caught.
A manufactured payment representative of a distribution within Schedule 7 is treated for all tax purposes as if it were itself such a distribution. But the detailed rules in Schedule 23A ICTA 1988 for such payments take precedence over this general rule where appropriate. This does not affect manufactured payments made by UK companies which are treated as Schedule 7 distributions made by that company. But it caters, for example, for the different treatment prescribed by Schedule 23A for manufactured payments made by overseas concerns and non-companies.
Dealers in shares, that is those for whom the proceeds of selling shares would be taken into account in computing their trading or business profits, were already subject to special treatment in respect of amounts received from the issuing company on the redemption or buy-back of shares. That treatment, set out in Section 95 ICTA 1988, is expanded by paragraph 8 to include other distributions within the scope of Schedule 7.
As a result, all Schedule 7 distributions and manufactured payments in respect of such distributions are taken into account as part of the trading profits of dealers. Any manufactured payments made in respect of Schedule 7 distributions are deductible in computing those profits. This treatment overrides both the normal tax rules for distributions and the special rules for manufactured payments in Schedule 23A.
Where a dividend is within the scope of Schedule 7, the voucher must provide the same information as for a FID which is not a deemed FID (paragraph 9). Therefore, it must say that the dividend carries no entitlement to a tax credit. But, in addition, it must also say that the dividend is a deemed FID by virtue of Schedule 7. As mentioned above, this information is necessary because in the hands of dealers the treatment of FIDs and deemed FIDs is different.
FIDs which are not deemed FIDs cannot be paid within a Section 247 ICTA 1988 election. But a "deemed FID" dividend can be paid within such an election if:
Where a deemed FID is received by an authorised unit trust (AUT) or open-ended investment company (OEIC) incorporated in the UK, amounts deriving from it which are shown in the distribution accounts of the trust or company as available for distribution to investors must be shown as being available for distribution as FIDs. In addition, if an AUT or OEIC makes a distribution which falls within the scope of Schedule 7, the distribution must be made in the form of a FID.
It is usual on a merger of an AUT with a continuing AUT for the merged AUT to pay a distribution to its unit holders. Such a distribution may be within Schedule 7, as illustrated in example 15. There are special rules relating to conversions of AUTs to OEICs and mergers of AUTs with continuing OEICs. Regulation 25 of the Open- ended Investment Companies (Tax) Regulations 1997 (Statutory Instruments 1997/1154) provides that, in certain circumstances, where an AUT (or sub-fund of an umbrella AUT) converts to an OEIC or a sub- fund of an umbrella OEIC, the exchange of the investors' units for shares will not be a transaction in securities for the purposes of Schedule 7. Broadly, this provision will apply where the AUT (or sub- fund) concerned is subsumed by an OEIC or a sub-fund of an umbrella OEIC and not, for example, where it splits into two or more parts which convert to different sub-funds of an umbrella OEIC. The effect of the provision is that any distribution made by the subsumed AUT (or sub-fund) by reference to the exchange of units for shares will not fall within the scope of Schedule 7.
1. A group may have an internal plan which sets out the preparatory steps that it intends to take in order to be in a position to enter into a transaction in securities. One step may be the payment of a dividend. But the internal plan is not of itself sufficient to constitute arrangements made by virtue of which a specified matter is made referable to the intended transaction. Equally an internal plan showing a dividend which will be paid after a transaction in securities is not sufficient.
2. A joint venture company is set up and issues shares. The arrangement requires the distribution by the company to its members of a certain percentage of profits. The joint venture company might never have profits, and dividends might never be paid. And if they are, they could be of an amount between nil and infinity. Accordingly a specified matter cannot be said to be made referable to the share issue.
3. A company derives all its profits from dealing in shares. There is clearly an economic link between any distribution and those transactions in securities, but that is insufficient to make a specified matter referable to any of those transactions.
4. Any distribution which is part of a scheme of demerger within Section 213, which is not itself protected by Section 213, is likely to be within the scope of Schedule 7 because there will be arrangements whereby a specified matter is made referable to a transaction in securities.
5. A UK parent company issues stapled stock on acquiring an overseas company, so that former shareholders of that target company can opt for dividends from the UK parent. Schedule 7 may apply since the exercise of the option is a transaction in securities to which the dividend is made referable.
6. A company proposes paying a special dividend on the understanding that the shareholders will apply an amount in subscribing for further shares in the company. The dividend is within the scope of Schedule 7, since the dividend is made referable to a transaction in securities, the subscription for the shares.
7. The terms of a recommended offer in relation to a company's preference shares provide for a different price to those who sell the shares cum dividend from that offered to those who accept the offer after the dividend payment date and who sell ex dividend. The amount of the dividend (which is not related to the take-over and was to be paid in any event) will be the same in either case. The dividend is outside Schedule 7 since no arrangements exist by virtue of which the amount, timing etc of the dividend have been made referable to a transaction in securities.
8. A proposed merger between A and B is announced. At the same time the Board of A announce that they have decided to pay a special dividend. This dividend is not conditional upon the merger proceeding and will be paid regardless of whether the merger goes ahead. The terms of the proposed merger are such that B shareholders will not become entitled to payment of the special dividend, regardless of when the merger goes ahead. Again, a specified matter cannot be said to have been made referable to a transaction in securities.
