Tax Bulletin Issue 17

In his Budget Statement in November 1994, the Chancellor of the Exchequer, the Rt Hon Kenneth Clarke, announced his intention to extend and simplify the Enterprise Investment Scheme. Budget Press Release IR15 issued on 29 November 1994 gave details of the Chancellor's proposals. This article expands some of the detail given in the Press Release and clarifies our views of the new rules contained in Finance Act 1995.

RELIEF ON REINVESTMENT: DATE OF ISSUE OF SHARES

We have been asked why the provision in paragraph 6(3) of Schedule 5B Taxation of Chargeable Gains Act (TCGA) 1992, introduced by paragraph 4(3) Schedule 13 of the Finance Act (FA) 1995, is necessary.

The House of Lords judgment in the cases National Westminster Bank plc v CIR and Barclays Bank plc v CIR (TL 3403) decided that, for the purposes of income tax relief under the Business Expansion Scheme (BES), the issue of shares is a process and an issue does not take place until the process has been completed. This decision also applies for Enterprise Investment Scheme (EIS) purposes. It is important to fix the time of issue precisely for a number of reasons, particularly because, in order to qualify for the 20 per cent income tax relief, an investor has to satisfy certain conditions for a period ending five years after the issue of the shares.

TCGA 1992 contains a specific provision, in Section 288(5), which would otherwise mean that, for the purposes of the capital gains tax relief under the BES and the EIS, shares which were comprised in a letter of allotment or similar instrument would be treated as issued at a time earlier than the time at which they are issued for income tax purposes.

For the purpose of exempting shares issued under the EIS from capital gains tax, as set out in Section 150A TCGA 1992, the precise time of issue is not important since exemption hangs on income tax relief having been given and not withdrawn. On the other hand, for the relief on reinvestment, the precise time of issue is important since a claim can only be made for shares issued under the EIS at a qualifying time. A qualifying time must fall in the period beginning one year before and ending three years after, the time at which the gain to be deferred accrues.

It is important that there should not be any uncertainty about the time of issue of EIS shares for the purposes of determining whether the issue was at a qualifying time. Paragraph 6(3) of Schedule 5B TCGA 1992, therefore, disapplies Section 288(5). This enables a precise and consistent time of issue to be applied for all EIS shares, in accordance with the House of Lords judgment mentioned above.

RELIEF ON REINVESTMENT: INSUFFICIENT TAX LIABILITY

The relief on reinvestment is available when a subscription has been made in respect of which income tax relief has been given. We have been asked to clarify the maximum gain which can be deferred where an investor's income tax relief is given at a rate less than the lower rate of tax (20 per cent) because of insufficient tax liability. In these cases, the amount of income tax relief given would be an amount which reduces the investor's tax liability to nil.

Paragraph 2(3) of Schedule 5B TCGA 1992 defines the amount of the gain that can be deferred in terms of the amount in respect of which income tax relief is given under Section 289A Income and Corporation Taxes Act (ICTA) 1988. The amount is determined by Section 289A(1) ICTA 1988, and is not limited by Section 289A(2). This means that when an investor makes a subscription within his or her annual limit, and the company issuing the shares has not raised more under the scheme than its permitted limit, a gain equal to the full amount subscribed may be deferred. This is the case even if the income tax relief is restricted because of insufficient tax liability.

Example

Jack subscribes £100,000 under the EIS in December 1994. His total income tax liability for 1994-95 before claiming EIS relief is £24,000.

He can therefore claim EIS income tax relief of £20,000.

He can also defer a gain of up to £100,000.

Jill also subscribes £100,000 under the EIS in December 1994. Her total income tax liability for 1994-95 before claiming EIS relief is £16,000.

Her claim for EIS income tax relief is restricted to £16,000.

But she can still defer a gain of up to £100,000.

MERGERS, TAKE-OVERS, ETC.

The Finance Act 1995 introduces measures which allow shareholders who have received and retained income tax relief to continue to enjoy capital gains exemption when one company which has raised money through the EIS or BES merges with or takes over another company which has also raised money in that way.

Paragraph 2(4) of Schedule 13 FA 1995 enables investors in EIS companies to keep their capital gains exemption in certain circumstances where, as part of a share exchange, reconstruction, etc, they acquire shares in a company which has previously issued shares under the EIS. Section 150A(12) TCGA 1992, however, does not allow them to keep their exemption where the company has previously issued shares under the BES rather than the EIS.

Similarly, Section 69 FA 1995 enables investors in BES companies to keep their capital gains exemption where they acquire shares in a company which has previously issued shares under the BES. In this case, Section 150(1) TCGA 1992 does not allow them to keep their exemption where the company has previously issued shares under the EIS rather than the BES.

Press Release IR15 was incorrect when it said that the exemption would still be available when an EIS company merged with a BES company.

INTRA-GROUP INTEREST AND SIMILAR
SUMS TREATED AS DISTRIBUTIONS

The parts of Section 209 Income and Corporation Taxes Act (ICTA) 1988 repealed by Section 87 of this year's Finance Act had a different impact on the tax treatment of cross-border intra-group interest payments according to whether, and how, the terms of double taxation treaties interacted with the statute. The law itself characterised all interest paid to certain non-resident group members as a distribution. Where no treaty applied or where a treaty did not restrict the operation of the law, this remained the result. In other cases, treaty wording prevented the law applying and intra-group interest could only be characterised as a distribution to the extent that it was excessive as a result of the interest rate being too high. In the most frequently occurring case, however, only the amount of an interest payment which exceeded, for whatever reason, what would have been paid between companies acting at arm's length was characterised as a distribution.

Section 87 puts this arm's length approach into United Kingdom domestic law. Consequently, it leaves the tax treatment of most existing intra-group financial arrangements unchanged. It provides for less harsh treatment in cases where no treaty applies or where a treaty imposed no restriction on the operation of the old domestic law. It may also have an impact on some cases where a treaty prevented the old law applying. This will only be the case if, and to the extent that, the interest payment exceeds what would have been paid in the absence of the group relationship.

