Introduction

1.These explanatory notes relate to the Income Tax Act 2007 (c.3) which received Royal Assent on 20 March 2007. They have been prepared by the Tax Law Rewrite project at HMRC in order to assist readers in understanding the Act. They do not form part of the Act and have not been endorsed by Parliament.

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.

3.The commentary on each section indicates the main origin or origins of the section. A full statement of the origins of each section is contained in the Act’s Table of Origins.

4.At the end of the commentary, there is supporting material in two annexes:

• Annex 1 contains details of the minor changes in the law made by the Act.

• Annex 2 contains lists of:

  • the extra-statutory concessions to which the Act gives effect;

  • the minor changes made by the Act which involve giving statutory effect to principles derived from case law; and

  • provisions not included in the Act on the grounds of redundancy.

Summary

5.The main purpose of the Income Tax Act 2007 is to rewrite the income tax legislation that has not so far been rewritten so as to make it clearer and easier to use.

6.The Act covers:

• the basic provisions about the charge to income tax, income tax rates, the calculation of income tax liability and personal reliefs;

• various specific reliefs, including relief for losses, the enterprise investment scheme, venture capital trusts, community investment tax relief, interest paid, gift aid and gifts of assets to charities;

• specific rules about settlements and trustees, manufactured payments and repos, accrued income profits, tax avoidance and deduction of tax at source; and

• general income tax definitions.

7.The Act does not generally change the meaning of the law when rewriting it. The minor changes which it does make are within the remit of the Tax Law Rewrite project and the Parliamentary process for the Act. In the main, such minor changes are intended to clarify existing provisions, make them consistent or bring the law into line with established practice.

Background

The Tax Law Rewrite project

8.In December 1995 the Inland Revenue presented a report to Parliament on the scope for simplifying the United Kingdom tax system (The Path to Tax Simplification). The main recommendation was that United Kingdom direct tax legislation should be rewritten in clearer, simpler language.

9.This recommendation was warmly welcomed, both in Parliament and in the tax community. In his November 1996 Budget speech the then Chancellor of the Exchequer (the Rt Hon Kenneth Clarke QC MP) announced that the Inland Revenue would propose detailed arrangements for a major project to rewrite direct tax legislation in plainer language.

10.The project team was given the task of rewriting the United Kingdom’s existing primary direct tax legislation. The aim is that the rewritten legislation should use simpler language and structure than previous tax legislation. The members of the project are drawn from different backgrounds. They include HMRC employees, private sector tax professionals and parliamentary counsel including (as head of the drafting team) a senior member of the Parliamentary Counsel Office.

Steering Committee

11.The work of the project is overseen by a Steering Committee, chaired by the Rt Hon the Lord Newton of Braintree OBE DL (who took over from the Rt Hon the Lord Howe of Aberavon CH QC at the beginning of 2006). The membership of the Steering Committee as at 31 October 2006 was:

The Rt Hon the Lord Newton of Braintree OBE DL (Chairman)

Dr John Avery Jones CBE

Adam Broke

Baroness Cohen of Pimlico

Ian Dewar

Mike Eland CB

The Rt Hon Michael Jack MP

Eric Joyce MP

District Judge Rachel Karp

David Swaine

Professor John Tiley CBE

Consultative Committee

12.The work is also reviewed by a Consultative Committee, representing the accountancy and legal professions and the interests of taxpayers. The membership of the Consultative Committee as at 31 October 2006 was:

Consultation

13.The work produced by the project has been subject to public consultation. This has allowed all interested parties an opportunity to comment on draft clauses.

14.This consultation took the form of a series of papers which publish clauses in draft. There were 30 of these, published between April 2004 and October 2005. A draft Bill was published for consultation in February 2006. And two further papers on provisions in FA 2006 were published in July 2006. All these documents were made available on the Tax Law Rewrite website.

15.In addition to formal consultation, the project presents its papers to the Committees to inform the Committees and seek their views on particular issues. The project has also consulted on an informal basis with specialists in particular subject areas. For example, there have been regular meetings of the VCS (venture capital schemes) rewrite group during the development of the EIS and VCT Parts of the Act. This is a small group of practitioners (who represent a number of professional bodies), policy and technical specialists from HMRC and members of the project.

