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Explanatory Notes to Income Tax (Earnings And Pensions) Act 2003
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These notes refer to the Income Tax (Earnings and Pensions) Act 2003 (c.1) which received Royal Assent on 6th March 2003 INCOME TAX (EARNINGS AND PENSIONS) ACT 2003EXPLANATORY NOTES1. These explanatory notes relate to the Income Tax (Earnings and Pensions) Act 2003 which received Royal Assent on 6 March 2003. They have been prepared by the Tax Law Rewrite project at the Inland Revenue in order to assist readers of the Act and to help inform debate on it. They do not form part of the Act. 2. The notes need to be read in conjunction with the Act. They are not, and are not meant to be, a comprehensive description of its contents. So if a section or part of a section does not seem to require explanation or comment, none is given. SUMMARY 3. The main purpose of the Income Tax (Earnings and Pensions) Act 2003 is to rewrite tax legislation relating to income from employment, pensions and social security so as to make it clearer and easier to use. 4. The Act also makes some minor changes to the legislation. These are within the remit given to the Tax Law Rewrite project and the Parliamentary process for the Act. BACKGROUND The Tax Law Rewrite Project 5. In December 1995 the Inland Revenue presented a report to Parliament on the scope for simplifying the UK tax system (The Path to Tax Simplification). The main recommendation was that UK direct tax legislation should be rewritten in clearer, simpler language. 6. This recommendation was warmly welcomed, both in Parliament and in the tax community. After further work on important practical issues and a period of preliminary consultation, the then Chancellor of the Exchequer (the Rt Hon Kenneth Clarke MP, QC) announced in his November 1996 Budget statement that the Inland Revenue would propose detailed arrangements for a major project to rewrite direct tax legislation in plainer language. 7. The project team was given the task of rewriting almost all of the United Kingdom's existing primary direct tax legislation. The aim is that the rewritten tax law should use simpler language and structure than legislation that it replaces. The members of the project are from different backgrounds, including Inland Revenue employees, private sector tax professionals and parliamentary counsel including (as head of the drafting team) a senior member of the Office of the Parliamentary Counsel. Steering Committee 8. The work of the project is overseen by a Steering Committee, chaired by Lord Howe of Aberavon CH, QC. The membership of the Steering Committee as at February 2003 is:
Consultative Committee 9. The work is also reviewed by a Consultative Committee, representing the accountancy and legal professions and the interests of taxpayers. Its members as at February 2003 were:
Consultation 10. The work produced by the project has also been subject to public consultation. This has allowed all interested parties an opportunity to comment on draft clauses. This consultation has taken the form of a series of Exposure Drafts which publish clauses in draft. The relevant ones for this Act are numbers 6, 11 and 12. They were published in May 1999, January 2001 and December 2001 respectively. A draft Bill was published for further consultation in July 2002. Those who responded to one or more of those documents include:
Note: this table excludes those who asked that their responses be treated in confidence. A brief history of the taxation of employment income 11. Income tax was introduced in 1799; Schedules A to E first appeared in 1803; and the income tax legislation of the Napoleonic period was given its final shape in an Act of 1806. That Act was also drafted in terms of the five Schedules A to E. Schedule E related to every public office or employment of profit; and the general rule was that income tax was to be "detained and stopped" at the public office. The Napoleonic wars ended in 1815, and income tax was then abolished. 12. Income tax was reintroduced in 1842, in an Act agreed to have been modelled on the 1806 Act, and the five Schedules accordingly reappeared. Income tax has been in continuous existence ever since. 13. Some provisions in the income tax legislation relating to Schedule E, therefore, now have a considerable history. One of these is the central provision concerning the deductibility of expenditure, with its requirement that the expenditure should be expended "wholly, exclusively and necessarily" in the performance of the duties of the employment (see section 336 in Part 5 of this Act). For well over a century this provision also included a reference to keeping and maintaining a horse in order to enable the employee to perform the duties of the employment; and only in 1998 was this reference removed. 14. In the years following 1842 the charge to income tax under Schedule E applied only if the office or employment held or exercised was of a public nature. If it was not, income tax was charged under Schedule D (the residual Schedule). There were fewer public offices than some had thought: in Great Western Railway Co - v - Bater (1922) 8 TC 231, [1922] 2 AC 1, the House of Lords, undoing the accepted practice of decades, placed a railway clerk in Schedule D and not in Schedule E. But the charge to income tax under Schedule E was widened by section 18 of FA 1922, which provided that profits or gains arising from employments chargeable under Schedule D, "other than the profits or gains chargeable under Case V of Schedule D", should be transferred to Schedule E. The profits or gains from some employments accordingly continued to be chargeable under Schedule D Case V; but that possibility disappeared when section 10 of FA 1956 provided that all income from employments was to be chargeable under Schedule E, and divided Schedule E into three Cases. 