9. A subsidiary declares a dividend but payment is dependent on its having become a member of another group. The shares in the subsidiary are then sold ex dividend so that any benefit from the dividend accrues to the vendor but the ACT paid by the subsidiary is available for set off against the corporation tax liability of the purchasing group. Schedule 7 applies because the timing of the dividend has been made referable (to an extent) to a transaction in securities, namely the disposal of the company's shares.
10. C wants to make a partial redemption of its loan stock and to pay a dividend to shareholders. Various shareholder class meetings are held to approve the proposals, and there is also an EGM. In advance of these meetings, the board of directors state that if any of the necessary resolutions in any of the meetings are not approved, then C will not go ahead with any of the proposals. Schedule 7 applies to the dividend, since arrangements have made it referable to the redemption.
11. D And if they arer for one of its subsidiaries. The sale proceeds would reduce group indebtedness, and also leave D with a significant amount of surplus cash. It is proposed that the cash surplus would be reduced by the payment of a special dividend to all shareholders. The company has existing reserves, which exceed the proposed special dividend. The circular to shareholders and the supporting resolutions seek approval for the disposal and the payment of a dividend. Approval to separate resolutions is required, firstly to accept the offer for the subsidiary and secondly to agree the payment of the dividend. If the special dividend is approved by the shareholders, a specified matter cannot be said to be made referable to the sale of the subsidiary.
12. A company decides to sell a subsidiary, and having given effect to that, then decides to pay a dividend. The dividend is expressed as being "subject to the consideration being received" but this is merely to state the obvious that liquid resources must be available before the distribution can be made. This may constitute a link but a specified matter cannot be said to have been made referable to the sale.
13. A foreign parent intends to spin off a UK subsidiary. The companies want to provide shareholders and markets with information concerning the anticipated dividends to be paid by the parent and subsidiary following the spin off. The UK company intends to include a statement specifying the amount of the next interim and final dividends. If it does so, those dividends are within Schedule 7, since amounts are linked to the sale.
14. A company sells shares in a subsidiary to a member for less than market value, giving rise to a distribution under Section 209(4). If the only transaction in securities is the sale of the shares in the subsidiary for less than market value, the distribution does not fall within the scope of paragraph 1(3) Schedule 7. Although the distribution arises from the transaction in securities, a specified matter cannot be said to have been made referable to it.
15. An AUT merges with a continuing AUT. The final distribution payable by the subsumed AUT may fall within the scope of Schedule 7. It will not fall within the scope of Schedule 7 if the merger takes place on the last day of a distribution period of the subsumed AUT, because a specified matter would not be made referable to the merger. That is because the timing of the distribution concerned would not be determined by the merger.
16. A UK company issues preference shares. The dividend together with the associated tax credit is to constitute a fixed amount. Accordingly the dividend will vary with tax rates, which are outside the company's control. The dividend and tax credit is simply a fixed percentage which is determined by reference to a standard published rate of interest. The dividends satisfy Section 95(5)(c)(i) ICTA by virtue of paragraph 5(2)(b).
17. The terms of issue of a preference share provide for the yearly payment of dividends (which accrue on a daily basis), and for accrued but unpaid dividends to be paid if a redemption of the preference share occurs. Since the transaction in securities simply triggers payment of a dividend which would in any case be payable under the terms of issue of the share, the paragraph 5 exclusion applies to the payment of the accrued dividend.
18. A share carries a dividend which is expressed as a fixed amount in a foreign currency, and is issued on terms which provide a reasonable commercial return. The share fulfils the terms of Section 95(5)(c) ICTA 1988.
19. Redeemable fixed rate preference shares carry a right to a dividend at a market rate payable half yearly in arrears. The shares redeem after a whole number of years, and the final dividend will fall due on the redemption date. Such a dividend will be paid at the same time as redemption occurs, but it is not an amount paid "on the redemption". So payment of such a dividend is within the scope of paragraph 1(3) -- and therefore subject to paragraph 5 -- and not within the scope of paragraph 1(2).
On 4 April 1997, the Board of Inland Revenue laid Regulations (The Income Tax (Schedule 22 to the Finance Act 1995) (Prescribed Amounts) Regulations 1997) (SI 1997 No. 1158) setting financial limits exempting small businesses and relatively small amounts of income from the scope of the anti-avoidance provisions introduced in Schedule 22 Finance Act (FA) 1995.
The provisions exist to prevent exploitation of the transition to the current year basis at the introduction of Self Assessment by shifting income from a normally taxed period into one of the periods to which the transitional rules apply (that is either the 'transitional period' for which profits are averaged, or the 'transitional overlap period' used to identify the transitional relief available). The intention of the legislation is to deter people from carrying out tax driven transactions, whilst not interfering with commercially driven transactions.
In broad terms, Schedule 22 FA 1995 works by first identifying behavioural "triggers" shifting income or expenses so that tax is reduced. Where a trigger is present the rules specify an appropriate counteraction, which removes the tax benefit sought and, in many situations, applies a built-in penalty.
