Chapter 6: Deduction from annual payments and patent royalties
Overview
2709.This Chapter requires the deduction of sums representing income tax from certain annual payments and patent royalties. It is based on sections 4, 125, 347A, 348 and 349(1) of ICTA and section 727 of ITTOIA.
2710.These rules are coupled with those providing for relief for certain of the payments concerned in computing net income: see Chapter 4 of Part 8 and the related commentary. Together, the rewritten rules replace the scheme of the source legislation relating to charges on income (which owes its origins to the historic concept of alienation of income). See Change 81 in Annex 1.
2711.Sections 348 and 349(1) of ICTA are at the heart of the material about deduction of tax in the source legislation and have a very long history. The basic structure is that a payment falls within section 348 if it is payable wholly out of income brought into charge on the payer, but falls within section 349(1) if it is not payable wholly out of such income. (Payments which are deductible in computing income from a given source are not made out of income charged to tax and therefore fall into section 349(1).)
2712.The main differences between those sections in relation to deduction of tax are that
deduction is optional under section 348 of ICTA but mandatory under section 349(1) of ICTA; and
under section 348 the tax is in effect collected as part of the tax charged on the payer’s income, but under section 349(1) the tax is directly assessed (section 350 of ICTA).
2713.As a result of Change 81 deduction is made mandatory in all cases and the machinery for collecting the sums deducted has been changed, with direct assessment applying in fewer cases.
Section 898: Overview of Chapter
2714.This section provides an overview of the Chapter. It is new.
Section 899: Meaning of “qualifying annual payment”
2715.This section defines “qualifying annual payment”. It is based on sections 7(1), 125(1), 348(1A), 349(1A) and 687(1) of ICTA.
2716.Under the source legislation, for an annual payment to be within the scope of sections 348 and 349 of ICTA it had to be charged to tax:
under Schedule D Case III;
under Chapters 7 or 10 of Part 4, section 579, or Chapters 4 or 7 of Part 5 of ITTOIA (and not be relevant foreign income); or
under sections 609 and 611 of ITEPA.
2717.This takes account of the amendments made by paragraph 62 of Schedule 10 to FA 2005 (pension schemes etc) with effect from 6 April 2007.
2718.Subsection (2) specifies that the payment must arise in the United Kingdom. This follows from the fact that historically Case III was limited to United Kingdom sources and it is necessary to introduce this specific condition because United Kingdom sources and foreign sources are dealt with together in ITTOIA.
2719.Subsection (3) addresses the case where the recipient is a person other than a company and identifies all the provisions in ITEPA and ITTOIA under which annual payments formerly within Case III may be chargeable.
2720.Subsection (4) addresses the case where the recipient is a company. If the company is liable to income tax then the income must be within the provisions set out in subsection (3). But if the company is liable to corporation tax Case III still applies.
2721.Subsection (5) excludes a number of types of payment from the provisions in this Chapter.
2722.Payments treated as made to unit holders from unauthorised unit trusts are not specifically excluded here. That is because they are dealt with in Chapter 13 of this Part and, following the approach adopted in Chapter 10 of Part 4 of ITTOIA, such amounts are no longer treated as annual payments. So it is irrelevant to consider whether they are “qualifying”.
2723.If an annual payment is made by a building society, it is subject to the rule that payment includes crediting: see the Income Tax (Building Societies) (Annual Payments) Regulations 1991 (SI 1991/512).
Section 900: Deduction from commercial payments made by individuals
2724.This section requires that individuals deduct sums representing income tax from qualifying annual payments made for commercial reasons. It is based on sections 4, 347A(2), 348(1) and 349(1) of ICTA and sections 727 and 728 of ITTOIA.
2725.These are the only qualifying annual payments made by individuals not taken out of taxation by section 347A(2) of ICTA and section 727 of ITTOIA.
2726.The section makes deduction mandatory and provides for the tax to be collected as part of the individual’s self-assessment (see Chapter 17), so there will be no direct assessments in such cases in future. See Change 81 in Annex 1.
2727.It is made explicit that the rate at which deduction must be made is the basic rate.
2728.It is also provided that the basic rate concerned is to be the basic rate for the year of payment. See Change 138 in Annex 1, which also affects sections 901, 902 and 903.
2729.The source legislation differentiates between cases where the individual is “liable to make the payment”, and cases where payments are made on behalf of someone else (through the formula “the person by or through whom the payment is made”). Since the tax in respect of all payments by individuals will in future be accounted for through the individual’s own self-assessment, this section simply says “the individual must, on making the payment, …”.
2730.ESC A16 gives relief to a payer who fails to make a payment from which tax was deductible in the year in which it was due to be paid (and in which the payer had income to at least partly cover the payment), but who makes the payment in a later year. This gave rise to an assessment under section 350 of ICTA. The concession will be amended to reflect the new legislative structure relating to annual payments.
