Extracts from the Revenue's fifty-fourth Tax Bulletin.

Gross Payments of Interest

Finance Act 2000 changes

The changes relating to gross payments of interest made by Finance Act 2000 included:

* repealed sections 118A to 118K, Taxes Act 1988 which placed an obligation on United Kingdom paying and collecting agents to deduct tax from foreign dividends (including interest);

* repealed section 124, Taxes act 1988 which deals with interest on quoted Eurobonds, and

* amended section 349,Taxes Act 1988 by bringing United Kingdom public revenue dividends into the general provisions for the deduction of tax at source, and incorporating within the section an updated definition of a Eurobond.

The rule for interest on United Kingdom gilt edged securities is set out at section 50, Taxes Act 1988. This provides that interest on bearer and registered gilts flows gross. A holder of registered gilts can, however, continue to request net payment under the provisions of section 50(2). These specific provisions override the general provisions for deduction of tax in section 349.

Under section 349(3)(c) payments of interest on a quoted Eurobond are excluded from the general requirement to deduct income tax. The updated definition of a quoted Eurobond can be found in section 349(4). A 'quoted Eurobond' now means any security that:

* is issued by a company;

* is listed on a recognised stock exchange; and

* carries a right to receive interest.

This definition is more widely drawn than the definition in section 124 so that all listed securities issued by companies will pay interest gross both to individuals and to companies.

Finance Act 2001 changes

The Finance Act 2001 inserted new sections 349A to 349D into the Taxes Act 1988. Under these provisions companies (or partnerships with at least one member which is a company) will be able to pay interest as well as certain royalties, annuities and annual payments without deducting income tax when the person beneficially entitled to the income is:

* a United Kingdom resident company;

* a partnership where all the members are United Kingdom companies; or

* a United Kingdom branch of a non resident company, where the income will be charged to corporation tax.

The normal section 349 requirement to deduct tax is switched off when the payer 'reasonably believes' that the recipient is within one of these categories. It should be noted that the provisions refer to a 'company' which, as defined by section 832, Taxes Act 1988, means: 'any body corporate or unincorporated association but does not include a partnership, a local authority or a local authority association'.

Thus payments made by and to local authorities are not included in the new provisions while payments made to a charity might be. They are included if the payments are made by a company and the recipient charity is constituted as a United Kingdom resident company.

Reasonable belief

Basing the obligation to deduct income tax on 'reasonable belief' rather than an objective test enables companies to make gross payments even when it is not possible to verify the circumstances of the recipient directly. For instance, where the payment will be made through a series of intermediaries it should be possible for the payer to reach a reasonable belief based on the evidence provided by an intermediary.

What would constitute grounds for 'reasonable belief' will vary depending on the relationship between the payer and payee. Where, for example, a payment is made between associated companies, the payer is in a good position to know whether the recipient is the beneficial owner and meets the conditions to receive the payment gross. Where the payer and payee are not known to each other, the payer may want to obtain documentary evidence of the status of the recipient, perhaps in the form of a statement signed by the appropriate officer of the company. Such a statement might contain either:

* confirmation that the recipient is beneficially entitled to the income and meets the conditions to receive the payment gross; or

* if the recipient is a nominee, confirmation that the beneficial owner meets these conditions.

The right to make a payment gross based on the payer's reasonable belief does not affect the Revenue's right to recover tax and interest from the payer where it is subsequently found that the recipient was not within any of the categories of recipient to which the new gross payments rule applies. It is for this reason that some payers may wish to seek indemnities as protection from the risk of paying gross where this is not appropriate.

There will not normally be any question of a penalty being imposed on a company which makes a mistake, but a penalty will be considered where a company could not have a 'reasonable belief' that the recipient is in one of the categories eligible for payment gross.

Personal liability notices

Personal liability notices were introduced by section 64, Social Security Act 1998. This amended section 121, Social Security Administration Act 1992 by introducing section 121C.

This section provides that where a body corporate has failed to pay contributions at the prescribed time and the failure appears to the Board to be attributable to fraud or neglect on the part of culpable officers, the Board may issue a personal liability notice requiring the culpable officers to pay the sum specified in the notice. Such notices may be issued to more than one officer of the company and in amounts which reflect the level of culpability of the individual officer, but the total cannot exceed the contributions that are due from the company.