A taxpayer brought within the scope of the anti-avoidance rules by one of the triggers will nonetheless escape counteraction if he or she can satisfy any one of three statutory tests:
It is the final test -- the de minimis test -- which is the subject of this article. The limits have been set at a level which should ensure that the anti-avoidance provisions will only apply to those taxpayers who have sought to gain a significant advantage through exploitation of the transitional rules. (The anti- avoidance rules in Schedule 22 FA 1995 are discussed in more detail in Chapter 10 of booklet SAT1(1995) "The new current year basis of assessment".)
Under the Regulations, taxpayers will be outside the scope of Schedule 22 FA 1995 in any of the following situations.
In the case of the shifting of business profits by an individual where:
or
In the case of the shifting of business profits by a partnership where:
or
In the case of 'partnership refinancing'where:
In the case of the shifting of interest or other income where:
The "aggregate" amount of shifted profit is a net figure. For example, if a change in business methods resulted in two adjustments, an increase in income of £15,000 and an increase in expenses of £6,000 then the net shifted profit is £9,000. This is below the limit of £10,000 and the taxpayer is not caught. It is important to remember that for any particular source of income only one of the limits needs to be satisfied to ensure that the anti- avoidance provisions do not apply to that source.
Although the legislation in Schedule 22 FA 1995 provides for de minimis limits set by reference to the proportion of the shifted profit, interest or other income relative to the total profit, interest or other income of either the transitional period or the transitional overlap period, no such limits were set. We believe that the limits that have been set provide all businesses, including those carried on in partnership, with an adequate level of protection. They exclude low value transactions on which the tax at stake is unlikely to be material, and the many businesses with a low level of turnover which, by their very nature, have little scope for avoidance. For example, over 80% of all self-employed businesses have an annual turnover of less than £50,000.
The limit on the profits shifted for partners is different from the limit for businesses carried on sole because a partnership business cannot simply be regarded as an aggregate of two or more separate businesses. For example, many small partnerships are simply vehicles set up as an efficient way to exploit the talents of a single fee earning partner. In addition, the ability to spread the fees to advisors in setting up any scheme across a number of partners may make a particular scheme tax efficient for partnerships when it would not be so for individuals. The different limits set for partnerships strike a balance between the need to provide a limit in proportion to the number of partners in any partnership, and the fact that the opportunity to avoid material amounts of tax may be greater for partnerships -- particularly the largest professional partnerships -- than for individuals.
Schedule 22 FA 1995 expressly provides for counteraction without penalty if a taxpayer voluntarily discloses a transaction or arrangement which is caught by the anti-avoidance rules. In such cases the taxpayer's 1996-97 tax bill is simply restored to the amount that would have been due if he/she had not attempted to avoid tax by shifting profit.
The purpose of this rule is to encourage taxpayers to be honest with the Revenue, rather than remaining silent in the hope that a doubtful point will not be tested in an enquiry. With this in mind Inspectors have been told that where:
then the 1996-97 self assessment should be revised but without penalty.
Under Self Assessment, as now, enquiry work will be targeted on those cases where there may be tax at risk. So taxpayers can expect Inspectors to raise enquiries where, for example, it appears from the pattern of business results that there may have been a trigger event involving sums in excess of the de minimis limits but box 3.8 is not ticked or where there is an admitted trigger event and the Inspector wishes to check that a let out applies. These rules are no different from any other aspect of the law so we expect them to be administered sensibly and that Inspectors will not be over zealous.
Consider a taxpayer whose business in the two years to 30.6.96 had a turnover of £35,000 and £60,000 respectively. The average annual turnover (ignoring the leap year) in the transitional period is £47,500 ((£35,000 + £60,000) x 50%). This is below the de minimis limit of £50,000 and Schedule 22 FA 1995 will not apply.
If turnover for the two years to 30.6.96 had been £45,000 and £60,000 respectively then the average annual turnover is (approximately) £52,500 ((£45,000 + £60,000) x 50%). This is above the de minimis limit of £50,000 and Schedule 22 FA 1995 may apply, but only if the taxpayer HAS artificially shifted profit AND none of the other de minimis limits or let outs apply.
Consider a taxpayer who has carried out a single transaction which shifted profit of £8,000 into the transitional period. This is below the de minimis limit of £10,000 and Schedule 22 FA 1995 will not apply.
But if the taxpayer also carried out a second artificial transaction, which shifted profit of £4,500 into the transitional period, the aggregate amount of shifted profit would be £12,500. This is above the de minimis limit of £10,000 and Schedule 22 FA 1995 may apply, BUT only if none of the other de minimis limits or let outs apply.
If a partnership comprised the same three members throughout the transitional period the de minimis limit for that partnership will be £7,500 x 3 = £22,500.
If, however, the maximum number of partners in the transitional period was 50 then the de minimis limit for that partnership will be (£7,500 x 20) + (£1,000 x 30) = £180,000.
The taxpayer is a partner in a partnership which draws its accounts up to 31 December each year. On 1/7/94 the partner takes out a loan of £300,000 which is advanced to the partnership to enable it to pay off a business loan. The partner pays interest and claims relief under S353 ICTA 1988 as follows:
1994-95 £21,000
1995-96 £28,000
1996-97 £28,000
Interest falling in transitional period is:
£7,000 (paid 1/1/95-5/4/95)
£28,000 (paid 6/4/95-5/4/96)
£21,000 (paid 6/4/96-31/12/96)
Total £56,000
The aggregate interest paid in the transitional period (1/1/95-31/12/96) is above the de-minimis limit of £15,000 and IF none of the other let outs apply a restriction of interest relief under Schedule 22 will be appropriate.
