Tax Bulletin Issue 25

INLAND REVENUE TAX BULLETIN 
Issue 25

CONTENTS

Transfer Pricing: New OECD Report: Guidance on Revenue Procedures (Article no longer current)

The Mutual Agreement Procedure in UK Double Taxation Conventions (Article no longer current)

Schedule A: IR150 -- Taxation of Rents:

Self Assessment:

Payments on Account:

interpretations

Incidental Costs of Corporate Borrowing: Section 84 FA 1996 (Superceded by CT12359 & CFM5210 onwards)

Deductions for Interest payable: Section 337A ICTA 1988 (Article deleted since index 2004)

Hong Kong: From 1 July 1997

miscellaneous

Employees and Double Taxation Agreements

Credit Relief for Foreign Taxes (Superseded by DT 2301/2302, DT2501,DT 3901/3902, DT 15251)

Pension Schemes Office:

Subscription

Statements of Practice and Extra-Statutory Concessions


EDITORIAL

Articles appearing in Tax Bulletin publicise our view of the law and indicate how the Department will apply the law in a particular area. Our view is not always accepted and there is of course nothing to preclude an argument being taken on appeal to the Commissioners or Courts.

Although I am unable to enter into correspondence with readers about
Tax Bulletin or its contents, I nevertheless welcome comments and suggestions, including suggestions for subjects you would like to see covered. Readers may write to me at the address given on the final page.

This Issue of the year gives information about subscriptions for 1997 on page 359.

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 This Article Is No Longer Current (Deleted Index 1999)

TRANSFER PRICING:
NEW OECD REPORT:
GUIDANCE ON REVENUE PROCEDURES

The OECD has recently published new Transfer Pricing Guidelines. In this issue the Inland Revenue sets out its position on those new Guidelines. And we also provide some practical guidance in one area we are often asked about which is of particular importance in the transfer pricing context - the operation of the Mutual Agreement Procedure contained in the United Kingdom's Double Taxation Conventions.

OECD TRANSFER PRICING GUIDELINES

In July 1995 the Organisation for Economic Co-operation and Development (OECD) published its report, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. This was followed in March this year by publication of the first of what is planned to be a number of releases of supplementary material.

The report is a reflection of the valuable work of the OECD in fostering international consensus in what is one of the foremost areas of importance in the taxation of multinational enterprises, work in which the UK has taken and continues to take, a full and active role. It also reflects considerable valuable input from Member countries' business communities, including the UK's. The Guidelines update the 1979 OECD Report, Transfer Pricing and Multinational Enterprises, and, in doing so, provide extended guidance in a number of areas relevant to the conduct of present-day international business. Importantly, the Guidelines emphasise the continuing adherence of OECD members to the application of the arm's length principle in evaluating transfer pricing. The Inland Revenue will be guided by the Guidelines in applying domestic transfer pricing legislation and in seeking to prevent double taxation under the terms of Double Taxation Conventions with OECD Member countries. The Inland Revenue encourages taxpayers to consult the Guidelines when evaluating whether their transfer pricing complies with the arm's length principle.

Copies of the Guidelines can be purchased from HMSO outlets in the UK or directly from

OECD Publications
2 rue André-Pascal
75775 Paris Cedex 16

Tel: (33-1) 45 24 81 81 or 45 24 81 67
Fax: (33-1) 49 10 42 76.

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

THE MUTUAL AGREEMENT PROCEDURE IN
UK DOUBLE TAXATION CONVENTIONS

INTRODUCTION

Chapter IV of the 1995 OECD Transfer Pricing Guidelines contains details of administrative approaches to avoiding and resolving transfer pricing disputes. One such approach to which it refers is that provided for under the mutual agreement procedure which is described and authorised by Article 25 of the OECD Model Tax Convention. The Guidelines suggest that it would be helpful if OECD Member countries were to develop and publicise their own domestic rules or procedures for using the mutual agreement procedure so that taxpayers more readily understand the process. This article provides guidance about the UK's practice on the operation of the mutual agreement procedure and the manner in which claims under the relevant Article in the UK's Double Taxation Conventions are handled, with particular reference to transfer pricing and multinational enterprises.

The UK has a large network of Double Taxation Conventions covering in excess of 100 countries. Double Taxation Conventions seek to protect taxpayers from double taxation, provide for the appropriate allocation of taxing rights in relation to profits from cross-border economic activities, and prevent fiscal discrimination by their signatories. The UK seeks to encourage and maintain an international consensus on international tax treatment of cross-border economic activity, and plays an important role in this field through its membership of OECD.

In this respect, the mutual agreement procedure performs an important function, establishing a process by which the competent authorities of treaty partners can consult each other to resolve matters relating to the application of the treaty.In what follows, references to the mutual agreement procedure are to arrangements of the sort which are typically incorporated in the UK's Double Taxation Conventions.

ADMINISTRATION

Claims under the mutual agreement procedure in respect of transfer pricing are dealt with by International Division with the exception of those made by oil companies which are handled by the Oil Taxation Office.

The procedure in most conventions empowers the competent authorities of the two contracting states to consult each other when a taxpayer claims that it is being taxed otherwise than in accordance with the convention, as a result of the actions of one or both of the fiscal authorities. It is a process of consultation, not litigation, between the two competent authorities, to which the taxpayer is not a party as such. But the extent to which the taxpayer is invited to participate informally is at the discretion of the competent authorities.

In the UK the competent authority is the Commissioners of Inland Revenue or their authorised representatives. For claims under the mutual agreement procedure which concern transfer pricing, the Commissioners have authorised to represent them:

  • for matters relating to transfer pricing generally

    Deputy Director (International Compliance), International Division

  • for matters relating to transfer pricing in the petroleum industry

    Controller, Oil Taxation Office

A taxpayer may initiate the mutual agreement process by making a claim to the competent authority for the country of which it is a resident or, in some cases, a national. In the UK there is no set form of claim: UK taxpayers may present their claims in writing to the person and at the address set out at the conclusion of this article. A claim should specify the year(s) concerned, the nature of the action giving rise to taxation not in accordance with the convention, and the full names and addresses of the parties to which the procedure relates, including the UK company's tax District and reference number.

