Inland Revenue Tax Bulletin - Issue 55

Contents

Interpretations

Miscellaneous

The Taxation of Share Options: Internationally Mobile Employees (superseded by article in TB76)

Share options

Share incentives available to internationally mobile employees can take various forms. This article is about share and stock options.

Employees can be granted options to acquire shares in their employing company or a company in the same group. Typically the employee is granted options to acquire a specified number of shares at a price fixed at grant - the "option price". This may be set at the market value of the shares at the date of grant or at a lower figure. The option will then be exercised some years later, when the employee buys shares at the option price. The shares then belong to the employee and can usually be immediately sold.

Domestic legislation

The UK tax treatment of such options in the hands of the employee depends on factors such as:

  • Whether or not it was granted under a plan providing income tax advantages - the Inland Revenue approved Company Share Option Plan or a SAYE share option plan within Schedules 9 and 10 Income and Corporation Taxes Act (ICTA) 1988, or an Enterprise Management Incentive (EMI) option within Schedule 14 FA 2000;
  • The employee's residence status at the dates of grant and exercise;
  • The period over which the option can be exercised;
  • Whether the option was granted at a price below the market value of the shares at the time of grant.

This article is concerned only with options granted under an unapproved share option plan and non-qualifying exercises of options granted under an Inland Revenue approved plan. A "non-qualifying" exercise here means one where the conditions for income tax relief have not been followed, such that there is an income tax charge. An EMI also provides income tax exemption on the exercise of certain share options, but income tax may be due if the options were issued at a discount to the share price or there has been a disqualifying event. To the extent that gains on such options remain in charge to income tax, this article applies to them in the same way as to unapproved share options.

Further information on approved plans and EMI can be found at www.inlandrevenue.gov.uk/shareschemes

There will normally be UK income tax implications only if the individual was resident in the UK at the date of grant, or the option was granted in respect of duties carried out in the UK. As the option over the shares is acquired by reason of employment a tax charge may arise under Schedule E at:

  • The date the option was granted;
  • The date the option was exercised; or
  • The date the shares acquired at exercise are disposed of.

Capital gains tax may be due where gains on the disposal of shares are greater than the gain chargeable to tax under Schedule E. Examples are where:

  • The sale price exceeds the exercise price, or
  • The individual was not resident in the UK at the date of the event.

Capital gains tax may arise where individuals are either resident or ordinarily resident in the UK at the date of disposal or if they are within the scope of the temporary non-residents rules contained in Section 10A, Taxation of Chargeable Gains Act (TCGA ) 1992. There are special rules for the tax year of commencement or cessation of residence and for non-UK domiciliaries.

A UK tax charge may be triggered by other events, such as the assignment or release of an option to acquire shares, or the conversion of shares acquired by reason of employment from one class of share into another class of share. This article cannot cover every possible situation but guidance about circumstances not dealt with here is available from the contacts listed at the end.

Interaction with Double Taxation Agreements

If the employee moves between countries a tax charge may also arise in another country when the option is exercised, assigned or released. This article sets out the Revenue's current practice for dealing with possible double taxation in the most common scenarios.

The UK is actively involved at the Organisation for Economic Co-operation and Development (OECD) with their work on reaching a common international consensus on the treatment of share option gains.

If there is no Double Taxation Agreement (DTA) with the other country then both countries are free to tax income in accordance with their domestic laws. In some circumstances, however, the United Kingdom will grant its residents unilateral relief in respect of foreign tax suffered on income that arises in another country but is taxed in the UK on the basis of residence.

However if a comprehensive DTA exists it will normally have an employment income Article along the lines of Article 15 of the OECD Model Tax Convention. Gains realised from the exercise of options granted to an employee fall within the provisions of this Article rather than those Articles that deal with other income or capital gains.

Article 15(1) provides that if a resident of one country performs the duties of his employment in the other country, then the latter country retains any domestic rights to taxation of remuneration and benefits from that portion of the employment.

To avoid double taxation, where an employee:

  • was granted a share option in the UK during the course of an employment,
  • exercised that employment in the other country during the period between the grant and exercise of the option,
  • remains in that employment at the date of the exercise and,
  • would be taxed by both of them in respect of the option gain; and
  • is not resident in the UK at the date of exercise;

then the UK will give relief in calculating the tax charge for the proportion of the option gain which relates to the period or periods between the grant and exercise of the option during which the employee exercised the employment in the other country.