We have been asked to clarify the requirement for those taxpayers whose annual turnover exceeds £15,000 to include SAI in their returns.
Section 8(1) Taxes Management Act (TMA) 1970 requires a taxpayer who has been issued with a statutory notice to make "a return containing such information as may reasonably be required." And Section 113(1) TMA 1970 provides that any return "shall be in such form as the Board prescribe." For any trade or profession the 'information as may reasonably be required' includes details of business income and expenditure. And for most Self Assessment (SA) taxpayers the prescribed form for this information is SAI. Section 8(1) TMA 1970 requirement is only satisfied by filing a return in the prescribed form. Are turn which omits the completion of the SAI boxes in circumstances where they should have been completed will fail to comply with the notice to make a return.
We have also been asked if completing only the SAI boxes covering 'turnover', 'other expenses' and 'net profit', and attaching the accounts and computations, satisfies the filing requirement. Except in the case of partnerships having a turnover of £15 million or more, the submission of accounts and computations in addition to the return is not relevant to the question of whether the filing requirement is satisfied. Our view is that a return in which the SAI is only partially completed is not made in the prescribed form, and it will therefore not comply with the notice to make a return. If the return is not fully completed before the date by which it is to be filed, then automatic penalties under Section 93 TMA 1970 (Section 93A in the case of a partnership) will apply.
We will apply the same criteria to returns submitted via the Electronic Lodgement Service as to those submitted in paper form.
Since 2 January 1996, companies holding Government securities (gilts) in STAR accounts at the Central Gilts Office of the Bank of England have received the interest paid on those gilts without tax being deducted at source. These arrangements are also open to Lloyd's syndicates and other 'eligible persons' such as UK exempt bodies.
Companies and Lloyd's syndicates (but not other eligible persons) then have to account quarterly for lower rate tax on the gross gilt interest they have received. Companies do this as part of their normal CT61 returns.
Details of these arrangements, which were introduced to facilitate the open gilt repo market which started on 2 January 1996, were set out in Tax Bulletin Issue 19 (page 250, October 1996).
Interest on those gilts which pay gross to all holders (as a result of a Treasury direction made under Section 50 Income and Corporation Taxes Act (ICTA) 1988) is not included in quarterly accounting. Until recently the only gilts this applied to were:
The purpose of this article is to draw attention to the fact that, to fit in with the Bank of England's plans for a market in gilt strips to start later in the year, there are now additional gilts which pay gross to all holders.
The gilts concerned are those which will be capable of being stripped once the gilt strips market starts. Paying the interest on such gilts gross is necessary to prevent tax considerations distorting the strips market. To pave the way for the strips market, the interest on an additional 7 gilts (in relation to which Section 50 directions have been made) is being paid gross to all holders from 7 June 1997 onwards.
The gilts concerned are:
The interest paid on these gilts on or after 7 June 1997, together with any manufactured interest received or paid in relation to such gilts, should accordingly be excluded from quarterly accounting returns.
This list will grow as other gilts are made strippable, or issued on strippable terms.
SP 4/85 was introduced to cover situations where individuals took out loans to buy land or property which is then occupied rent- free for the purposes of a trade carried on by a partnership or company of which the borrower was a partner or director. Because the land was occupied rent-free the interest was often paid by the trading entity rather than by the individual borrower.
At the time the Statement of Practice was formulated there was some doubt as to whether the trading entity could get relief for the payment. The aim of Statement SP4/85 was to ensure that the trading entity obtained a deduction for the payments of interest. In the case of partnerships, this was achieved by treating the payment of interest as rent in the hands of the partner who made the property available. This 'rental income' was in turn covered by the interest relief available under Sections 353 and 355(1)(b) Income and Corporation Taxes Act (ICTA) 1988, which ensured that the landlord's tax position was the same as if rent had actually been paid to him and used to fund his liability for interest on the loan. The payment was also regarded as rent payable by the partnership in the calculation of any capital gains tax (CGT) retirement relief available to the partner who made the property available.
There was a corresponding practice where a company occupied a property owned by one of the directors. We have now reviewed our practice in this area following changes made to primary legislation since SP 4/85 was first published. In particular the new Schedule A rules applying for income tax purposes, introduced by Section 39 and Schedule 6 Finance Act (FA) 1995. The Revenue's view of the status of the payments made by the trading entity following these legislative changes is as follows.
When considering whether the partnership or company can claim the payment of interest as a trading expense, the normal rules in Section 74(1)(a) ICTA 1988 will apply. Where the payment arises from the occupation of property used solely for trading purposes it will ordinarily constitute an allowable deduction in the trading profits. There will of course be some exceptions -- for example, where the interest payments exceed ordinary commercial consideration for the use of the property in the course of trade, it is unlikely they will have been incurred wholly and exclusively for the purposes of the trade. Or if the interest payments are in respect of a property used partly for business and partly for some other purpose, such as private occupation by a business proprietor, the deductions for tax purposes will be restricted to the business proportion.