Companies are liable for Class 1, both primary and secondary, Class 1A and Class 1B National Insurance contributions. Any amount of these that are unpaid are included in the contributions that may be recovered from the officers of the company. The legislation also brings into the definition of contributions any interest and penalties charged in respect of them.

Personal liability notices can be issued to individuals who were 'officers of the body corporate'. The word 'officers' is defined in section 121C(9) as including:

'(a) any director, manager, secretary or other similar officer of the body corporate, or any person purporting to act as such; and

'(b) in a case where the affairs of the body corporate are managed by its members, any member of the body corporate exercising functions of management with respect to it or purporting to do so'.

Generally a personal liability notice will only be issued to a person who is not a director or secretary of the company where that person substantially manages the affairs of the company or is a person in accordance with whose direction or instructions the directors of the company are accustomed to act.

In law, a personal liability notice may be issued whenever contributions are unpaid because of the neglect of a culpable officer. Clearly any failure to pay on time can constitute neglect as a taxpayer who knows of an obligation, i.e., the need to pay National Insurance contributions by a certain date, and fails to fulfil that obligation is negligent.

However, in practice, a personal liability notice will only be issued in the most serious cases. What the Revenue looks at is persistent failure to pay against a background of other payments being made on time or, for instance, the continued drawing of a director's salary. It will focus on cases where the culpable officer has been involved with other companies which have had persistent or substantial failures to pay.

Before consideration is given as to whether a personal liability notice should be issued, the full facts behind the company's failure to pay the contributions due will be enquired into. The Revenue will aim to identify the officers whose negligence or fraud has led to the non-payment and the extent of the responsibility of each culpable officer.

Broadly there are six aspects of a case which will be considered when deciding whether to issue a personal liability notice. These are:

* Has there been a failure to pay contributions on time?

* Who were the officers of the company?

* Was the failure due to the negligent or fraudulent behaviour of an officer of the company?

* Which officers acted negligently or fraudulently?

* What is the amount of contributions which could be subject to a personal liability notice?

* How should that amount be apportioned between the culpable officers?

* What happens to the amount owed by the company when a personal liability notice is issued?

The issue of a personal liability notice does not change the position of the company and it is still liable to pay the outstanding contributions. If any amount is paid in respect of a personal liability notice, then the amount due from the company is correspondingly reduced. Equally if the company pays any of the outstanding contributions, then the amount charged on a personal liability notice will be reduced.

Self-assessment payments on account

The Revenue has realised that publication SAT2 'Self Assessment: the legal framework', issued in 1995, is misleading on the subject of directions that income tax self- assessment payments on account do not apply. It suggests that the Revenue will issue directions in much wider circumstances than it actually should do.

The correct position is that the Revenue issues directions, under section 59A(9), Taxes Management Act 1970, that payments on account do not apply:

* where the taxpayer has ceased to be within self assessment;

* for tax equalised foreign national employees whose employers have entered into an agreement with the Inspector to use the modified pay-as-you-earn scheme.

A taxpayer can still make a claim to reduce the payments on account, under section 59A(3) or (4), Taxes Management Act 1970, giving the reasons and at his own risk of an interest charge on any payments that turn out to have been due. Both directions by an officer and claims by the taxpayer must be made before 31 January following the year of assessment.

Discovery provisions

Normally, where the Inland Revenue has concerns about a self-assessment tax return, it will open an enquiry. But there are a few cases, in limited circumstances, where it is easier and quicker to raise a discovery assessment (or recognise the potential to do so in the amount of a contract settlement) despite an open enquiry window. The Revenue is changing its guidance to describe those cases where it is quicker and easier, both for its employees and taxpayers, to reach agreement using the discovery provisions.

The cases where the Revenue would (or would recognise the potential to) raise a discovery assessment are those:

* Where a taxpayer negligently sends in an incorrect return while an earlier return is still under enquiry, and the later return seems likely to contain errors similar to those identified during the enquiry. This is particularly apt where the Revenue has agreed with the taxpayer a formula by which to calculate additions to profit or the same contentious issue arises for all years.