The gain will normally be time-apportioned on a straight-line basis. Periods not in that particular employment are left out of account so that the apportionment is still made on the basis of relative periods of employment in each country. Very occasionally this may not provide a sufficiently accurate apportionment. If so, another method may be used provided this does not produce double taxation or lead to income going untaxed in either country.

In other cases credit relief may be appropriate.

In the following examples:

  • All the share option plans are unapproved;
  • All references are to the Income and Corporation Taxes Act 1988 (ICTA) unless otherwise stated;
  • There is a comprehensive DTA with the overseas country containing a provision along the lines of Article 15 of the OECD Model.

Example 1

Mr. A is resident and ordinarily resident in the UK and working here on 1 January 1997. On that day he is granted an option to purchase 1,000 shares in the company in four years' time at the 1 January 1997 market price of £1. On 1 January 2001 he is moved to another country and is still in the employment there when the option is exercised on 1 January 2002. At that date the shares are worth £5 each.

A is resident and ordinarily resident in the UK at the date of grant and is therefore liable to income tax under Section 135 on any gain realised at exercise. The gain is calculated as the difference between (a) the value of the shares at the date of exercise and (b) the option price paid plus any consideration given for the option itself; in this case the gain is 1,000 x £4 = £4,000. The charge falls to Schedule E generally [Section I35(1),] rather than through any of the Cases of Schedule E and, as such, it arises regardless of the individual's residence status at the date of exercise.

Since the date of grant the employment has been performed in the UK for 4 years and in the other country for one year. 80% of the gain (£3,200) will therefore be assessed in the UK and 20% (£800) will be regarded as attributable to the other country.

The exercise of the option will be within the scope of PAYE by virtue of Section 203FB if the shares are readily convertible assets (see Tax Bulletin Issue 36, August 1998). Under Section 203F(3) the amount on which PAYE should be operated is the amount which, on the basis of the best estimate that can reasonably be made, is the amount of income likely to be chargeable to UK income tax. So if the employer has sufficiently accurate information on periods of employment spent abroad they may be able to operate PAYE for the non-resident employee only on the UK proportion.

Example 2

The facts are the same as for example 1 except that A takes the whole of 1998 as a sabbatical year when he does not exercise his employment anywhere.

Four years have been spent in employment over the period between the grant and exercise of the option. The total gain in value of £4,000 is apportioned 75% to the UK and 25% to the other country.

Example 3

Mr. B is resident and ordinarily resident in the UK and working here on 1 December 1996 when he is granted a share option. He works overseas during 1997. He returns to the UK on 1 January 1998 and is still in the employment here when he exercises the option on 1 January 2001.

As B is not resident in the other country either when the option is granted or when it is exercised it is very unlikely that any tax could be charged there in respect of the share option. As he is resident in the UK at both grant and exercise, the UK will tax the whole gain. If any tax has been paid in respect of the option in the other country for the year spent working there then the UK will give credit for this against the Section 135 charge.

Example 4

Mrs. C is resident but not ordinarily resident in the UK when an option is granted. She is still resident in the UK when she exercises the option and sells the shares.

At the time of grant the UK charge in respect of the employment is not under Case I of Schedule E therefore Section 135 will not apply. C will be liable to UK income tax under Section 162(5) at the time of disposal of the shares. The charge is on the difference between the market value of the shares at the time of exercise less any amounts paid. This is treated as a notional loan written off within Section 160(2) and as emoluments of the employment.

If an individual is resident in the UK at both the date of grant and the date of exercise the UK will have primary taxing rights even where a treaty partner country wishes to tax the gain under its own domestic legislation. However a claim under the employment income Article of the DTA may be relevant if the duties of the employment have been carried out in the other country during the period between grant and exercise of the option and double taxation has occurred.

C may, however, be liable to UK capital gains tax on any gain she makes on selling the shares acquired by exercising the option. Her allowable cost will be the total of the amounts she paid for the option and shares together with any amount charged to UK income tax under Section 162(5). There are special capital gains rules for non-domicilairies at Section 12, TCGA 1992.

Example 5

Mrs. D is not resident and not ordinarily resident in the UK when her employer grants her an option to purchase shares. At some time before exercise she moves to the UK and performs the duties of the employment there. She exercises the option when working in the UK and sells the shares.

D will not be liable to UK income tax on any gain realised at exercise, unless the grant of the option is clearly related to duties performed in the UK. In this case there could be a liability under Section 162 although all relevant facts and circumstances would need to be considered before determining whether or not a liability arises.