Section 901: Deduction from annual payments made by other persons
2731.This section requires persons other than individuals to deduct sums representing income tax from annual payments. It is based on sections 4, 347A(3), 348(1) and 349(1) of ICTA and sections 727 to 728 of ITTOIA.
2732.For persons other than individuals the range of payments within sections 348(1) and 349(1) of ICTA is wider than it is for individuals because the provision that certain payments are not to be charges on income (section 347A(1) of ICTA and section 727 of ITTOIA) applies only to payments by individuals. Accordingly, while section 900 applies only to commercial payments, this section applies to any annual payment that is a qualifying annual payment within section 899.
2733.This section does not apply to a payment made by an individual’s personal representatives unless it would have constituted a commercial payment within section 900 if paid by the individual before the individual’s death.
2734.Subsections (3) to (5) set out the conditions that determine which method is used to collect the tax. Deduction at the applicable rate (see the commentary on section 902) is mandatory in all cases, but the method of recovery depends on whether the payer does, or does not, have any modified net income in the year in which payment is made.
2735.If the payer has some modified net income, then the tax is collected as part of the payer’s self-assessment by virtue of Chapter 17. If the payer has no modified net income, then the tax is collected under Chapter 15 if the payer is a UK resident company, and otherwise under Chapter 16. See Changes 81 and 138 in Annex 1 and the commentary on section 900.
2736.Where the payer is not an individual and will not be accounting for the tax under Self Assessment, the term “the person by or through whom the payment is made” has been retained.
Section 902: Meaning of “applicable rate” in section 901
2737.This section defines “applicable rate” in section 901. It is based on section 4 of ICTA.
2738.Payments within section 900 are all subject to deduction at the basic rate. Deductions from annual payments made by persons other than individuals are also normally at the basic rate. The only exceptions, where the savings rate applies instead, are certain payments under purchased life annuities, namely those charged to tax under Chapter 7 of Part 4 of ITTOIA.
2739.Subsection (4)(b), which is based on section 4(1A) of ICTA, caters, for example, for the case where the recipient is a company within the charge to corporation tax.
2740.This section is subject to provisions requiring or permitting deduction at special rates - see Chapter 8 of this Part. It is also subject to regulation 3 of the Double Taxation Relief (Taxes on Income) (General) Regulations 1970 (SI 1970/488) which provides for a different rate of tax to be deducted from a gross payment if a notice under regulation 2(2) has been given.
2741.In all cases, the rate is determined by the year in which the payment is made. See Change 138 in Annex 1 and the commentary on section 900.
Section 903: Deduction from patent royalties
2742.This section requires the deduction of sums representing income tax from patent royalties. It is based on sections 4, 7, 125, 348(2) and 349(1) of ICTA.
2743.In addition to annual payments, deduction applies to any royalty or other sum in respect of the use of a patent under sections 348(2) and 349(1)(b) of ICTA.
2744.If a payment in respect of a patent is also a qualifying annual payment then this section does not apply (subsection (2)(a)). This clarifies that deduction does not apply to a patent royalty which is an annual payment and is paid by an individual otherwise than in connection with the individual’s trade. See Change 139 in Annex 1.
2745.In the case of annual payments, the source legislation states explicitly that to be caught by the deduction rules a payment has to be assessable under Schedule D Case III. That rule carries with it the requirement that the payment should arise in the United Kingdom. There is no such explicit statutory rule covering patent payments that are not annual payments. Normally those payments are not assessable under Case III. But in practice it has always been the case that, for such a payment to be subject to the deduction rules, it must arise in the United Kingdom. Subsection (3) makes this explicit.
2746.Subsection (4) makes explicit that deduction is to apply only where the payment is charged to income or corporation tax. See Change 140 in Annex 1.
2747.This section applies to payments by any person, but otherwise largely follows the format of section 901. If the payer is an individual or has some modified net income, then the tax is collected as part of the payer’s self-assessment under Chapter 17. If the payer is not an individual and has no modified net income, then the tax is collected under Chapter 15 if the payer is a UK resident company, and under Chapter 16 otherwise. See Changes 81 and 138 in Annex 1 and the commentary on section 900.
Section 904: Annual payments for dividends or non-taxable consideration
2748.This section provides a definition of “annual payment for dividends or non-taxable consideration”. It is based on section 125 of ICTA.
2749.With certain exceptions, subsection (3) has the effect of excluding from the duties to deduct under this Chapter any annual payment that is made for consideration that is either:
for a dividend or the right to receive a dividend; or
not taxable.
2750.The exceptions to that general rule are given in subsections (4) to (7).
2751.The source legislation specifies that the payment must not be interest (section 125(2)(a) of ICTA). Annual payments within subsection (2) do not include interest, so this does not need to be stated explicitly. In addition, no specific reference is made to annuities (also mentioned in the source legislation) as these are simply one type of annual payment.
Section 905: Interpretation of Chapter
2752.This section clarifies that the references to an individual in this Chapter include a Scottish partnership if at least one partner is an individual. It is based on section 347A(6) of ICTA.
