UK: Finance Bill 2013 - Draft Clauses - Limit On Income Tax Reliefs

Last Updated: 9 January 2013
Article by Smith & Williamson

Introduction

In his Budget speech on 21 March 2012 the Chancellor George Osborne announced several measures to tackle aggressive tax avoidance, including provision to "deal with the unlimited use of income tax reliefs". The intention being to cap certain currently unlimited income tax reliefs to £50,000 or 25% of income, whichever is greater.

The Budget report gave a little more detail, confirming that the Government would introduce legislation on this measure in 2013, after consultation.

The initial proposals would have included charitable donations in the list of reliefs to be capped, but public reaction led to Ministers making it clear that tax relief on charitable donations would be excluded from the cap.

A consultation process was carried out and the Government's response to that consultation was published on 11 December 2012 together with draft legislation.

Reliefs affected

Section 24 Income Tax Act 2007 details various specific reliefs that may be deducted in the calculation of income tax liability, including reliefs which can be relieved against general income. There is currently no upper limit on the amount of income tax relief claimed for the year of the claim or, where relevant, any other earlier year or any later year to which the relief claimed is allocated.

The draft legislation provides for a limit in respect of a number of reliefs.

  • Trade Loss Relief against general income– available for losses made by an individual carrying on a trade, profession or vocation. Relief for losses attributable to overlap relief and Business Premises Renovation Allowances (BPRA) will not be capped.
  • Early Trade Losses Relief – available to an individual in the first four years of the trade, profession or vocation. Relief for losses attributable to overlap relief and BPRA will not be capped.
  • Post-cessation Trade Relief – available for qualifying payments or qualifying events within seven years of the permanent cessation of the trade.
  • Property Loss Relief against general income – available for property business losses arising from capital allowances or agricultural expenses. Losses attributable to BPRA will be excluded from the cap.
  • Post-cessation Property Relief – available for qualifying payments or qualifying events within seven years of the permanent cessation of the UK property business.
  • Employment Loss Relief against general income– available in certain circumstances where losses or liabilities arise from employment.
  • Former Employees Deduction for Liabilities – available for payments made by former employees for which they are entitled to claim a deduction from their general income in the year in which the payment is made.
  • Share Loss Relief on non-EIS/SEIS shares – available for capital losses on the disposal (or deemed disposal) of certain qualifying shares.
  • Losses on Deeply Discounted Securities – available only for losses on gilt strips and on listed securities held since at least 26 March 2003; and
  • Qualifying Loan Interest – available for interest paid on certain loans. These include loans to buy an interest in certain types of company, or to invest in a partnership.

How the cap will be calculated

The cap will be set at £50,000 or 25% of 'adjusted total income', whichever is greater.

For the purposes of the 25% calculation, an individual's income will be calculated as set out below.

  • Start with the total taxable income liable to income tax.
  • Add the individual's charitable donations made via payroll giving and to exclude pension contributions (to create a level playing field between those whose deductions are made before they pay income tax, and those whose deductions are made after tax).
  • The result, called 'adjusted total income', will be the measure of income for the calculation.

The limit will apply to the year of the claim and any earlier or later year in which the relief claimed is allocated.

Note that the calculation of 'adjusted total income' for this purpose differs to that for the very similar calculation of 'adjusted net income'.

Example

Henry has trade losses in 2014/15 of £200,000 and 2013/14 profits from the same trade of £70,000. He has other income in each year of £120,000.

His relief against general income is capped at £50,000 for both 2013/14 and 2014/15.

Henry makes a claim to set £50,000 trade loss relief against his 2014/15 general income and to carry back £70,000 against 2013/14 profits from the same trade. He also claims £50,000 carried back against his general income in 2013/14.

Henry's income chargeable to tax is:

2014/15

Income £120,000

Less sideways trade loss relief (capped) £ 50,000

Income chargeable to tax £ 70,000

2013/14

Income (£70,000 + £120,000) £190,000

Less 2014/15 trade loss relief against same trade (uncapped) £ 70,000

Less 2014/15 trade loss relief (capped) £ 50,000

Income chargeable to tax £ 70,000

When the cap takes effect

The new rule will take effect on 6 April 2013.