TIME LIMITS

The 6-year time-limit laid down for making claims in Section 43 Taxes Management Act (TMA) 1970 applies to claims made under the mutual agreement procedure. However, it is recognised that transfer pricing investigations may take many years to resolve and the UK competent authority will therefore accept protective claims. Claimants should, however, bear in mind that other jurisdictions may operate different time limits for claims.

In deciding when to make a claim taxpayers are advised to consider the procedures adopted by different jurisdictions in settling transfer pricing issues. It should be noted that an adjustment made in relation to a transfer pricing issue raised in the UK and settled either by determination of an appeal under Section 54 TMA 1970 or following a case stated to the Courts, may not be varied. However, in such case, the UK competent authority would expect, on request, to take the matter up under the mutual agreement procedure with the appropriate treaty partner with a view to obtaining the partner's agreement to a corresponding adjustment.

SCOPE FOR GRANTING RELIEF

The terms of the Article establishing the mutual agreement procedure circumscribe the competent authority's freedom of action. The Article provides no guarantee of relief from double taxation: but the competent authorities are enjoined to consult each other and to endeavour to resolve each case with a view to the avoidance of taxation which is not in accordance with the treaty. And in the UK, the mutual agreement procedure has proved itself very effective in doing so.

On considering the case presented to it, the UK competent authority may conclude that the taxation of relevant transactions proposed or applied by a treaty partner does not accord with the provisions of the convention. It may not, for instance, accept that a transfer pricing adjustment complies with the arm's length principle. Where this is so, it is likely that the UK competent authority will take up the matter with its counterpart in the other contracting state. If, following this, the UK remains dissatisfied, there is no obligation on it to grant relief.

However, where there is adequate evidence to satisfy the UK competent authority that an adjustment imposed by a treaty partner is in accordance with the convention and was required in order to comply with the arm's length principle, there will normally be no difficulty in granting a corresponding adjustment.

International Division's experience has shown that it is advantageous for companies involved in transfer pricing investigations to make early claims under the mutual agreement procedure. Where the convention allows this (and the terms of individual conventions do vary) early action by the competent authority can sometimes help to ensure that unrelievable double taxation does not arise from the actions of one fiscal authority. As noted above, the taxpayer is not directly involved in the negotiations between the competent authorities but, as happens in the UK, it may participate indirectly through discussions with the competent authority of its state of residence/nationality.

OECD GUIDANCE

In determining whether taxation of relevant transactions will satisfy the arm's length principle and thus result in taxation in accordance with the provisions of a convention, the UK will be guided by the 1995 OECD Transfer Pricing Guidelines. The Guidelines represent the consensus view of OECD Member countries on the application of the arm's length principle and are also expected to be influential outside OECD Member countries.

METHODS OF GIVING RELIEF

The manner in which relief is granted by the UK depends on the facts and circumstances of the particular case. Relief may be granted either by deduction against UK profits or by tax credit. Following agreement between the competent authorities, the UK company will usually be invited to submit revised computations reflecting the agreed relief.

The UK does not accept that it is permissible for a taxpayer to make, unilaterally, an adjustment through its accounts in order to obtain corresponding relief for an adjustment imposed by another jurisdiction. The only avenue to relief is a claim under the mutual agreement procedure.

SECONDARY ADJUSTMENTS

Complexities sometimes arise where an overseas jurisdiction makes a secondary adjustment following a transfer pricing settlement. Secondary adjustments may be defined as adjustments that are intended to restore the financial situation of the associated companies which have entered into transactions giving rise to a transfer pricing adjustment to that which would have existed had the transactions been conducted at arm's length. This thus recognises that, while the primary transfer pricing adjustment will adjust the taxable profits of the associated enterprises, it will not rectify the situation that one enterprise actually retains funds that it would not have retained had the transactions in question been undertaken at arm's length. A secondary adjustment seeks to rectify this situation, most commonly by assuming that a constructive dividend, constructive equity contribution or constructive interest-bearing loan has been made in an amount equal to the transfer pricing adjustment. For example, a jurisdiction making a primary adjustment to the income of a subsidiary of a foreign parent may treat the excess profits in the hands of the foreign parent as having been transferred as a dividend, in which case withholding tax may be levied.

A secondary adjustment may, however, itself give rise to double taxation unless a corresponding credit or some other form of relief is provided by the other country for the additional tax liability that may result from a secondary adjustment. The UK will consider the merits of claims to deduct interest relating to the deeming of a constructive loan by a treaty partner following a transfer pricing adjustment. The claim would, however, be subject to the arm's length principle and would be considered in the light of any relevant provisions relating to payments of interest. Where a treaty partner applies a secondary adjustment by deeming a distribution to have been made, the UK neither taxes the deemed distribution nor grants relief for tax suffered on the distribution in the other jurisdiction.

REPATRIATION OF FUNDS

The repatriation of funds to restore the cash position of the associated enterprises to that which would have existed had arm's length terms applied to the transactions giving rise to a transfer pricing adjustment may remove the need for secondary adjustments, and some jurisdictions encourage repatriation and have specific rules governing the procedure.

Repatriation of profits to the UK can be made without further tax consequences providing the amount does not exceed the amount of profits reallocated under the transfer pricing adjustment. There is no opposition in principle to the repatriation of profits by a UK enterprise to an overseas enterprise following a transfer pricing adjustment. However, if under the mutual agreement procedure the amount of the transfer pricing adjustment is modified, then the amounts repatriated in excess of the modified transfer pricing adjustment may in certain circumstances be regarded as a distribution. In order to avoid such a result, it is recommended that any repatriation from the UK is only made following agreement of the transfer pricing reallocation as part of the mutual agreement procedure.