She may, however, be liable to UK capital gains tax on any gain realised as a result of selling the shares acquired following the exercise of the option. This would be so if she is either resident or ordinarily resident in the UK at the date of disposal or if she is within the scope of the temporary non-residents rules contained in Section 10A, TCGA 1992. There are special capital gains rules for the tax year she commences UK residence and for the case where she is a non-UK domiciliary. D's allowable capital gains cost would be the total of her payments for the option and shares together with any amount charged to UK income tax under Section 162(5).

Even though exercise will not normally trigger a UK income tax liability in this case, it may well give rise to a tax charge in another country. Strictly, the exercise of the option and the subsequent disposal of the shares are two distinct events and the UK is not obliged to allow a foreign tax credit for any foreign tax paid on exercise against any UK capital gains tax payable on disposal. Nevertheless, where tax has been paid in a treaty partner country, we will treat all or part of the gain as falling within the provisions of the employment income Article of the relevant double taxation agreement and allow the relevant proportion of the foreign tax paid as a credit against the UK capital gains tax:

  • If the options are exercised and the shares sold on the same day, the whole gain is treated as falling within the provisions of the employment income Article of the relevant DTA.
  • If the shares are disposed of at a later date, part of the gain may be treated as falling within the employment income Article of the agreement. All the facts and circumstances in a particular case will be considered and the tax treatment will depend on such factors as whether the share price has increased or decreased, or whether there have been significant changes in the share price since exercise.
  • We will allow a proportion of the foreign tax paid as a credit against UK capital gains tax normally calculated on a time apportionment basis by reference to periods of employment abroad. It does not matter whether the foreign tax was charged on grant, exercise or some other occasion. The credit for foreign tax can never exceed the UK tax payable on the relevant proportion of the total gain.

Further advice

We intend to publish a further article shortly covering other issues around share incentives for internationally mobile employees, principally National Insurance Contributions.

For further advice on the PAYE treatment of share options, contact:

Peter Walker
Personal Tax (Solihull)
550 Streetsbrook Road
Solihull
West Midlands
B91 1QU

Tel: 0121 713 4602

e-mail: Peter.R.Walker@ir.gsi.gov.uk

And for further advice on international aspects, contact:

Susan New
Revenue Policy International
Victory House
30-34 Kingsway
London
WC2B 6ES

Tel: 020 7438 7250

e-mail: Susan.New@ir.gsi.gov.uk

The Late Notification Penalty

This article supersedes the article published in Tax Bulletin Issue 53 (June 2001) at page 849.

This article is about the Class 2 National Insurance Contributions (NICs) late notification penalty. With effect from 31 January 2001, anyone who becomes liable to pay Class 2 NICs must register within 3 months from the end of the month in which their liability commenced in order to avoid a penalty of £100.

Lord Grabiner's recommendations

In his report on the informal economy in March last year, Lord Grabiner expressed concern that people in business can drift into the hidden economy. They then find it difficult to put their affairs in order and so take advantage of the support advice and business opportunities available to those operating in the formal economy. Lord Grabiner recommended that:

  • more assistance should be given to the newly self-employed at the outset to avoid trouble later on with the revenue departments and possibly other regulatory bodies; and
  • to facilitate the provision of support there should be an effective requirement to notify the Inland Revenue on or soon after the start of business.

Consultation

In October 2000 the Inland Revenue published Starting up in Business, a consultation paper setting out its proposals for implementing these recommendations. The paper proposed:

  • streamlining the process for the newly self-employed to register for NICs purposes, and for this registration to trigger the provision of information and support to them;
  • improving that information and support; and,
  • making the existing requirement for the newly self-employed to register for NICs purposes more effective by imposing a fixed penalty if it is not done within a reasonable time.

Legislation Amendments

Previously, regulation 53A of the Social Security (Contributions) Regulations 1979/591 required anyone becoming liable to pay Class 2 NICs to notify Inland Revenue immediately. This requirement was effectively unenforceable as liability to pay Class 2 NICs starts in the week in which people start working for themselves. The amendments to regulation 53A, which are now found in regulation 87 of the consolidated Social Security (Contributions) Regulations 2001 SI No 1004 (the Contributions Regulations) retain the requirement to notify liability immediately. However, regulation 87(4) effectively provides a defined time limit for registration in order to avoid the new penalty.