The new provisions, like their predecessors, are concerned with payments of interest and similar sums in respect of securities. For this purpose "security" has the extended meaning set out at Section 254(1) ICTA 1988 and therefore covers most forms of indebtedness. The focus on the existence of certain 75% shareholding relationships also remains. Unlike the old domestic law, however, only that part of the interest or similar payment which exceeds what would have been paid in the absence of the group relationship is characterised as a distribution. (This could, of course, be the whole amount.) The previous restriction to non-resident companies has also been removed. Instead, all intra-group payments where the shareholding condition is satisfied are within the scope of the legislation, unless the recipient is within the charge to corporation tax in respect of the sum or is a charity.

Concerns have been expressed about the complexity of the new provisions and also the lack of certainty for taxpayers and potential investors to which some have felt they give rise. This article outlines the Revenue's approach to the new law and indicates how guidance on our likely reaction in specific cases may be obtained. A subsequent Tax Bulletin will deal with some of the more detailed points which have been raised about the new Section.

THE ARM'S LENGTH APPROACH

The legislation requires taxpayers and Inspectors to consider what would have happened in the absence of the intra-group relationship between the issuer and holder of the securities in question. As a result, the focus is on the facts and circumstances at the time the actual security was put in place or assigned.

It is worth stressing that the legislation is extremely broad in its scope. It is capable of applying where, even though a loan could have been obtained from a third party on identical terms, the transaction would not have taken place but for the group relationship. Such a case might arise where, for example, a company has a fixed-term third-party loan bearing interest at LIBOR + 1.00 % which still has three years to run at the relevant time. This loan is repaid and replaced by a three-year intra-group loan carrying interest at LIBOR + 1.50 %, but which otherwise has terms and conditions identical to the third-party loan it replaces. It is accepted that, arm's length interest rates having increased since the original loan was obtained, LIBOR + 1.50 % is an arm's length rate for a three year loan at the time the new loan is made. Nonetheless, given the lack of commercial logic in this change, we would contend that the arrangement would not have been entered into but for the group relationship and that the legislation applies with the result that all of the interest will be a distribution.

This is one reason why there can be no blanket "let-out" for intra-group loans satisfying some crude formulaic test. Although we are aware of the importance to arm's length lenders of ratios of debt to equity or pre-tax and pre-interest profit to total interest payable ("income cover") they are insufficient, in themselves, to determine what would have happened at arm's length. Moreover, ratios such as these are far from being the only factors which potential lenders take into account. Among the others probably the most important are:

the business sector concerned;
the nature of, and title to, any assets which might provide security;
cash flow; and
the general state of the economy.

Nonetheless, the legislation will most often be relevant in cases of thin capitalisation (a high ratio of debt to equity) or insufficient income cover. Consequently it may be helpful to explain our approach to these two aspects of the arm's length test.

Commentators have suggested that the Revenue has been content to accept a 1:1 ratio of debt to equity and a 3:1 income cover ratio. Often the possibility of satisfying us that, in the circumstances of a specific case, arm's length ratios would have differed from these is also mentioned. While we understand why our approach has been construed in this way, it is to some extent misleading and certainly needs to be considered in context.

As with our approach to the legislation as a whole, when we consider such ratios, we focus on what would have been expected to happen at arm's length.

In our experience, third party lenders in the United Kingdom market almost always look at the consolidated debt to equity ratio of the group of companies to which the borrower belongs and the resources on which it could draw within that group to fund interest charges and capital repayments. Consequently, in the overwhelming majority of cases, we too look beyond the company issuing the security to the wider company grouping to which it belongs. Of course, the legislation is designed to protect the United Kingdom tax base. Accordingly, it limits the extent to which the wider group is taken into account by specifying that, for certain purposes, relationships with connected companies which are not part of the (defined) UK grouping as well as with the holder of the securities (except in respect of the securities in question) are to be disregarded.

It is also our experience that arm's length lenders in the United Kingdom revise their view of an acceptable level of gearing or income cover for particular groups at different times -- although the variation has not been large in recent years. As a result, we may be able to say that a particular debt to equity ratio meets the arm's length standard today. We could not say that the same ratio would meet that standard even a year from now.

We are also aware that the relative importance of debt to equity ratios and other factors such as income cover or cash flow varies over time and between industries. In recent years, we have detected a trend away from simple debt to equity ratio criteria, perhaps reflecting the realisation that balance sheets can show flattering snapshots which are not representative of the position as a whole. This has been coupled with increased evidence of the continuing availability of loans being made subject to satisfying certain covenants -- including meeting gearing and income cover targets at specified intervals. Our approach endeavours to reflect such trends.

As for the precise ratios themselves, arm's length lenders have always applied different standards when lending to different industries at any one time. So, for example, financial concerns and property holding groups have always been able to gear up to a greater extent than most other borrowers. Here too we follow the market pattern.

Despite the industry spread of acceptable ratios and the variation over time, we understand that the average debt to equity ratio of United Kingdom quoted companies has historically ranged around 0.6:1. It remains in that region at present. Similarly, we are aware of comment that lenders are currently concerned when the level of operating profit is less than four times the interest payable. Partly because an average is a point between the high and low positions and partly as a result of a desire to use our resources most effectively, we have in recent years tended to accept that, where a loan otherwise meets the arm's length test, if the United Kingdom grouping remains geared at something less than 1:1 and its income cover is at least 3:1, its financing should be regarded as satisfying the test as a whole. If not, further consideration would be appropriate. It must be stressed, however, that there are no hard and fast rules in this area and each case has to be considered on its own facts.

THE NEGOTIATION PROCESS

Where detailed consideration of the position is necessary, we generally endeavour to advance matters by way of discussion with the group and its advisers, with a minimum of correspondence. This speeds the resolution of our enquiries and enables groups to understand the tax position at an early stage. We recognise that applying the arm's length test can never be a precise science. We are, therefore, able to show some flexibility in the course of the discussions, provided we are satisfied that the result is about right at the end of the day.

As a consequence of these discussions, groups sometimes restructure their investment entirely by putting in additional equity finance as well as the debt or by replacing part of the debt with an equity injection. In some cases, however, we are content if they simply make part of the loans interest-free: provided interest-bearing debt is repaid in preference to interest-free debt.

