Annex 1: Minor changes in the law made by the Act: Change 138: Foreign income: special rules: specifying deductions available: section 838
This change concerns specifying the type of deductions available under section 65(1)(a) of ICTA for income within Schedule D Cases IV and V and extending the availability of these deductions to profits of foreign trades.
Section 65(1)(a) of ICTA allows certain deductions in computing the charge to income tax under Schedule D Cases IV and V where the income is taxed under the arising basis. Section 65(1)(a) of ICTA is drafted in very vague terms, referring to “the same deductions and allowances as if it [the income] had been so received [in the United Kingdom]”. In this context, the word “received” is thought to be a reference to income taxed on the remittance basis.
In practice, the Inland Revenue treat these words as referring to expenses incurred in the “management and collection” of the income and the expenses allowed are confined to expenses incurred outside the United Kingdom. (See paragraph 1669 of the Inland Revenue’s Inspector’s Manual (IM 1669).) This interpretation is in accordance with the decision in Atkin v McDonald’s Trustees (1894), 3 TC 306 (Court of Exchequer, Scotland, First Division) which involved income assessed on the remittance basis. In that case it was held that expenses incurred in the United Kingdom could not be deducted from the remitted income. So it follows that if deductions under section 65(1)(a) of ICTA are to mirror the position a taxpayer might find himself or herself in under the remittance basis, the section 65(1)(a) of ICTA expenses are confined to expenses incurred outside the United Kingdom.
Section 838 uses the words “collection or payment” rather than “management and collection” because the use of the word “management” might imply that the costs of managing a portfolio of investments should be allowed, but that is not so. The deductions that are allowed are those solely concerned with the costs of handling the income. There is nothing in the legislation that confines those costs to costs involved in sending the money to the United Kingdom, so no such restriction has been imposed.
Section 65(3) of ICTA provides that section 65(1)(a) of ICTA does not apply to income arising from a trade, profession or vocation carried on wholly outside the United Kingdom (“a foreign trade”). But, in practice, the Inland Revenue treat section 65(1)(a) of ICTA as conferring a deduction for certain extra expenses of a foreign trade that result from the income arising outside the United Kingdom, although in fact it is unlikely that there are any expenses within section 65(1)(a) of ICTA that would not be allowable in arriving at the profits of a foreign trade. Such trades are thus treated in the same way as overseas property businesses, since section 65A(5) of ICTA does not disapply section 65(1)(a) of ICTA.
In rewriting section 65(1)(a) of ICTA, section 838 does not exclude income from a foreign trade. So the costs attributable to the collection or payment of income from a foreign trade are deductible.
This change is adverse to some taxpayers and favourable to others in principle but in practice is expected to have only favourable effects and those small, and in few cases, because the incidence of these costs is rare.