For 1995-96 and subsequent years of assessment, the concept of a 'Schedule A business' has been introduced. The computational rules found in Case I of Schedule D are imported into new Schedule A and receipts of the Schedule A business may include payments in kind such as payments of interest by a trading entity (whether a partnership or company) on behalf of the proprietor of that Schedule A business. However, a deduction may be given to the proprietor for interest payable even though it is in fact paid by someone else. The landlord will have an obligation to pay interest and that interest will have been paid by the tenant. We would therefore generally expect, following normal accountancy principles, to treat the proprietor's Schedule A profit in relation to this Schedule A business as nil.
Paragraph 8 of SP 4/85 suggests that in the case of a company paying interest on the director's behalf, the amounts so paid out may be treated as part of the director's Schedule E emoluments. We take the view that such a charge is unlikely to arise in practice. In most circumstances there will be no charge under Section 19 ICTA 1988 because the payment will not represent an emolument "from" employment. Similarly, if the payment of interest by the company is no more than fair commercial consideration for the use of the property there will be no benefit within the scope of Section 154 ICTA 1988.
Finally, changes have been made to CGT retirement relief since SP 4/85 was introduced. Paragraph 10(3) of Schedule 6 to the Taxation of Chargeable Gains Act 1992 will now operate to preserve the restriction of retirement relief which SP 4/85 set out.
The combination of these changes means that the Revenue's practice in relation to the old law, as set out in SP 4/85 is now achieved automatically under current legislation. We have therefore taken the view that SP 4/85 is obsolete.
Finance Act 1997 included provisions targeting transactions designed to turn income into capital or capital expenditure into a revenue deduction. If a particular transaction is known to the Revenue but not the subject of specific legislation, the inference is sometimes drawn that the Revenue are somehow "content" with it. This is not necessarily so. An alternative inference might be that the Revenue expect the arrangements to be susceptible to challenge under existing law. The purpose of this article is to say something about a type of property transaction which, in part, relies on converting income into capital.
A simplified example involves the use of an intra-group lease of land and the sale of the entitlement to the rental stream (but not the lease itself) to a financial trader for a defined period. The effect of the transaction is that it is a loan in substance but not in form. The perceived asymmetry is that the sum paid for the rental stream, it might be argued, constitutes a capital receipt in the hands of the vendor but an allowable expense in the hands of the purchaser.
The Revenue are considering whether such arrangements work. In particular, the Revenue will wish to test whether, in the hands of the vendor, the receipt is more properly assessable under Schedule A and/or whether, in the hands of the purchaser, adjustments would be needed in the tax computations for the sums charged in the purchaser's accounts in respect of the cost of the rental stream.
This article has been triggered, in part, by a perception that most companies will be influenced in their tax planning by an awareness of the likely attitude of the Revenue and an assessment of the chances of success. Where other schemes or arrangements are brought to our attention in the future, similar articles may follow. Comments should be sent to:
Special Investigations Section
Room 420
22 Kingsway
London
WC2B 6NR
In this article we outline how the new legislation for charity owned companies works and answer some of the most frequent questions we have been asked about it.
Wholly owned companies are often set up by charities to carry out certain activities which might result in an income tax or corporation tax liability if these activities were carried out by the charities themselves. This is because some activities fall outside the tax exemptions afforded to charities by Section 505(1) Income and Corporation Taxes Act (ICTA) 1988 and Section 256(1) Taxation of Chargeable Gains Act (TCGA) 1992. An example of such an activity would be trading in goods or services which do not fall within the charitable purposes of the charity. These companies normally enter into a profit-shedding deed of covenant with the parent charity under which they pay to the charity a sum equivalent to the profits assessable to corporation tax. Other deeds may provide for a percentage of the taxable profit to be paid, or even a fixed amount.
Before the introduction of this new legislation, companies owned by charities, like all other companies, could only claim a deduction for a charge under Section 338(1) ICTA 1988 in the accounting period in which the charge was paid. They were therefore obliged to estimate their corporation tax profit by the end of the accounting period and make an estimated payment under the deed of covenant to the parent charity. For obvious reasons estimation often proved difficult.
If the company overestimated the amount of its corporation tax liability, there would not be a tax problem. The charity could arrange with its subsidiary to set off the excess tax repaid to the charity against the tax overpaid by the company, once the corporation tax profit had been settled ('estimate and pay'). If, however, the company under-estimated the amount of its corporation tax profit, corporation tax would be due on the difference between the finalised corporation tax profit and the estimated amount paid over to the charity under the deed.
Under the new provisions in Section 64, charity owned companies now have nine months from the end of the accounting period in which to 'top up' an underestimate of the amount payable under the deed of covenant, yet still get the deduction against the corporation tax profits of the accounting period in which the payment was due.
The new provisions in Section 64 are to be inserted as Sub-sections (7AA), (7AB) and (7AC) in Section 339 ICTA 1988.
Section 64(1)(7AA)(a) Finance Act 1997 applies the new provisions to companies which are wholly owned by a charity. Sub- sections (7AB)(a) and (b) and (7AC)(a) and (b) defines what is meant by "wholly owned by a charity."