16.Those who responded to one or more of the papers, or to the draft Bill, include:

Anne Wilson

Anthony Davis

Association of Charitable Foundations

BDO Stoy Hayward LLP

Boodle Hatfield

British Bankers’ Association

Building Societies Association

Chartered Institute of Taxation

Charity Commission

Charity Law Association

Charles King-Farlow

Charles Pocock

Christine Harpin

City of Westminster & Holborn Law Society

Colin Campbell

Confederation of British Industry

David F Williams

Deloitte & Touche LLP

Department for Constitutional Affairs

Department of Finance and Personnel for Northern Ireland

Department for Social Development in Northern Ireland

Ernst & Young LLP

Euroclear

Francis Sandison

Freshfields Bruckhaus Deringer

George Harrison

Helen Billing

Horwath Clark Whitehill LLP

Investment Management Association

Institute of Chartered Accountants in England and Wales

Institute of Chartered Accountants of Scotland

James Kessler QC

John Avery Jones

John Clark

John Jeffrey-Cook

Ken Moody

KPMG LLP

Law Society of England and Wales

London Investment Banking Association

London Society of Chartered Accountants

Lovells

Low Incomes Tax Reform Group

Mark Whitehouse

Mazars LLP

Office of the Legislative Counsel, Northern Ireland

PricewaterhouseCoopers LLP

Sayer Vincent

Society of Trust and Estate Practitioners

Terry Hopes

Wedlake Bell

Wellcome Trust

Note: this list excludes those who asked that their responses be treated in confidence.

Income Tax Act 2007

17.The Act:

• applies for income tax, continuing the general approach of previous rewrite Acts of separating income tax and corporation tax legislation;

• contains the basic provisions of income tax, such as the charge to income tax, tax rates, how a person’s income tax liability is calculated, personal reliefs, and general definitions which apply for income tax purposes;

• deals with various specific reliefs, including reliefs for losses, the enterprise investment scheme, venture capital trusts, community investment tax relief, interest paid, gift aid and gifts of assets to charities;

• broadens the picture by filling in the rest of the income tax picture, in particular in relation to settlements and trustees, avoidance and deduction of tax at source; and

• will take the place of ICTA as the main Act about income tax, complemented by ITEPA and ITTOIA (which dealt with the charges to income tax on employment, pension, trading and other income).

18.The Act has 1035 sections and 4 Schedules.

19.The sections are arranged as follows:

Part 1: Overview

Part 2: Basic provisions

Part 3: Personal reliefs

Part 4: Loss relief

Part 5: Enterprise investment scheme

Part 6: Venture capital trusts

Part 7: Community investment tax relief

Part 8: Other reliefs

Part 9: Special rules about settlements and trustees

Part 10: Special rules about charitable trusts etc

Part 11: Manufactured payments and repos

Part 12: Accrued income profits

Part 13: Tax avoidance

Part 14: Income tax liability: miscellaneous rules

Part 15: Deduction of income tax at source

Part 16: Income Tax Acts definitions etc

Part 17: Definitions for purposes of Act and final provisions

20.The Schedules are:

Schedule 1: Minor and consequential amendments

Schedule 2: Transitionals and savings

Schedule 3: Repeals and revocations

Schedule 4: Index of defined expressions

21.Tables of Origins and Destinations have also been prepared. The Table of Destinations shows the destination not only of repealed provisions but of all provisions rewritten in the Act.

Glossary

22.The commentary uses a number of abbreviations. They are listed below.

