Tax Bulletin Issue 12

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MATRIX SECURITIES:
GUIDANCE TO TAXPAYERS

Some readers will have seen the consultative document "Post Transaction Rulings" published on 12 May. Although the document is mainly about post-transactions/pre-return rulings, it did trail the prospect of a subsequent consultative document about pre-transaction rulings -- and it promised a Code of Practice, later this year, about the Department's current approach to the provision of advice to taxpayers.

In the meantime, readers may be interested to see the following letter sent by the Deputy Chairman to the main representative bodies with whom we have regular exchanges. It picks up the same theme, commenting on the case of Matrix Securities Ltd and responding to enquiries put to us about the implications of that case for taxpayers seeking to rely on Inland Revenue guidance.

"From correspondence, discussion and press comment it is clear that there is some uncertainty following the speeches in the House of Lords in the Matrix Securities case, particularly concerning the extent to which taxpayers can rely on guidance provided by the Revenue. It may be helpful if I comment briefly on the position, as we see it, in relation to the provision, by the Revenue, of non- statutory' guidance.

There are two things to say about the Matrix Securities case. First, it seems to us that, in the end, the Matrix case broke little new legal ground; for all their Lordships, whatever the individual differences in their reasoning, the case involved the application of established law (or legal principle) to the particular facts.

Second, however the case does provide further endorsement at the highest level of MFK and the guidelines set out in that case. In particular, the case underlines the need for complete frankness in circumstances where taxpayers expect to rely on guidance given by the Revenue; disclosure must be full, accurate and fair as to the facts and the complete context in which the ruling is sought.

My letter of 18 October 1990 therefore holds good; we would not wish to withdraw the help we have undertaken, in certain circumstances, to give. Indeed, as you will have seen from the recent Press Release on Rulings, we plan to build on the proposals for a post-transactions rulings system and in due course issue a consultative document exploring the options for an advance rulings system. In the meantime, we are working on a Code setting out our present practice on the provision of advice to taxpayers. We shall wish to seek your views on a draft of that code in a few months time.

I have been asked whether, following Matrix, taxpayers and their advisers are expected to judge for themselves the appropriate level of Revenue officials to whom they should address requests for guidance. It seems to me, on the basis of the case, that the question crucially arises where those seeking Revenue guidance are already aware of views held within the Department contrary to the confirmations being sought. That fact cannot be ignored if people are intending to rely on the advice they get; apart from that there is little to add to what I said in my letter of 18 October 1990.

In the ordinary way, it may be appropriate to write to the Inspector of Taxes who handles the affairs of the taxpayer concerned; but if it is known, for example, that Head Office have recently been considering the issue the appropriate course would be either to write to the relevant Inspector, pointing out the Head Office interest and the need for its clearance or, alternatively, to Head Office direct. In either event an answer should not be sought in an unreasonable time, bearing in mind the complexity of the issues involved and the volume of material to be examined.

Similarly, I have been asked how far taxpayers and their advisers are expected to go in disclosing not only the facts but also the main legal issues arising in particular circumstances. In answering that point I would refer back to my letter of 18 October 1990 when I said that we will provide guidance in certain circumstances and in particular where the operation of the law is uncertain. We are not setting out to give our comprehensive blessing to transactions and schemes put to us but rather responding to the uncertainties in the minds of taxpayers and their advisers on the specific points on which guidance is sought. By definition, therefore, it will invariably be appropriate to spell out those uncertainties and the legal issues on which comfort is being sought as well as it being made clear for what purpose the ruling is required."

In case readers have not seen it (although it was published by most if not all of the bodies to whom it was sent) we also reproduce below an extract from the Deputy Chairman's earlier letter of 18 October 1990 to which reference was made in his recent letter.

"We have told our Head Office staff that they should be prepared when they can to answer requests for guidance on the Revenue's interpretation of tax law, not only where they involve the interpretation of recent legislation, Statements of Practice and other published information, but also in cases where there is a major public interest in developments in an industry or in the financial sector but where the operation of the law is uncertain. In addition, local Inspectors of Taxes will of course continue where practicable to inform practitioners about the Revenue's interpretation of tax law as it applies to any case which falls within the responsibility of that office.

In no case, however, whether at Head Office or local office, would a member of the Department seek to advise a taxpayer or a practitioner on the arrangement of a person's own affairs: that must remain the responsibility of his professional advisers. Still less of course could we advise in the area of tax planning.

Where guidance is sought, the enquirer will doubtless bear in mind the principles set out by Bingham LJ in the MFK case. In addition to providing details such as the tax district and the reference, the enquirer should bear in mind that if he wishes to rely on Revenue guidance he must

a. put all his cards face upwards on the table;

b. indicate the guidance sought;

c. make it plain that it is fully considered guidance that is being sought; and

d. indicate the use which it is intended to make of the guidance, and in particular whether he proposes to tell others of it.

Where guidance is given it should not be relied on to the extent of any qualification it contains. Moreover the actual application of the law will depend on the precise way in which the transaction is carried out and of course on the precise terms of the law at the time.

There may occasionally be cases, in particular where a representative body would find it helpful to be given an informal view of the interpretation of new legislation, where it would be appropriate for a reply to be given on an explicitly non-binding basis. Such cases will of course be quite different from Statements of Practice on the one hand or the more formal guidance with which this letter is otherwise concerned."

(Superceded by INTM 204050)
CONTROLLED FOREIGN COMPANIES

Section 134 Finance Act 1994 changes the measure of profits used in the acceptable distribution policy (ADP) test for non-trading controlled foreign companies (CFCs) from accounting profits to chargeable profits. This article answers various questions that we have been asked about our interpretation of the legislation and how the new rules will operate in practice. It follows consultations with bodies representing companies and their advisers.

WHAT DOES THIS MEAN FOR TRADING CFCs?

There is no change to the ADP for trading CFCs (as defined in Section 756(1) of the Taxes Act), which continues to use the accounting profits.

WHEN DO THE NEW RULES COME INTO EFFECT?

The new rules come into effect for accounting periods ending on or after 30 November 1993.

CAN A CFC SPLIT ITS ACCOUNTING PERIOD AT 30 NOVEMBER 1993?

Yes. A non-trading CFC can choose to split its accounting period spanning 30 November 1993 into separate accounting periods, so that the old rules apply to the part period up to 30 November and the new rules to the part period after that date. We will accept informal accounts for the part periods for this purpose. They should be made up on the same basis as the accounts for the full period.

WOULD THE ANTI-AVOIDANCE RULE FOR SHORT ACCOUNTING PERIODS (PARAGRAPH 3(2) SCHEDULE 25) APPLY TO THESE PART PERIODS?

Splitting the accounting period for this purpose would not of itself be regarded as avoidance. But Paragraph 3(2) could be invoked if there was also manipulation of profits between the part periods which resulted in profits being removed from charge.

CAN INTEREST PAID TO A NON-RESIDENT OUT OF INCOME FROM THE UKBE DEDUCTED FROM THE CHARGEABLE PROFITS?

Yes, where the UK income was paid gross, with a corresponding adjustment where it was paid net to ensure that the tax deducted was not repaid or set against the liability on other income.

Annual interest paid by a CFC, for non-trading purposes, to a person not resident in the UK would normally only be deductible as a charge if it was paid out of foreign income (Section 338(4)). If the CFC has both UK and non-UK income then, subject to the CFC indicating to the contrary, the interest would be treated as paid first out of the foreign income.

Where a direction was made under Section 747, we would, in making the just and reasonable apportionment under Section 752(8), apportion annual interest paid out of UK income to the loan creditor, thus reducing the amount apportioned to persons controlling the CFC by that amount. Notwithstanding Section 417(9), which is applied to the CFC provisions by Section 756, we would accept that an overseas bank can be a loan creditor for this purpose.

Where the UK income was received gross by the CFC, the reduction in the amount apportioned to persons controlling the CFC would equal the interest paid.

Where the UK income was received under deduction of UK tax, the reduction would be limited to the amount needed to ensure that the tax charged under the direction, after giving tax credit relief for the tax deducted, equalled the amount which would have been charged under the above rule if in the computation of chargeable profits the interest paid and the income received under deduction of tax had both been reduced by the lesser of the two, with a corresponding reduction in the tax deducted and tax credit relief. Alternatively, the administrative short cut may be followed by agreement with the Revenue of allowing the reduction in full and making the corresponding adjustment to the tax credit relief.

We will follow the same principle for the ADP. We will not make a direction where a distribution is made to the UK which, after giving tax credit relief, would raise 90% of the additional UK tax that would be payable under the above rules if a direction had been made.

Numeric examples of the position where income is received gross and where income is received under deduction of tax are given at the end of the article.

WHAT ABOUT INTEREST WHICH MAY BE TREATED AS A DISTRIBUTION UNDER SECTION 209(2)(e)(iv) OR (v)?

This will also be allowed as a reduction to the amount apportioned to persons controlling the CFC where a direction is made, or to the net chargeable profits for the purposes of the ADP, except where the interest is paid as part of arrangements for the indirect payment of an amount from the UK to a person outside the UK which would be treated as a distribution if it was paid directly.

WHAT ABOUT SHORT INTEREST?

Short interest which is not otherwise deductible will be treated in the same way, subject to the restrictions explained above for interest paid out of UK income taxed at source. No reduction will be allowed for short interest which is treated as a distribution because of the arrangements described in the previous paragraph.

CAN SECTION 770 APPLY TO THE ACCEPTABLE DISTRIBUTION POLICY?

Yes, but only where the Board of Inland Revenue makes a direction that Section 770 will apply to the profits of the accounting period. A direction may be made at any time, but would not normally be made more than six years after the end of the period. Where the direction relates to transactions with a CFC or person chargeable to UK tax, the Board will ensure by whatever means appear appropriate that it does not result in double taxation in the UK. As there are no provisions for corresponding adjustments for CFCs under double taxation treaties, it is for the CFC to arrange its affairs to avoid international double taxation.

HOW WILL THE NEW RULES ON FOREX APPLY TO CFCS?

This is being reviewed as part of the continuing consultations on the new rules on FOREX. An announcement will be made as soon as possible.

CAN ADDITIONAL DISTRIBUTIONS BE MADE TO SATISFY THE ADP IF THE COMPUTATION OF NET CHARGEABLE PROFITS IS REVISED BY THE REVENUE?

Yes. The distributions must be made within 18 months of the end of the accounting period or such further time as the Board may allow. Further time will be allowed where additional distributions are needed to meet the ADP as a result of revisions made to the computation of net chargeable profits by the Revenue.

CAN CREDIT HE GIVEN FOR TAX PAID ON DISTRIBUTIONS IF A DIRECTION IS MADE?

The rules work the other way round, but with a similar effect. Where a direction is made, Schedule 26 Paragraph 4 treats tax paid under the direction as underlying tax for distributions made out of the total profits of that accounting period. Unilateral tax credit relief can thereby be given for tax paid under the direction against tax due on the distribution, by repayment if necessary where tax has already been paid on the distribution.

WHAT HAPPENS IF THE DISTRIBUTION HAS TO BE MADE FOR A DIFFERENT ACCOUNTING PERIOD?

Where a direction is made for an accounting period under Section 747, Schedule 26 Paragraph 4 allows tax credit relief to be given against distributions out of the total profits of that accounting period. That allows relief to be given against distributions up to that figure out of the profits of that period. But distributions out of the profits of the accounting period may not be used to satisfy the acceptable distribution policy for a different accounting period under Section 134 Finance Act 1994.

Where the company can show that profits included in the total profits of the accounting period were distributed out of the profits of a different period, tax credit relief would be given for tax paid under the direction as if the distribution was out of the total profits of the accounting period for which the direction was made. This is provided the other condition of Section 134, that the distribution is not used to satisfy the acceptable distribution policy for another accounting period, is also met.

WILL I HAVE TO MAKE DETAILED CALCULATIONS OF UK TAXABLE PROFITS EVERY YEAR FOR EVERY NON-TRADING CFC IN THE GROUP?

No. The large majority of CFCs are excluded from the direction making power by the excluded countries list, the exempt activities test and the motive test. No computation of UK taxable profits will be required in these cases.