In the case of a company limited by share capital, all the ordinary share capital must be owned by one or more charities. The share capital can be owned directly or indirectly (through an intermediate company, for example). Section (7AC)(a) applies the control test in Section 838 ICTA 1988, expanded to allow for ownership by a charity which is a trust for tax purposes.
The provisions in Section 64 are not confined to share capital companies. Some companies controlled by charities are companies limited by guarantee. Sub-section (7AB)(b) provides for them too to be included in the provisions. If :
is a charity or a company wholly owned by a charity, then a company limited by guarantee can fall within the provisions of Section 64. The Memorandum and Articles of a company limited by guarantee will normally indicate if the company meets the conditions outlined above.
Although most charity owned companies pay to the charity under a profit-shedding deed, Section 64 is not confined to this type of deed. A deed providing for payments of fixed amounts would also be within the new provisions if the other conditions are met. What is important is that the deed must require the payment to be made IN the accounting period. It is therefore necessary to ensure that any new deeds entered into do not require the payment to be made after the end of the accounting period in question.
In order to fall within the provisions of Section 64 the payment must meet the requirements of Section 339(7) ICTA 1988. In other words, to be a charge within Section 338 ICTA 1988 the company making the payment to the charity must deduct income tax and account for the tax under Schedule 16 ICTA 1988 using Form CT61(Z). Although the payment will be deemed by the new provisions to be a charge in the accounting period in which it was required to be made under the terms of the covenant, for Schedule 16 purposes the amount should be entered on the CT61(Z) for the return period in which it was actually paid.
As stated above, the company must make the postponed payment due under the deed within nine months of the end of the accounting period in which the payment was due.
The new provisions in Section 64 are applicable to donations made in accounting periods beginning on or after 1 April 1997 (Section 64(2) FA 97). They operate in relation to the accounting period in which the payment is made, not the accounting period in which the payment is due under the deed. Also, the operative date for Section 64 will depend on the date on which the accounting period of a company commences.
The workings of the new provisions are best illustrated by the following examples:
A charity owned company has entered into a profit-shedding deed of covenant with its parent charity. Its accounting periods commence on 1 April. Each year and end on 31 March. In relation to which accounting period can the provisions of Section 64 first operate?
The company can make a postponed payment required under the deed for the accounting period 1 April 1996 to 31 March 1997, provided the payment is made by 31 December 1997.
The first accounting period for this company commencing on or after 1 April 1997 is 1 April 1997 to 31 March 1998. The company can therefore make a postponed payment required by the deed for the accounting period ended 31 March 1997 in the next accounting period (i.e. that ending on 31 March 1998), provided the payment is made within 9 months of the end of the accounting period 1 April 1996 to 31 March 1997 (i.e. by 31 December 1997).
A charity owned company has entered into a profit-shedding deed of covenant with its parent charity. Its accounting periods commence on 1 January each year and end on 31 December. In relation to which accounting period can the provisions of Section 64 first operate?
The company can make a postponed payment required under the deed for the accounting period 1 January 1997 to 31 December 1997, provided the payment is made by 30 September 1998.
The first accounting period for this company commencing on or after 1 April 1997 is 1 January 1998 to 31 December 1998. The company can therefore make a postponed payment required by the deed for the accounting period ended 31 December 1997 in the next accounting period (i.e. that ending on 31 December 1998), provided the payment is made within 9 months of the end of the accounting period 1 January 1997 to 31 December 1997 (i.e. by 30 September 1998).
Q1. Can a charity owned company wait to pay all the amount due under the deed until after the end of the accounting period in question?
A. This is not a matter on which we can comment. Deeds of covenant are matters of general law. As far as the taxation treatment is concerned, however, the payment will fall within the provisions of Section 64 provided all the conditions in that Section are met.
Q2. My company has a deed requiring payment by the end of the accounting period. Can I arrange to cancel the old deed and replace it with a new one requiring payment 9 months after the end of the accounting period?
A. This is not advisable. Payments will not fall within the Section 64 provisions if this is done. Section 64 (1)(7AA)(c) states that the covenant under which the donation is made must require the payment to be made in an accounting period ending before the time (i.e. date) when the payment was actually made.
Q3. Will the 'estimate and pay' procedure cease?
A. No, it will not. The provisions in Section 64 are designed to address the problem of charity owned companies underestimating their corporation tax profits and paying too little to the charity within the accounting period, thereby ending up with corporation tax to pay. They are not designed to replace the 'estimate and pay' procedure.
Q4. Does the new legislation apply to qualifying donations made under the gift aid scheme?
A. Section 64, responding to requests from the charitable sector, makes it easier for companies to covenant their profits to their parent charities. It does not apply to qualifying donations under the Gift Aid Scheme. FURTHER INFORMATION
If you have any queries on Section 64, please contact:
Charity Technical Section
Unit 380D
T&R2, Financial Intermediaries and Claims Office
St John's House
Merton Road
BOOTLE
Merseyside
L69 9BB.
Tel. 0151 472 6046
Fax 0151 472 6068
Over the last few months we have been considering the treatment of United States limited liability companies (LLCs) under the Double Taxation Convention between the United Kingdom and the United States (the Convention).
Generally speaking, United States federal income tax is charged on the profits of LLCs on the basis that they are fiscally transparent, ie tax is imposed on the members of the LLC and not on the LLC itself.