15. The twentieth century saw major increases in the revenue obtained from income tax, in the rates of that tax, and in the importance of income tax to central finance. It became a matter of major operational importance, therefore, (and not least during the Second World War) that employees should account for income tax on their earnings. The result was the Pay As You Earn (PAYE) system. The developments leading to the introduction of that system are discussed in greater detail in the introductory explanatory notes for Part 11 of this Act; and that Part deals with the primary legislation relating to the PAYE system. 16. Since the Second World War both earnings and income tax rates have been very high by historical standards; and national insurance contributions may well make further demands on both employer and employee. 17. Against this background, it might well be worthwhile for employers and employees to try to arrange for payments and benefits to be received in a way that minimises income tax - and for the Inland Revenue to contest those arrangements. There are, accordingly, numerous cases in which the Inland Revenue has alleged, and the taxpayer has denied, that the receipt of a particular advantage was within the ambit of the Income Tax Acts. Hochstrasser - v - Mayes (1959) 38 TC 673, [1960] AC 376 is one example that may represent others. And against this same background it was also to be expected that the legislation relating to income tax charged under Schedule E would become more extensive and more complicated. 18. One legislative consequence related to the subject described in Part 3 of this Act as "the benefits code" - and dealt with in that Part. Legislation on this subject featured in FA 1948, and has been extended in other Finance Acts since - not least in FA 1976. 19. A second legislative consequence was that the charge to income tax under Schedule E was extended to receipts with characteristics specified in the legislation in question. The first, and very important, example was the legislation relating to payments and benefits received on the termination of an employment, originally enacted in FA 1960. In this Act these provisions may be found in Chapter 3 of Part 6. The provisions of that Part do not deal with earnings from an employment, charged to income tax under Schedule E by virtue of paragraph 1 of section 19(1) of ICTA 1988, but with other payments and benefits specifically charged to income tax under Schedule E by virtue of paragraph 5 of section 19(1). In this Act this income is referred to as "specific employment income", and it is distinguished, very carefully, from "general earnings" (see section 6(1) of this Act). 20. A third legislative consequence concerned share-related income, dealt with in Part 7 of this Act. Companies might well wish to reward employees by allowing them to acquire shares on advantageous terms - including arrangements designed to minimise income tax. The income tax legislation on this matter accordingly consists in part of legislation designed to counteract schemes that have been in existence at various times, and in part of legislation designed to promote share schemes with meritorious characteristics. These matters are discussed in greater detail in the introductory explanatory notes for Part 7 of this Act. That Part is extensive. It occupies 138 sections and four Schedules with a total of 245 paragraphs (and there is further material in Schedule 6 dealing with consequential amendments). Some of this material is very recent: of the provisions just mentioned 43 of the sections and 159 of the paragraphs in the Schedules derive from legislation on topics first dealt with in FA 2000. Employment income, pensions and social security 21. As mentioned above, employment income is taxed under Schedule E in ICTA. During the course of the work leading up to the production of this Act, it became apparent that it would be more sensible to rewrite the whole of Schedule E, rather than just picking out those parts relevant to employment income. 22. The grouping of employment income, pensions and social security income represents income within Schedule E as set out in section 19 of ICTA. Rewriting the charging provisions for these categories of income makes possible a repeal of Schedule E as a whole. 23. In order to have all the charging provisions relating to pensions in one place, Part 9 of the Act also includes some pensions within Schedule D as set out in section 18 of ICTA. THE ACT 24. The Act has 725 sections and eight Schedules. 25. The sections are arranged as follows:
26. The Schedules are:
COMMENTARY ON SECTIONS 27. At the end of the commentary there is more detailed supporting material in three annexes. 28. Annex 1 contains details of the minor changes in the law made by the Act. 29. Annex 2 gives notes on technical points of interpretation of the sections. These notes concentrate on points where it may not be immediately apparent that the Act preserves the effect of the existing law. 30. Annex 3 contains a table of destinations for the Extra-Statutory Concessions to which this Act gives statutory effect.
Glossary 31. The commentary uses a number of abbreviations. They are listed below.