ADVANCE PRICING AGREEMENTS

An Advance Pricing Agreement or Arrangement (APA) is an arrangement that agrees an appropriate set of criteria for the determination, in advance, of the transfer pricing of transactions between associated enterprises over a fixed period of time. The UK has no formal mechanism for entering into an APA. Other jurisdictions have legislation establishing such a mechanism and it is becoming more common for UK corporate taxpayers to seek the participation of the UK competent authority in APAs into which their affiliates enter with such other jurisdictions.

The mutual agreement procedure allows the UK to negotiate with a treaty partner where there is difficulty or doubt as to the interpretation or application of the treaty. This provides authority for the UK to participate in a treaty partner's APA process where those conditions are satisfied with a view to agreeing with the treaty partner how to apply the terms of the treaty, particularly the arm's length principle, to the circumstances of the individual case. The UK considers each case on its merits, but it should be noted that the basis on which the UK enters into bilateral discussions with another fiscal authority is constrained by the terms of the mutual agreement procedure in the relevant convention. Enquiries about APAs should be addressed to the person identified at the end of this article.

ARBITRATION CONVENTION

An alternative to the mutual agreement procedure under the UK's Double Taxation Conventions, which may be available to resolve transfer pricing disputes, is represented by the Arbitration Convention to which the UK, along with the other member states of the European Union, is a signatory. The Convention came into force on 1 January 1995 for an initial period of five years and provides for independent arbitration to ensure the elimination of the double taxation which could result from transfer pricing adjustments in the signatory states. To date, experience of implementing the provisions of the Arbitration Convention has been negligible.

It is proposed to provide further guidance on the application of the Convention in a future edition of Tax Bulletin. In the meantime, enquiries about the Convention, including questions about the possibility of invoking its provisions, or presenting a case, should be addressed to the people named at the end of this article, overleaf.

FURTHER INFORMATION

Requests for further information on these procedures and claims to relief should be addressed to:

GENERAL TRANSFER PRICING ISSUES

Daniel O'Mahony
International Division
Melbourne House
Aldwych
London
WC2B 4LL

Telephone: 020 7438 6838
Fax: 020 7438 7518

FINANCIAL ISSUES

Martin Brooks
International Division
Melbourne House
Aldwych
London
WC2B 4LL

Telephone: 020 7438 7758
Fax: 020 7438 7629

APA REQUESTS (GENERAL AND FINANCIAL TRANSFER PRICING ISSUES)

Andrew Hickman
International Division
Melbourne House
Aldwych
London
WC2B 4LL

Telephone: 020 7438 6916
Fax: 020 7438 7629

OIL TAXATION ISSUES

Keith Cartwright
Oil Taxation Office
Melbourne House
Aldwych
London
WC2B 4LL

Telephone: 020 7438 6829
Fax: 020 7438 7602

(Superseded by PIM2100 and PIM1050)

SCHEDULE A: IR150 --
TAXATION OF RENTS:
A GUIDE TO PROPERTY INCOME

We continue to receive helpful comments on matters relating to the new Schedule A rules (which apply to income tax cases for 1995-96 onwards) which could usefully be incorporated in the next rewrite of the revenue Guide IR150 -- "Taxation of Rents -- A Guide to Property Income".

We intend to include the following guidance when the next rewrite occurs but readers might like to have details now.

INTEREST RATE HEDGING INSTRUMENTS

Where an interest rate hedging contract such as a swap or cap is taken out to hedge interest payments which are deductible in computing the profits or losses of a Schedule A business, then profits or losses on that contract will normally be taxed or relieved as receipts or deductions of that Schedule A business. We would normally expect profits and losses on such instruments to be computed on an accruals basis so that payments and receipts are allocated to the periods to which they relate, without regard to the periods in which they are made or received or become due and payable, in accordance with normal accounting practice.

DEPOSITS/BONDS TAKEN FROM TENANTS

Deposits paid by tenants or licensees to landlords will, ordinarily, be receipts of Schedule A business.

Deposits should be recognised in accordance with generally accepted accounting practice, normally by being deferred and matched with the costs of providing the services or carrying out repairs. To the extent that a deposit taken from a tenant or licensee exceeds any relevant costs, and is subsequently refunded, we accept that it should be excluded from the receipts of the Schedule A business.

CESSATIONS AFTER 5 APRIL 1996

The published guidance notes on Schedule A transition (which have been incorporated in "The new current year of assessment" -- SAT 1 (1995)) indicated that:

"If the Schedule A source ends in 1995-96, the new rules do not apply; that is, the computation is still made on the old rules. If it is clear that the source is likely to come to an end soon after 1995-96, then the existing Schedule A rules may be continued until the source ceases." (paragraph 9.103 of SAT 1(1995))

There is some uncertainty as to what "soon after the end of 1995-96" means. To remove that uncertainty, we will accept that where the Schedule A source ceases after 1995-96 but before 6 April 1997, the old rules may continue to be used up to the date of cessation:

  • if the taxpayer so chooses and
  • no new Schedule A business is commenced before 5 April 1997.

However, there is no statutory authority for giving relief for interest under Section 355(1)(b) Income and Corporation Taxes Act (ICTA) 1988 beyond 5 April 1996 (see Section 42(4) Finance Act (FA) 1995). So no interest relief will be available for 1996-97 under Section 355(1)(b) ICTA 1988 or as a Schedule A expense where the old rules are used for sources which cease between 6 April 1996 and 5 April 1997.

Further suggestions for improving the IR150 could should be sent to:

Inland Revenue
Business Profits Division (Sch. A)
Room 433
22 Kingsway
London
WC2B 6NR

(Superseded by EM7002)

SELF ASSESSMENT -- SCHEDULE A:
CO-OWNERSHIP OF PROPERTY

We have been asked to explain how we will handle enquiries under Self Assessment into the return of a taxpayer who receives income from co-owned property where the letting activity does not amount to a partnership. This request reflects concerns that an enquiry into one co-owner's return might automatically lead to enquiries into the others.