However, for the purposes of United Kingdom tax we have taken the view in relation to those LLCs that we have so far considered that they should be regarded as taxable entities and not as fiscally transparent. Accordingly we tax a United Kingdom member of a LLC by reference to distributions of profits made by the LLC and not by reference to the income of the LLC as it arises. If tax is paid in the United States on the profits of the LLC, we regard that tax as underlying tax and credit relief is available for it if the member is a United Kingdom company which controls, directly or indirectly, at least 10 per cent of the voting power in the LLC.
If a LLC derives income from the United Kingdom, the question arises of whether it is entitled to claim relief from United Kingdom tax under the Convention. A key issue is whether, under the conditions laid down in the Convention, which in this respect does not follow the approach of the OECD Model, the LLC can be said to be a resident of the United States. In our view a LLC cannot be said to be a resident of the United States within the terms of the Convention: it is not a United States corporation, nor is it a person resident in the United States for the purposes of United States tax (because the United States taxes the profits of a LLC not on the LLC itself but on its members).
However, we have decided as a matter of practice that, in order to relieve double taxation under the Convention where tax would otherwise be imposed on the same income both in the United Kingdom and in the United States, we will accept claims to relief from United Kingdom tax under the Convention from a LLC, but only to the extent that the income in question is subject to United States tax in the hands of those members of the LLC who are residents of the United States.
Section 90 Finance Act 1997 inintroduced a new Section 801A Income and Corporation Taxes Act (ICTA) 1988. The new Section restricts double taxation relief for underlying tax in cases where a claim to credit relief is made as part of an avoidance scheme. The following indications of Revenue practice in connection with the new legislation are intended to be of assistance to practitioners when considering transactions undertaken by clients who have interests in overseas companies.
Concerns have been expressed about the application of Section 801A(7). We can confirm that we would not regard a company acquired "off the shelf" as not having been under the control of a UK company at any time by reason only of the fact that it was owned by a company formation agent throughout the period between its incorporation and its acquisition by the UK company. Also generally speaking, we accept that a company is not caught if there was a time before the doing of anything as part of, or in pursuance of, the avoidance scheme when it was under the control of the UK company. However, we will not necessarily be bound to adopt that approach in a case involving a company that was under the control of the UK company in the past, which then ceased to be so and in which an interest is subsequently acquired as part of, or in pursuance of, an avoidance scheme.
The simple introduction of a new "mixer" company into an existing group would not of itself trigger the new legislation, assuming that it does not form part of an avoidance scheme within Section 801A. Equally, the new rules will not apply in cases where the acquisition of an interest in a highly-taxed company is not, or is not part of, a scheme or arrangement having as its purpose, or as one of its main purposes, obtaining relief for underlying tax, even though the interest may, at the time of acquisition or later as a result of an intra-group reorganisation, be held through a "mixer" company.
Of course, each case must be examined by reference to its own particular facts. We may also have to reassess the position if new schemes come to light which are designed to circumvent Section 801A, especially if they seek to take advantage of our practice as set out above. We will publish any new or revised approach to the application of Section 801A.
An enquiry where, in a particular case, there is concern that a bona fide commercial acquisition might lead to a restriction of relief under the new rules may be referred to:
International Division
(Double Taxation)
3rd Floor
Strand Bridge House
138-142 Strand
London
WC2R 1HH
The enquiry must identify all the parties concerned, the full details and the purposes of the transactions that are the subject of the enquiry and the reasons why it might be thought that Section 801A will apply.
[S801A ICTA 1988]
Finance Act (FA) 1996 introduced new rules for taxing profits, gains and losses from loan relationships in the hands of companies. Loan relationships are, essentially, all debts apart from trade debts for goods and services. This article concerns the treatment of debt where the purchaser is connected with the debtor under Section 87 FA 1996. Where there is a connection, the purchaser must assume that the debt is repayable in full (bad debt relief is not generally available between connected parties). The question arises of how the purchase discount ought to be treated where, as is often the case, the loan is repayable on demand.
We have amended our original view that all purchased loans repayable on demand had to be shown immediately at full value. This would have produced an immediate credit of the difference between acquisition cost and full value.
We now accept that in some circumstances the legislation does not require that the full amount of purchase discount on a loan repayable on demand should be brought into account as a credit in the accounting period of acquisition. The problem is in deciding the period to which the discount on a loan repayable on demand should be said to relate for the purposes of Section 85(3)(a) FA 1996. We think it is reasonable to take into account the prospects of the demand for repayment being made. Where normal accountancy practice would not operate to recognise discount in the accounting period of acquisition, whether or not the debt was doubtful, immediate recognition of this profit for tax purposes may also be inappropriate. Where the parties to the loan relationship are connected persons the requirement remains that the accounting method must assume that all amounts will be paid in full without relief for bad or doubtful debts. This means that discount should start to be recognised on a time-scale which would be realistic for a loan repayable on demand which was neither bad nor doubtful.
[S87 FA96]
We explained in Tax Bulletin Issue 3 (page 20, May 1992 ) that a fresh herd basis election is required after a change in the membership of a partnership if herd basis treatment is to continue. We have been asked whether the changes to Section 113 Income and Corporation Taxes Act (ICTA) 1988 introduced as part of the preparation for Self Assessment remove this requirement.