Comments made on the consultation paper proposals for a registration time limit pointed to the difficulty of establishing a precise date on which self-employment starts. We decided that a deadline at the longest of the proposed periods - 3 months - was sufficient to ensure that proper business records were kept from the early days of a new business and that the newly self-employed person was able to access help, guidance and support from the start. Consequently anyone starting in self-employment is now required to register with the Inland Revenue within three months from the end of the calendar month in which they start self- employment: if they fail to do they can incur a fixed penalty of £100. So, a person who started self-employment on or before 31 January 2001 must have registered by 30 April, otherwise the penalty could be imposed from 1 May 2001. Anyone starting during September 2001 must register by 31 December 2001 to avoid the penalty, and so on.

Failing to register in time

Registrations for Class 2 NICs and administration of the new penalty will be dealt with centrally by the National Insurance Contributions Office (NICO) at Newcastle-upon-Tyne. The majority of late notifications will be identified by NICO when the individual registers by phone or in writing. Regulation 87(3) of the Contributions Regulations provides that a penalty is incurred for lateness unless the self-employed person can:

  • provide a reasonable excuse for failing to notify in time. NICO will apply the criteria set out in the paragraph 5060 onwards of the Investigation Handbook, which is available on the Inland Revenue website; or,
  • show that throughout the period between starting self-employment and registering, their net earnings were less than the pro rata equivalent of the annual Small Earnings Exception limit (£3825 in 2000-2001 and £3955 in 2001-2002).

When a penalty is imposed a bill will be issued advising the person to make their payment by cheque to NICO Central Banking Services. If the individual disputes the penalty, the bill explains that they can avoid it by showing their earnings were below the Small Earnings Exception limit, or if they have an reasonable excuse for failing to notify commencement of their Class 2 liability within the time limits. The bill will give the contributor an address and telephone number of who to contact at NICO if they wish to dispute the penalty. If the dispute cannot be resolved a formal decision will be issued which will carry a right of appeal to the General Commissioners. The contributor will have 30 days to either lodge their appeal or pay the penalty.

If the person does not pay the penalty and makes no appeal against the decision, or their appeal is rejected and no payment is made, normal recovery action will follow along with recovery of any tax and NICs that may be due.

Notification of Income tax liability

There is a separate requirement, under Section 7 Taxes Management Act 1970 (TMA), to notify chargeability to tax within six months of the end of the tax year. This requirement does not apply to people who have been sent a tax return for the year in question. People who register for Class 2 NICs liability will now also be registered for Self Assessment and should be sent a tax return for the year they start business. They will therefore not need to give separate notice of their chargeability to income tax for that year.

Deferment of Class 2 contributions

A person starting self-employment who is also employed as an employee and who is likely to pay the maximum amount of Class 1 NICs, must register for Class 2 NICs although they may not be required to pay any Class 2 contributions. Once they have registered as liable to pay Class 2 contributions the person can apply to the Deferment Services at NICO to have their liability deferred until after the end of the tax year. The deferment procedure enables the Class 2 liability to be accurately assessed in the light of Class 1 NICs paid. Deferment is considered only if earnings from self-employment are above the Small Earnings Exception Limit, otherwise the deferment application is treated as an application for a Small Earnings Exception. If Class 2 NICs are deferred, Deferment Services will also defer the Class 4 NICs, which will then be collected separately from any self-assessment income tax payable. However, deferment cannot be given retrospectively and applications are considered only for the current tax year.

Publicity

Publicity was given about the new arrangements for registering for Class 2 NICs in Inland Revenue news releases dated 10 January 2001, 23 February 2001 and 24 April 2001. The News releases along with the consultation document, the amendment Regulations and the new Starting up in Business support guide and leaflet can be found on the Inland Revenue website. www.inlandrevenue.gov.uk

Contact Point

Jenny Fox
Cross-Cutting Policy
Room S11
West Wing
Somerset House
London
WC2R 1LB

Tel: 0207 438 7544

Email: jenny.fox@ir.gsi.gov.uk

Interpretation

Change of Interpretation: Non-Resident Trusts - Gains and Losses Accruing in the Transitional Period to Trusts brought within the Settlor Charge by FA 1998 - Treatment for Tax Year 1999-2000

Summary

This change of view is applicable only to non-resident trusts which were outside the scope of the Section 86 TCGA 1992 settlor charge until the enactment of Section 132 FA 1998.

As a consequence of recent legal advice, the Revenue has changed its position on the availability of net losses realised by non-resident trustees in the "transitional period" from 17 March 1998 to 5 April 1999 for set off against capital gains accruing to such trustees during 1999-2000, in respect of which a settlor is chargeable under Section 86 TCGA 1992. Until now we have taken the view that net capital losses incurred in the transitional period are not available for set off against 1999-2000 gains. However we now accept that such losses can in fact be set off in this way.