WILL THE INLAND REVENUE GIVE AN ADVANCE RULING ON WHETHER A CFC IS EXCLUDED FROM THE DIRECTION MAKING POWER BY THE EXEMPT ACTIVITIES TEST OR THE MOTIVE TEST?

We are very conscious of the need to avoid introducing unnecessary administrative burdens and to limit compliance costs from this change to the legislation. Accordingly, we are planning to introduce an informal clearance procedure. The details will be announced in a Press Release. In that Press Release, we will set out the procedural steps which companies should follow to obtain advance rulings. We expect that, in many cases, it will be possible to give an advance ruling which covers a number of years, provided that all the relevant facts have been accurately disclosed and there has been no change in the nature and conduct of the business of the CFC.

WILL THE ADVANCE RULING PROCEDURE DEPEND ON SATISFYING THE MOTIVE TEST?

No. The motive test only needs to be considered where a company has failed all the other exclusions from the CFC provisions. It has been found in practice that the main effect of the motive test is to act as a back-stop when a company is unable to meet one of the other tests solely for reasons other than to achieve a reduction in UK tax or the failure is marginal or due to isolated causes. Outside this narrow band, it has been found that companies which fail the other tests are very unlikely to meet the stringent requirements of the motive test.

EXAMPLES SHOWING EFFECT OF INTEREST PAID TO A NON-RESIDENT OUT OF INCOME FROM THE UK

EXAMPLE 1: OVERSEAS COMPANY ISSUES DEBT TO THIRD PARTIES AND LENDS THE PROCEEDS TO ITS UK PARENT. THE U.K. PARENT IS NOT OBLIGED TO WITHHOLD TAX.

Assumptions:

Principal of 50,000 lent to UK parent by overseas company at 10%.
Principal of 50,000 borrowed by overseas company at 9%.
Overseas company earns other UK source income of 1,500.
Overseas tax rate of 10% for which relief is due under a Double Taxation Agreement.

Question 1: Is the company subject to a lower level of taxation?
OVERSEAS TAX COMPUTATION Interest received from UK parent 5,000 Other income 1,500 LESS: Interest paid to third parties (4,500) Profits chargeable to overseas tax 2,000 Overseas tax payable (at 10%) 200NOTIONAL UK TAX COMPUTATION Interest received from UK parent 5,000 Other income 1,500 LESS: Interest paid to third parties (disallowed by Section 338(4) ICTA 88) 0 Profits chargeable to notional UK tax 6,500 Notional UK tax payable (at 33%) 2,145
Since overseas tax payable is less than 75% of notional UK tax payable this company is subject to a lower level of taxation.

QUESTION 2: What profits will be apportionable to the UK parent?
Interest received from UK parent 5,000 Other income 1,500 LESS: Interest paid to third parties (4,500) (apportioned to loan creditors under Section 749(7) ICTA 88) Profits apportioned to UK parent 2,000 UK tax (at 33%) 660 LESS: Relief for overseas tax paid (200) Additional UK tax payable (460)
QUESTION 3: What dividend is required in order to meet the acceptable distribution test?
Chargeable profits apportionable to parent 2,000 Less: Overseas tax paid (200) Net chargeable profits 1,800 Acceptable distribution 90% of above) 1,620 Additional UK tax payable (1,800 at 33%) 594 LESS: Relief for overseas tax paid (180) Additional UK tax payable 414
EXAMPLE 2: OVERSEAS COMPANY ISSUES DEBT TO THIRD PARTIES AND LENDS THE PROCEEDS TO ITS UK PARENT. THE UK PARENT IS OBLIGED TO WITHHOLD TAX

Assumptions:

Principal of 50,000 lent to UK parent by overseas company at 10%. UK parent withholds tax on interest paid at 25%.
Principal of 50,000 borrowed by overseas company at 9%.
Overseas company earns other UK source income of 1,500.
Overseas tax rate of 10% for which relief is due under a Double Taxation Agreement.

Question 1: Is the company subject to a lower level of taxation?

Overseas Tax Computation
Profits chargeable to overseas tax 2,000 (as in Example 1, Question 1) Overseas tax payable at 10%) 200
Notional UK tax computation
Profits chargeable to notional UK tax 6,500 (as in Example 1, Question 1) Notional UK tax at 33%) 2,145
Less:
Credit for UK tax withheld (1,250) National UK tax payable 895
Since overseas tax payable is less than 75% of national UK tax payable, this company is subject to a lower level of taxation.

Question 2: What profits will be apportionable to the UK parent.?
FORMAL SHORT METHOD CUT Interest received from UK parent 5,000 5,000 Other income 1,500 1,500 Interest paid to third parties /1/ (1,091) (4,500) Profits apportionable to UK parent 5,4092,000 Additional UK tax (at 33%) 1,785 660 Less: Credit for UK tax withheld /2/ (1,250) (125) Relief for overseas tax paid (200) (200) Additional UK tax payable 335335
/1/ Restricted to produce correct tax payable (as demonstrated by the short-cut method).

/2/ Restricted to tax deducted from the excess of the interest received (5,000) over the interest paid (4,500).

Question 3: What dividend is required in order to meet the acceptable distribution test?

We would not make a direction if a distribution was made on which the additional UK tax payable was 90% of the additional UK tax which would be payable if a direction was made (ie 90% of 335 = 301.)

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FOREIGN INCOME DIVIDENDS

Section 138 and Schedule 16 Finance Act 1994 introduce the FID legislation at Sections 246A to 246Y ICTA 1988. As announced by the Chancellor in his Budget statement, this legislation is intended to provide some help in relieving the long-standing problem of surplus ACT for many of the companies which want to pay dividends out of foreign source profits. This will help reduce distortions in international and domestic investment and make the United Kingdom a more attractive place in which multinational businesses can locate international headquarter companies.

Companies which have profits which have suffered foreign tax may have insufficient UK tax liability to set off all the ACT on dividends they pay out of those profits, because of the availability of DTR. From 1 July 1994 a company can elect that a dividend it pays is a FID and, if it can match this FID with distributable foreign profits, claim set off or repayment of all or part of any surplus ACT arising in respect of the FID. In addition a company which thinks it satisfies the definition of an international headquarters company (IHC) will not account for ACT when it pays a FID. It may have to subsequently.

A FID is not a franked payment, but comes within the Schedule 13 machinery provisions and will be returned separately on form CT61. The FID and franked payment accounting procedures run in parallel. A corporate shareholder uses a FID received to frank a FID paid in the same way that franked investment income is set off against franked payments. A FID does not carry any tax credit.

In this article we summarise how the legislation operates in practice, consider specific aspects of the scheme, and provide examples of the operation of the legislation.

A summary of how the legislation operates in practice

1. The company must make an election no later than the time of payment for a dividend to be a FID. This election is effective as long as the dividend is paid in cash and the anti-streaming rules are not in point (Sections 246A and 246B).

2. The company elects to match a FID paid with a distributable foreign profit (DFP), either its own or that of a 51% subsidiary (Sections 246J and 246K). The DFP is any foreign source profit (FSP), less the tax thereon (both foreign and UK corporation tax) (Section 2461). Foreign tax includes tax which has been spared but for which tax credit relief is allowed. The FSP is a profit which is included in chargeable profits (net of any deductions such as group relief) for which tax credit relief for foreign tax is given. Where any deductions such as group relief have been made the foreign tax deducted in computing the DFP may be different from the amount of tax credit relief allowed in the corporation tax computation (see Example 2).

3. If the company has matched a FID paid with a DFP, and if the company has not treated itself as an international headquarters company (IHC) (Section 2465) at any time in the accounting period concerned, the amount of ACT available for set off or repayment is the smaller of:

the ACT which has not already been dealt with (Section 246N)
the ACT which would be surplus if certain assumptions were made (Section 246P).

4. This amount will be set off against unpaid mainstream corporation tax after any ACT set off under Section 239(1) for the accounting period, with any balance being repaid (Section 246Q).

5. If the ACT set off or repaid has already been carried forward and used under Section 239(1) for a later period, a Section 252 assessment is required for that later period (Section 246Q).

6. The company can subsequently claim to match DFPs of later accounting periods with another part of that FID or another FID paid in that accounting period. The calculation is then repeated (Section 246R).

7. If the profits or foreign tax are revised the FID computations are revised (Section 246X).

8. When paying a FID a company may believe itself to be an IHC and not account for ACT at that time (Section 246T).

9. If a company treats itself as an IHC but is found not to be an IHC for an accounting period, it is liable to account for ACT on any FID paid (net of FIDs received) (Section 246V). Where it has not done so, an assessment will be issued (Paragraph 3B Schedule 13). The assessment can be issued during the accounting period if the inspector concludes that the company will not be an IHC for that accounting period. The rules outlined above then apply.

10.If a company treats itself as an IHC and is an IHC in the accounting period, payment will be made to or by the company as appropriate after the accounting period (Section 246U). The amount and direction of the payment are found by comparing the ACT which the company has not paid because of its assumed IHC status with the amount that would be set off or repaid to the company under the FID provisions if it had not treated itself as an IHC at any time in the accounting period.

11. An IHC required to pay ACT in such circumstances may subsequently match DFPs of later accounting periods with a FID paid in that accounting period. A further reckoning is then needed (Section 246W).

Specific aspects of the operation of the scheme

IN WHAT FORM SHOULD AN ELECTION FOR A DIVIDEND TO BE
A FID (SECTION 246A), AND FOR A FID TO BE MATCHED WITH
DISTRIBUTABLE FOREIGN PROFITS (DFPS) OR ELIGIBLE PROFITS
(SECTIONS 246J AND 246K), BE MADE?

An election under Section 246A should be made by letter to the company's inspector, identifying clearly the dividend to which the election relates.

A parent company elects under Sections 246J(1) or 246K(5) for a FID to be matched with DFPs or eligible profits. An entry in the parent's computation showing the matching with the DFP or eligible profit will be accepted as an election. Where the election is under Section 246K(5) written consent from the subsidiary is required. This consent should be signed by the company secretary or an authorised person (Section 108 TMA 1970).

WHAT FORM SHOULD THE DIVIDEND VOUCHER TAKE? (SECTION 246G)

The voucher must include a statement that the dividend carries no entitlement to a tax credit. No specific form of voucher is specified, but the following guidance may be helpful.

At the top of the certificate a heading "Foreign Income Dividend Certificate" should appear.
The usual "tax credit" box should be replaced by a box headed "Income tax treated as paid which is not repayable."
The tax position for the recipient can be given by the following text:

"For income tax purposes the FID is treated as having suffered income tax at the lower rate. Your taxable income is the sum of the dividend and the income tax treated as paid. Lower and basic rate taxpayers will have no more tax to pay. Higher rate taxpayers will have further tax to pay. Where all or part of the FID is taxable at higher rate, relief will be given for the income tax treated as paid on that income. This income tax treated as paid is not repayable."

IN WHAT FORM SHOULD THE CLAIM TO REPAYMENT OF ACT BE MADE?

We normally expect a claim to repayment of ACT to be made in a return. The corporation tax return has been amended to accommodate a claim to repayment of ACT. A return under Section 11 TMA 1970 is treated as a claim if the return contains the required particulars, although a claim need not be made in a return.

DOES THE EXISTENCE OF AN ARTICLE PERMITTING DIRECTORS TO OFFER A SCRIP ALTERNATIVE PREVENT A FID DISTRIBUTION FROM BEING MADE? (SECTION 246A)

The existence of an article permitting directors to offer a scrip alternative will not prevent a company from electing for a particular dividend to be a FID, as long as the company does not offer a scrip alternative to that particular dividend.

CAN PROVISIONAL REPAYMENT OF ACT BE MADE IN ADVANCE OF FIGURES FOR THE ACCOUNTING PERIOD CONCERNED BEING FINALISED?

The amount of ACT to be repaid cannot be finally quantified until the company's corporation tax liability for the accounting period has been settled. However if the company's inspector is satisfied on the basis of provisional corporation tax computations that an amount of ACT will ultimately be repayable under the FID provisions then he or she will be able to make a provisional repayment of ACT to the company. The extent of any provisional repayment will depend on the information which is provided to the inspector. Such repayment cannot in any event be made until after 9 months from the end of the accounting period concerned. Since repayment of ACT is only available after the company has made an election to match a FID with a distributable foreign profit or eligible profit, the computation submitted in support of the claim to repayment will be treated as an election to match the FID with the distributable foreign profit or eligible profit concerned.