PROCEDURAL MATTERS

In the past, enquiries have often been triggered either by an Inspector's examination of accounts showing the intra-group funding or by receipt of a tax treaty claim for exemption from, or reduction in, withholding tax on the payment to the non-resident group member. No doubt this will continue.

In future, when consideration of the legislation is triggered in one of these ways, the Inland Revenue will normally issue a letter commenting on the relevance of Section 209(2)(da) ICTA 1988 to the specific intra-group arrangement. If companies are concerned about the position and do not receive such a written notice they should contact us at the address given below.

Although the new legislation makes no difference to most existing intra-group funding arrangements, there could be some change where the funds have come from one of a dozen countries. These are:

Austria;
Barbados;
The Faroe Islands;
Fiji;
Germany;
Israel;
Japan;
Kenya;
Luxembourg;
South Africa;
The Sudan; and
Zambia.

We have attempted to identify such arrangements and have written to the groups concerned commenting on the legislation's impact in each case. Companies who have not received any communication from us about existing advances from group members in one of the above countries and who are concerned about the possible impact of the new legislation, should also contact us at the address below.

More generally, in recent years groups and their advisers have increasingly taken the initiative by approaching International Division at the time when finance is being put in place to obtain guidance on their plans. Where sufficient information to reach a view has been available, we have normally been able to give groups some certainty as to the tax treatment likely to apply to what they propose. (The Financial Secretary to the Treasury drew attention to this during the Committee Stage debate on this provision of the Finance Bill.) It is our intention to continue to offer this service to groups considering investment or reinvestment in the United Kingdom.

Guidance on this and other aspects of the new legislation may be obtained by writing to:

Inland Revenue
International Division 5/2
Melbourne House
Aldwych
LONDON WC2B 4LL

Correspondents should identify the parties to the transaction and supply as much information as possible about the group's existing financial structure and/or its proposals.

EMPLOYEES AND DOUBLE TAXATION AGREEMENTS

Most of the United Kingdom's double taxation agreements contain a provision which may enable an employee who comes to work in the United Kingdom on a short-term basis to be taxed only in his or her home country. An employee must show that he or she fulfils a series of conditions specified in the agreement to make a valid claim to exemption from UK tax. Usually one of those conditions is that the employee's remuneration must be "paid by or on behalf of an employer" who is not resident in the United Kingdom.

In many cases, it is clear that the employer is the non resident company for whom the taxpayer was working before he or she came to the United Kingdom. In other cases, the employee may have been seconded by his or her overseas employer to work for a United Kingdom company, or the overseas employer may carry on a business of hiring out staff to other companies. A formal contract of employment remains with the overseas employer, but the employee works in the business of the United Kingdom company, which obtains the benefits and bears any risks in relation to the work undertaken by the employee. In economic terms this state of affairs is recognised by the overseas employer recharging the cost of the employee's remuneration to the United Kingdom and the UK company might be described as the "economic employer".

As mentioned in paragraph 1920(b) of the Inland Revenue's recently published Double Taxation Relief manual, we have in the past accepted, other than in cases involving tax avoidance, that where the employee continued to be paid by the overseas employer and had no contract of employment with the United Kingdom company, the condition that the employee's remuneration must be "paid by or on behalf of an employer" who is not resident in the United Kingdom, was met regardless of the relationship between the employee and the United Kingdom company.

More recently, the question of the identity of the employer in cases like these has been the subject of guidance in the 1992 and 1994 Editions of the Commentary on the OECD Model Double Taxation Convention. The Commentary concludes that the context of the provision concerning exemption for short stay employees requires that it is the "economic employer", and not the formal employer, who should be considered as the employer for the purposes of applying the provision.

The United Kingdom is a member country of the OECD and the terms of modern United Kingdom double taxation agreements, including the condition concerning payment of remuneration, are based on the OECD Model Convention. The Revenue seeks, as far as possible, to apply double taxation agreements consistently with the guidance in the Commentary on the Model Convention. Consequently, the Revenue now intends to take an approach consistent with the guidance in the Commentary on the Model Convention in cases where remuneration is paid by a non-resident but the cost of that remuneration is borne by an "economic employer" in the United Kingdom. Inspectors dealing with claims to exemption from employees who commenced a work assignment in the UK after 1 July 1995 and with all claims for 1996-97 onwards, will take into account the terms of the Commentary on the OECD Model Convention. They will not accept claims where the cost of an employee's remuneration is borne by a United Kingdom company which acts as the "economic employer".

! This Article Is No Longer Current (Deleted Index 1999)

MORTGAGE INTEREST RELIEF:
LETTING A PRIVATE RESIDENCE --
NEW RULES FROM 6 APRIL 1995

Tax Bulletin Issue 14 (December 1994) explained the rules which apply from 6 April 1994 for giving relief on interest paid on a loan to purchase a private residence which is also commercially let. This article explains the new rules which apply from 6 April 1995 and reiterates the main points on the 1994-95 rules for the benefit of those who did not see Issue 14.

The most common circumstances in which a private residence is also let are where the borrower is living in job-related accommodation or is temporarily absent by reason of employment (see Extra-Statutory Concession A27).

NEW RULES FROM 6 APRIL 1995

From 6 April 1995, the rules for calculating income from property under Schedule A and furnished lettings underSchedule D Case VI have changed. Profits from these sources of income are assessable under the new Schedule A rules introduced by Section 39 Finance Act (FA) 1995 and are calculated in much the same way as trading profits under Schedule D Case I.

Accordingly, interest paid is no longer allowable as a deduction or set off against letting income under Section 353 Income and Corporation Taxes Act (ICTA) 1988. Instead, interest payable in respect of a Schedule A business is allowable as a deduction in calculating the profits of the business, under the same rules as apply for other expenses incurred for the purposes of the business.

Section 355(1)(b) ICTA 1988 has been repealed and a borrower who is eligible for mortgage interest relief in respect of a property which is let may choose each year whether to:

claim mortgage interest relief (restricted to interest on the qualifying maximum of £30,000 and to the rate of 15%); or
make a deduction in computing the profits of the Schedule A business.

Loans eligible for MIRAS

For loans eligible for relief under the MIRAS arrangements, relief must be given under MIRAS unless the borrower elects to make a deduction in computing Schedule A profits.