Where property is owned by two or more persons, one of them (the managing co-owner) will often take responsibility for carrying out the transactions relating to the letting and the overall supervision. We wish to avoid, so far as possible, carrying out what would amount to an in depth review of the managing co-owner's records solely through the medium of an enquiry into a passive co-owner's return. We also wish to avoid opening enquiries routinely into each co-owner's return in circumstances where such enquiries may be better conducted through an enquiry into the managing co-owner's return.

Thus, where the name and address of the managing co-owner is provided in a co-owner's return, we will normally confine our initial enquiries relating to income derived from co-owned property to the managing co-owner's return. If it appears that the returns of the other co-owners may need to be amended to give effect to the outcome of those enquiries, separate notices of enquiry will be issued to each co-owner at that stage. Section 29 Taxes Management Act 1970 as amended by Section 191 Finance Act 1994 will normally enable discovery assessments to be made, so far as that source is concerned, on the other co-owners if it is too late for their self assessments to be amended or an enquiry begun.

We included an article in the Tax Bulletin Issue 20 (December 1995 at pages 271-272) dealing with situations where, under Self Assessment, jointly owned property constitutes partnership income. Where a partnership exists, the profits or losses arising from let property should be included in the partnership return which may subsequently be subject to enquiry.

SELF ASSESSMENT:
CLAIMS AND PAYE CODING
PAY AS YOU EARN (PAYE)

PURPOSE OF ARTICLE

A code number for any tax year reflecting claims made in that year -- for example, to the married couple's allowance -- can simply apply for the next tax year without any claims being made formally for the next year. In other words, the claims for the previous year are simply 'rolled forward' to the next on the assumption that there has been no change in the taxpayer's circumstances. Or a code number can be set before the start of a tax year to reflect information given by the taxpayer about claims he or she is likely to make.

And, once the tax year has started, the taxpayer may make formal claims during the year (in-year claims) for the purpose of adjusting a PAYE code number.

This article explains the finality arrangements in relation to claims given effect in PAYE coding; that is, it sets out the time limits within which the Inland Revenue must open any enquiries. And in particular, where formal claims have not been made, gives those taxpayers who will not normally receive Self Assessment tax returns an assurance that once 22 months have elapsed after the end of the tax year, the Inland Revenue will not routinely ask them to complete tax returns, or otherwise make formal claims, solely to be able to enquire into amounts 'rolled forward' or put into a code number before the start of the tax year.

SELF ASSESSMENT CLAIMS -- GENERAL BACKGROUND

Chapter 6 of "Self Assessment: the legal framework" -- SAT 2 (1995) -- sets out the procedures which apply to all claims made in Self Assessment.

Wherever possible, claims are to be included in a return (or in an amendment to a return). The return as a whole, including claims, will be subject to a 'process now - check later' system. This means that unless the Inland Revenue open an enquiry into the return within the time limit set for enquiries (or into an amendment within the enquiry period for amendments) then all matters are final, subject to incomplete disclosure or fraudulent or negligent conduct.

But claims can be made otherwise than in a return, for example the in-year claims referred to in paragraph 2 above which are made before any return is issued. Such claims will come within the 'process now -- check later' system which applies to all claims in Self Assessment which are made outside a return. However taxpayers' code numbers will continue to be kept as accurate as possible. The Inland Revenue will not therefore change code numbers in respect of such in-year claims unless they are satisified relief is due; where they are not so satisfied they will open an enquiry.

In-year claims, or claims made in a return issued shortly after the end of a tax year, will all normally become final at the same time, at the first anniversary of the 31 January filing date after the end of a tax year (almost 22 months after the tax year) .

SELF ASSESSMENT: CLAIMS AND PAYE CODING

For this tax year (1996-97) and future years a taxpayer can, as now, make an in-year claim and ask for the PAYE code number operating for the year to be changed to reflect the claim. (Most commonly these are claims to the personal reliefs such as married couple's allowance). As explained in paragraph 7 above, such claims will normally become final (no longer the subject of a possible enquiry) at 22 months after the end of the tax year for the claim, whether or not a tax return is issued at the end of the year. (Where a return is issued after the end of the tax year, the in-year claim has to be repeated in the tax return to enable the correct self assessment to be made.)

Also as now, as set out in paragraph 1 above, a code number reflecting adjustments in relation to claims for one tax year may simply be carried forward to the next year. Or a code number for a tax year may be set before the start of the year on the basis of preliminary information about claims given by the taxpayer.

For 1996-97 onwards, those taxpayers who file returns by the normal date of 31 January after the end of the tax year will make claims for the year covered by the return. The self assessment will reflect those formal claims and automatically correct the position where the code number used for the year contained 'rolled forward' claims or adjustments put in before the start of the tax year. Taxpayers will get finality for the claims in the return at the normal finality date for the return. That is, all claims in the return will become final within 22 months of the end of the tax year if the Inland Revenue do not open an enquiry.

As now, the vast majority of Schedule E taxpayers will not get Self Assessment tax returns. They will get finality at the 22 month point for in-year claims. But, as the law stands, other claims carried forward automatically, or put in into the code number before the start of the tax year on the basis of preliminary information given by the taxpayer, do not become final at that point. The Inland Revenue is entitled to enquire into such claims at any time up to 5 years 10 months after the end of the tax year.

This position will continue to apply where a code number for one tax year is simply applied for the next year and the taxpayer has provided no information for the later year, but the Inland Revenue discovers at a later date that the adjustments for claims in the code number were not due or the amounts given were excessive. And this will also be the position if the Inland Revenue discover that any preliminary information given by the taxpayer was incomplete or misleading.