CAA the Capital Allowances Act 2001

CAA 1990 the Capital Allowances Act 1990 (and similarly CAA 1968)

CRCA the Commissioners for Revenue and Customs Act 2005

ESC extra-statutory concession

HMRC Her Majesty’s Revenue and Customs

FA 1989 Finance Act 1989 (and similarly for other Finance Acts)

F(No 2)A Finance (No. 2) Act

FISMA the Financial Services and Markets Act 2000

ICTA the Income and Corporation Taxes Act 1988

ICTA 1970 the Income and Corporation Taxes Act 1970

IHTA the Inheritance Tax Act 1984

ITEPA the Income Tax (Earnings and Pensions) Act 2003

ITTOIA the Income Tax (Trading and Other Income) Act 2005

MOD manufactured overseas dividend

PAYE Pay As You Earn

R&D research and development

TCGA the Taxation of Chargeable Gains Act 1992

TMA the Taxes Management Act 1970

VAT value added tax

Commentary on Sections

Part 1: Overview

Section 1: Overview of Income Tax Acts

23.This section provides an overview of the location of the main legislation dealing with income tax. It is new.

Section 2: Overview of Act

24.This section provides an overview of the Act. It is new.

Part 2: Basic provisions

Overview

25.This Part contains basic provisions about the charge to income tax.

Chapter 1: Charges to income tax

Overview

26.This Chapter sets out the provisions of the Income Tax Acts where the main charges to income tax are to be found and contains basic rules about the annual nature of income tax.

Section 3: Overview of charges to income tax

27.This section is based on section 1(1) of ICTA.

28.Subsection (1) lists the principal provisions that contain charges to income tax, which are all in ITEPA and ITTOIA.

29.Subsection (2) makes it clear that there are also charges to income tax in other legislation. The main ones are shown, but the list is not exhaustive.

Section 4: Income tax an annual tax

30.This section is based on sections 1(2), 2(2) and 832(1) of ICTA.

31.Section 2(1) of ICTA, which provides for the due proportion of income tax to be charged for every fractional part of one pound, has not been rewritten as it is otiose.

Section 5: Income tax and companies

32.This section provides that income of companies that is liable to corporation tax is not charged to income tax. It is based on sections 6(2) and 11(1) of ICTA.

33.In brief, a company’s income (other than income arising to it in a fiduciary or representative capacity) is within the charge to corporation tax if:

• the company is UK resident; or

• the company is non‑UK resident and:

  (a)

  the income is trading income arising through or from a permanent establishment in the United Kingdom of the company; or

  (b)

  the income arises from property or rights used by, or held by or for, the permanent establishment.

See the commentary on section 835 in relation to the residence of companies.

Chapter 2: Rates at which income tax is charged

Overview

34.This Chapter sets out all the rates of income tax and provides rules about the rates of tax at which income is charged. It is based on sections 1, 1A, 1B and 686(1A) of ICTA.

35.Two main principles are at work:

• first, the rate of tax depends on the type of income concerned; and

• second, income may be subject to progressively higher rates of tax depending on the overall amount of income of the person concerned.

36.The second principle applies only to individuals (subject to a special rule about the first £1,000 of trustees’ trust rate income in Chapter 6 of Part 9 of this Act).

Section 6: The starting rate, basic rate and higher rate

37.This section sets out the main rates at which income tax is charged. It is based on section 1(2) of ICTA.

38.With some exceptions, notably savings and dividend income (see sections 12 and 13), any income of an individual is taxed at either the starting rate, the basic rate or the higher rate, depending on the level of the individual’s income.

39.Subsection (2) specifies that the main rates are determined each year by Parliament.

40.Other rates at which income tax is charged do not have to be specified by Parliament annually and are instead set out in the sections signposted by subsection (3).

Section 7: The savings rate

41.This section sets out the savings rate of income tax. It is based on section 1A(1B) of ICTA.

42.The “savings rate” is a new name for what is called “the lower rate” in the source legislation.

Section 8: The dividend ordinary rate and dividend upper rate

43.This section sets out these two rates of income tax that apply to dividend income. It is based on section 1B(2) of ICTA.

Section 9: The trust rate and dividend trust rate

44.This section sets out the two rates of income tax that apply, in particular, to accumulation or discretionary income of trustees. It is based on section 686(1A) of ICTA.

45.The “trust rate” is a new name for what is called “the rate applicable to trusts” in the source legislation.