EXAMPLE 1

A company's results for the year ended 31 December 1995 are as follows:
Case I 4,000 Chargeable gains (UK) 2,000 Case V: Dividend (gross) from company A 5,000 foreign tax rate 40% B 10,000 35% C 4,000 30% D 8,000 20%
It pays FIDs of 20,000 (ACT 5,000) and ordinary dividends 10,000 (ACT 2,500). It surrenders ACT of 1,000 to a subsidiary. Assume the company is liable to corporation tax at 33%, and the ACT rate is 1/4. The company's corporation tax liability is computed. There are no deductions to be set against foreign source profits (FSPs).
Profit Tax at DTR ACT MCT 33% set off Case I 4,000 1,320 -- 800 520 Chargeable gains 2,000 660 -- 400 260 Case V: Dividend (gross) from company A 5,000 1,650 1,650 -- -- B 10,000 3,300 3,300 -- -- C 4,000 1,320 1,200 120 -- D 8,000 2,640 1,600 1,040 -- 2,360 780
Matching of FIDs with distributable foreign profits (DFPS)

The FSPs brought into charge to tax, and the foreign and UK tax suffered, are:
Dividend from company A 5,000 - foreign 2,000 - UK tax 0 = DFP 3,000 B 10,000 tax 3,500 0 6,500 C 4,000 1,200 120 2,680 D 8,000 1,600 1,040 5,360 17,540
Foreign tax to be taken into account is the amount suffered on the FSP, and is not necessarily the amount of the tax credit relief allowed in the corporation tax computation. The maximum FIDs which can be matched are 17,540, and the company elects to match this amount of FIDs with these DFPs.

Calculation of ACT available for set off or repayment

ACT is not available if it has already been dealt with (Section 246N). Returning to the corporation tax computation, of the 7,500 ACT paid 2,360 is set off under Section 239(1). 1,000 has also been surrendered. The ACT which has not been dealt with is therefore 4,140. The notional foreign source ACT must then be calculated (Section 246P).

The company elects for FIDs of 17,540 to be qualifying FIDs (Section 246P). The ACT which the company would have paid in respect of the qualifying FIDs is 4,385. The matched FSPs underlying the matched DFPs are treated as the profits chargeable to corporation tax, being the dividends from companies A, B,C and D (Section 246P).

The corporation tax computation shows that ACT of 1,160 would be set off against the corporation tax liability on such profits. The notional foreign source ACT is therefore 4,385 - 1,160 = 3,225. The surplus ACT available for set off or repayment is then the lower of 4,140 and 3,225. ACT of 780 is set off under Section 246Q against the remaining unpaid corporation tax liability of the period and the balance of 2,445 is repaid.

EXAMPLE 2 -- This example shows the effect of deductions available,

A company's results for the year ended 31 December 1995 are as follows:
Case I 4,000 Chargeable gains (UK) 2,000 Case V: Dividend (gross) from company A 5,000 foreign tax rate 40% B 10,000 35% C 4,000 30% D 8,000 20% Group relief received (15,000)
It pays FIDs of 20,000 (ACT 5,000) and ordinary dividends of 10,000 (ACT 2,500). It surrenders ACT of 1,000 to a subsidiary. Assume the company is liable to corporation tax at 33%, and the ACT rate is 1/4.

The company's corporation tax liability is computed. The company allocates the group relief first against UK profits and then against foreign profits which have suffered the least foreign tax.
Profit Group Net Tax at DTR ACT MCT Relief Profit 33% set off Case I 4,000 4,000 - - - - - Chargeable gains (UK) 2,000 2,000 - - - - - Dividend from company A 5,000 - 5,000 1,650 1,650 - - B 10,000 - 10,000 3,300 3,300 - - C 4,000 1,000 3,000 990 990 - - D 8,000 8,000 - - - - -
Matching of FIDs with DFPs

Assuming the company allocates the group relief for FID purposes in the same way as for corporation tax purposes, the FSPs brought into charge to tax, and the foreign and UK tax suffered, are:
Dividend from company A 5,000 - foreign tax 2,000 - UK tax 0 = DFP 3,000 B 10,000 3,500 0 6,500 C 3,000 900 90 2010 11,510
In computing the DFP, the foreign tax on dividend C is only 900 rather than 990 as in the corporation tax computation because the FSP is the net figure of 3,000, and the foreign tax is found by applying the foreign tax rate to this amount. The figure for UK tax of 90 is obtained by deducting this figure of foreign tax from the gross corporation tax on the part of dividend C included in the profit chargeable to corporation tax. The maximum FIDs which can be matched are 11,510 and the company elects to match this amount of FIDs with these DFPs.

Calculation of ACT available for set off or repayment

ACT is not available if it has already been dealt with. Returning to the corporation tax computation, no ACT is set off against corporation tax. Of the total 7,500 ACT paid 1,000 has been surrendered leaving 6,500 which has not already been dealt with. The notional foreign source ACT must then be calculated.

The company elects for FIDs of 11,510 to be qualifying FIDs. The ACT which the company would have paid in respect of the qualifying FIDs is 2,877.

The matched FSPs underlying the matched DFPs are treated as the profits chargeable to corporation tax, being:
Dividend from company A 5,000 B 10,000 C 3,000
In computing the notional corporation tax, the notional DTR is found by applying the foreign tax rate to the FSP. Thus for dividend C which has been reduced by group relief the DTR is 900 rather than 990 as in the real corporation tax computation, so that ACT of 90 is set off. The notional corporation tax liability on dividends A and B is fully covered by DTR. The notional foreign source ACT is therefore 2,787.

The surplus ACT available for set off or repayment under the FID provisions is then the lower of 6,500 and 2,787. No amount can be set off since there is no corporation tax liability after DTR and ACT set off under Section 239(1), and 2,787 is repaid.

The company has only matched FIDs of 11,510, leaving 8,490 which is capable of further matching. In the year ended 31 December 1996 the company's results are as follows:
Case V: Dividend (gross) from company E 10,000 foreign tax rate 35% F 8,000 30% G 6,000 25% Group relief received (10,000)
The company also has a subsidiary whose income for its year ended 31 December 1996 consists only of a dividend (gross) of 10,000 from company H, with a foreign tax rate of 35%. The subsidiary had no foreign income in earlier years.

The company pays a further FID of 5,000, with ACT 1,250. Assume the company is liable to corporation tax at 33%, and the ACT rate is 1/4. The company's corporation tax liability is computed. The company allocates the group relief against foreign profits which have suffered the least foreign tax.
Profit Group Net Tax at DTR ACT MCT f Profit 33% set off Case V: Dividend from company E 10,000 - 10,000 3,300 3,300 - - F 8,000 4,000 4,000 1,320 1,320 - - G 6,000 6,000 - - - - -
Matching of FIDs with DFPs

Assuming the company allocates the group relief for FID purposes in the same way as for corporation tax purposes, the FSPs brought into charge to tax, and the foreign and UK tax suffered, are:
Dividend from company E 10,000 - foreign tax 3,500 - UK tax 0 = DFP 6,500 F 4,000 1,200 120 2,680 9,180
The foreign tax on dividend F of 1,200 is found by applying the foreign tax rate to the FSP of 4,000. The figure for UK tax of 120 is found by deducting this figure of foreign tax from the gross corporation tax on the part of dividend F included in the profit chargeable to corporation tax.

The subsidiary has DFPs of 6,500, and these can be treated as eligible profits of the parent and as available for matching.

The maximum FIDs which can be matched are 15,680. The company elects for the previous period's unmatched FID of 8,490 to be matched with DFPs deriving from dividends from companies E (6,500) and F (1,990). It elects for the current period's FID of 5,000 to be matched with 5,000 of the subsidiary's DFP. The parent then has DFPs which have not been used for matching of 690 (deriving from dividends from company F) and the subsidiary has unused DFPs of 1,500.

Calculation of ACT available for set off or repayment

ACT is not available if it has already been dealt with. The corporation tax computation for the period ended 31 December 1996 shows no ACT is set off against corporation tax. None of the ACT of 1,250 has been dealt with. The corporation tax position for the period ended 31 December 1995 has been considered above. The repayment previously made under the FID provisions must be deducted (Section 246N). Thus ACT of 6,500 - 2,787 = 3,713 has not already been dealt with.

The notional foreign source ACT must be calculated for the period ended 31 December 1996, and recalculated for the period ended 31 December 1995, and then for each period compared with the ACT which has not already been dealt with.

Period ended 31 December 1996

The company elects for FIDs of 5,000 to be qualifying FIDs. The ACT which the company would have paid in respect of the qualifying FIDs is 1,250.

The matched FSPs underlying the matched eligible profits are treated as the profits chargeable to corporation tax, being:

Dividend from company H 7,692 (which net of 35% foreign tax gives 5,000).

The notional corporation tax is covered by DTR and so no ACT is set off. The notional foreign source ACT is therefore 1,250.

The surplus ACT which is available for set off or repayment under the FID provisions is then the lower of 1,250 and 1,250. No amount can be set off and so 1,250 is repaid to the company.

Period ended 31 December 1995

The FIDs previously treated as qualifying FIDs are ignored (Section 246R). The company elects for FIDs of 8,490 to be qualifying FIDs. The ACT which the company would have paid in respect of the qualifying FIDs is 2,122.

The matched FSPs underlying the matched DFPs are treated as the profits chargeable to corporation tax, being:
Dividend from company E 10,000 F 4,000 x 1,990 = 2,970 2,680
In computing the notional corporation tax, the notional DTR is found by applying the foreign tax rate to the FSP. Thus for the dividend of 2,970 from company F the DTR is 891, and ACT of 89 (2,970 x 3%) is set off. The notional corporation tax liability on the dividend from company E is fully covered by DTR. The notional foreign source ACT is therefore 2,122 - 89 = 2,033. The ACT available for set off or repayment under the FID provisions is then the lower of 3,713 and 2,033. No amount can be set off, so 2,033 is repaid.

SELF ASSESSMENT:
NEW PROCEDURES FOR TAXING PARTNERSHIPS

Finance Act 1994 introduced new rules which change the way partnerships are taxed. Previous Tax Bulletin articles have dealt with the computational aspects of the changes. In this article we outline the administrative framework which will apply generally from 1996-97. We also explain the slightly different position for 1994-95 and 1995-96 for partnerships which commence or are deemed to commence in those years.

A technical guide to the new computation rules -- "The New Current Year Basis of Assessment (SAT 1) -- has just been published. If you do not have a copy please contact your local tax office. Details of the changes made by the Finance Act 1994 to the Taxes Management Act will be given in a technical guide (SAT 2) to be published and distributed to practitioners shortly.

1996-97 AND LATER YEARS

Under the new self assessment provisions each partner will be required to self assess his or her total income. This means that partners will have to include their share of the partnership's profits in their total income. Composite Case I and II partnership assessments will not be made after 1996-97. For 1996-97 only, partners will be separately assessable on their share of partnership profits but, for partnerships its existence at 5 April 1991 a composite partnership assessment nay also be made.

One reason for this is the deal with payments on account for 1996-97. For individuals these payments on account ("interim payments") will be based on their tax situation for the previous year. But partners have no such situation for the previous year, except in relation to non-partnership income because partnership profits were assessed on the partnership. So payments on account for partnerships will be put in place by way of assessment, estimated if necessary, with the "old" rights of appeal. Any tax due is paid by the partnership.

When the partner comes to self assess for 1996-97 his or her share of the partnership income will be included and the overall tax liability computed will include tax on his or her share of transitional profits. But a credit will be due equal to the amount of tax already paid by the partnership in respect of that partner's share. In other words, the partner will be treated as if partnership profits were received under deduction of tax. This is not necessary for later years as the amount shown on the partner's self assessment for 1996-97, including tax on partnership income, will form the basis for the interim payments for 1997-98.