But, outside of cases of specific discovery, once 22 months after the tax year have elapsed, the Inland Revenue will not, as a matter of routine, issue tax returns or other forms simply to check claims details in code numbers for the tax year. Individual cases will only be looked at where information comes to hand which suggests that there has been incomplete disclosure or fraudulent or negligent conduct.

This assurance is intended to give taxpayers who do not normally get tax returns the same finality arrangements as those which apply to those who do get returns.

(No longer relevant)
EMPLOYEE SHARE SCHEMES:
IMPLICATIONS FOR SELF ASSESSMENT

This article explains:

  • reporting requirements for directors and employees;
  • arrangements for payment of tax due, and
  • payments on account,

in respect of income tax liability arising from shares or share options received by reason of employment.

EMPLOYEES WHO DO NOT ROUTINELY GET TAX RETURNS

Employees are required to notify the Inland Revenue of income or gains which have not been taxed in full, including any liability arising from shares or share options. The separate reporting of these details by employers does not relieve employees of this obligation. The notification has to be given within 6 months of the end of the tax year (that is by 5 October).

If the only thing to be notified is liability in respect of shares or share options and the total tax is under £1,000, employees can contact their tax office with details of the extra income and ask for their PAYE code to be adjusted to collect the tax. As the tax will then be paid through PAYE there is normally no need for the employee to obtain and fill in a tax return.

Where the extra tax due is £1,000 or more, however, the employees will normally have to obtain and fill in a tax return and pay the tax directly by 31 January after the tax year. The new SA return includes special pages for share schemes and share related benefits and the employee should ask the Inland Revenue to include the share schemes pages with the return.

The share scheme pages explain how taxable income is to be calculated and give examples and guidance. An employee who completes a return and self assesses for any year may be liable to make payments on account for the next year. Payments on account are dealt with later in this article.

EMPLOYEES AND DIRECTORS WHO DO RECEIVE TAX RETURNS

Payment of Tax Due

Where a return has been filled in and a self assessment made any extra income tax due is payable by 31 January after the tax year concerned. A self assessment for any year determines the level of payments on account due for the next year.

Tax Due Under £1,000

Even where a return is completed it will be possible for tax bills due at 31 January after the tax year of under £1,000 to be collected through PAYE by a coding adjustment. Coding out can be requested where the tax bill due at 31 January is under £1,000 and the return is received by 30 September. (It may be possible to have coding out even where the 30 September deadline is missed, but taxpayers wanting coding out should file returns as soon as possible.) Coding out of any underpayment will reduce the amount of any payment on account due for the next year.

Payments on Account

Where the payments on account calculation, after taking into account any amount coded out, shows a figure of less than £500, then no payments on account will be due for the following year. Even where the calculation shows £500 or more, no payments on account will be due if in fact more than 80% of the tax due for the year was paid by deduction at source. Where neither of these exceptions apply payments on account are due.

Share option gains and other share related charges taxable under Schedule E will not be taken into account in computing payments on account for 1996-97 due in January and July 1997.

But for 1997-98 onwards, where a return has been filled in and a self assessment made, income tax due on the exercise of share options, or the receipt of other share related benefits in any year, will increase the relevant amount in the payment on account calculation for the next year. This can therefore mean that payments on account will be required solely because of share option exercises or other share related benefits. The first payment on account is due by 31 January in the year of assessment.

Where the taxable income only arises for one year the taxpayer may need to claim to eliminate the payment on account for the following year using form SA303. ( See the following article in this Bulletin on Payments on Account.) The taxpayer can claim to reduce or eliminate the payments on account, including that due by 31 January, to avoid overpaying tax. If it subsequently becomes apparent that payments on account were in fact due the taxpayer can make payments to stop any interest running where a payment on account due date has been passed.

GUIDANCE

Income tax liability can arise where any directors or employees:

  • have been granted a share option or have exercised a share option in connection with their employment, but not under an Inland Revenue approved share option scheme,
  • have exercised a share option under an Inland Revenue approved scheme but the various conditions for tax relief were not satisfied,
  • have received something for giving up, or for not exercising, a share option,
  • have acquired shares in connection with their employment ( but not under an Inland Revenue approved profit sharing scheme),
  • have acquired shares by reason of their employment and subsequently:
    • received 'special benefits' by virtue of those shares,
    • restrictions have been removed from those shares,
    • ( for shares in certain subsidiaries) have sold them, or have held them for seven years.

Individuals do not need to complete the share schemes pages where they:

  • exercise an option under an approved savings-related share option scheme and the option is exercised more than three years from the date of grant,
  • receive shares under an approved profit sharing scheme. ( If a taxable amount arises they will be taxed under PAYE, any adjustments for higher rate tax being made by including the P60 figures in the employment pages of the tax return.)

Further guidance on income tax liabilities arising from shares and share options can be found in the following Inland Revenue leaflets and booklets:

IR95 Approved Profit Sharing Schemes: an outline for employees,

IR97 Approved Save As You Earn share option schemes: an outline for employees,

IR101 Approved company share option plans: an outline for employees,

IR16 Share acquisitions by directors and employees: explanatory notes, and

IR17 Share acquisitions by directors and employees: an outline for employees.

(Article deleted since index 2002)

SELF ASSESSMENT:
PAYMENTS ON ACCOUNT

PURPOSE OF ARTICLE

In November and December 1996 the Inland Revenue will be sending out notifications to around 1.9 million people that they will need to make payments on account (POAs) of income tax (and Class 4 National Insurance Contributions (NICs)) on 31 January 1997 and 31 July 1997 in respect of tax year 1996-97. The taxpayers affected -- mainly the self employed -- will be told what to pay and how to pay it, and also how to claim to reduce their payments on account if this is appropriate. They will also get an explanatory leaflet (SA 351)which is reproduced on pages 354 & 355.

The Agent Information Pack issued last month announced that from the end of October the Inland Revenue would be offering a new round of Tax Return Workshops. The workshops will cover POAs, and give examples of how they are calculated. And the information pack also contained a draft of the leaflet SA 351 referred to above and a draft of a claim form to reduce POAs (SA 303).

