ANNEX 1:: MINOR CHANGES IN THE LAW MADE BY THE BILL This change is in principle favourable to some taxpayers. It also affects when and how tax is paid and administrative requirements. But the numbers affected are expected to be few (and the amounts involved small).
Change 82: Charges on income: when payments are made “out of” profits or gains brought into charge to income tax: sections 450, 505, 1025 and 1026
This change concerns the rewrite of the phrase “out of profits or gains brought into charge to income tax”, in the context of the general approach to the rules about charges on income (see Change 81).
The question whether a payment is made out of profits or gains brought into charge to income tax is easily answered if a payer has no income subject to income tax (such as a company, an exempt person, or an individual who happens to have no income). The difficulties arise where a payer has some income subject to income tax.
Where a payer does have some such income, a number of questions can arise in deciding whether or not the payment can be said to have been made out of that income, and there is a good deal of case law on the point. The significance of the point, under the new approach, is whether or not the payer can deduct the payment at Step 2 of the tax calculation (see section 23 of this Act).
The first issue is whether or not the income is sufficient overall. And this is the only question which now matters in the case of individuals – see CIR v Plummer (1979), 54 TC 1 HL at page 41 (Lord Wilberforce). So here it is necessary to compare the amount of the individual’s “modified net income” (as given by section 1025) with the amount of the payment. For this purpose it is necessary to ignore this relief itself and any “non-qualifying income” as provided by section 1026.
In other instances the position is less straightforward and regard must be had to a number of decided cases. For persons other than individuals, additional tests can be discerned from these cases which outlaw deductions for payments which:
	are reimbursed (unless the reimbursement is taxable);
	can only lawfully be made out of capital or exempt income; or
	are treated by the payer as made out of capital or exempt income (when they need not have been) and this has a real world effect.
The following paragraphs provide more detail on cases that illustrate the three principles mentioned in the bullets above.
As to the first bullet: a number of cases (Dickson v Hampstead Borough Council (1927), 11 TC 691 KBD, Corporation of Birmingham v CIR (1930), 15 TC 172 HL, Scarborough Corporation v CIR (1947), 28 TC 147 KBD) have concerned statutory subsidies for interest payable on borrowings for capital works. (Such interest was then an annual payment.) The subsidies, which were not taxable in the recipients’ hands, were for the gross amount of the interest, but in each case the corporation (which had taxed income) sought to obtain relief by retaining the tax deducted from the interest it paid. And in each case the courts held that this was inadmissible, and that the tax should be handed over.
As to the second bullet: in Sugden v Leeds Corporation (1913), 6 TC 211 HL the corporation borrowed money for two purposes: for investment into gasworks, waterworks and tramways (“municipal” undertakings), which were highly lucrative, and into sanitary works, which were not. There was in effect a statutory provision that the two funds could not be mixed. The corporation had insufficient money in the “sanitary” fund to meet the interest, so paid the balance of interest (which then was an annual payment) out of the Consolidated Fund, the income of which was untaxed (the borough rates). It was held that the corporation could not use the income from the “municipal” fund to frank the payment, and was assessable for the tax on the balance of the interest. It was not that the corporation had acted outside its powers, but that, had it made such an actual payment out of the “municipal” fund, it would have been so acting.
As to the third bullet: in Central London Railway Co v CIR (1936), 20 TC 102 HL and Chancery Lane Safe Deposit and Offices Co Ltd v CIR (1965), 43 TC 83 HL the respective companies borrowed money for capital works and charged such interest to capital in their accounts. It was held that this policy was not a matter of “domestic bookkeeping” but had a real effect on persons’ rights and liabilities (absolute or contingent), because the fund of distributable profits was affected. In CIR v Ayr Town Council (1938), 22 TC 381 CS at page 403, Lord Normand said:
“Though the taxpayer is not bound by the mere form of the accounts, he is bound by the accounts so far as they have recorded a decision to debit the various funds in a particular way which has practical results apart from his right to retain Income Tax …”
And in the circumstances dealt with in the first two cases mentioned above it was held to be inadmissible for the taxpayer to state that for one purpose it had made a capital payment, while for another it had made the same payment out of taxed income.
Under the approach to rewriting sections 348 and 349(1) of ICTA, the regime that applies for deducting and accounting for tax will no longer depend on whether the payment is made out of income brought into charge to income tax. Accordingly the rules on relief for payments are rewritten without direct appeal to that concept. On this approach, the restrictions on relief for persons other than individuals discerned from the cases mentioned above must be set out explicitly.