But dealing with partners separately would be unnecessarily cumbersome if each partner had to submit full accounts of the partnership in support of his or her return etc. So there are special rules in the 1994 Finance Act which mean that accounts, enquiries (and appeals where necessary), will be dealt with centrally. The partnership's "representative partner" will have responsibility for filing the "partnership statement". The statement will contain full details of the partnership income and the allocation between the partners, as well as information to enable the return to be linked with each partner's tax record.

WHAT IS DIFFERENT ABOUT 1994-95 AND 1995-96

Partnerships in existence at 5 April 1994

For a partnership which exists at 5 April 1994 and which has no changes in composition between 6 April 1994 and 5 April 1997 inclusive, nothing will change, and 1996-97 will be dealt with as above. Where there are changes in partnership composition again nothing changes where the change generates a Section 113(2) election. Composite Case I and II assessments for the years 1994-95 to 1996-97 are to he made on its trading and professional profits up to the date of any change in membership for which a section 113(2) election could be but is not made. For subsequent periods separate assessments are to be made on the individual partners.

Where, in a particular year of assessment, there is a change in membership and a continuation election is made a new partner is for tax purposes allocated a share of the partnership's assessable profit according to his entitlement in that fiscal year. This share is part of the composite assessment. There is no question of the new partner being individually assessed under the new rules whilst the remaining partners continue to be assessed under the old (and transitional) rules.

The old Taxes Management Act rules relating to the issue of partnership returns (Section 9 TMA 1970) and the handling of appeals will continue to apply to composite partnership assessments.

Partnerships commencing, or deemed to commence, on or after 6 April 1994

The new rules by which partners are to be separately assessed on their share of the partnership profits apply to partnership businesses which commence on or after 6 April 1994. They also apply to the period subsequent to a change in the membership of a partnership for which a Section 113(2) election could be made but is not.

You will find examples of how these rules work in Tax Bulletin Issue 11 and the booklet SAT 1.

The new Taxes Management Act rules for partnership returns and partnership statements do not come into effect until 1996-97. There is no special legislative provision for dealing with returns for "new" partnerships for 1994-95 and 1995-96, and this article describes how we propose in practice to deal with this situation.

The rest of this article refers only to partnership businesses which commence, or are deemed to commence, on or after 6 April 1994.

The Legal Position

There are no special interest provisions to handle the change over from partnership to individual assessments in 1994-95 and 1995- 96. If an estimated assessment is made on the wrong basis it may need to be discharged and new assessments made on the individual partners. As soon as the possibility emerges that a continuation election may not be made the Inspector will consider whether to make assessments on the individual partners as alternatives to the partnership assessment.

Partnership Returns

For these new partnerships the Taxes Acts provide no specific authority to require a partnership to make a return for 1994-95 and 1995-96. Existing Section 9 TMA 1970 provides for a return to be issued "for the purposes of making assessment to income tax in the partnership name". The new power to issue a partnership return (Section 184 FA 1994) does not take effect until 1996-97 (Section 199 FA 1994).

Because a partnership has two years after a partnership change to decide whether a continuation election is to be made, it will not be clear for some time after a change under which rules a partnership should be taxed.

We propose therefore to issue partnership returns to all partnerships, both old and new, for 1994-95 and 1995-96. Old partnerships will be required to complete the return but new partnerships will only be requested to do so. The return will contain guidance to partnerships enabling them to decide whether they are required or only requested to complete the return.

Personal Returns

Although a new partnership cannot be required to complete a partnership return the Revenue will still be able to obtain details of a partnership's income. A personal return can be issued to each partner under Section 8 and we will, where necessary look to these as the statutory means of obtaining information about partnership income. The statutory position is that each partner is required to make a return of income for the purpose of making an assessment and this will include his share of the partnership profits.

Assessments and Appeals

Each partner will have a personal assessment with an individual right of appeal. But it will be to the mutual advantage of the Revenue, taxpayers and Commissioners if points at issue are only subject to appeal proceedings once. Any disputes relating to the partnership income, or the allocation between the partners, could affect all the partners even though the appeal is against only one partner's assessment. We consider it desirable for all partners to receive equal treatment and for all appeals to be resolved in the same way and we therefore intend that no appeals on these aspects will be determined without reference to the relevant assessments on all the other partners.

Where only some of the partners appeal against their assessments on their share of partnership income, we propose to invite those partners who have not appealed to do so. In such circumstances we will be prepared to accept a late appeal. For this purpose we propose to deal with and agree a partnership's affairs centrally. We will however take care to continue to treat the appeals against the individual partners' assessments separately, but in parallel, by the issue of similar letters, notices and determinations in each case.

There is presently no mechanism for Commissioners to hear such appeals together, other than where all the parties agree. But the new Procedural Rules for the General and Special Commissioners (see page 158) include provisions whereby Commissioners can direct that appeals should be heard together where they are satisfied that they involve a common issue. We envisage that appeals against these assessments would come within that category.

A Practical Approach.

So far as possible we would hope to deal with partnerships that commence on or after 6 April 1994 in the same way as we will do for 1996-97 and later years. We would therefore ask practitioners to submit a single copy of the partnership accounts and computations to the Inspector on behalf of all partners. Any necessary enquiries would then be dealt with by the Inspector in correspondence with a single partner or agent, and agreement reached as to the amount of partnership income and its allocation between the partners.

If it becomes necessary to take any issue on these questions to the Commissioners we will seek to join appeals, so that all partners' appeals are heard together.

revenue interpretations

CAPITAL GAINS TAX:
WHEN IS AN OPEN OFFER TREATED
AS A SHARE REORGANISATION?

We have been asked for our views on when an open offer is treated as a share reorganisation within Section 126 Taxation of Chargeable Gains Act (TCGA) 1992. An open offer is an arrangement under which a company invites its shareholders to subscribe for shares subject to a minimum entitlement based on their existing shareholdings. The shareholders may also be given the opportunity to subscribe for shares which other shareholders do not want. This may be subject to a maximum.

For capital gains tax purposes the Revenue will treat any subscription for shares, which is equal to or less than the shareholder's minimum entitlement, as a share reorganisation. Any shares subscribed for in excess of the minimum entitlement will be treated as a separate acquisition.

[Section 126 TCGA 1992]

! Superseded by CG 64200 onwards

PRINCIPLE PRIVATE RESIDENCE RELIEF

We have been asked to clarify our interpretation of a number of points that arise on principal private residence relief (Sections 222-226 Taxation of Chargeable Gains Act (TCGA) 1992).

SCOPE OF THE DWELLING-HOUSE -- MEANING OF CURTILAGE

Lewis v Rook (TL 3308) gave guidance on determining whether a building, with one or more ancillary buildings, could together form a single dwelling-house for the purposes of Section 222. In cases where there is an identifiable main house it was held that no building can form part of a dwelling-house with the main house unless that building is appurtenant to, and within the curtilage of, the main house. Curtilage is defined by the Shorter Oxford Dictionary as "a small court, yard, or piece of ground, attached to a dwelling-house and forming one enclosure with it". This definition has been adopted by the Courts in non-tax cases and emphasis is placed on the smallness of the area comprised in the curtilage. Buildings standing around a court yard together with the main house will be within the curtilage of the main house.

Where more dispersed groups of buildings have a clear relationship with each other they will fall within a single curtilage if they constitute an integral whole. In the Leasehold Reform Act case of Methuen-Campbell v Walters, quoted with approval in Lewis v Rook, the Court held that "For one corporeal hereditament to fall within the curtilage of another, the former must be so intimately associated with the latter as to lead to the conclusion that the former in truth forms part and parcel of the latter". Whether one building is part and parcel of another will depend primarily on whether there is a close geographical relationship between them. Furthermore, because the test is to identify an integral whole, a wall or fence separating two buildings will normally be sufficient to establish that they are not within the same curtilage. Similarly, a public road or stretch of tidal water will set a limit to the curtilage of the building.

Buildings which are within the curtilage of a main house will normally pass automatically on a conveyance of that house without having to be specifically mentioned. There is a distinction between the curtilage of a main house and the curtilage of an estate as a whole and the fact that a whole estate may be contained within a single boundary does not mean that the buildings on the estate should be regarded as within the curtilage of the main house.

SALE OF A HOUSE AND GARDEN AFTER IT HAS CEASED TO BE USED AS A RESIDENCE

Varty v Lynes (51 TC 419) established that no principal private residence relief was due on the sale of a garden where it was sold separately and after the dwelling-house. Certain dicta in that case also suggested that where a dwelling-house and garden were sold together, but after the taxpayer had ceased to occupy the property, the sale of the garden would not qualify for relief. This particular point was not directly in issue in that case, and so was not decided by it, but the case provided grounds for taking that view. Since then we have not taken this line in cases where house and garden were sold together and not for development. Recently we have received advice that arguments based on those dicta are misconceived and we no longer seek to apply them at all.

We do however apply the decision itself, so that no relief is due on the sale of a garden which takes place after a prior sale of the dwelling-house.

STATEMENT OF PRACTICE D4

Statement of Practice D4 explains that certain delays in occupying a dwelling-house as a residence at the start of a period of ownership will be regarded as a period of residence in that dwelling- house for the purposes of Private Residence Relief. For SP D4 to apply the delay must not exceed a period of one year, or somewhat longer if there are good reasons for exceptional delay. Where a period of delay falls within SP D4 the dwelling-house must be occupied as a residence immediately thereafter. Otherwise no extension to the actual period of residence is allowed.

What constitutes a good reason for exceptional delay is a matter left to the discretion of local District Inspectors, subject to an overall time limit of two years. Where the period of delay is greater than two years no extension is allowed. We expect good reasons for exceptional delay to be factors outside the taxpayer's control.

Where SP D4 does apply, and as a result two houses are treated as residences for the same period, no Section 222(5) election is required. Relief can be given on both houses for the period covered by SP D4.

PERIODS OF ABSENCE

Relief is only due for periods of absence from the home falling within Section 223(3) if both before and after the period of absence there was a time when the home was the taxpayers residence. We take the same view of residence for this purpose as we take for determining whether Section 222 applies generally, so that the question is whether during the period concerned the property has as a matter of fact been a residence.

A minimum period is not specified and we do not attempt to impose one. We take the view that it is quality of occupation rather than length of occupation which determines whether a dwelling-house is its owner's residence. As Millet J in Moore v Thompson, 61 TC at page 24 comments:

". . . the Commissioners were alive to the fact that even occasional and short residence in a place can make that a residence; but the question was one of fact and degree . . ."

APPORTIONMENTS

In broad terms the apportionment rules work as follows:

Section 222(10) apportions consideration where required;
Section 223 apportions the gain over time;
Section 224(l) restricts relief to parts of the property not used exclusively for a business etc;
Section 224(2) provides for a just and reasonable apportionment to apply where there is a change in use.

Section 224(1) only applies where the part of the property concerned has been exclusively so used throughout the period of ownership. It does not refer to use only at the date of disposal. Where Section 224(1) applies no relief is due on the part of the dwelling-house used for business etc, even for the last 3 years of ownership. This is because Section 224(1) only applies Section 223 to the part of the dwelling-house not exclusively used for business etc. Section 223 specifies how much relief is due, and since it does not apply to the business part no relief can be given for that part for any period.

Section 224(2) provides for a just and reasonable apportionment to apply where there is a change in use, and for this purpose commencement or cessation of use of a dwelling-house as a residence is not a change of use. Section 223 already gives the rules required for such cases and there is therefore no need to apply Section 224(2). Our approach in cases falling within Section 224(2) is to deal with each case on its merits, and to produce an adjustment which so far as possible reflects:

the extent to which, and
the length of time over which,

each part of the dwelling-house has been used as part of the residence.

This approach broadly follows the statutory method of apportionment for more straightforward cases set out in Section 223 and Section 224(1). We do not normally consider it is appropriate to take into account intervening market values when apportioning gains to different periods in Section 224(2) cases since Section 223 clearly provides for time apportionment as the appropriate method.

ELECTIONS BY MARRIED COUPLES

When a couple marry and both spouses own a residence a new two year period for making an election under Section 222(5) begins.