The limit will also apply where loss relief is claimed for a tax year before 2013/14 in relation to losses made in 2013/14 or a later year.

The limit will not apply to property loss relief arising from a loss made in 2012/13 where the loss is claimed for relief against general income in tax year 2013/14.

Comments

There were complaints that the capping of reliefs was not subject to a proper consultation process in so far as Ministers had made it clear at the outset that the policy itself was not negotiable.

The Government did however listen to some of the points of detail made in the course of the consultation.

  • It agreed that share loss relief for shares qualifying for EIS/SEIS should be excluded from the cap. Share loss relief on shares not within EIS/SEIS will remain within the cap.
  • Overlap relief will also be excluded from the cap and treated as a computational adjustment rather than a relief for this purpose. It appears that this particular relief was initially overlooked and it would have been particularly unfair if it had been capped.

The Impact Assessment indicates that the capping of tax reliefs will affect only around 8,000 people with the highest incomes, with a median loss of around £20,000, and over 90% of the revenue from the measure will come from those with incomes over £150,000.

The Government's intention is to apply the cap to reliefs that an individual is able to claim against their general income. It is not intended to cap reliefs used against profits in another year from the same business.

The new rules could have a substantial impact on relatively common business scenarios, for example:

  • A major professional firm with 200 partners carries on a business in UK. The decision is made to start a new business venture on a trial basis and five representative partners for a new partnership. Predictably the new venture makes substantial losses in the first year which are allocated to the five partners. Their profit shares from the main business are increased accordingly so that they are not out of pocket. If a partner's share of the loss exceeds both £50,000 and 25% of their total profits then they will end up paying tax on more profits than they have actually earned in that year.
  • A farmer has two separate diversified businesses. He buys new plant and machinery costing £100,000 and claims the annual investment allowance which gives him a 100% deduction, which in turn creates a loss for tax purposes of £75,000. Unless his other income exceeds £200,000 his loss will be restricted to £50,000. The balance of the tax relief on the remaining £25,000 will be carried forward, thereby delaying the cash flow impact of the tax reduction.

The Chartered Institute of Taxation issued the following press release regarding the draft legislation:

"Tax experts are surprised that the Government is pressing ahead with its proposed cap on income tax reliefs, subject only to a few technical changes. During the recent consultation representative bodies warned the Government that the proposals, as framed, were anti-business and would hit some with modest net incomes, leading to them being taxed on more income than they actually receive.

The Chartered Institute of Taxation (CIOT) reiterates its concerns around the cap now included in the draft Finance Bill clauses issued today. Commenting, CIOT President Patrick Stevens said:

"We appreciate that the Chancellor is keen to ensure that those on high incomes pay a significant amount of tax. However, the proposed cap goes well beyond that. It will affect some ordinary business scenarios that we really cannot imagine the Government wants to catch.

We welcome the changes to the original proposals to exclude both share loss relief for shares qualifying for EIS or SEIS2 and also overlap relief from the cap. These were highlighted during the consultation and it is good to see that the Government listened on these points.

However it is very disappointing that the other changes were not made to make the proposals more business friendly. Restricting the ability to offset genuine business losses and interest relief could suppress UK entrepreneurship. It is not uncommon to fragment business interests for commercial or regulatory purposes; the results are currently effectively aggregated for tax purposes and the person is taxed on the net income from all activities. The cap as drafted will prevent this happening in many cases, taxing many in business on more than they earn.

The cap is likely to have a significant negative impact on economic growth and employment.

We hope that the Government will continue to listen to concerns and reconsider the decision to include those on modest net incomes, such a farmer who has diversified his farm business activities to remain self-sufficient and incurs losses in one business due to investing in machinery and claiming the recently proposed higher annual investment allowance."

The CIOT's key recommendation is that business profits and losses, including relief for interest on a loan to the business, should be capable of being offset against each other before considering if the cap applies. As a minimum, the small number of individuals with gross income under £150,000 that claim significant loss relief should be excluded from the provisions."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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