1.Section 27 introduces Schedule 11 which makes changes to tax rules on deduction of income tax from interest relating to compensation payments, specialty debt and interest in kind.
2.Paragraph 1 of the schedule provides for Chapter 3 of Part 15 of the Income Tax Act 2007 (ITA 2007) to be amended. Chapter 3 sets out the tax rules on deducting income tax from payments of ‘yearly interest’. The meaning of ‘yearly interest’ is derived from case law and refers, broadly, to interest on a debt where the debtor and creditor intend that the debt should exist for more than a year, or where it is mutually accepted that the interest may be paid from year to year.
3.Paragraph 2 amends section 874 of ITA 2007 by inserting new subsections (5A) and (5B). The new subsections provide that interest that is payable to an individual in respect of compensation is to be treated as a payment of yearly interest. As a consequence, the person paying the interest will be required to deduct income tax at source from it. This is subject to a regulation-making power to allow for this requirement not to apply in certain circumstances.
4.Paragraphs 3 and 4 amend sections 875 and 878 of ITA 2007, to disapply the exception from the duty to deduct income tax from yearly interest that currently applies to building societies and banks Building societies and banks will therefore have to deduct income tax from interest payable in respect of compensation, where previously they would have been able to reply on the relevant exception.
5.Paragraph 5 amends section 874 of ITA 2007 by inserting a new subsection (6A) to clarify the position on the obligation to deduct income tax from yearly interest arising on ‘specialty debt’ (that is, debt paid under a deed).
6.Paragraph 6 inserts a new section 370A into the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005). The new section provides a rule to determine how interest paid in kind in the form of goods, services or vouchers is to be valued
7.Paragraphs 7, 8 and 11 amend section 380 of ITTOIA 2005, section 939 ITA 2007 and section 413 of the Corporation Tax Act 2009 (CTA 2009) respectively to exclude interest in kind from the definition of a funding bond for income tax and corporation tax. The amendments make it clear that the legislative provisions applying to funding bonds and interest in kind are mutually exclusive.
8.Paragraph 9 amends section 975 of ITA 2007 to ensure that the duty to issue a statement under that section only applies if new section 975A of ITA 2007 does not apply.
9.Paragraph 10 inserts a new section 975A into ITA 2007. The new section requires a person who pays interest in kind, or in the form of funding bonds where the issuer is under an duty to retain bonds under section 939 ITA 2007, to provide the recipient with a statement in writing. The statement must show the amount of the interest paid in kind or as a funding bond, the amount of tax deducted (if any), the net amount paid, and the date of payment.
10.Unlike the similar requirement in section 975 ITA where interest is paid in cash, a statement under new section 975A will be required in any case when any interest is paid in kind or by funding bonds where bonds must be retained, not just if the recipient requests it.
11.New section 975A will not apply to a payment of interest by funding bonds where there is no requirement on the issuer to deduct a sum representing income tax from the payment.
12.Paragraph 12 sets out the commencement provisions which, for building societies and other institutions such as banks paying interest on compensation payments, relate to the quarterly returns made by such institutions in respect of tax deducted from interest. Other changes made by the Schedule have effect from the date of Royal Assent.
13.This legislation follows consultation in 2012 on a number of possible changes to income tax rules on interest and on deduction of income tax from interest.
14.The application of the current rules on deducting income tax from interest can be unclear and inconsistent in certain situations. For example, tax is required to be deducted from interest on compensation payments if it is ‘yearly interest’, but not if it is ‘short interest’; and, even if it is yearly interest, no tax is required to be deducted if the institution paying it is a building society or a bank paying it in the ordinary course of its business. A common example of interest paid on such compensation is that paid by financial institutions in cases of financial mis-selling.
15.Similarly, the amount of tax to be deducted when any interest is paid in kind can be difficult to ascertain in the absence of a clear rule providing how the interest is to be valued.
16.The changes clarify the application of the legislation and ensure that the rules on deduction of income tax operate in a consistent manner.