Similarly, the Revenue now accepts that net losses incurred by non-resident trustees in 1999-2000 can be set against gains arising in the transitional period in respect of which a settlor is chargeable under Section 86.

Action

Settlors affected by the transitional provisions whose capital gains position for 1999-2000 has been settled on the basis of our previous interpretation may now amend their self assessments for 1999-2000 in order to put into effect our changed interpretation. The amended self assessment must be submitted before the time limit for amending self assessments expires. In most cases this will be 31 January 2002.

Background

Section 86, TCGA 1992, which charges certain UK domiciled and resident settlors in respect of gains realised by non-resident, or dual resident trustees, was first enacted in FA 1991. This "settlor charge" taxes settlors of trusts in respect of the capital gains accruing from disposals of trust assets by the trustees, where the settlor or certain members of his family has an interest in the trust and certain other conditions are met. The 1991 legislation excluded from the charge all non-resident trusts created before Budget day, 19 March 1991, subject to certain conditions. Trusts whose gains are within the scope of Section 86 are known as 'qualifying settlements'.

Under Section 132 FA 1998, all trusts created before 19 March 1991 and otherwise meeting the conditions in Section 86, were brought within the definition of qualifying settlements. This was announced on Budget Day 1998 (17 March) and took effect from 6 April 1999. The period from 17 March 1998 to 5 April 1999 was covered by transitional provisions. These are at Schedule 23 FA 1998.

The aim of the transitional provisions was to allow time for trustees not wishing their trusts to become qualifying settlements to remove them from the scope of the settlor charge (e.g. by removing beneficiaries from the trust, or by certain other means). There were also anti-avoidance provisions to stop trustees realising gains in the transitional period and then removing their trusts from the scope of the settlor charge before 6 April 1999. For those trusts where the requisite steps to remain outside Section 86 TCGA 1992 were not taken by 6 April 1999, paragraph 1(2)(a) of Schedule 23 FA 1998 applied to treat gains and losses arising between 17 March 1998 and 5 April 1999 as accruing on 6 April 1999 for the purposes of the settlor charge.

Until now our interpretation of the transitional provisions has been that a settlor is taxable in 1999-2000 on any net gain arising in the transitional period, but any net loss arising in the transitional period cannot be set off against any actual gains accruing in 1999-2000. Equally, we considered that losses incurred in 1999-2000 were not available for setting off against net gains which arose during the transitional period. This view was seen as consistent with the general basis of the settlor charge, which attributes only net gains, and not losses, to settlors, and with Section 132(5) FA 1998, which prohibits gains and losses arising before 6 April 1999 from being taken into account for the purposes of Section 86 TCGA 1992.

However, following recent legal advice we now accept that the wording of paragraph 1(2)(a) Schedule 23 FA 1998 allows for both net gains, and net losses, to be treated as accruing on 6 April 1999.

Consequences

In cases falling within the provisions of paragraph 1(2)(a) of Schedule 23 FA 1998:

  1. Net capital losses arising on disposals made between 17 March 1998 and 5 April 1999 are available for set off against net capital gains accruing on disposals made between 6 April 1999 and 5 April 2000, for the purposes of calculating the amount on which a settlor is chargeable for 1999-2000 under Section 86. To the extent that such losses are not so utilised, they will be available for carry forward in accordance with paragraph 1(6) Schedule 5 TCGA 1992, and so may reduce the amount on which a settlor is charged under Section 86 TCGA 1992 for a later year.
  2. Net capital losses arising on disposals made between 6 April 1999 and 5 April 2000 are available for set off against net capital gains arising on disposals made between 17 March 1998 and 5 April 1999, for the purpose of calculating the amount on which a settlor is chargeable under Section 86 TCGA 1992 for 1999-2000.

This interpretation will apply to all current open and future self assessments for 1999-2000. As noted above self assessments for 1999-2000 already settled on the basis of our previous view may be reopened, but the amended self assessment must be submitted to the Revenue before the time limit under Section 9(4)(b) TMA 1970 expires.

Further information

This article repeats the one issued in the "non-residents" pages of the Inland Revenue Internet site on 8 August 2001.

For further advice on how this revised interpretation affects a particular case, write with full details to:

Mike Corcoran (Technical Adviser)
Centre for Non-Residents 2 (Non-Resident Trusts)
Room 310
St John's House
Merton Road
Bootle
Merseyside
L69 9BB

(No longer relevant)
Foot and Mouth Disease

This article supplements the material in the special Foot and Mouth edition of Tax Bulletin issued in May this year.