This applies whether or not the loan was actually in MIRAS in 1994-95. Where a loan was outside of MIRAS at 5 April 1995, Tax Offices will ask borrowers whether they intend to elect to make a deduction in computing Schedule A profits, before putting the loan into MIRAS. (In most cases, it will only be possible to put the loan into MIRAS from 6 April 1996 and relief for 1995-96 will be given in the borrower's code number or assessment.)

Where a loan was in MIRAS at 5 April 1995, no action need be taken unless the borrower wishes to elect to make a deduction in computing the profits of the Schedule A business.

An election must be made in writing within 22 months of the end of the tax year in which it is first to have effect (for example, an election having effect from 1996-97 can be made at any time up to 6 February 1999). This is to coincide with the date a Self Assessment return will become final. There is no specific form for an election. Once made, the election is irrevocable and the loan must remain outside the MIRAS arrangements until the Schedule A business ceases.

Even where an election has been made, and consequently the loan cannot be dealt with under the MIRAS arrangements, the borrower may still choose each year whether to claim mortgage interest relief outside MIRAS or make a deduction in computing the profits of the Schedule A business.

Joint borrowers

For loans not eligible for relief under the MIRAS arrangements, each borrower can choose each year whether to claim mortgage interest relief or make a deduction in computing the profits of the Schedule A business.

For loans eligible for relief under the MIRAS arrangements, an election by any one borrower will require the whole loan to be taken out of MIRAS. Any borrower who does not make an election will be given relief as an income tax reduction.

RULES FOR 1994-95

Interest paid by a borrower who let his or her main residence is eligible for relief under either:

Section 355(1)(a) ICTA 1988 (main residence) or Section 356(1) (job-related accommodation) as an income tax reduction against general income, or
Section 355(1)(b) ICTA 1988 (let property) against letting income.

Section 353(1C) ICTA 1988 provides that, where a borrower had dual eligibility, relief is given as a deduction or set off against letting income, unless an election is made for relief to be given as an income tax reduction (restricted to interest on the qualifying maximum of £30,000 at 20%).

Elections

An election must be made in writing by 5 April 1996. It may only take effect from:

6 April 1994, or if later,
the date when dual eligibility first occurred.

Once made, an election will remain in force until the earliest of :

5 April 1995,
the date the letting ceases, or
the date the conditions in Section 355(1)(a) ICTA 1988 or Section 356(1) cease to apply.

An election may be withdrawn at any time up to 5 April 1996. No specific form is required for making or withdrawing an election. The election should be sent to the borrower's tax office together with a certificate of interest paid.

Loans eligible for MIRAS

Where a borrower has dual eligibility and his or her loan was in MIRAS for 1994-95, the tax office will withdraw the relief obtained under MIRAS unless the borrower makes an election by 5 April 1996. If no election is made, or if an election is withdrawn, relief will be given against letting income and any excess MIRAS relief will be recovered in the Schedule A (or Schedule D Case VI for furnished lettings) assessment or in an assessment under Regulation 19(4) SI 1982 No 1236.

Relief for any period covered by an election but for which the loan was not in MIRAS will be given in the borrower's code number or assessment, or, if the borrower is a not a taxpayer, by payment from Financial Intermediaries and Claims Office (FICO) (under Section 375(8) ICTA 1988).

Joint borrowers

Each borrower can make or withdraw an election and receive relief accordingly.

TRANSITIONAL PROVISIONS FOR 1995-96

Where a source of letting income ceases in 1995-96, the letting income for that year is assessable under the "old" Schedule A or Schedule D Case VI rules as appropriate and any excess interest over income from 1994-95 can be set against that income.

In all other cases, any excess interest over income from 1994-95 is carried forward to 1995-96 or a subsequent year as a loss under the new Schedule A rules.

revenue interpretations

(Article deleted since index 2002)

FOREIGN EXCHANGE AND
FINANCIAL INSTRUMENTS:
CURRENCY CONTRACTS AND TRANSITION --
BOARD'S DIRECTION UNDER
SECTION 747 ICTA 1988

A company may hold a currency contract for a period which straddles its commencement day (the first day of the company's first accounting period to start on or after 23 March 1995) and on which any profit or loss does not fall to be dealt with in computing trading profits. Here, the transitional provisions at Section 175 Finance Act (FA) 1994 enable Section 153(4) and (5) FA 1994 to operate to bring in unrealised pre-commencement foreign exchange gains or losses as a deemed forward premium or discount. This is intended to ensure that the commercial profit or loss over the life of the contract is recognised for tax purposes. Concern has, however, been expressed that the operation of these provisions alone might inappropriately result in a company becoming subject to a direction under the Controlled Foreign Company ("CFC") legislation. This is because, prior to the FOREX legislation, such a contract would have been subject to capital gains rules which do not apply to CFCs.

Paragraphs 2.27 and 6.34 of the Inland Revenue's Explanatory Statement (published in December 1994) explain how the transitional provisions will apply to CFCs. Broadly, where a CFC would have been subject to a direction under Section 747 Income and Corporation Taxes Act (ICTA) 1988 (or would have been, had it not paid an acceptable distribution) in the accounting period prior to it becoming subject to the FOREX rules, it is treated in the same way as a UK resident company for the purposes of both the foreign exchange and the financial instrument transitional rules. However, where this is not the case, but the CFC might otherwise become subject to a direction under Section 747 ICTA 1988 in the following accounting period, purely because of Section 153(4) and (5) FA 1994 operating to impute a deemed receipt in respect of pre-commencement exchange gains, then the Board will take this factor into account when considering whether a direction should be made.

[Section 148(2) and(3), Section 153(4) and (5) and Section 175 FA 1994, Section 747 ICTA 1988]

(Article deleted since index 2002)

GRANDFATHERING AND
OTHER ELECTIONS

"Grandfathering" is a feature of both the new Foreign Exchange Regulations supporting the FOREX legislation in the 1993 Finance Act and the new Financial Instrument legislation in the 1994 Finance Act, both of which came into force on 23 March 1995.