Where one spouse owns more than one property, and the other owns no property, and there is no change on marriage, then we take the view that a fresh period does not begin since there has been no change in the combination of residences owned by either spouse, and neither spouse needs to become a party to any existing election to which they had not previously been a party. Section 222(6)(a) only requires a notice to be given by both spouses where it affects them both. Where only one spouse owns property only that spouse is affected and he or she will already have had a two year period in which to make the election.

Where the spouses jointly own more than one property at marriage but neither separately owns any other property, a new two year period for making an election would still begin. Although both parties own the same properties as before, and have previously had a two year period in which to elect, they now have to make a joint election and a new period is required accordingly.

The right to receive a notice under Section 222(6)(b) only applies to a spouse who owns a residence. Otherwise a spouse, who had no financial interest in a property, would be given a right of appeal against a determination relating to that property owned by the other spouse, and with possibly adverse consequences for that other spouse.

SUCCESSIVE INTERESTS

Section 222(7)(a) stipulates that where a spouse inherits a dwelling-house from the other spouse he or she also inherits the other spouse's period of ownership for principal private residence relief purposes. This is not overridden by Section 62 TCGA 1992 which provides that a legatee acquires an inherited asset for CGT purposes on the date of death. Section 62 sets out the rules for computing the gain arising to a legatee, but says nothing about how any private residence relief which might be due is to be calculated, the rules for which are in Section 222 etc. Thus Section 222(7) continues to apply with the result that periods of ownership prior to the death of the first spouse to die fall to be taken into account in determining qualifying periods of residence.

One effect of this is to produce results different to those which would be obtained by only looking at the period after the death of the first spouse to die. This can work to the advantage or to the disadvantage of the taxpayer.

SECTION 224(3)

To prevent abuse of principal private residence relief there is anti-avoidance legislation at Section 224(3) which is widely drawn. Section 224(3) applies

where a dwelling-house is acquired wholly or partly for the purpose of realising a gain from its disposal, or
where there is subsequent expenditure on the dwelling-house wholly or partly for the purpose of realising a gain from its disposal.

Where the first part of Section 224(3) applies no relief is due on any gain arising from the disposal of that dwelling-house. Where the second part applies no relief is due on any part of the gain attributable to the expenditure.

Anyone who buys a dwelling-house is likely to hope that, in the fullness of time, they will make a gain on its disposal. One house may be chosen over another because its value is more likely to appreciate over time. These cases could be said to fall within the first part of the Section but, if the house was genuinely acquired and used as a residence and the conditions for relief are met, relief will not be restricted. The legislation will only be applied when the primary purpose of the acquisition was an early disposal at a profit. The same approach will be taken when considering whether a restriction of relief is appropriate under the second part of the Section.

In many cases in which the first part of Section 224(3) would be applied the transaction of purchase and sale will amount to an adventure in the nature of trade. In these cases the charge to income tax will take priority over the charge to capital gains tax. In some cases subsequent expenditure on the dwelling-house may also be part of an adventure in the nature of trade, giving rise to an income tax charge. The income tax charge will again take priority.

The second part of Section 224(3) is more often applied than the first. It denies relief on the part of a gain which is attributable to particular expenditure. Common circumstances in which it may be applied are

acquisition by a leaseholder of a superior interest in the property
conversion of an undivided dwelling-house into flats
barn conversions and other developments of outbuildings or of the land attached to the dwelling-house.

The legislation does not dictate how this part of the gain should be computed but in practice it implies a comparison between the gain which accrues and the gain which would have accrued if the relevant expenditure had not been incurred.

In deciding whether a restriction to relief is appropriate under the second part of Section 224(3) we ignore cases in which the only relevant expenditure is incurred on

obtaining planning permission, or
removing restrictive covenants.

Where there is a delay between the expenditure and the disposal the effect of inflation may need to be considered. The part of the gain which is excluded from relief is the part attributable to the expenditure incurred. This part may have been increased by the effect of inflation. If so, the effect of inflation will be mitigated by indexation allowance.

DECEASED PERSON'S ESTATES -- ESC D5

Extra-Statutory Concession D5 provides relief to Personal Representatives where they dispose of a house which before and after the deceased's death has been used as their only or main residence by individuals who under the will or intestacy are entitled to the whole or substantially the whole of the proceeds of the house. This is aimed at beneficiaries who have been living in the dwelling-house prior to and at the time of death, where there has therefore been continuity of occupation, and 'before' is interpreted accordingly. The intention is that beneficiaries who have lived in the house throughout should not be deprived of relief because their home happened to be sold by the Personal Representatives rather than by themselves as legatees. It is not intended that relief should as a result be extended to beneficiaries for whom the house has not been their only or main residence. To avoid this would mean insisting that resident beneficiaries should have a 100% interest in the dwelling- house which in turn could operate harshly against resident beneficiaries with very nearly a 100% interest. Hence the reference to 'substantially the whole' which we interpret as 75% or more.

DISPOSALS BY BENEFICIARIES

Where there is a disposal by a beneficiary of an inherited property the combined effect of Section 62(4) and Section 222(7) is that the beneficiary's period of ownership begins on the date of death. Where the beneficiary does not become resident until a later date the period prior to taking up occupation will not qualify for relief (unless it falls within the final 36 month period prior to disposal (Section 223(2)).

[Sections 222-226 TCGA 1992]

(Superceded by CT909)
CORPORATION TAX: CHARGES ON INCOME COMPANY PAYING ANNUITIES

A decision may be taken to incorporate a business carried on by a partnership, and on incorporation the company may assume a liability to pay an existing annuity to a former partner and reflect this in the agreement for the purchase of the business. The Inland Revenue will accept that Section 338(5)(b) ICTA 1988 will not operate to deny relief for what might otherwise be a charge.

If a company takes over a business on incorporation, and will subsequently have to pay an annuity, then if the agreement under which the company takes over the business makes reference to the company having ultimately to pay the annuity, again the annuity will not be prevented by Section 338(5)(b) ICTA 1988 from being a charge.

This will be the case only so long as the annuity is commercial in amount. The further question of whether Section 125 ICTA 1988 will apply can only be considered in the light of the particular facts and circumstances of each case, but it has been the Revenue's longstanding practice to regard such payments in respect of a bona fide commercial transaction as outside the scope of that provision.

The circumstances giving rise to a liability of this kind which is then assumed by a company will normally be such that the outlay will not be incurred wholly and exclusively for the purposes of a trade carried on by the company. That being so, any excess of charges paid over profits will not be eligible for carry forward under Section 393(9) ICTA 1988.

If a company takes over a business on incorporation, at a later date pays an annuity and the agreement under which the company takes over the business does not make reference to the company s liability ultimately to pay the annuity, Section 338(5)(b) will be applicable.

[Sections 125 and 138(5) ICTA 1988]

(Superseded by BIM55340 & BIM55315)

FARMING:
MILK PRODUCTION -- SUPERLEVY

Milk production is limited by quotas but producers can exceed their quota without penalty provided national limits are not exceeded. For the 1993-4 quota year national limits have been exceeded. Producers who have exceeded their quota will be required to pay superlevy if the excess was more than a threshold. The threshold above which superlevy is payable is based on national results. Calculations will be shown and the superlevy deducted on the September 1994 milk statement for August 1994 deliveries. Producers who exceeded their quota by less than the threshold will not pay superlevy.

We have been asked whether superlevy is an allowable Case 1 deduction. We can confirm that it is.

Some producers bought additional quota in order to ensure that they would not have to pay superlevy. It has been suggested that they can claim a deduction for the amount of superlevy they would have paid if they had not bought the quota or for the sum they would have paid if they had leased quota instead of buying it. We do not accept this. In the hands of a farmer who uses it in the business of milk production quota is a fixed capital asset and the cost of fixed capital assets is not an allowable revenue deduction.

! This Article Is No Longer Current (Deleted Index 2004)

INTERNATIONAL TAX:
OUTWARD INVESTMENT IN CORPORATE SECTOR

INTRODUCTION

New rules relating to the taxation of certain indebtedness in the corporate sector were introduced in Sections 61-66 Finance Act 1993. This article provides a general description and explanation of the legislation as well as clarifying a number of points which have arisen so far.

BACKGROUND

Interest or any equivalent return such as the yield on deep discount or deep gain securities is normally chargeable to tax when it arises (that is, generally, when it becomes payable and is effectively paid or made available to the person to whom it is due) rather than as it accrues -- unless the income is charged to tax as a receipt of a trade. In contrast many of the UK's major trading partners both tax and relieve interest etc. as it accrues. Some taxpayers have sought to take advantage of this difference in tax treatment. The legislation ensures that interest etc. payable to UK company lenders by overseas associated company borrowers, whether directly or through an intermediary, is charged to tax as it accrues rather than as it arises, subject to a number of important exceptions.

LEGISLATION

The terms of the legislation are that where a UK resident company has

made a loan directly or through a third party to an associated company which is resident outside the UK, and
the terms of the loan are such that (at any time during the life of the loan) the full payment of interest -- or other return -- may be deferred for a period longer than 12 months (the "qualifying terms")

then such loans are termed "qualifying debts" and the interest (or other return) will be taxed as it accrues in each accounting period rather than when it is paid to the lender.

There are three possible exceptions to the general rule:

The first is designed to exclude from the legislation those loans etc. where the deferred payment terms are for wholly commercial rather than for tax reasons -- such as in a loan to finance a long term construction or exploration project where there is likely to be a long continuous period of expenditure before any income is generated. To qualify for this exemption the taxpayer must satisfy the Inspector firstly, that the possibility of returns on the debt being charged to tax as they arise, rather than as they accrue, was not the main reason (or one of the main reasons) why the debt was created on the "qualifying terms". And, secondly, that a debt on those same qualifying terms would still have been created if the UK lender and overseas borrower were unrelated. The Inland Revenue will have regard to a number of factors, including the purpose or purposes for which the debt was created and the borrowing capacity of the overseas borrower, when examining any claims that a debt falls outside the legislation by virtue of this exemption.

The second exception is designed to deal with business start-up situations more generally and instances of temporary trading difficulties where sufficient income is unlikely to be generated to fund the debt on other than "qualifying terms". In these circumstances, provided the terms of the loan etc. are such that either

a. the loan has to be repaid within 2 years, or

b. the only deferral of interest is for an initial period of 2 years or less and interest will thereafter be payable as it accrues at intervals of 12 months or less.

it may be excepted from the general rule.

To qualify for exception in these cases it remains necessary, additionally, for the Inspector to be satisfied that the possibility of returns on the debt being charged to tax as they arise, rather than as they accrue, was not the main reason or one of the main reasons why the debt was created on the "qualifying terms". But it is not necessary also to satisfy the Inspector that a debt on those same terms would still have been created if the UK lender and overseas borrower were unrelated.

The third exception is designed to exempt debt in circumstances where it becomes clear that the borrower will be unable to pay. Those circumstances are where the overseas borrowing company is being, or likely to be, wound up or dissolved because of its inability to pay its debts.

Where one or other of these three sets of conditions is satisfied the loan will be exempt and interest (or other return) will be taxed in accordance with other provisions in the Taxes Act, that is, normally as it arises.

BASIS OF CHARGE

Where a loan falls within the scope of the legislation because it is a qualifying debt a charge to tax is brought about by means of deeming there to be a disposal of the debt at the end of each accounting period and a reacquisition at the beginning of the next accounting period. The amount of income to be taxed is then arrived at by applying existing legislation dealing with the transfer of securities.

In a case where the return to the lender is in the form of interest each actual or deemed transfer of the debt gives rise to a charge to tax by operation of the accrued income scheme (Sections 710-728 ICTA 1988). The security is deemed to be a variable rate security so that the amount to be taxed each period is the "just and reasonable amount" in accordance with Section 717(9) ICTA 1988. In cases where the lender derives a return from enhanced loan principal on repayment the deemed transfers are dealt with in accordance with the deep discount legislation (Schedule 4 ICTA 1988) or the deep gains legislation (Schedule 11 FA 1989). In the former case the annual taxable amount will be arrived at by applying the formula contained in Schedule 4 and in the latter case by measuring the difference between the market value of the security at the beginning and at the end of the accounting period.