So this is an opportune time to cover the issue of POAs generally and to mention the special features of 1996-97 POAs.

PAYMENTS ON ACCOUNT: GENERAL

In Self Assessment, income tax (and Class 4 NICs) and capital gains tax have to be paid according to a fixed set of dates. For each tax year POAs of income tax (and NICs) have to be paid on 31 January in the tax year and 31 July after the tax year. A final balancing payment of any residual income tax (and NICs) due, and any capital gains tax, has to be paid by 31 January following, which is also the normal filing date for the tax return.

POAs will be due on 31 January in the tax year and 31 July after the tax year. Each POA will be equal to half the previous year's income tax (and NICs) liability (after taking into account tax deducted at source and tax credits).

However, not all of those who will be sent Self Assessment returns for any year will have to make payments on account. This is because under Regulations laid on 26 June 1996 (the Income Tax (Payments on Account) Regulations 1996 (Statutory Instrument No 1654 1996)), taxpayers will not need to make POAs if they satisfy at least one of two tests.

Under the Regulations taxpayers will not need to make POAs if:

a. their income tax (and NICs) liability for the preceding year -- net of tax deducted at source or tax credits on dividends -- is less than £500 in total, or

b. more than 80% of their income tax (and NIC) liability of the preceding year was met by deduction of tax at source or from tax credits on dividends.

The most common ways of paying tax by deduction are through Pay As You Earn (PAYE), the sub-contractors' deduction scheme, and tax paid on interest received.

These tests mean that most employees and pensioners who get returns (and
others who receive the bulk of their income under deduction of tax or who have relatively small outstanding tax liabilities) will not have to make payments on account. Instead such taxpayers will simply have to make one balancing payment after the end of the tax year (or will have the balancing payment collected through PAYE).

WHO CALCULATES PAYMENTS ON ACCOUNT?

Tax returns for any year will normally be issued in April after the end of the tax year. Those who wish the Inland Revenue to calculate their liability for the year just ended should file their returns by 30 September after the tax year. As well as calculating the balancing payment for the year just ended, the Revenue will also calculate any POAs due for the following (current) year. The taxpayer will be advised in good time of the amounts due for the balancing payment on 31 January and the first payment on account for the current year which is also due on that date.

Where returns issued at the normal time are filed after 30 September for Revenue calculation, the Inland Revenue will still calculate the balancing payment and POAs, but if the Revenue cannot notify taxpayers of amounts due by 31 January interest and surcharge (interest only for POAs) will apply as normal in respect of any late payment of the balancing payment or POAs.

Where taxpayers choose to self calculate for the tax year just ended they will also have to calculate their POAs for the current year. The Tax Calculation Booklet which will be issued with the tax return will contain appropriate guidance.

CLAIMS TO REDUCE POAs

POAs are calculated by reference to the tax liability for the preceding year. But taxpayers may consider that because of a change in their circumstances the calculation may overstate their liability for the year for which the POAs are being made. In these circumstances taxpayers can claim to reduce or cancel POAs. (The Inland Revenue cannot reject such claims but there is a penalty provision to prevent gross or persistent abuse.)

INLAND REVENUE LEAFLET SA 351:
YOUR STATEMENT OF ACCOUNT -- PAYMENTS ON ACCOUNT
Leaflet SA 351

Leaflet SA 351

If a claim to reduce POAs subsequently proves to be excessive then interest will arise on the difference between the amounts actually paid and the amounts that should have been paid.

WHERE TO FIND FURTHER INFORMATION

Payments on account are covered in detail in the Inland Revenue Booklet SAT2 (1995) -- Self Assessment: The Legal Framework -- at paragraphs 3.23 to 3.54. Interest charges on payments on account are covered at paragraphs 3.65 to 3.78.

SPECIAL ARRANGEMENTS FOR 1996-97

1996-97 is the first year of Self Assessment and special arrangements apply.

First: POAs for 1996-97 will be based on certain assessments made by the Inland Revenue for 1995-96, rather than on a self assessment as will be the case in future years.

The 1996-97 payments on account will be based on the following income from 1995-96:

  • profits of businesses or professions;
  • rents or investment income received gross;
  • certain pensions and employment earnings usually taxed in 4 instalments.

The liabilities which are ignored are most employment and pension income and investment income from shares or which is paid after deduction of tax at source. Tax Bulletin Issue 22 (April 1996 pages 298-299) sets out the special arrangements for carry back of Personal Pension Contributions made in 1996-97 and how they affected 1996-97 payments on account.

Second: for 1996-97 the Inland Revenue will calculate whether POAs are due and notify taxpayers affected in November and December 1996, in good time for 31 January 1997. The explanatory leaflet which is reproduced with this article will also be sent. This shows how POAs for 1996-97 are calculated and how they are split between 31 January 1997 and 31 July 1997. The leaflet also explains how to claim to reduce or cancel 1996-97 POAs

In calculating whether or not POAs are due for 1996-97, the Inland Revenue will take into account only the £500 test. So where the calculation shows £500 or more, payments on account will be due. The "more than 80%" test is not appropriate for 1996-97 because the calculation is not based upon total income. Accordingly the Regulations bring it into force for 1997-98 onwards but not for 1996-97.

WHERE TO FIND FURTHER INFORMATION ABOUT 1996-97 PAYMENTS ON ACCOUNT

Payments on account for 1996-97 are covered in the Inland Revenue Booklet SAT2 (1995) -- Self Assessment: The Legal Framework -- at paragraphs 3.115 to 3.125.

(No longer relevant)
PAYMENTS ON ACCOUNT --
FURNISHED HOLIDAY LETTINGS

We would like to clarify the position regarding payments on account in furnished lettings cases.