Section 10: Income charged at the starting, basic and higher rates: individuals

46.This section sets out that the three main rates of income tax charged on the income of individuals are charged in three slices. It is based on section 1(2) of ICTA.

47.The first slice (subsection (1)) is income up to the starting rate limit – the starting rate band. The second slice (subsection (2)) is income between the starting rate limit and basic rate limit – the basic rate band. The third slice (subsection (3)) is income above the basic rate limit – the higher rate band.

48.Subsection (4) is a signpost to provisions that apply different rates of tax to certain types of income falling within each band. Income has to be placed in order so that the rates which would otherwise apply can be established. The rules on how this is to be done are in section 16.

Section 11: Income charged at the basic rate: other persons

49.This section charges tax at the basic rate on income of persons other than individuals. It is based on section 1(2) of ICTA.

50.Of the three main rates, only the basic rate applies. But other rates apply to specific sorts of income. In particular, savings income is charged at the savings rate and dividend income at the dividend ordinary rate. And income of discretionary and accumulation settlements is charged at the trust rates. There is a signpost to these exceptions in subsection (2).

Section 12: Income charged at the savings rate

51.This section charges savings income at the savings rate to the extent that it would otherwise fall within the basic rate band. It is based on section 1A(1) of ICTA.

52.There are a number of exceptions that provide that certain savings income is charged differently, usually at the trust rate. These are signposted in subsection (2).

Section 13: Income charged at the dividend ordinary and dividend upper rates: individuals

53.This section applies either the dividend ordinary rate or the dividend upper rate to dividend income of individuals. It is based on sections 1A(1), (1AA), (1A) and (4) and 1B(1) of ICTA.

54.To the extent that the dividend income (other than dividend income charged on the remittance basis) would otherwise fall within the starting rate or basic rate bands, subsection (1) provides that the dividend ordinary rate applies instead.

55.To the extent that the dividend income would otherwise fall within the higher rate band, subsection (2) provides that the dividend upper rate applies instead.

56.Subsection (3) provides that subsections (1) and (2) are subject to any provisions to the contrary.

57.“Dividend income” includes income chargeable under Chapter 5 or 6 of Part 4 of ITTOIA (see the definition in section 19). See Change 1 in Annex 1.

Section 14: Income charged at the dividend ordinary rate: other persons

58.This section applies the dividend ordinary rate to dividend income of persons other than individuals. It is based on section 1A(1), (1A) and (4) of ICTA.

59.Subsection (1) applies the dividend ordinary rate in place of the basic rate to dividend income (other than dividend income charged on the remittance basis). A number of provisions which override this rule (typically to provide that one of the trust rates applies instead), are signposted by subsection (2).

Section 15: Income charged at the trust rate and the dividend trust rate

60.This section provides a signpost to Chapters 3 to 6 of Part 9, which are about the circumstances in which income tax is charged at the trust rate and the dividend trust rate. It is new.

Section 16: Savings and dividend income to be treated as highest part of total income

61.This section provides the ordering rules that determine at what rate a particular type of income would be charged but for the sections imposing the savings rate or the dividend rates. It is based on section 1A(5) of ICTA.

62.Subsection (2) says that the rules apply for all other income tax purposes as well, except in the cases mentioned.

63.Subsections (3) to (5) contain the ordering rules. In essence, dividend income is the top part of income, savings income the middle part, and other income the lowest part.

64.Subsection (6) is a signpost to section 1012 which deals with the relationship between the rules in this section and other rules requiring particular income to be treated as the highest part.

65.Subsection (7) ensures that dividend income charged on the remittance basis does not count as dividend income for the purposes of this section.

Section 17: Repayment: tax paid at basic rate instead of starting or savings rate

66.This section allows a repayment claim outside Self Assessment if a person has suffered tax at the basic rate on income received and the person is only liable at the starting rate or the savings rate on that income. It is based on sections 1(6A) and 1A(6A) of ICTA.

Section 18: Meaning of “savings income”

67.This section defines “savings income”. It is based on section 1A(1AA), (2), (3) and (4) of ICTA.