Herd Basis and Partnership changes

It is fairly well known that a herd basis election comes to an end when there is a change in the membership of a partnership. This is because the new partnership is a different farmer for the purposes of the herd basis from the old one. So a genuine partnership change between the compulsory slaughter of a herd and replacement may serve to crystallise a tax free gain on the sale of the herd. But the cost of the new herd will not, of course, be allowable.

We have been asked whether a herd basis election lapses if a partnership converts to a Limited Liability Partnership (LLP) without a change in membership. The answer in our view is no. This is because the LLP is deemed to be a partnership, has the same members, and so is not a different farmer.

Slaughter of immature animals intended to be replacements

Ministers have approved a new Extra Statutory Concession to help with a situation which was not contemplated when the herd basis rules were written. Where a farmer buys in or breeds replacements for ewes culled from his herd they do not normally (there are special rules for home bred replacements in hefted flocks) enter the herd until they bear their first lamb. That is because of the definition of maturity in the herd basis rules (paragraph 8(2) to (4) Schedule 5 Income and Corporation Taxes Act (ICTA) 1988). In some flocks slaughter took place this year during lambing with the result that some ewes were slaughtered before they gave birth but others from the same batch of intended replacements may have had lambs at foot when they were slaughtered.

This may lead to an unexpected profit because animals which were slaughtered before they enter the herd are treated as trading stock. The concession, which applies to animals slaughtered as a result of the present outbreak of foot and mouth disease, enables farmers to treat such animals as if they had entered the herd before slaughter. Similar situations may arise with animals other than sheep so the concession is written in general terms. The text is as follows:

Where

  • a farmer has disposed of production animals subject to a herd basis election with the intention of replacing them with young animals which would have qualified as replacements when they gave birth to their first young; and
  • the intended replacements did not give birth to their first young because they were slaughtered while pregnant as a result of the 2001 foot and mouth disease outbreak;
  • the intended replacements may be regarded as mature for the purposes of paragraph 8(4) Schedule 5 ICTA 1988.

The concession does not apply to animals which were intended to be additions to a herd but any profit arising on the slaughter of such animals may be spread under ESCB11.

Forward spreading under ESCB11

The Inspectors Manual at IM2268b says that spreading under Extra Statutory Concession B11 applies to mature animals which do not constitute the whole, or a substantial part, of a production herd. This may be incorrect on a strict reading of the concession but we do not propose to change it while the current outbreak of foot and mouth continues.

Later IM2268b suggests that for animals borne in the year of slaughter profit can be computed as compensation less 75%. That figure is correct for sheep and pigs but the figure for cattle in BEN19 is 60%. The use of 60% for cattle will be acceptable to the Revenue here as well.

If the trade is carried on in partnership, spreading under ESCB11 applies at partner rather than partnership level (IM2268c). Where a partner wishes to claim, the reduction should be made in box 4.8 of the Partnership Pages of the partner's personal Tax Return. An explanatory note should be included in the additional information box 4.79. We are grateful to people who have pointed out that there is nowhere obvious for partners to include the profit spread forward in subsequent returns. We will deal with this point in the guidance to next year's returns.

Foot and Mouth Disease: Quality of replacement animals

Where animals which are part of a production herd on the herd basis are slaughtered because of the present outbreak of foot and mouth disease a special provision in the herd basis rules may be relevant.

When animals on the herd basis rules are replaced the normal rules provide that the proceeds of the old animal are included and the cost (subject to an appropriate restriction if the replacement is of better quality) of the new animal is deducted in computing the farming profits. The special rule in paragraph 3(6) of Schedule 5 ICTA 1988 (IM2305) says that if slaughtered animals are replaced by animals of lower quality then the amount included as a trading receipt shall not exceed the amount allowable as a deduction. The effect is that when a farmer replaces a herd with animals of lower quality which cost less than the compensation received for the old animals, the excess of the compensation over the cost of the new animals is not taxable.

We have been asked how we interpret the term 'quality' in this context. The point may be of particular relevance when the animals concerned are expensive pedigree bulls or rams.

The quality of an animal is a question of fact. Farmers will generally have well informed views on the quality of their animals. It does not follow that if the cost of the replacement is lower or higher than the proceeds of the animal slaughtered then the quality is lower or higher for two reasons:

  • Quality does not depend upon age. But the compensation might reflect the fact that the animal concerned was getting to the end of its productive life. A replacement might cost more because it was younger.
  • Price depends upon the state of the market on the day. There is a strong correlation between quality and price so a good animal will fetch a better price than a poor one. But a poor one next month might cost more or less than a good one this month.