In all furnished holiday lettings cases, where the tax was payable in two instalments in 1995-96, the tax on such profits will continue to be payable in two instalments under the special payments on account rules for 1996-97.

interpretations

(Superceded by CT12359 & CFM5210 onwards)

INCIDENTAL COSTS OF CORPORATE
BORROWING -- SECTION 84 FA 1996

An article explaining the timing of tax deductions for the incidental costs of business borrowing allowable under Section 77 Income and Corporation Taxes Act (ICTA) was contained in Tax Bulletin Issue 22 (April 1996 at pages 306-307). For companies, Section 84 Finance Act 1996 has replaced Section 77 ICTA 1988 as from 1 April 1996. This article explains the operation of the new rules.

The new provisions on government and corporate finance contained in Chapter II, Part IV of FA 1996 bring into account profits and gains on 'loan relationships' (Section 80 FA 1996). A loan relationship exists wherever a company stands as a debtor or creditor in respect of a money debt and that debt arises from a transaction for the lending of money (Section 81 FA 1996).

The debits and credits which can be brought into account in respect of a loan relationship include all charges or expenses incurred by a company under or for the purposes of its loan relationships or related transactions - Section 84(1)(b) FA 1996. Related transactions are any acquisitions or disposal of any of the rights or liabilities of a loan relationship. The term includes part disposals but not the original setting up of the loan relationship.

Section 84(3) requires that charges and expenses must be incurred directly:

  • in bringing the loan relationship into existence;
  • in entering into or giving effect to related transactions;
  • in making payments under the loan relationships or in pursuance of the related transactions; or
  • in pursuing payments due under the loan relationship or in accordance with a related transaction.

Expenditure may be incurred without a company finally entering into the loan relationship. In such cases abortive expenditure of the types shown above will still be allowable under Section 84(4) FA 1996.

Following the introduction of the new legislation, we have received a number of enquiries about some specific types of incidental expenditure.

  • We have confirmed that Section 84 allows the costs directly incurred in varying the terms of a loan relationship to be taken into account as a debit.
  • Guarantee fees incurred in connection with loan relationships are not considered to be allowable under Section 84 FA 1996 as they do not relate directly to a loan relationship or related transaction. However guarantee payments might be allowable as trading deductions where, when made, the payment was wholly and exclusively for the purposes of the trade and was not a payment in respect of capital.

Where the company has entered into the loan relationship for the purposes of its trade, any debits in respect of allowable incidental costs are taken into account in calculating the profits of the trade. Otherwise the costs will represent a debit in calculating either the Case III profit or the non-trading deficit relievable under Section 83 FA 1996.

On the issue of the timing of a deduction, the April 1996 article noted the emphasis put on accountancy treatment in recent tax cases such as Threlfall v Jones (66TC77). The loan relationships legislation operates on the basis of authorised accounting methods (Section 85 FA 1996). Under an accruals basis of accounting the appropriate treatment of incidental costs would often be to accrue them over the life of the loan relationship. Section 85(3) FA 1996 specifically requires payments to be allocated to the period to which they relate and, where they relate to two or more periods, to be apportioned on a just and reasonable basis. This treatment would also be in line with the guidance contained in Financial Reporting Standard No 4 (Capital Instruments) on issue costs.

However, where incidental costs have been allowed in full -- perhaps because they were allowed on a paid basis before 1 April 1996 -- there is provision in the loan relationship legislation to ensure that they cannot be allowed again as they accrue (paragraph 14 Schedule 15 FA 1996).

[Section 77 ICTA 1988 and Sections 84, 85 and Schedule 15 FA 1996]

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

DEDUCTIONS FOR INTEREST PAYABLE --
SECTION 337A ICTA

Section 337A Income and Corporation Taxes Act (ICTA) was introduced by paragraph 15 Schedule 24 Finance Act (FA) 1996 as part of new provisions relating to corporate debt. Section 337A states that, in computing a company's income, no deduction is available for interest except in accordance with the new loan relationship rules in Chapter II of Part IV FA 1996. We have been asked whether this precludes a deduction for interest payable by a company within the charge to income tax rather than corporation tax. Such companies are comparatively rare, but for example, non-UK resident companies, with only UK property income, would be chargeable to income tax rather than corporation tax.

It is our view that Section 337A can only apply for the purposes of corporation tax and therefore does not preclude a deduction for interest for companies within the income tax provisions.

[Section 337A ICTA 1988, Schedule 24, and Chapter II part IV FA 1996]

HONG KONG -- FROM 1 JULY 1997

We have been asked to outline some of the tax consequences which will apply to Hong Kong after the transfer of sovereignty on 30 June 1997.

APPLICATION OF UK/CHINA DOUBLE TAXATION AGREEMENT

The existing Double Taxation Agreement between the Government of the People's Republic of China and the Government of the United Kingdom, signed on 26 July 1984 will not apply to the Hong Kong Special Administrative Region which comes into existence from 1 July 1997.

SECTION 278 ICTA 1988 RELIEF

Present Hong Kong residents who are British Dependent Territories citizens by virtue of connection with Hong Kong will lose that status from 1 July 1997. Along with the loss of status they will also lose their entitlement to claim UK personal allowances and reliefs under Section 278 Income and Corporation Taxes Act (ICTA) 1988.

By that date, however, it is expected that most Hong Kong British Dependent Territories citizens will have registered as British Nationals (Overseas) and will therefore continue to be Commonwealth citizens who may continue to claim under Section 278 ICTA 1988. Those who have decided not to register will either become British Overseas citizens (also a form of Commonwealth citizenship) or, if a citizen of another state, will cease to hold any form of British nationality. Of this last group, only persons who are citizens of other Commonwealth countries (e.g. India) and/or European Economic Area nationals will continue to benefit from the reliefs provided under Section 278 ICTA 1988.

[Section 278 ICTA 1988]

miscellaneous

EMPLOYEES AND DOUBLE TAXATION AGREEMENTS

Tax Bulletin Issue 17 (June 1995 at page 220-221) announced a change of approach by the Inland Revenue when considering claims by employees under the United Kingdom's double taxation agreements. The article explained that claims to exemption from UK tax would not be admitted where the cost of an employee's remuneration was borne by a UK company which could be regarded as his or her employer.