Schedule 5 ICTA 1988 (the herd basis) applies to "animals kept by a farmer." It is clear from paragraphs 2(3) and 5 that in this context, where the farming is carried on in partnership, the partnership is the farmer. Moreover, a partnership before a change in its membership is not the same partnership as that after the change. An election applies to all production herds of the class concerned kept "by the farmer making the election."
Under the new Self Assessment rules, Section 113(2) ICTA 88 disapplies Section 113(1) so that a change in the membership of a partnership does not trigger a cessation and recommencement of the trade. But this does not alter the fact that the farmer carrying on the trade before the change is not the same as the farmer after the change. So the herd is no longer kept by the farmer making the election. It follows that a fresh herd basis election by the new farmer is still required after a partnership change, if the new partnership wants the herd basis to apply. Thus there is no change from the view of the law we set out in the May 1992 article.
There is no special form for making a herd basis election, nor is there a requirement that the election be signed by the farmer. Where it is clear from material submitted to the Revenue within the time limit that a farmer has applied the herd basis, then we would regard an election as having been made. For example, the Help Sheet IR224 which assists farmers in completing the self-employed pages of their returns, suggests that the additional information space on the return is used to record an analysis of herds on the herd basis and details of any adjustments. If this information is provided we would not need a separate election. But if the new partnership wants the herd basis to apply and this is not obvious from the return or other information routinely submitted, a written election stating the class of herd should be made.
[Section 113, Schedule 5, ICTA 1988]
CGT 6, 11, 14 and 16, bearing an imprint date of March 1996, and leaflet CGT 4, bearing an imprint date of July 1995, were all withdrawn from circulation with effect from 31 March 1997.
Introductory guidance on Capital Gains Tax issues is now contained in a revised CGT14 leaflet. The new CGT14 has been completely rewritten and provides a general introduction to Capital Gains Tax for taxpayers who do not receive a Self Assessment (SA) tax return, and for anyone who needs further information to help decide whether they need to complete one. More expansive introductory guidance for those who need to file a SA return is available within the notes supporting the SA Capital Gains pages.
Further CGT guidance on specific aspects of CGT is available to both those who need to file a return, and all other taxpayers, through the new SA Help sheets.
Copies of the new CGT 14 leaflet can be obtained from any Tax Enquiry Centre. The SA Helpsheets can be obtained from the SA Orderline:
telephone: 0845 9000 404
fax: 0845 9000 604
or visit the Online Order Form to order stationery on-line
or by writing to:
PO Box 37
St Austell
PL25 5YN
The new comprehensive Double Taxation Convention between the UK and the Russian Federation, which was signed on 15 February 1994 in Moscow, entered into force on 8 April 1997. The text of the Convention has been published as the Schedule to the Double Taxation Relief (Taxes on Income) (Russian Federation) Order 1994 (Statutory Instrument 1994 No. 3213), copies of which can be obtained from The Stationery Office.
The provisions of the Convention will take effect in the UK from 1 April 1998 for corporation tax and from 6 April 1998 for income tax and capital gains tax; in the Russian Federation the provisions will apply from 1 January 1998.
Following the changes made to the Enterprise Investment Scheme by Finance Act 1997, it has been necessary to amend form EIS 1, which companies use to notify issues of shares. The new print, which also incorporates various minor changes and is identified as EIS 1(1997), should be available very soon. Companies should use it where the issue takes place after 26 November 1996.
Where shares were issued before 27 November 1996, the company will need to satisfy the old conditions up to that date and the new conditions thereafter. In these circumstances Inspectors will accept either form EIS 1(1996) or form EIS 1(1997). The declaration on page 3 of the form should be amended so as to cover the period up to or from 26/27 November as appropriate, and the form should be accompanied by a letter confirming that the company also satisfies the conditions in force for the remainder of the period between the date of issue of the shares and the date of signature of the form.
In Tax Bulletin Issue 26 (page 363, December 1996) the first column under the heading "How is effect to be given to the claim" we said:
"b) where liability for any year is outstanding (or will become due within 30 days of the claim) relief will be given by set-off (see example 3b)."
Since the article was published we have brought our process for allocating overpayments on a taxpayer's account to charges on a taxpayer's account into line with our process for issuing statements of account, which picks up charges becoming due within the 35 days not 30 days. So the reference to 30 days should now read 35 days.
As a further point of clarification the 35 days will run from the day on which the claim is processed not the day on which the claim is made. We will, of course, try to give effect to the claim as soon as it is received, but in practice this may be several days after the claim was actually received by the tax office.
There have been no Extra Statutory Concessions issued in this period
There have been no Statement of Practice issued in this period
You can get copies of SPs and ESCs from Christine Jordan at the Inland Revenue Information Centre, Ground Floor, South West Wing, Bush House, Strand, London WC2B 4RD. Telephone 020 7438 7772
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 on an annual basis.
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, David Richardson, Room 402, 22 Kingsway, London WC2B 6NR. We are sorry though that neither he nor our contributors will normally be able to enter into correspondence about Tax Bulletin or its contents.
The subscription for 1997 is £20. 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".
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