Where a qualifying company holds "fluctuating" debts at its commencement day (the first day of its first accounting period to start on or after 23 March 1995), subject to certain conditions, these are kept out of the new FOREX tax regime for six years (i.e. they are "grandfathered"), unless the company elects otherwise (Regulation 3(2) and (5) of the Exchange Gains and Losses (Transitional Provisions) Regulations 1994 (Statutory Instrument 3226/94). Similarly, if a qualifying company holds an interest rate contract or option at its commencement day, this is also kept out of the new Financial Instrument regime for six years, again unless the company elects otherwise (Section 148(2) and (3) Finance Act 1994).

Such elections should be made by the company concerned. However, it is appreciated that in the case of a Controlled Foreign Company ("CFC") this requirement may cause practical difficulties. Therefore, the Inland Revenue will be prepared to accept an election made on behalf of the CFC, by a company resident in the UK which alone or jointly with other companies resident in the UK has a majority interest in the CFC, as long as the secretary or director of the CFC has given specific authority to this effect.

This same principle will be applied for elections under Regulation 6(2) and Regulation 15(1) of the Exchange Gains and Losses (Transitional Provisions) Regulations 1994. (Under Regulation 6(2), a company may elect to adopt the original cost price as the basic valuation for certain qualifying assets. Under Regulation 15(1), it can elect for certain pre-commencement exchange gains or losses to be treated as accruing over the 6 years following commencement.)

[Statutory Instrument 3226/94, Exchange Gains and Losses (Transitional Provisions) Regulations 1994, Section 148 FA 1994.]

(Article deleted since index 2002)

LOSS RELIEF:
RECALCULATION ON CESSATION
UNDER ESC A88: TIME LIMITS

On 16 November 1994, the Board issued Extra-Statutory Concession (A88). The concession applies where relief:

is given under Section 380 Income and Corporation Taxes Act 1988 ("sideways relief"),
is calculated on the accounts year basis, and
is followed by a cessation of trading.

The sideways relief in the cessation year must be calculated on the strict fiscal year basis. As a result, there is a gap between the end of the basis period for the loss claimed in the penultimate year and the start of the basis period for the loss of the final year. The concession enables:

loss relief claims for earlier (consecutive) years to be recalculated on the fiscal year basis and, if appropriate, any increased relief to be given;
a late claim to be made for the year preceding the first of those consecutive years if, as a result of the recalculation, an unrelieved loss is created for that preceding year.

We have been asked to clarify the time limits for making claims under this concession.

Recalculation on fiscal year basis

Any additional relief arising out of the recalculation is given with the sideways relief claim for the year of cessation. Claims should, therefore, be made at the same time as the claim for the final year.

Loss relief for preceding year

A new claim to loss relief for the year preceding the years for which loss relief has been recalculated (which will necessarily be made after the normal time limit for that year) should be made within thirty days of the date on which effect is given to the claim for the year of cessation.

(Superseded by BIM57620)

SCHEDULE D CASE I:
INITIAL SUM PAYABLE FOR A FRANCHISE

Various forms of agreement are often described, somewhat loosely, as franchises, (for example licences, dealerships and concessions) but this article is particularly concerned with payments under "business system franchise agreements". Under such an agreement, the owner of an established business format (the franchisor) grants to another person (the franchisee) the right to distribute products or perform services using that system.

The terms of agreements vary considerably but, generally, the franchisee gets the use of the system, training and any necessary management back-up for a specified period, of perhaps five to ten years, in return for:

an initial fee (payable in one sum or in instalments), and
continuing, usually annual, fees.

Franchisee: Treatment of the Initial Fee

The capital or revenue quality of the initial payment by the franchisee depends upon what it is for. Normally, it is paid wholly or mainly for substantial rights of an enduring nature to initiate or substantially extend a business. To that extent, the initial payment, whether payable in one sum or instalments, is capital, as are any related professional fees. It is immaterial that the expenditure may prove abortive. Nor is the tax treatment of the receipt in the hands of the franchisor relevant.

In some instances, the franchisor also provides, under the terms of the franchise agreement, goods or services of a revenue nature at the outset, for instance, trading stock or services such as the training of staff (other than the franchisee -- see below). Inspectors will accept that an appropriate part of the initial fee is for such revenue items, and hence allowable, where:

the sum claimed in respect of revenue items fairly reflects the actual goods and services provided, and
it is clear that those services are not separately charged for in the continuing fees.

Normally, the costs of the initial training of the franchisee are disallowable - see Tax Bulletin Issue 11 (August 1991) "Expenditure on training courses for the proprietors of a business".

Generally, the annual fee payable by the franchisee will be a revenue expense.

[Atherton v British Insulated Helsby Cables Ltd (10 TC 155), CIR v Granite City Steamship Company Ltd (13 TC 1), Strick v Regent Oil Co, Ltd, (43 TC 1) and S Ltd v O'Sullivan, (1972) Irish Tax Cases No.108.]

(Superseded by BIM46351 & BIM46355)

SCHEDULE D CASES I AND II:
PRE-TRADING EXPENDITURE

There was an article on this topic in Tax Bulletin Issue 5 (November 1992). Since then the legislation governing relief for expenditure incurred prior to the commencement of a business has been amended in a number of ways:

the period in which the expenditure must be incurred has been extended to cover the seven years prior to commencement,
unrelieved charges on income paid by a company wholly and exclusively for trading purposes, prior to the commencement of trading, are now treated for corporation tax purposes as if they were paid on the first day of trading,

(both these changes apply in cases where the trade etc commenced after 31 March 1993.)

in the case of a non-resident company, a payment made wholly and exclusively for the purposes of a trade which it plans to carry on in the UK through a branch or agency, can now qualify as a charge. (This applies to payments after 31 March 1993.)

Thus, relief for pre-trading expenditure is extended to interest which could not have been regarded as a deductible Case I expense incurred on the first day of trading under the rules as they stood prior to these amendments.

Finally, pre-trading expenditure will no longer be regarded for income tax purposes as giving rise to a separate business loss. Instead, where the business commences on or after 6 April 1995, pre-trading expenditure will be treated as if it had been incurred on the first day of business. In other words, the relief is now given as a deduction in computing the taxable profit or the allowable loss for the first period of business. It will no longer be necessary to make separate income tax loss relief claims for pre-trading expenditure.

We continue to hold the view expressed in the earlier article that no relief is available to a business for pre-trading expenditure incurred by another person.

[Section 401 ICTA 1988, Section 109 FA 1993, Section 120 FA 1995]

(Superseded by BIM46015)

UNAPPROVED RETIREMENT BENEFIT SCHEMES

Prior to 1989, Unapproved Retirement Benefit Schemes were rare. This was because the conditions governing "Exempt Approved Schemes" prevented an employer operating the two different types of scheme in tandem for the same employees.

These restrictions were repealed by Section 75 and Schedule 6 Finance Act (FA) 1989. At the same time, unapproved schemes were given statutory recognition. The intention behind this was to give greater flexibility and freedom in providing for pensions. But, as was made clear at the time, tax advantages were restricted to those available for approved schemes. No tax advantages were to be conferred on unapproved schemes.

This intention was achieved by Section 76 FA 1989.

The Section ensures that no relief is given for the cost of providing some retirement benefits and determines the time at which relief is given for others.

Section 76(1)-(3) provides that:

to the extent that benefits are provided by an employer under arrangements which count as a "retirement benefit scheme"; and
the arrangements are not approved by the Revenue's Pension Schemes Office; and
the provision of the benefits does not give rise to any tax charge on the employee or former employee;

the employer cannot obtain any relief (whether as a deduction in computing taxable profits from a trade, profession or vocation or as management expenses) for the expenses of providing the benefit.

The latter subsections of Section 76 contain a timing rule. It applies to the provision of benefits which result in a charge to tax on the employee or former employee. In these circumstances the Section does not prevent the employer from obtaining relief subject to the general rules on whether an expense is deductible. But it does ensure timing symmetry between the timing of relief and the charge to tax. Relief is not given to the employer before the period in which the expense of providing the benefit is actually laid out. (see Section 76(4)-(6) FA 1989).

We have seen it suggested that the legislation does not achieve timing symmetry. We do not accept that there is any drafting ambiguity in the legislation. But, in the absence of agreement, the Commissioners and the courts can consider the intentions of Parliament, as expressed in debates during the passage of the 1989 Finance Bill, on Pepper v Hart principles. In introducing amendments to the Bill, including what is now Section 76(4) FA 1989, the then Financial Secretary to the Treasury said:-

"The amendments deal with drafting shortcomings in clause 73. The intention is that non-approved top-up pension schemes should not benefit from the tax advantages available to approved occupational schemes .... As drafted the clause disallows those costs unless the employee is chargeable .... but it says nothing about the timing of deductions where costs are allowable. The effect is that the employer could claim a deduction in advance of payments being made if, at some point in the future, the employee would be chargeable to tax on these payments. The amendments prevent an employer from obtaining such a timing advantage."

We consider that the above puts the matter beyond doubt.

[Section 76 Finance Act 1989, Hansard, 8 June 1989, Column 346.]

miscellaneous

(No longer relevant)
SELF ASSESSMENT:
TRANSITIONAL ARRANGEMENTS --
SUBMISSION OF ACCOUNTS

In 1996-97, transitional arrangements will apply to allow self-employed taxpayers to move from the preceding year (PY) basis of assessment to the new current year (CY) basis. These arrangements mean that accounts for periods ending in 1995-96 will not, by themselves, provide a basis for calculating 1996-97 business income. This article considers the implications of these arrangements for the 1995-96 tax return.

1995-96 will be the last year in which income can be taxed on a PY basis. Therefore, the last accounts required as the basis for a PY assessment are those ending in the tax year 1994-95. These accounts will form part of the taxpayer's return of income for the tax year 1994-95, normally issued in April 1995.

For 1996-97, all income will be taxed by reference to a basis period ending in that year. In any case where a PY basis of assessment is used in 1995-96, the profits assessed in 1996-97 will be a percentage of the profits of a transitional basis period. The transitional basis period is the aggregate of:

a notional CY basis period for the year, identified as the 12 months to the date to which accounts are made up in 1996-97, and
the period beginning immediately after the end of the basis period for 1995-96 and ending immediately before the beginning of the period given above.

More detailed guidance and examples can be found in the Inland Revenue booklet (SAT1) entitled 'The new current year basis of assessment'.

Taxpayers will be required to include the income of the transitional basis period in the Self Assessment tax return issued in April 1997.

1995-96 TAX RETURN -- NORMALLY ISSUED IN APRIL 1996

Generally, the only circumstances in which taxpayers with a Case I or II business will be required to send in accounts for periods ending in 1995-96 with their 1995-96 tax returns are where:

the income is assessable for 1995-96 on a CY basis, or
a claim is made to offset losses suffered in a period ending in1995-96 against other income for 1995-96, or earlier years.

The CY basis will apply to 1995-96 business income in the following cases:llane

businesses that commenced, or are deemed to commence following a change in ownership under Section 113(1) Income and Corporation Taxes Act (ICTA) 1988, after 5 April 1994;
businesses which cease during 1995-96;
where a claim is made under Section 62(2) or 62(4) ICTA 1988 for 1995-96 to be assessed on an actual basis of assessment;
where, following a partnership change, Section 61(4) ICTA 1988 applies and 1995-96 is to be assessed on an actual basis of assessment.

The notes which accompany the tax return issued for 1995-96 will set out the limited circumstances in which the Inland Revenue will require accounts. Any other accounts submitted (even though not required) will be acknowledged. But the figures in those accounts cannot be agreed by the Inland Revenue, for two reasons:

first, they will form only part of the 1996-97 basis period, and
Second, 1996-97 will be the first year of Self Assessment.

Under Self Assessment, the Inland Revenue will not have to agree returns on receipt but will have at least a year to decide whether to make enquiries into them.

1996-1997 TAX RETURN -- NORMALLY ISSUED IN APRIL 1997

Self-employed taxpayers whose 1995-96 assessment was made on a PY basis, will be required to provide information relating to their transitional basis period (see above) in order to calculate their 1996-97 income.