32. There is a list of abbreviations used in the Act at the start of Schedule 1 to this Act. Part 1: Overview Section 1: Overview of contents of this Act 33. This section summarises the charges to tax and other matters covered in the Act. It also provides, in subsection (2), the link to the general charge to income tax in section 1(1) of ICTA. It is new. Section 2: Abbreviations and defined expressions 34. This is another new section. It provides information on where to find lists of the various abbreviations and defined expressions used in this Act. Part 2: Employment income: charge to tax Chapter 1: Introduction Section 3: Structure of employment income Parts 35. This section sets out what is in Parts 2 to 7 of this Act and provides "the employment income Parts" as a collective label for them. It is new. Section 4: "Employment" for the purposes of the employment income Parts 36. This section is new. It casts some light on what is meant by "employment". It is not an attempt to delineate the boundary between employment and self-employment. That boundary depends on fact and the degree to which a number of indicators exist. This section is simply intended to confirm that employments that are clearly nowhere near that boundary are squarely within this Act, by providing a non-exhaustive definition. 37. This change of approach is explained in detail in Note 1 in Annex 2. Section 5: Application to offices and office-holders 38. This section sets out that the employment income Parts apply to offices and office-holders in the same way as they apply to employments and employees. 39. Subsection (3) provides a non-exhaustive definition of the term "office". It is based on guidelines derived from case law. This change in approach is explained in detail in Note 1 in Annex 2. Chapter 2: Tax on employment income Section 6: Nature of charge to tax on employment income 40. This section provides in subsection (1) that the charge to tax on employment income under Part 2 is split into a charge to tax on "general earnings" and "specific employment income". The labels "employment income", "general earnings" and "specific employment income" are new, and are explained in section 7. 41. Subsection (2) provides a signpost to section 9 which sets out how to work out the amount of general earnings or specific employment income that is charged to tax in a particular tax year. 42. Subsection (3) is a pointer to Chapters 4 and 5 which derive from the Cases of Schedule E. Those Chapters set out the rules relating to residence, domicile etc that apply to general earnings. Those Chapters have no application to "specific employment income". 43. Subsection (4) provides a signpost to section 13 which in turn makes clear who is liable for tax under this Part. 44. Subsections (1) to (4) are new, although subsection (1) derives in part from paragraphs 1 and 5 of section 19(1) of ICTA. 45. Subsection (5) provides the one exception to the basic rule that employment income is charged to tax on income from employments. This Act replaces all charges to tax under Schedule E, but there is one category of income from employment that is not charged to tax under Schedule E. The employment duties of specified types of divers and diving supervisors are treated as if they constitute a trade and are charged to tax under Schedule D. Subsection (5) of this section reflects the effect of section 314(1) of ICTA in removing the income from employment of those divers and diving instructors from the scope of Schedule E. Section 7: Meaning of "employment income", "general earnings" and "specific employment income" 46. This section sets out the definitions of these terms introduced in the preceding section. It is new. See Notes 2 and 3 in Annex 2. 47. Those Notes explain in full why it is necessary to distinguish between the two elements to the employment income charged in this Part. The first element is "general earnings", which relate to "emoluments" brought into charge by paragraph 1 of section 19(1) of ICTA. The basis of assessment for "general earnings" depends on the residence, ordinary residence and domicile status of the employee. The second element, "specific employment income", relates to the free-standing charges under Schedule E, chargeable under paragraph 5 of section 19(1) of ICTA. The basis of assessment for "specific employment income" is blind to issues of residence, ordinary residence and domicile. Section 8: Meaning of "exempt income" 48. This section provides the definition of exempt income for the purposes of the employment income Parts. It is new. Chapter 3: Operation of tax charge Section 9: Amount of employment income charged to tax 49. This is a new section that explains what amounts are charged to tax for each stream of employment income. Subsection (2) sets out that for earnings, the amount charged to tax is "net taxable earnings" - this is another new label. It describes the amount of income from the employment that has been allocated to a particular tax year by reference to the timing rules as determined by the Cases of Schedule E in section 19(1) of ICTA (now contained in Chapters 4 and 5 of this Part), less any available deductions. 50. Subsection (3) explains where to find the mechanics of how to calculate net taxable earnings in the following provisions of Part 2. 51. Subsection (4) sets out that, for specific employment income, the amount charged to tax is "net taxable specific income" - this is another new label. It is the amount allocated to that year by the relevant provisions less any available deductions. 52. Subsection (5) explains where to find the mechanics of how to calculate net taxable specific income in the following provisions of this Chapter. 53. Subsection (6) makes it clear that tax may only be charged under this Chapter for a particular year on taxable earnings and taxable specific income. Paragraph (a) derives from the closing words of paragraph 1 of section 19(1) of ICTA. Paragraph (b) is new. Section 10: Meaning of "taxable earnings" and "taxable specific income" 54. "Taxable earnings" and "taxable specific income" are two more new labels to help identify income at the various stages from when it arises to when it becomes chargeable to tax in a particular tax year. This section explains each of those terms, setting out where to find the other provisions that set out particular rules for arriving at either "taxable earnings" or "taxable specific income". | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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