Commencement date

The legislation applies to interest or equivalent returns which accrue from 1 April 1993. Interest etc. on relevant indebtedness which accrues prior to that date is charged to tax on the earliest of

the date when it arises on ordinary principles, or
the earliest date on which the lender, under the terms of the debt, is entitled to require the debt to be redeemed, or
the date the loan etc. is transferred or otherwise disposed of by the lender.

POINTS ARISING

Double charging

Steps have been taken to avoid a double or excessive charge to tax. It is possible for a debt with the characteristics of a deep gain security to carry interest and thereby be potentially subject to the rules in both Section 63 and Section 65. This is avoided by Section 66(1) and (2) which provide that such debts shall be treated only as deep gain securities.

Section 66(3) provides that where a debt is deemed to be a debt on a security then income which is charged to tax as a result of this legislation cannot be charged again when it actually arises.

More generally when interest or equivalent return has been the subject of a charge under this legislation in one accounting period and is subsequently paid to the same person in a later period, the Case IV or V charge arising on ordinary principles will be reduced by the amount which has previously been brought into charge under this legislation. This follows from the Revenue's understanding that in these circumstances there is a single source of income. Case law provides that the same person cannot be assessed more than once on income derived from a single source.

Debts with the characteristics of deep gain securities may, in theory, be vulnerable to a charge in excess of the overall actual profit realised, by virtue of the provisions which deem such a debt to be sold and reacquired for each accounting period throughout its life. This is because, under the terms of the deep gain legislation, profits are charged to tax but no relief is allowed for losses -- a profit for one period is not reduced by a loss in another. However, the return on most deep gain securities is linked to a recognised inflation index and it is expected, in practice, that inbuilt uplift each year will normally ensure that the security increases in value.

"Just and reasonable amount"

In determining the amount of accruing interest to be charged for any particular period under the legislation on a "just and reasonable" basis, in accordance with the terms of the accrued income scheme, any interest actually paid in respect of a loan will be taken into account. It is recognised that it would be unreasonable to disregard interest which has been paid and taxed as such.

[Sections 61-66 Finance Act 1993]

TREATY CLAIMS AND LOAN INTEREST

(Superseded by INTM 574030 & INTM 574040.)

When a company pays yearly interest to a non-UK resident with some specific exceptions it is obliged to deduct Income Tax by virtue of Section 349(2) and account for that tax to the Revenue.

Where the recipient of the interest is a resident of a territory with which the UK has a Double Taxation Treaty, the UK may, depending on the terms of the appropriate Treaty, exempt the interest from UK tax or tax it at a reduced rate.

We give such relief under our Treaties in one of two ways. Either we repay the non-resident any tax that has been suffered (or the appropriate part of that tax) or we issue a Notice to the payer of the interest authorising him (under SI 1970 No 488) to pay interest without deduction of tax (or at a reduced rate) according to the terms of the Treaty.

Relief from UK tax under a Treaty has to be claimed by the non- resident recipient of the interest in a claim made to the Board (Section 788(6) ICTA 1988). In the absence of an accepted and agreed claim, the payer of the interest is obliged to deduct and account for Income Tax under Section 349(2) in the normal way.

The Revenue closely monitor Treaty claims involving loan interest, to ensure that the interest in question qualifies under the terms of the Treaty. We are particularly concerned with the possibility that a loan may be standing in the place of equity, and that the payment of interest should in reality be characterised as a distribution of UK profits or, with the possibility that transactions may fall foul of particular anti-abuse provisions in the Treaty.

It is important therefore, that nonresident recipients of loan interest comply with their obligations to make Treaty claims. It is also important that such claims are examined as soon as possible after the transaction giving rise to interest etc. takes place, so that we can more easily focus on current material relevant to the claim. We often need to establish a company's arm's length borrowing capacity at the time a loan is made and it is helpful to be able to consider contemporaneous information.

We recognise that examination of some Treaty claims takes time and we do not wish to penalise the overseas recipients of the interest for any delay in processing their claims. Equally, we do not wish the UK resident payers to assume the benefit of a Treaty by allowing them to pay interest without deduction of Income Tax, simply provided a claim is made at some time within the statutory period. It is therefore Revenue policy, where a claim under the Treaty is accepted as valid, to provide that a Notice allowing for Treaty relief to be given at source by the payer of interest may have retrospective effect: but only to the date that the certified Treaty claim is received by Financial Intermediaries and Claims Office (FICO) (International) -- formerly The Inspector of Foreign Dividends -- on behalf of the Board of Inland Revenue.

FICO (International) deals with a large number of Treaty claims. The vast majority of those claims are made when a loan is put in place, and we are able to issue statutory Notices well in advance of interest payment dates. Most borrowers who pay interest before the issue of a Notice authorising them to pay interest without deduction of tax (or at a reduced rate of tax), deduct Income Tax and account for it in the normal way. A problem arises only where a claim is lodged after a payment of interest has been made and the payer has failed to deduct Income Tax in accordance with its statutory duty.

Where interest is paid before a certified claim is received, the Revenue expect the payer of interest to meet the statutory obligations and deduct Income Tax. If tax is not deducted then Section 87 TMA 1970 interest is exigible irrespective of whether relief. as claimed, is ultimately agreed. In practice, where a claim has been successful, the Inspector may arrange for acceptance of payment of the Section 87 interest due without raising an assessment to collect the Income tax from the UK payer. Of course, an assessment is raised and interest charged, as appropriate, where a payer of interest has failed to deduct Income Tax, whether before or after the certified claim has been received by the UK Revenue, where the claim is refused in whole or in part.

Treaty claims have to be certified by the Revenue authorities in the recipient's tax territory. There can be delay in such authorities forwarding certified claim forms to FICO (International). It is possible, in cases of extreme urgency, for claimants to recover certified claim forms from the overseas Revenue authorities and to send them to FICO (International) themselves. Indeed some authorities -- the German Revenue authorities for example -- return claim forms to claimants for this purpose.

FICO (International) intend publishing a leaflet entitled Double Taxation Relief Inter-company Loans and Royalties. This will be a guide for those companies resident in a country where we have a Double Taxation Treaty (where the agreement provides for relief from UK tax on interest or royalties) on how to claim repayment of UK tax already deducted and/or relief from UK tax at source in respect of future income.

Once published the leaflet will be obtainable from FICO (International) Lynwood Road, Thames Ditton, Surrey, England KT7 ODP, and all local districts will be issued with a small supply.

Any queries should be addressed to:

Lyn McDonald
International Division
Melbourne House
Aldwych
London WC2B 4LL
Tel: 071-438-6860

(Superseded by PIM4002)

RENT A ROOM:
ACCOMMODATION USED FOR TRADE
OR BUSINESS PURPOSES

Section 59 and Schedule 10 Finance (No2) Act 1992 contain rules for determining whether Rent a Room relief may be due in respect of income which would otherwise be chargeable under Case I or Case VI of Schedule D (or both those Cases).

There have been some suggestions in the professional press that relief could be available where a residence, or part of a residence, is used as an office or for other trade or business purposes (other than the business of providing furnished living accommodation) and sums are paid in respect of that use. We take the view that such claims are inadmissible since

the words of the legislation, in our opinion, do not permit such claims, and
the legislation was never intended to give relief in such circumstances.

Where a room is used exclusively as an office or as other trade or business premises, it is no longer occupied or intended to be occupied as a separate residence -- one of the conditions for Rent a Room relief. As such, it is no longer, for Rent a Room purposes, part of the "residence" because Paragraph 7 Schedule 10, permits the identification of parts of buildings which are occupied or intended to be occupied as a residence.

Rent a Room relief can only apply where "relevant sums" accrue in respect of the use of "furnished accommodation" in a "qualifying residence". The Act does not define "accommodation" which should therefore take its everyday meaning. The dictionary meaning of "accommodation" is "lodgings" or "a place to live" and in our opinion, the normal unqualified meaning of "accommodation" is "living accommodation". Consequently, even if an entire residence, or part of a residence, is used as trade or business premises and payments are made in respect of that use, we take the view that Rent a Room relief will not be due. The payments will not have been made in respect of the use of living accommodation as such.

The Standing Committee Debate in Parliament on Rent a Room indicates that the context in which Rent a Room was being considered was that of providing additional residential accommodation and not office or business accommodation. We do not think that the legislation is ambiguous or obscure. However, should Commissioners, for example, consider that it is, then following the decision in the case of Pepper v Hart (TL 3339) it may be possible for them to refer to relevant Parliamentary material. This material supports our interpretation that lettings other than furnished residential lettings are excluded from Rent a Room relief.

The foregoing does not apply to genuine lodgers such as students who are provided with study facilities in their lodgings. In such cases, we would not want to deny relief where a lodger living in the home is provided with a desk, or the use of a room with a desk, which he or she uses for work or study.

!This article is no longer current (Deleted Index 2002)

SCHEDULE D CASES I AND II:
BAD AND DOUBTFUL DEBTS

Entries for bad debts and bad debts reserves are common features within the accounts of most traders and many professionals.

Our view is that a deduction for bad or doubtful debts is to be made in arriving at the profits of the year in which the debts become bad or doubtful, provided that the amount reserved may reasonably be regarded as based on a separate valuation of each debt.

ACCOUNTANCY PRACTICE

This accepts that events arising after the balance sheet date and before accounts are finalised may need to be reflected in the provision for bad and doubtful debts if they furnish additional evidence of conditions that existed at the balance sheet date.

Our interpretation of this is that if:

a debt existed at the balance sheet date, and
the creditor at that date had no reason to believe that he would not be paid, but
before the accounts were finalised he discovered that the financial position of the debtor at the balance sheet date was such that he was, even at that time, unlikely to be paid,

the creditor would be entitled to make a provision for the debt in computing his profit.

A common example of the above is where a debtor at the balance sheet date goes into administration or liquidation shortly after the balance sheet date and before the date on which the financial statements are approved by the trader. Whilst the administration or liquidation took place after the balance sheet date, its occurrence before the accounts were finalised normally sheds light on the financial position of the debtor at the balance sheet date. If the period since the balance sheet date is short it is unlikely that a debtor would go from financial good health to insolvency in that period. In these circumstances it would normally be reasonable for the trader to regard the debt as doubtful. The amount of the acceptable provision would depend upon the information available.

SLOW PAYERS

If the debtor is habitually a slow payer, and there are no grounds to believe his financial position has changed, then we would not accept that the length of time a debt has been outstanding is on its own sufficient reason to regard it as doubtful. We would therefore reject a provision made on these grounds as not being 'estimated to be bad'.

EVIDENCE REQUIRED

Where Inspectors cannot satisfy themselves, from the information available to them, that a deduction for a bad debt or bad debt provision fulfills the above criteria, additional details will be sought. The Inspector will need to identify each debt involved and establish

how the extent of its doubtfulness was evaluated,
when this was done,
by whom, and
what specific information was used in arriving at that valuation.

Typically, this requires sight of all the evidence available, at the relevant date, to the taxpayer creditor regarding the creditworthiness of the debtor. This will include copies of all correspondence, both internal (such as memos and minutes of meetings at which the matter was considered) and external (correspondence with the debtor, solicitors, banks, factoring agencies, etc. and any reports obtained concerning the financial position of the debtor), relating to the transactions in question covering the period up until the time a reserve for the debts was entered in the creditor's books.

[Section 74(1)(j) ICTA 1988 -- as amended by Section 144 FA 1994]

! This Article Is No Longer Current (Deleted Index 2004)

DEDUCTION FOR COSTS
OF SECRETARIAL ASSISTANCE

Our attention has been drawn to recent press articles which indicate that a new "concession" has been given to barristers in private practice for part of the costs of employing a nanny. We wish to make it clear that neither by law nor Revenue concession is tax relief available for a business person's own child-care costs.

THE LAW

Expenditure is not deductible in computing the profits of a trade, profession or vocation unless it is incurred wholly and exclusively for the purposes of the business. But where an outgoing is such that a definite part or proportion of it can be identified as being wholly and exclusively expended for business purposes a deduction may be due for that part. This widely held understanding of the law has been approved by the courts.

USE OF NANNY TO UNDERTAKE SECRETARIAL DUTIES

A nanny may be partly employed to carry out material secretarial duties in the business of her employer. If so, a deduction may be due for that part of the costs of employing her referable (on a time basis) to those duties.