In the case of a business drawing up accounts to a regular annual accounting date, this will mean providing details for two successive 12 month periods in the one return. The profits assessable for 1996-97 will be the 12 month average profits of the two periods. But there is no requirement for separate accounts to be prepared for each period. It is entirely a matter for taxpayers to decide whether to have a single account prepared for the whole transitional basis period, or to draw up separate accounts for each component period. For example, there may be benefits to having separate accounts made up where a loss is incurred.

It is intended that information from either the single account or each set of accounts prepared will be required in a standardised form, as will computations in respect of the two year period as a whole. The accounts themselves and other supporting documents will not be required for submission with the return, but may be asked for at a later date. The design of the return incorporating this approach is currently being tested in the Leicester area.

INLAND REVENUE CONFIRMATION OF INCOME OR EARNINGS

Self-employed taxpayers sometimes ask the Inland Revenue to confirm figures of business profits that have been agreed for assessment to support applications for mortgage advances and educational grants, for example. Subject to certain caveats, Inspectors have usually been able to do so.

We will continue to respond to such requests under Self Assessment, but will only be able to confirm that a certain figure has been returned, not that it has been agreed.

Further details of these arrangements were given in the Inland Revenue Press Release of 24 April 1995.

! This article is no longer current

LAUNCH OF PUBLIC INFORMATION
CAMPAIGN FOR SELF ASSESSMENT

A campaign to inform taxpayers about Self Assessment was launched on 8 June. Spearheaded by TV and press advertising, the first phase of the campaign will run until mid-July. Subsequent phases are planned for the Autumn and New Year.

The TV advertisements aim to raise general awareness of Self Assessment while the press advertisements specifically target self-employed people and those who need to bring their tax affairs up-to-date. All advertisements carry a telephone number -- 0845 7161514 -- that people may call to request further information. Booklets and a video are available for self-employed taxpayers.

The TV advertising features a cartoon 'taxman' animated by the Oscar-winning film company, Snowden Fine, and a voice-over by Sir Alec Guinness. The humour of the cartoon character, carried across onto press advertisements, booklets and posters, aims to attract attention and get information across on the difficult subject of tax and Self Assessment.

From 8 June, to coincide with the launch of the campaign, tax agents, solicitors and financial advisers will receive a Self Assessment information pack that includes sample copies of the booklets for taxpayers.

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

FOREIGN INCOME DIVIDENDS

Tax Bulletin Issue 12 (August 1994) contained an article on Foreign Income Dividends ( FIDs). That article included guidance on the form of a FID voucher.

If a company pays two dividends, one an ordinary dividend and one a FID, we are content for both dividends to be included on a single document, as long as the document sets out clearly the separate elements, and in particular makes plain that the tax credit relates only to the ordinary dividend. Any advice on the form of the document can be obtained from Ken Mortimer at

Financial Intermediaries and Claims Office (Scotland)
Trinity Park House
South Trinity Road
EDINBURGH
EH5 3SD

We accept that, where a company pays a single dividend of which part is a FID, this falls within the scope of Section 246A(1) Income Tax and Corporation Taxes Act 1988.

! This article is no longer current

INLAND REVENUE
NEWS RELEASES AND THE INTERNET

News Releases announce changes in practice, law and interpretations by the Inland Revenue. These are now available on a next day basis via the Internet.

Readers who are not Internet users but who would like to obtain copies of Inland Revenue News Releases should write to Tom Davies for details of how to subscribe at:

Inland Revenue Press Office
6th Floor
North West Wing
Bush House
Aldwych
London WC2B 4PP

INLAND REVENUE STATEMENTS OF PRACTICE AND
EXTRA-STATUTORY CONCESSIONS ISSUED BETWEEN
1 APRIL 1995 AND 31 MAY 1995.

EXTRA-STATUTORY CONCESSIONS

Number   Title                                            Date of Issue
A89        Mortgage Interest Relief: Property used for
residential & business purposes                        3/5/95
D51        Transfers from a close company at undervalue           12/5/95
D52        Share exchanges, company reconstructions and
amalgamations: Incidental costs of aquisition
and disposal and warranty payments                     12/5/95
A90        Jobmatch pilot scheme                                  16/5/95
A27        Mortgage Interest Relief: Temporary absence from       3/5/95
mortgaged property                                     (revised)
D22        Relief for the replacement of business assets:         12/5/95
Expenditure on improvements on existing assets         (revised)
A24        Foreign social security benefits exemption             18/5/95
(revised)

STATEMENTS OF PRACTICE

There have been no new or revised SPs issued in this period.

You can get copies of SPs and ESCs from Christine Jordan of the Public Enquiry Room, Somerset House. Telephone: 020-7438 7722.

CONSULTATIVE DOCUMENTS: Deadline for comments

Title           Price  Deadline for Address for comments                       comments
The Taxation of   £3.00   30/6/95        Jeff Worrell
Gilts and Bonds                          Financial Institutions Division
Inland Revenue
Room 503, 22 Kingsway
LONDON WC2B 6NR
Equalisation      Free     7/7/95        Debora Matthews
Reserves for                             Financial Institutions Division
Insurance                                Inland Revenue
Companies Non-                           Room 516, 22 Kingsway
Life Business                            LONDON WC2B 6NR
OR
Charles Langley
Insurance Division
Dept. of Trade and Industry
10-18 Victoria Street
LONDON SW1H 0NN

You can get copies of the above from the Inland Revenue Reference Library, New Wing, Somerset House, London WC2R 1LB. Copies of the latter are also available from the Dept. of Trade and Industry, Information and Library Centre, Room 101, 123 Victoria Street, London SW1E 6RB.

CONTENT

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

You can expect that interpretations of the law contained in the Bulletin will normally be applied in relevant cases, but this is subject to a number of qualifications.
Particular cases may turn on their own facts, or context, and because every possible situation cannot be covered there may be circumstances in which the interpretation given here will
not apply.
There may also be circumstances in which the Board would find it necessary to argue for a different interpretation in appeal proceedings.
"Revenue decisions" report conclusions that were reached on the facts of individual cases, but do not necessarily include all the detailed facts which may have been relevant to the decision. They provide an indication of the approach the Revenue has adopted in the past, but have not been drafted as generally applicable statements of the Revenue's position. It cannot be assumed therefore, that interpretations of the law contained or implicit in these decisions will necessarily be applied in other cases.
The Bulletin does not replace formal Statements of Practice.
The Board's view of the law may change in the future. Readers will be notified of any changes in future editions.