In many cases the amount of compensation for the slaughtered animals depended upon quality and professional valuers advised when compensation was quantified. In the event of doubt the farmer might instruct the same valuer to give an opinion as to whether the replacements were of different quality.

If there are disputes which cannot be settled by agreement they will be referred to the Commissioners who are arbiters on questions of fact. Our experience after the 1967 outbreak of foot and mouth disease is that such action was very seldom necessary.

Sugar Beet Outgoers Scheme

British Sugar and the NFU announced on 23 July a new, one off, scheme that allows sugar beet growers to relinquish all or part of their Contract Tonneage Entitlement. We have been asked about the taxation consequences for farmers who sell or buy Contract Tonneage Entitlement. We consider that the transactions are on revenue account, with the result that amounts received are taxable receipts of the trade and amounts paid are deductible in computing trading profits.

Why transactions are on revenue account

Sugar beet contracts are sometime described as sugar beet quota. This is a misnomer which can lead to misunderstandings and should be avoided. Sugar beet contracts are not quotas but may be best understood as annual personal contracts, between British Sugar and the farmer, for the supply and delivery of a maximum tonneage of sugar beet to an identified processing plant. As such they are part of the ordinary arrangements farmers make for disposing of their products.

There is a long succession of decided tax cases where sums derived from the disposal of such contracts have been held to be income. Taxpayers (or the Revenue when the case was about an expense) have argued that contracts were fundamental to the structure of the business and therefore capital assets following Van den Berghs Ltd v Clark (1935) 19 TC 390. But it is only where a contract is one the cancellation of which would effectively destroy or cripple the whole structure of the taxpayer's profit-making apparatus that it falls to be treated exceptionally as a capital asset. That is not the case here.

The decisions of the Special Commissioners in the cases of Croydon Hotel & Leisure Co Ltd v Bowen (1996) SpC 101 and A Consultant v H M Inspector of Taxes (1998) SpC 180 show how difficult it is for an argument based on the Van den Burghs case to succeed.

In farming cases it is also necessary to take account of the statutory definition of farming in Section 832 Income and Corporation Taxes Act 1988 as the occupation of land for the purposes of husbandry. It is the land that is fundamental to a farming business. Payments which result from changes in the way it is farmed are very unlikely to be on capital account. An example is the payments for conversion from dairying to beef production in White v G & M Davies, (1979) 52TC597 and CIR v Biggar, (1982) 56TC254.

Timing of revenue deductions

We understand that accounts prepared in accordance with generally accepted accountancy practice will show payments for Contract Tonneage Entitlement on the balance sheet and amortise them over the period for which they may reasonably be expected to be of value to the business.

Where revenue expenditure is treated in this way the amortisation charged to profit and loss account is allowable. For a more detailed explanation of the principles involved please see the article on 'deferred revenue expenditure' in the August 2001 edition of Tax Bulletin.

Landlords

Our understanding is that landlords do not have an interest in transactions in Contract Tonneage Entitlement by their tenants unless there is a clause in the tenancy agreement or a separate agreement which gives them one. If there is such a provision then the tax treatment of sums received under it will depend upon its terms so we cannot make any general statement.

Miscellaneous

Inheritance Tax: Accumulation & Maintenance Trusts

An article in Tax Bulletin Issue 50 (December 2000) reminded practitioners that after the relevant period of 25 years has elapsed a settlement will only qualify under S71 of the Inheritance Tax Act 1984 so long as all beneficiaries are grandchildren of a common grandparent (or are a surviving spouse or child of such a grandchild).

We have been asked whether the mere existence of a power to appoint (which does not offend the conditions of S71(1)(a)) in favour of beneficiaries who are not grandchildren of a common grandparent will take the settlement outside the common grandparent rule. We have said that in our opinion the mere existence of such a power, as opposed to its actual exercise, does not take a trust outside the common grandparent category.

(No longer relevant)
An Update on Double Taxation Conventions (DTCs) and Double Contribution Conventions (DCCs)

Recent Developments

Chile

A third round of talks on a DTC was held in Santiago in July 2001 and work continues to settle the outstanding issues.

Jordan

A comprehensive DTC between the UK and the Hashemite Kingdom of Jordan was signed in Amman on 22 July by Ben Bradshaw, Parliamentary Under Secretary of State at the Foreign and Commonwealth Office and Dr Marto, Minister of Finance.