What proportion of the employment costs may be deductible in this way depends on the facts and circumstances of individual cases. But, where a District Inspector handles the returns of a number of businesses carried on in an essentially similar way, he or she may decide, as a matter of local practice, to set down guidelines regarding the treatment of particular items of expenditure.

In the case of a barrister's nanny it has been reported that the local Inspector has accepted that a secretarial "allowance" can be claimed. This misrepresents the position. What the Inspector has done is to give an indication of the maximum deduction he would ordinarily accept.

It remains the case that no deduction at all will be due if the employee does not undertake material secretarial duties. Conversely, in a case where detailed records showed that exceptionally heavy duties were undertaken, a contention that a greater sum should be deducted would have to be considered on its merits. And in any event the figures have no application to other businesses where the need for a nanny to undertake secretarial duties may be very different.

[Section 74(1)(a) ICTA 1988]

(deleted since index 2002)

MOTOR DEALERS STOCK VALUATIONS

BASIC PRINCIPLES

Accounting practice requires that stocks normally need to be stated at cost, or, if lower, at net realisable value. The computation of net realisable value should take into account events occurring between the balance sheet date and the date when the accounts are approved which may provide additional evidence of the value of stocks at the balance sheet date. The profit computed by the correct application of generally accepted accounting practice to the particular facts is the starting point for the computation of the taxable trading profit.

THE MOTOR DEALERS SITUATION

Accountancy

Subject to some adjustment to the price to reflect the age and condition of a used vehicle, a motor dealer will only pay the trade value, arrived at from trade publications, for a used car except where it is acquired in a part exchange transaction. In that situation the price paid may be more than the dealer would otherwise have been willing to pay for the used car in order to secure the sale of the new car. The documentation generally shows the inflated price of the used car as its cost, but arguably the excess of that cost over the trade value is in substance a discount on the new car. It is a widespread industry practice for dealers to arrive at the stock value of used cars acquired in part exchange transactions from the published "bottom book" trade value. The accountancy advice we have received is that the correct application of the accrual's concept, stated in SSAP 2, requires the substance of the transaction rather than the form to be reflected in the accounts. In the situation described above the true substance is that the excess of the part exchange price over that derived from the trade publication is a discount on the new car and the cost of the used car is its appropriate published trade value at the date of acquisition. For stock valuation therefore correct accounting practice allows the consistent use of the appropriate trade price of a used car taken in such a part exchange transaction as its cost.

Tax

Our view was that notwithstanding the accountancy substance the legal form of the part exchange agreement was decisive and therefore for tax purposes the legal cost of the used vehicle should be used in arriving at the stock valuation. In the light of legal advice we have received following the Court of Appeal decision Gallagher v Jones and Threlfa1l v Jones (TL 3373) we now accept that the legal form of the part exchange agreement need not override the correct application of the accruals concept in these particular circumstances. Therefore we accept that for stock valuation purposes the published trade value at the time of acquisition may be used to arrive at the cost of used cars acquired in part exchange transactions.

Use of Trade Value at the balance sheet date

Some dealers arrive at the stock value of a used car acquired in a part exchange transaction from its published trade value at the balance sheet date (TVBS) rather than from its published trade value when it was acquired.

As a car tends to depreciate with age valuation on a TVBS basis will involve a write down below cost, in substance, as well as in legal form. That basis will be justifiable if that figure is a reasonable approximation of the car's net realisable value taking into account the market in which it is likely to be sold and the further costs to be incurred. In making that comparison the actual sale proceeds (and further costs) should be taken into account when these were known at the time the accounts were drawn up. The use of hindsight is in accordance with SSAP 17.

Sometimes cars which were not acquired in a part exchange transaction are automatically valued on a TVBS basis in the accounts. In that situation there is no justification for the cost of such vehicles for stock valuation purposes being regarded as anything other than the legal cost and again TVBS will only be acceptable if it provides an accurate appraisal of the net realisab1e value of a particular car.

Inspectors may challenge the use of the TVBS basis where it leads to a significant loss of tax or timing differential.

Other Accounting Bases

Where accounts are prepared using another different basis we will accept it provided that it reflects the correct application of generally accepted accounting practice, as interpreted by the courts to the particular facts and is consistently applied.

A trader who has settled his or her past Case I liability in accordance with our previous view may want to change to a basis we would now accept is appropriate for determining the Case I profits for unsettled and future years. Such a change would be acceptable provided that the new basis was consistently used in the accounts. Paragraph 3 of Statement of Practice 3/90 would apply to the year of change.

Background papers

Statement of Standard Accounting Practice No.2 (Disclosure of accounting policies), No.9 (Stocks and Long-term Contracts) and No. 17 (Accounting for post balance sheet events). Revenue Statement of Practice 3/90 dated 10 January 1990.

(Superseded by BIM24230)

TRADING RECEIPTS OF MEMBERS' GOLF CLUBS

We have been asked whether non-proprietary members' golf clubs are liable to tax on trading income such as visitors' green fees. This article gives our views on when income received by members' clubs for the use of their facilities by non-members is taxable trading income.

Any surplus arising to a members' club from transactions with its members is not normally taxable. Payments by members in respect of their personal guests, even when these are described as 'visitors' fees' are normally regarded as part of that surplus.

But receipts from visitors who, in return for payment on a commercial basis, are allowed to use a club's facilities will be receipts from a taxable trade in the club's hands. This applies to individuals who arrive at a club to use its facilities on a casual basis and to groups who may book in advance.

Such visitors may become 'temporary members' of the club. But this will not prevent receipts from their use of the club's facilities from being taken into account for tax unless their rights as temporary members (such as rights to vote at meetings, participate fully in club activities and generally to exercise control over the running of the club), and the opportunities to exercise them, are similar to those of full members. In computing the taxable income derived from non-members in this way the related expenses will be deductible, including a reasonable proportion of course overheads.

[Section 18 ICTA 1988]

[Carlisle & Silloth Golf Club v Smith 6 TC 48]

(Superceded by EIM26158 onwards)

SCHEDULE E:
BENEFICIAL LOANS:
EXEMPTION FOR COMMERCIAL LOANS

Section 88(3) of the Finance Act 1994 introduced an exemption from the benefit in kind charge on loans which are "commercial loans" -- loans made to employees on the same terms and conditions as loans made by lenders to members of the public (Section 161(1A) and (1B) ICTA 1988). We have been asked to give guidance on some of the expressions in the new provisions.

SUMMARY OF EXEMPTION

The exemption takes effect from 1994-95 and applies to existing as well as new loans which satisfy all the following conditions:

o the loan to the employee was made by a person in the ordinary course of a business which includes the lending of money;

o at the time the loan to the employee was made, comparable loans (loans made for the same or similar purposes, and on the same terms and conditions as the loan to the employee) were available to ordinary customers;

at or about the time the loan to the employee was made, a substantial proportion of the relevant loans (the loan to the employee plus comparable loans) were made to members of the public at large; and
all the relevant loans are held on the same terms, and where those terms are different from the original terms, the changes were made in the ordinary course of the lender's business.

COMMENTS

We have printed in bold above the expressions on which we have been asked to comment.

SAME TERMS AND CONDITIONS

For loans made on or after 1 June 1994, only loans made on the same terms and conditions as loans made to the general public will qualify for the new exemption. It is not sufficient for the terms and conditions to be similar or broadly the same.

A loan to an employee would not be on the same terms and conditions if for example:

a. the lending criteria (eg loan-to-income ratio or loan-to-value ratio) were relaxed in favour of the employee; or

b. fees or charges normally made in connection with the application for the loan (eg valuation fees, administration or arrangement fees, reservation or booking fees) or in connection with the loan itself (eg where the loan is greater than a certain percentage of the value of the security) were waived or reduced in favour of the employee.

For loans made before 1 June 1994, the waiver or reduction of the incidental costs of obtaining a loan (eg valuation, administration, arrangement, reservation or booking fees) can be ignored (Section 88(5)). All the other terms and conditions of a loan to an employee made before that date must however be precisely the same as for loans to the general public if the loan to the employee is to come within the exemption.

AT OR ABOUT THE TIME THE LOAN TO THE EMPLOYEE WAS MADE

The timespan for comparing the loan to the employee and comparable loans is not specified in the legislation. This is to allow a reasonable, common sense approach in determining whether loans to employees are genuinely "commercial" loans within the context of the provisions. Any fixed period would have produced arbitrary results. For example, a particular offer to the public might open on 1 April and close the following 31 March. In the period 1 April to 5 April the majority of loans might be made to employees. However in the period 6 April to 31 March more members of the public take up the offer so that in the overall period from 1 April to 31 March it is clear that a substantial proportion of the loans were made to members of the public as opposed to employees. It would be reasonable in those circumstances to take the whole period 1 April to 31 March in deciding whether the loans to employees were exempt.

A SUBSTANTIAL PROPORTION

This condition requires lenders to make a large or considerable proportion of loans to members of the public rather than to employees. We will accept as a matter of course that 50% or more of the total number of loans is a "substantial proportion". Whether something less than 50% would qualify would depend on the circumstances in any particular case.

MEMBERS OF THE PUBLIC AT LARGE

The public at large means here the public in general, as opposed to a particular section of the public. The purpose of the expression is to ensure that a substantial proportion of loans are made by the lender to ordinary customers at arm's length rather than to a selected group (eg suppliers or former employees). However, loans made by merchant banks or other specialised lenders can still come within the exemption, provided all of the conditions are met. The requirement does not mean that lenders have to make loans to everyone on the Clapham omnibus.

[Section 88 Finance Act 1994]

miscellaneous

! This Article Is No Longer Current (Deleted Index 2001)

THE MULTIPLE LAND VALUATION SCHEME

This article aims to respond to enquiries about the above scheme and to explain it's purpose and operation. We hope that more taxpayers will take part.

In recent years there has been a significant increase in valuation work, particularly since the rebasing of gains to 31 March 1982. The compliance burden on taxpayers and practitioners as well as on Inspectors and the Valuation Office Agency has increased.

The Multiple Land Valuation scheme was piloted in 1990 to help where taxpayers dispose of 30 or more interests in land in a year of assessment or in an accounting period. It has proved successful and is being extended to any taxpayer who qualifies for inclusion. A group of companies is considered together to decide if the disposal threshhold has been reached.

Sampling is carried out by the Capital Gains Tax Sampling Unit of the Valuation Office Agency (CGTSU). Usually between 25% and 50% of valuations (depending on the total number of valuations involved) is selected for review. These are referred to the local District Valuers who conduct any negotiations necessary to reach agreement.

When the results of the sample are known they are discussed with the taxpayer by the CGTSU. This may result in changes to the valuations returned by the taxpayer: (1) for those sampled in the light of the District Valuer's reports; and, (2) for the non-sampled properties where a discernible pattern has emerged from the reports received. Where no pattern has emerged, or where particular properties need to be looked at, the sample group may be expanded and the results are discussed to settle all the valuations.

If the sampling exercise is successful the CGTSU will agree with the taxpayer the valuations that have been amended and confirm all other valuations for that year or accounting period are agreed as returned. The Inspector is informed of the outcome.

If the initial sample indicates that all returned valuations should be checked then they are all referred to the local District Valuer. The scheme does not, of course, restrict either party's right of appeal in the event of disagreement but in practice this has rarely occurred.

If you require further information about the scheme or would like to be considered for inclusion in it, the address to write to from September 1 is:

Capital Gains Tax Sampling Unit
Valuation Office Agency
1st Floor, 6 Dormer Place
Leamington Spa
Warwickshire
CV32 5AF
Tel: 0926 470499

(Article deleted since index 2002)

SCHEDULE E:
MOBILE TELEPHONES -- BOOKLET 480

In our last issue, we explained that the chapter on mobile telephones in the 1994 version of Booklet 480 contained an error (Tax Bulletin Issue 11 page 134). It has been pointed out that that article may appear confusing as far as the rental costs of a mobile telephone are concerned. We therefore give below the revised text on the definition of 'full cost' of any private use of a mobile telephone, which will appear in the next version of booklet 480:

"'Full cost' means
a. the cost of private calls plus b. a proportionate share of the higher of (i) 20% of the market value of the telephone when it was first used to provide a benefit, and (ii) the equipment rental costs plus c. unless the purpose of the provision of the telephone was to make it available for business use, a proportionate share of any other expenses incurred (eg line rental) in connection with its provision."
[Sections 159A and 156 ICTA 1988]

PROCEDURAL RULES FOR
GENERAL AND SPECIAL COMMISSIONERS

A consultative document on the conduct and administration of tax appeals was issued jointly by the Inland Revenue and the Lord Chancellors' Department in 1991. It proposed a number of changes in the way in which hearings before Commissioners were conducted.