* Where a previously undisclosed source of income is returned and acceptable figures for that source in previous years are supplied without returns being issued.

To open a series of enquiries or issue returns in these circumstances introduces delay and further paperwork. It will often be possible for the officer to agree with the taxpayer that the better course is to include these later or earlier years in a total settlement or for discovery assessments to be made.

Matching share acquisitions

This item discusses how the matching rules work when shares are transferred between a married couple and section 58(1), Taxation of Chargeable Gains Act 1992 applies so that the transfer is treated as being made at no gain/no loss to the transferor.

Whenever necessary, this item assumes that:

* section 58(1) applies to the transfer between husband and wife;

* the normal share matching rules in section 106A apply; and

* purchases and sales are at arm's length to unconnected persons.

The first point in relation to husbands and wives is that a transfer under section 58(1) of shares, or any other asset, is still a disposal by one spouse and an acquisition by the other one for capital gains tax purposes. Section 58(1) does not change the date on which either spouse's disposal or acquisition is made. It simply fixes the disposal and acquisition value at whatever amount results in there being neither gain nor loss on the transfer.

From the point of view of the spouse making the disposal, this means that the shares transferred are identified with acquisitions under the normal section 106A rules, and the deemed amount of consideration for the transfer follows from that. From the other spouse's angle, those shares are treated as a single acquisition and will be matched with disposals by him under the normal rules by reference to the date on which they were acquired on the transfer.

If and when the transferee spouse comes to dispose of the shares and needs to work out what taper relief is available, he will have to take into account paragraph 15 of Schedule A1 to the Taxation of Chargeable Gains Act 1992. This lays down that, where there is a transfer within section 58(1), the transferee spouse is treated for the purposes of taper relief as acquiring the asset at the time when the other spouse originally acquired it. This is relevant to determining the transferee spouse's qualifying holding period and the relevant period of ownership.

If the shares transferred were originally acquired on different days, and the spouse receiving the shares disposes of only some of them, it is not immediately clear how to work out the holding period(s) and relevant period(s) of ownership of the shares disposed of on that occasion.

The Revenue's view is that in these circumstances:

* the spouse receiving the shares is treated as acquiring them as a single asset;

* a disposal of some of those shares is therefore a part-disposal and the cost of the shares is apportioned under the normal part-disposal formula in section 42;

* the section 42 apportionment does not attribute the cost of the holding to any particular shares within it; and

* for taper purposes you apply the normal last in, first out rule in working out the period for which the shares disposed of have been held by both spouses overall.

The Tax Bulletin includes an example to illustrate how this works out in practice.

Social Security regulations

The Social Security (Contributions) (Amendment No 5) Regulations 2001, which came into force on 26 July, will:

* ensure that certain cash rewards paid by the finance sector to retail staff do not incur a National Insurance liability;

* correct an omission in the Social Security (Contributions) Regulations 2001 (which consolidate secondary legislation on National Insurance contributions for both Great Britain and Northern Ireland) to ensure that where an employee's share option was not capable of being exercised after more than ten years, there would be no National Insurance on the grant of the option;

* confirm the existing National Insurance exemption on luncheon vouchers by ensuring that contributions are paid only on the excess value of the voucher over 15 pence;

* revoke three pieces of Northern Ireland legislation which are obsolete as a result of the consolidation of National Insurance regulations.

Cash rewards from third parties

Third parties such as credit card companies, banks and building societies pay cash rewards to the employees of retailers who detect lost or stolen credit cards, debit cards or cheque guarantee cards (these rewards are around £50 on average).

To provide certainty in relation to the pay-as-you-earn due, the Revenue has decided to regulate so as to exclude from earnings for National Insurance purposes the rewards made by banks, building societies, etc. to workers, who are not their employees, who detect fraudulent use of credit, debit and cheque guarantee cards. The regulations apply from 26 July, and the Revenue will not seek to enforce a liability on rewards paid by third parties before that date.

The foregoing are extracts from longer articles published in the Tax Bulletin which is Crown copyright, and to which reference should be made for details of the full text.

For information regarding subscription, contact Ms Nahid Shariff on 020 7438 7842. It is also available free of charge at www.inlandrevenue.gov.uk.

Issue: 3821 / Categories: