BIM73055 - Averaging: creators of literary and artistic works: particular points

This guidance supplements the introduction at BIM73051.

The rules are in ICTA88/SCH4A. The main features are explained in Help sheet IR234.

Who can claim?

The heart of the legislation is ICTA88/SCH4A paragraphs 1 and 2. These paragraphs say who is able to use profits averaging and in respect of what profits.

An individual may use averaging for profits earned from a qualifying trade profession or vocation.

A trade, profession or vocation is ‘qualifying’ if:

• the taxpayer’s profits from it are derived wholly or mainly from qualifying creative works created by the taxpayer personally, or, if activity is carried on in partnership, by one or more of the partners personally, and
• the profits are chargeable as trading income.

HMRC regards the ‘wholly or mainly’ test as satisfied if more than 50% of the profit is derived from qualifying creative works.

’Qualifying creative works’ are defined as, literary, dramatic, musical or artistic works or designs. Generally these are works which are intellectual property of the creator, protected by law. The terms are derived from the previous rules about spreading and reflect the policy intention that the new rules should apply to broadly the same people as qualified for the previous reliefs. The terms are defined in the Copyright Designs and Patents Act 1988 in relation to UK property. The relief also extends to similar property protected under foreign jurisdictions. Profits may be derived by allowing others to reproduce the creative works (for example authors' royalties or advances on royalties) or by outright sale.

Someone who is providing a service will not qualify as their income is derived from services rather than from qualifying creative works. For example, consider the case of a solicitor and assume that all her work is done in writing. Each letter, opinion, note, etc is a qualifying creative work because written material is protected by copyright irrespective of artistic merit and comes within the term, ‘literary works’. But the solicitor does not derive profit from these literary works. Rather they are evidence of the work which the solicitor has done in providing legal services in return for fees. Creation of them is an incident of the work of the solicitor but she does not derive her income from them. So she does not qualify for the relief. It would be different if the solicitor designed a legal form and then made royalties which gave rise to more than half her profit by allowing others to reproduce it but that is a rare occurrence.

The work may be physical property (for example sculptures or paintings) but the relief does not apply to profits derived from works of craft (for example furniture making or dress making).

Because of the requirement that the taxpayer or his or her partners create the work personally, the relief does not apply to people who manage the creation of work created by employees or others who are not partners.

Companies do not qualify. Nor do individuals whose income is assessed under Case VI of Schedule D.

Years for which a claim may not be made

Claims may not be made:

• If a claim has already been made for a later tax year in respect of the same source (ICTA88/SCH4A/PARA4 (1).
• For the year in which a person commences or ceases to have the source of income concerned. (ICTA88/SCH4A/PARA4 (2)(a)).
• For the year the source first becomes qualifying or ceases to qualify (ICTA88/SCH4A/PARA4 (2)(b)).

So, for example:

• A claim may not be made to average year 3 with year 4 if year 4 has already been averaged with year 5.
• A partner cannot make a claim for the year she joins a partnership.
• An author who has been resident abroad cannot claim for the year he returns to the UK.
• Where a profession evolves into a qualifying profession a claim may not be made for the first year it qualifies.

What profits are averaged

The profit averaged is the amount after capital allowances. Losses count as Nil (ICTA88/SCH4A/PARA11).

Where profits for either year are changed by backwards (2000/01 only) or forwards spreading under the old rules, it is the profit after spreading which is averaged.

When profits for a pair of years have been averaged the new (averaged) profit for the second year is used in any claim to averaging with the following year (ICTA88/SCH4A/PARA6 (4)).