The proposals were generally well received and the amendments to primary legislation needed to implement the proposals were introduced by Finance (No.2)Act 1992 (Sections 46A, 56B, 56C and 56D Taxes Management Act 1970). The Lord Chancellor has introduced regulations by statutory instrument which give detailed effect to the proposals as amended after representations made on the consultative document. A news release about the regulations was issued by the Lord Chancellor's Department on 14th July 1994.

The Regulations provide for

the introduction of procedural rules for both General and Special Commissioners
the Special Commissioners to publish their decisions
the Special Commissioners to award costs in certain limited circumstances
Special Commissioners' hearings to be held in public in most circumstances

There are separate statutory instruments for the Special Commissioners and for the General Commissioners being:

The Special Commissioners (Jurisdiction and Procedure) Regulations 1994 (SI 1994 No. 1811), and
The General Commissioners (Jurisdiction and Procedure) Regulations 1994 (SI 1994 No. 1812).

The repeal and amendment of existing legislation which is necessary as a result of the introduction of the regulations is dealt with separately in The General and Special Commissioners (Amendment of Enactments) Regulations 1994 (SI 1994 No. 1813).

The Regulations apply with effect from 1st September 1994.

! This Article Is No Longer Current (Deleted Index 2004)

SALE OF CONSULTATIVE DOCUMENTS

Until recently, all sales of Consultative Documents and Business Economic Notes were handled through Somerset House Reference Room. The Reference Room has now closed and documents can be obtained by post from the Somerset House Library or in person from the Public Enquiry Room at Somerset House.

Postal applications should be addressed to: Inland Revenue Library, Mid Basement, Somerset House, Strand, London WC2R 1LB.

Telephone enquiries should be directed to the Library on 071-438 6325 though callers should be aware that telephone orders cannot be taken.

TAX BULLETIN
CORRECTION TO ISSUE 11

The Revenue Interpretation entitled "Corporation Tax: Allowance of Interest Paid by Companies with neither Trading nor Investment Status" on page 129 of Issue 11 contained a mistake in the final paragraph. The date "16 May 1993" should have read "16 May 1994". The Editor apologises for any confusion caused.

INLAND REVENUE STATEMENTS OF PRACTICE AND
EXTRA-STATUTORY CONCESSIONS ISSUED BETWEEN
1 MAY 1994 AND 29 JULY 1994

EXTRA-STATUTORY CONCESSIONS
Number Title Date of Issue D28 Assets of negligible value 31/5/94 (revision) C9 Associated Companies 20/6/94 (revision) A43 Interest Relief: Investments in 20/6/94 Partnerships, Co-Operatives, (revision) Close Companies And Employee-Controlled Companies
STATEMENTS OF PRACTICE
Number Title Date of Issue 2/94 Enterprise Investment Scheme: 9/5/94 Location of Activity 3/94 Business Expansion Scheme and Enterprise 9/5/94 Investment Scheme: Loans to Investors 4/94 Enhanced Stock Dividends Received By Trustees Of Interest In 17/5/94 Possession Trusts
You can get copies of SPs and ESCs from Christine Jordan at the Public Enquiry Room, Somerset House. Telephone 071-438 7772.

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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.
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"Revenue decisions" report conclusions that were reached on the facts of i

Tax Bulletin Issue 12

INLAND REVENUE TAX BULLETIN Issue 12

CONTENTS

FOREWORD

! This Article Is No Longer Current (Deleted Index 2004)

MATRIX SECURITIES: GUIDANCE TO TAXPAYERS

(Superceded by INTM 204050) CONTROLLED FOREIGN COMPANIES

WHAT DOES THIS MEAN FOR TRADING CFCs?

WHEN DO THE NEW RULES COME INTO EFFECT?

CAN A CFC SPLIT ITS ACCOUNTING PERIOD AT 30 NOVEMBER 1993?

WOULD THE ANTI-AVOIDANCE RULE FOR SHORT ACCOUNTING PERIODS (PARAGRAPH 3(2) SCHEDULE 25) APPLY TO THESE PART PERIODS?

CAN INTEREST PAID TO A NON-RESIDENT OUT OF INCOME FROM THE UKBE DEDUCTED FROM THE CHARGEABLE PROFITS?

WHAT ABOUT INTEREST WHICH MAY BE TREATED AS A DISTRIBUTION UNDER SECTION 209(2)(e)(iv) OR (v)?

WHAT ABOUT SHORT INTEREST?

CAN SECTION 770 APPLY TO THE ACCEPTABLE DISTRIBUTION POLICY?

HOW WILL THE NEW RULES ON FOREX APPLY TO CFCS?

CAN ADDITIONAL DISTRIBUTIONS BE MADE TO SATISFY THE ADP IF THE COMPUTATION OF NET CHARGEABLE PROFITS IS REVISED BY THE REVENUE?

CAN CREDIT HE GIVEN FOR TAX PAID ON DISTRIBUTIONS IF A DIRECTION IS MADE?

WHAT HAPPENS IF THE DISTRIBUTION HAS TO BE MADE FOR A DIFFERENT ACCOUNTING PERIOD?

WILL I HAVE TO MAKE DETAILED CALCULATIONS OF UK TAXABLE PROFITS EVERY YEAR FOR EVERY NON-TRADING CFC IN THE GROUP?

WILL THE INLAND REVENUE GIVE AN ADVANCE RULING ON WHETHER A CFC IS EXCLUDED FROM THE DIRECTION MAKING POWER BY THE EXEMPT ACTIVITIES TEST OR THE MOTIVE TEST?

WILL THE ADVANCE RULING PROCEDURE DEPEND ON SATISFYING THE MOTIVE TEST?

EXAMPLES SHOWING EFFECT OF INTEREST PAID TO A NON-RESIDENT OUT OF INCOME FROM THE UK

EXAMPLE 1: OVERSEAS COMPANY ISSUES DEBT TO THIRD PARTIES AND LENDS THE PROCEEDS TO ITS UK PARENT. THE U.K. PARENT IS NOT OBLIGED TO WITHHOLD TAX.

EXAMPLE 2: OVERSEAS COMPANY ISSUES DEBT TO THIRD PARTIES AND LENDS THE PROCEEDS TO ITS UK PARENT. THE UK PARENT IS OBLIGED TO WITHHOLD TAX

! This Article Is No Longer Current (Deleted Index 2001)

FOREIGN INCOME DIVIDENDS

Specific aspects of the operation of the scheme

IN WHAT FORM SHOULD AN ELECTION FOR A DIVIDEND TO BE A FID (SECTION 246A), AND FOR A FID TO BE MATCHED WITH DISTRIBUTABLE FOREIGN PROFITS (DFPS) OR ELIGIBLE PROFITS (SECTIONS 246J AND 246K), BE MADE?

WHAT FORM SHOULD THE DIVIDEND VOUCHER TAKE? (SECTION 246G)

IN WHAT FORM SHOULD THE CLAIM TO REPAYMENT OF ACT BE MADE?

DOES THE EXISTENCE OF AN ARTICLE PERMITTING DIRECTORS TO OFFER A SCRIP ALTERNATIVE PREVENT A FID DISTRIBUTION FROM BEING MADE? (SECTION 246A)

CAN PROVISIONAL REPAYMENT OF ACT BE MADE IN ADVANCE OF FIGURES FOR THE ACCOUNTING PERIOD CONCERNED BEING FINALISED?

Matching of FIDs with distributable foreign profits (DFPS)

SELF ASSESSMENT: NEW PROCEDURES FOR TAXING PARTNERSHIPS

1996-97 AND LATER YEARS

WHAT IS DIFFERENT ABOUT 1994-95 AND 1995-96

Partnerships in existence at 5 April 1994

Partnerships commencing, or deemed to commence, on or after 6 April 1994

The Legal Position

Partnership Returns

Personal Returns

Assessments and Appeals

A Practical Approach.

revenue interpretations

CAPITAL GAINS TAX: WHEN IS AN OPEN OFFER TREATED AS A SHARE REORGANISATION?

! Superseded by CG 64200 onwards

PRINCIPLE PRIVATE RESIDENCE RELIEF

SCOPE OF THE DWELLING-HOUSE -- MEANING OF CURTILAGE

SALE OF A HOUSE AND GARDEN AFTER IT HAS CEASED TO BE USED AS A RESIDENCE

STATEMENT OF PRACTICE D4

PERIODS OF ABSENCE

APPORTIONMENTS

ELECTIONS BY MARRIED COUPLES

SUCCESSIVE INTERESTS

SECTION 224(3)

DECEASED PERSON'S ESTATES -- ESC D5

DISPOSALS BY BENEFICIARIES

(Superceded by CT909) CORPORATION TAX: CHARGES ON INCOME COMPANY PAYING ANNUITIES

(Superseded by BIM55340 & BIM55315)

FARMING: MILK PRODUCTION -- SUPERLEVY

! This Article Is No Longer Current (Deleted Index 2004)

INTERNATIONAL TAX: OUTWARD INVESTMENT IN CORPORATE SECTOR

INTRODUCTION

BACKGROUND

LEGISLATION

BASIS OF CHARGE

Commencement date

POINTS ARISING

Double charging

"Just and reasonable amount"

TREATY CLAIMS AND LOAN INTEREST

(Superseded by INTM 574030 & INTM 574040.)

(Superseded by PIM4002)

RENT A ROOM: ACCOMMODATION USED FOR TRADE OR BUSINESS PURPOSES

!This article is no longer current (Deleted Index 2002)

SCHEDULE D CASES I AND II: BAD AND DOUBTFUL DEBTS

ACCOUNTANCY PRACTICE

SLOW PAYERS

EVIDENCE REQUIRED

INLAND REVENUE TAX BULLETIN
Issue 12

MATRIX SECURITIES:
GUIDANCE TO TAXPAYERS

(Superceded by INTM 204050)
CONTROLLED FOREIGN COMPANIES

IN WHAT FORM SHOULD AN ELECTION FOR A DIVIDEND TO BE
A FID (SECTION 246A), AND FOR A FID TO BE MATCHED WITH
DISTRIBUTABLE FOREIGN PROFITS (DFPS) OR ELIGIBLE PROFITS
(SECTIONS 246J AND 246K), BE MADE?

SELF ASSESSMENT:
NEW PROCEDURES FOR TAXING PARTNERSHIPS

CAPITAL GAINS TAX:
WHEN IS AN OPEN OFFER TREATED
AS A SHARE REORGANISATION?

(Superceded by CT909)
CORPORATION TAX: CHARGES ON INCOME COMPANY PAYING ANNUITIES

FARMING:
MILK PRODUCTION -- SUPERLEVY

INTERNATIONAL TAX:
OUTWARD INVESTMENT IN CORPORATE SECTOR

RENT A ROOM:
ACCOMMODATION USED FOR TRADE
OR BUSINESS PURPOSES

SCHEDULE D CASES I AND II:
BAD AND DOUBTFUL DEBTS

DEDUCTION FOR COSTS
OF SECRETARIAL ASSISTANCE

SCHEDULE E:
BENEFICIAL LOANS:
EXEMPTION FOR COMMERCIAL LOANS

SCHEDULE E:
MOBILE TELEPHONES -- BOOKLET 480

PROCEDURAL RULES FOR
GENERAL AND SPECIAL COMMISSIONERS

TAX BULLETIN
CORRECTION TO ISSUE 11

INLAND REVENUE STATEMENTS OF PRACTICE AND
EXTRA-STATUTORY CONCESSIONS ISSUED BETWEEN
1 MAY 1994 AND 29 JULY 1994