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

Letters on any article appearing in Tax Bulletin should be sent to the Editor, David Richardson, Room 402, 22 Kingsway, London WC2B 6NR. We are sorry though that neither he nor our contributors will normally be able to enter into correspondence about Tax Bulletin or its contents.

SUBSCRIPTION

The subscription for 1995 is £18. If you would like to subscribe to Tax Bulletin please send your name and address together with your cheque to Inland Revenue, Finance Division, Barrington Road, Worthing, West Sussex BN12 4XH. Cheques should be crossed and made payable to "Inland Revenue".

Subscribers to our Press Release mailing list automatically receive copies of Tax Bulletin and will continue to do so under current arrangements with the Press Office. If you would like to receive Tax Bulletin and News Releases please contact Tom Davis or Alan Brown at Inland Revenue Press Office, 6th Floor, North West Wing, Bush House, Aldwych, London WC2B 4PP. Telephone: 020-7438 6692/6706/7327.

COPYRIGHT

Tax Bulletin is covered by Crown Copyright. There is no objection to firms copying the Bulletin for their own use. Anyone wishing to republish Tax Bulletin or extracts more widely should write for permission to Nahid Shariff, Room 435, 22 Kingsway, London WC2B 6NR.

TAX BULLETIN PROVIDED IN WEB READY FORMAT COURTESY OF TAX ANALYSTS AND TAXBASE

Tax Bulletin Issue 17

INLAND REVENUE TAX BULLETIN Issue 17

CONTENTS

! This Article Is No Longer Current (Deleted Index 1999)

ENTERPRISE INVESTMENT SCHEME: CAPITAL GAINS RELIEF

RELIEF ON REINVESTMENT: DATE OF ISSUE OF SHARES

RELIEF ON REINVESTMENT: INSUFFICIENT TAX LIABILITY

MERGERS, TAKE-OVERS, ETC.

INTRA-GROUP INTEREST AND SIMILAR SUMS TREATED AS DISTRIBUTIONS

THE NEGOTIATION PROCESS

PROCEDURAL MATTERS

EMPLOYEES AND DOUBLE TAXATION AGREEMENTS

! This Article Is No Longer Current (Deleted Index 1999)

MORTGAGE INTEREST RELIEF: LETTING A PRIVATE RESIDENCE -- NEW RULES FROM 6 APRIL 1995

NEW RULES FROM 6 APRIL 1995

Joint borrowers

RULES FOR 1994-95

TRANSITIONAL PROVISIONS FOR 1995-96

revenue interpretations

(Article deleted since index 2002)

FOREIGN EXCHANGE AND FINANCIAL INSTRUMENTS: CURRENCY CONTRACTS AND TRANSITION -- BOARD'S DIRECTION UNDER SECTION 747 ICTA 1988

(Article deleted since index 2002)

GRANDFATHERING AND OTHER ELECTIONS

(Article deleted since index 2002)

LOSS RELIEF: RECALCULATION ON CESSATION UNDER ESC A88: TIME LIMITS

Recalculation on fiscal year basis

Loss relief for preceding year

(Superseded by BIM57620)

SCHEDULE D CASE I: INITIAL SUM PAYABLE FOR A FRANCHISE

Franchisee: Treatment of the Initial Fee

(Superseded by BIM46351 & BIM46355)

SCHEDULE D CASES I AND II: PRE-TRADING EXPENDITURE

(Superseded by BIM46015)

UNAPPROVED RETIREMENT BENEFIT SCHEMES

miscellaneous

(No longer relevant) SELF ASSESSMENT: TRANSITIONAL ARRANGEMENTS -- SUBMISSION OF ACCOUNTS

1995-96 TAX RETURN -- NORMALLY ISSUED IN APRIL 1996

1996-1997 TAX RETURN -- NORMALLY ISSUED IN APRIL 1997

INLAND REVENUE CONFIRMATION OF INCOME OR EARNINGS

! This article is no longer current

LAUNCH OF PUBLIC INFORMATION CAMPAIGN FOR SELF ASSESSMENT

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

FOREIGN INCOME DIVIDENDS

! This article is no longer current

INLAND REVENUE NEWS RELEASES AND THE INTERNET

INLAND REVENUE STATEMENTS OF PRACTICE AND EXTRA-STATUTORY CONCESSIONS ISSUED BETWEEN 1 APRIL 1995 AND 31 MAY 1995.

EXTRA-STATUTORY CONCESSIONS

STATEMENTS OF PRACTICE

CONTENT

SUBSCRIPTION

COPYRIGHT

INLAND REVENUE TAX BULLETIN
Issue 17

ENTERPRISE INVESTMENT SCHEME:
CAPITAL GAINS RELIEF

INTRA-GROUP INTEREST AND SIMILAR
SUMS TREATED AS DISTRIBUTIONS

MORTGAGE INTEREST RELIEF:
LETTING A PRIVATE RESIDENCE --
NEW RULES FROM 6 APRIL 1995

FOREIGN EXCHANGE AND
FINANCIAL INSTRUMENTS:
CURRENCY CONTRACTS AND TRANSITION --
BOARD'S DIRECTION UNDER
SECTION 747 ICTA 1988

GRANDFATHERING AND
OTHER ELECTIONS

LOSS RELIEF:
RECALCULATION ON CESSATION
UNDER ESC A88: TIME LIMITS

SCHEDULE D CASE I:
INITIAL SUM PAYABLE FOR A FRANCHISE

SCHEDULE D CASES I AND II:
PRE-TRADING EXPENDITURE

(No longer relevant)
SELF ASSESSMENT:
TRANSITIONAL ARRANGEMENTS --
SUBMISSION OF ACCOUNTS

LAUNCH OF PUBLIC INFORMATION
CAMPAIGN FOR SELF ASSESSMENT

INLAND REVENUE
NEWS RELEASES AND THE INTERNET

INLAND REVENUE STATEMENTS OF PRACTICE AND
EXTRA-STATUTORY CONCESSIONS ISSUED BETWEEN
1 APRIL 1995 AND 31 MAY 1995.