(N.B. The UK/Jordan Double Taxation Convention has now entered into force and the text of the Convention can be found on the HMSO website)

Lithuania

You can now access the text of the comprehensive DTC between the UK and Lithuania, signed in Vilnius on 19 March, on the Internet.

The texts of these two new Conventions will in due course be laid before the House of Commons as Schedules to Draft Orders in Council. They will then be available from the Stationery Office. They are presently available on the Internet at, respectively:

www.inlandrevenue.gov.uk/pdfs/ukjordan_dtconvention.pdf (N.B. The UK/Jordan Double Taxation Convention has now entered into force and the text of the Convention can be found on the HMSO website) and www.inlandrevenue.gov.uk/pdfs/uklithuania_dtconvention.pdf

The Conventions will enter into force, in each case, once both countries involved have completed their legal procedures.

United States of America

A new comprehensive DTC between the UK and the USA was signed on 24 July 2001 in London by Chancellor of the Exchequer Gordon Brown and US Treasury Secretary Paul O'Neill.

It is expected that the text of the new Convention will be laid before the House of Commons as a Schedule to a Draft Order in Council on 15 October 2001. It will then be available from the Stationery Office. Until then the text can be viewed on the Internet at: www.inlandrevenue.gov.uk/pdfs/ukusa_dtconvention1.pdf although until it has been approved and ratified by both countries it has no legal effect.

Representations

In order to set its treaty priorities each year, the Inland Revenue consults top UK companies, the main representative bodies and other Government departments. Representations from other interested parties are also invited and details of the review for the coming year will be announced shortly through a Press Release. Further information will also be available on the Inland Revenue website.

General representations concerning new DTCs or DCCs, or suggestions about changes to existing conventions, are welcomed and should be addressed to:

Jas Sahni
Revenue Policy, International
Inland Revenue
Victory House
30-34 Kingsway
London
WC2B 6ES

Queries regarding the effects of a double taxation convention on a particular taxpayer's tax liability should always be referred to the Inland Revenue office responsible for dealing with their tax affairs.

Further Information

Further information on double taxation and related issues can be obtained via the Internet on the Inland Revenue website at: www.inlandrevenue.gov.uk

Copies of double taxation conventions published from 1997 onwards can be found on the Stationery Office's website at: www.hmso.gov.uk

Copies of older conventions can be obtained from the Stationery Office:

Telephone 0870 600 5522.

Further information on double contribution conventions can be obtained from:

Inland Revenue
National Insurance Contributions Office International Services
Longbenton
Newcastle Upon Tyne
NE98 1ZZ

General double taxation issues arising in connection with estates, inheritances and gifts should be addressed to:

Angela Cole Inland Revenue
Capital and Savings Room 121
3rd Floor
New Wing
Somerset House
London
WC2R 1LB

Subscription

Our aim is to maintain value for money for the annual subscription paid, whilst covering the costs. We are pleased to announce that the subscription charge for 2002 will remain at £22. We hope readers will continue to find this publication, informative helpful and value for money.

Inland Revenue Statements of Practice and Extra-Statutory Concessions issued between 1 August 2001 and 30 September 2001.

Extra-Statutory Concessions

Number

Title

Date of Issue

B56

Slaughter of immature animals intended to be replacements
(Please note, this is only available in electronic format)

12/10/01

Statement of Practice

There have been no Statements of Practice issued in this period.

You can get copies of SPs and ESCs from the Inland Revenue Visitors Information Centre, Ground Floor, South West Wing, Bush House, Strand, London WC2B 4RD or by ringing the Inland Revenue Enquiry line on 020 7438 6420.

Content

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

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

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

Letters on any article appearing in Tax Bulletin should be sent to the Editor, Sarah Guerra, Room S18, West Wing, Somerset House, Strand, London, WC2R 1LB or e-mail Sarah.Guerra@ir.gsi.gov.uk. We are sorry though that neither she nor our contributors will normally be able to enter into correspondence about Tax Bulletin or its contents.

Subscription

The subscription for 2001 is £22. If you would like to subscribe to Tax Bulletin please send your name and address together with your cheque to Inland Revenue, Finance Division, Barrington Road, Worthing, West Sussex BN12 4XH. Cheques should be crossed and made payable to "Inland Revenue".

If you would like information regarding Tax Bulletin, please contact Ms Nahid Shariff, Assistant Editor, on 020 7438 7842 or at the address below.

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 Ms Nahid Shariff, Assistant Editor, Room S15, West Wing, Somerset House, Strand, London, WC2R 1LB.