68.The definition includes income on which personal representatives are liable under section 466 of ITTOIA (gains from contracts for life insurance etc), removing an anomaly in the source legislation. See Change 2 in Annex 1.

Section 19: Meaning of “dividend income”

69.This section defines “dividend income”. It is based on section 1A(1AA), (2), (3) and (8) and section 1B(1) and (3) of ICTA.

Section 20: The starting rate limit and the basic rate limit

70.This section sets out the starting rate limit and the basic rate limit. It is based on section 1(2) to (3) of ICTA.

71.The figures used in this Act are those for 2006-07. They will be updated for 2007-08 by means of an indexation order.

Section 21: Indexation of the starting rate limit and the basic rate limit

72.This section provides for indexation of the starting rate and basic rate limits. It is based on section 1(4) to (6) of ICTA.

73.Subsections (2) and (3) set out in step form how to compute the limit for a given year by reference to the limit for the previous year and the percentage rise in the retail prices index. The words “unless Parliament otherwise determines” in section 1(4) have been omitted as it is always open to a Finance Act to disapply this provision, so no express provision to this effect is needed.

74.Subsection (4) is an administrative provision to reflect the fact that it is usually only known at the time of the Chancellor’s Budget speech whether statutory indexation will apply. This leaves insufficient time before the start of the tax year for employers to update their payroll systems. This rule gives employers until the first pay-day after 17 May to make the necessary changes.

75.Subsection (5) obliges the Treasury to specify the indexed amounts in a statutory instrument which must be made in the tax year before the tax year to which they are to apply.

Chapter 3: Calculation of income tax liability

Overview

76.This Chapter deals with the calculation of a person’s income tax liability for a tax year.

77.The calculation sets out how the rules about the rates at which income is charged, and provisions about reliefs, allowances, tax reductions etc, are applied to the components of a person’s total income to arrive at the person’s income tax liability.

78.The calculation does not deal with amounts of tax suffered (eg under PAYE or by way of deduction of tax at source) as these are set off against a person’s liability rather than deducted in arriving at it. See section 59B(1) of TMA.

79.Nor does it deal with relief given by discharge or repayment, as here too the relief can operate only once the amount of a person’s liability has been determined. Examples of such reliefs include paragraph 6 of Schedule 14 to ICTA (life insurance relief for non-residents) and section 416 of CAA (mineral extraction allowance - expenditure on restoration within 3 years of ceasing to trade).

Section 22: Overview of Chapter

80.This section provides an overview of the Chapter. It is new.

81.The persons liable to income tax include individuals, trustees, personal representatives, non-UK resident companies, and companies acting in a fiduciary or representative capacity.

82.But where non-UK resident companies carry on a trade in the United Kingdom through a permanent establishment, they are liable to corporation tax instead of income tax on their chargeable profits. See the commentary on section 5.

Section 23: The calculation of income tax liability

83.This section sets out the steps to be taken in calculating a taxpayer’s liability to income tax for a tax year. It is based on many provisions in the source legislation, in particular section 835 of ICTA.

84.Step 1 brings together all the amounts of income on which a taxpayer is charged to income tax for the tax year. The sum of these amounts is called “total income”, and each of the amounts is a “component” of total income.

85.In the source legislation there were some contexts in which “total income” was used in a different sense (eg in section 1 of ICTA, where it meant what is defined in Step 2 as “net income”). But in this Act it is used consistently to denote this first stage result. And the consequential amendments to other legislation in Schedule 1 ensure that it will always be used in this sense elsewhere.

86.Step 2 deals with those reliefs (other than personal allowances) which are given by deduction from income.

87.Most of the reliefs listed in section 24 may be deducted from any type of income. But some may only be deducted from certain components of total income. See section 25(3).

88.Step 2, combined with the provisions about the reliefs themselves and the rules in section 25 about the way in which deductions are made, ensures that the reliefs are allowed in the proper way to arrive at “net income”.

89.It is important that this is done by reference to the components of total income, to pave the way for Step 4.