In July this year, in response to a question during a Standing Committee debate on the proposed UK/Argentina double taxation agreement, the Financial Secretary to the Treasury provided useful clarification of the circumstances in which a UK company might be regarded as an employer in the absence of a formal contract of employment between the employee and the UK company. The Minister indicated that the Inland Revenue would not consider that a short term business visitor was sufficiently integrated into the business of a UK company for it to be regarded as the employer where the employee concerned is in the UK for less than 60 days in a tax year and that period does not form part of a more substantial period when the taxpayer is present in the UK.

! This Article Is No Longer Current (Deleted Index 2002)

CREDIT RELIEF FOR FOREIGN TAXES

The following foreign taxes have been reconsidered by the Inland Revenue in accordance with Statement of Practice 7/91 and are now considered to be admissible taxes for the purposes of unilateral tax credit relief.

Algeria
Tax on income of foreign construction companies (impôt sur le revenu des enterprises étrangères de construction) (IREEC)

Tax on profits of non-commercial professions (impôt sur les bénéfices des professions non-commerciales) where charged on non-Algerian taxpayers having no permanent establishment in Algeria.

Argentina
Income tax (impuesto a las ganancias) on the gross receipts of a trade, profession or vocation.

Brazil
Withholding tax imposed on the gross receipts of a business.

Peru
Income tax (impuesto sobre la renta) imposed on the gross receipts, or a percentage of the gross receipts, of a business.

The Double Taxation Relief manual for Inspectors is being amended to reflect the changes of view on these taxes. The manual is available for inspection at Tax Enquiry Centres and is published by Tolleys. The Inland Revenue booklet IR146 (Admissible and Inadmissible Taxes) has been withdrawn.

PENSION SCHEMES OFFICE:
SYNOPSIS OF UPDATES

The Pension Schemes Office (PSO) has recently issued four further Updates to all practitioners on the PSO Mailing List. Update No. 18 was issued on 11 July 1996 and Updates No. 19, 20 and 21, on 22 August 1996.

PSO Update No. 18 announces new Regulations (Statutory Instrument (SI) 1996 No 1582) which effectively remove the statutory deadline of 27 December 1996, imposed in earlier Regulations (SI 1993 No 3016) by which pension schemes approved before 27 December 1993 were required to amend their rules to deal with surplus funds arising from additional voluntary contributions. Schemes are nonetheless expected to comply with the 1993 Regulations and an industry-wide Code of Practice until their rules are amended.

PSO Update No. 19 explains the change to the Taxes Acts which enables occupational and personal pension schemes to purchase annuities and term assurance from insurance companies in European Community countries.

PSO Update No. 20 is concerned with two topics:

Calculation of final remuneration

The glossary definition of final remuneration as set out in Appendix 1 to the Practice Notes (IR12 1991) has been amended to avoid a difficulty which can occur when benefits are calculated and provisionally paid by reference to remuneration upon which tax liability has not been finally determined. If the lump sum paid turns out to have exceeded the maximum approvable, then the excess will be chargeable to tax. The new wording avoids this difficulty by permitting a supplementary payment of both pension and lump sum when the final remuneration has been re-calculated.

Continuous service for controlling directors

The Update sets out in detail the PSO's requirements in relation to controlling directors in take-over, merger or reconstruction situations in order for service with two employers to be treated as a continuous unbroken period for pension purposes.

A major change from the date of the Update is that the prior approval of the PSO must also be sought for continuous service for a controlling director where that person moves from one employer to another and the two employers are associated by virtue of common control. Paragraph 7.11 of the Practice Notes (IR12 1991) has been amended to reflect the change.

PSO Update No. 21 provides information about the tax treatment of payments made to compensate people who suffered material loss as a result of bad investment advice, which led them to forego occupational pension scheme membership in favour of retirement annuity contracts, personal pension schemes or buy-out (Section 32) contracts.

Copies of PSO Updates can be obtained by writing to:

PSO Supplies Section
Yorke House
PO Box 62
Castle Meadow Road
Nottingham
NG2 1BG

or by telephoning 0115 974 1670.

SUBSCRIPTION

1996 has been a particularly successful year for Tax Bulletin, with an ever increasing number of new subscribers. Our aim is to maintain the value for money the annual subscription represents, whilst covering costs and we are pleased to announce that the subscription for 1997 will remain at £20. We hope that readers will continue to find our publication, informative, helpful and good value for money.

A renewal application is enclosed with this issue.

INLAND REVENUE STATEMENTS OF PRACTICE AND
EXTRA-STATUTORY CONCESSIONS ISSUED BETWEEN
1 AUGUST 1996 AND 31 SEPTEMBER 1996

EXTRA STATUTORY CONCESSIONS.

Number     Title                                Date of Issue
C28        Connection within Section 87 FA 1996        08/08/96

(Correction -- please note that the following ESC published in Tax Bulletin 24 should have read B49 and not D49)

B49        Capital Allowances Act 1990:
Grants repaid.                              19/06/96

STATEMENT OF PRACTICE

There have been no statements of practice issued in this period.

You can get copies of SPs and ESCs from Christine Jordan at the Public Enquiry Room, Somerset House. Telephone 071-438 7772.

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 1996 is £20. If you would like to subscribe to Tax Bulletin please send your name and address together with your cheque to Inland Revenue, Finance Division, Barrington Road, Worthing, West Sussex BN12 4XH. Cheques should be crossed and made payable to "Inland Revenue".

If you would like further information regarding Tax Bulletin please contact Ms Nahid Shariff, Room 435, 22 Kingsway, London WC2B 6NR. Telephone: 020 7438 7842.

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, Room 435, 22 Kingsway, London WC2B 6NR.

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