ANNEX 1:: MINOR CHANGES IN THE LAW MADE BY THE BILL This change is adverse to some taxpayers and favourable to others in principle and in practice. But the numbers affected and the amounts involved are likely to be small.
Change 10: Trading losses: trade leasing allowance given to individuals: alignment of individual’s time commitment with period during which trade carried on: section 75 and Schedule 2Part 5 (sideways relief: trade leasing allowances given to individuals)
This change eliminates an inconsistency that arose following the change from preceding year basis to current year basis of assessment introduced by FA 1994.
A mismatch exists between the requirement that, to benefit from a trade leasing allowance, an individual must carry on the trade giving rise to the trade leasing allowance throughout one defined period and that during a different defined period substantially all of the individual’s time must be devoted to carrying on the trade.
For example, the accounts of the trade could show a loss for the year from 1 July 2003 to 30 June 2004. So the basis period would cover the same period. But the individual must carry on the trade for a continuous period of at least six months in the tax year ending 5 April 2005 and substantially the whole of the individual’s time throughout the year ending 5 April 2005 must be given to carrying on the trade.
The mismatch between these periods arose when individuals became taxable on a current year rather than preceding year basis. This change, introduced by FA 1994, also resulted in losses being determined for a tax year by reference to a basis period ending in that tax year, rather than the losses being those arising in the tax year itself.
Section 384(6) to (8) of ICTA deal with the restriction of set-off of leasing allowances against the general income of an individual. It addressed a concern that an individual could obtain an advantage by entering into a leasing activity in partnership simply to benefit from capital allowances, but not actually participate in the business, and then leave the partnership once the allowances had become available. The provision was designed to distinguish, in a broad way, between those activities, which were not commercially motivated, and those that were. It did this by looking at the taxpayer’s degree of personal involvement in the leasing activities.
The provision was originally enacted as section 70 of FA 1980. The use of capital allowances on assets provided for leasing in the course of a trade was restricted such that the allowances could not be used to establish a loss available for set-off against general income unless, in accordance with section 70(1):
“(a)the trade is carried on by him for a continuous period of at least six months in, or beginning or ending in, the year of loss as defined in that section; and(b)he devotes substantially the whole of his time to carrying it on throughout that year or if it is set up or permanently discontinued (or both) in that year, for a continuous period of at least six months beginning or ending in that year.”
The definition of “year of loss” was “any year of assessment” in respect of which a loss was sustained in any trade. Accordingly losses were looked at on a fiscal year basis, that is by looking at the loss actually sustained in the year from 6 April to the following 5 April. And the time commitment test was looked at for the same period.
But, when the preceding year basis of assessment was abolished by Chapter 4 of Part 4 of FA 1994, the “year of loss” provisions were amended by section 209(3) of that Act so that losses are computed for the same period as profits, in other words they are measured by reference to a basis period ending in a year of assessment. But the time commitment test was not updated. So an individual sufficiently involved in the business during a basis period, but not sufficiently involved during a year of assessment, will fail to meet the time commitment test. Equally, the reverse circumstances could occur.
Accordingly the drafting complexities and illogicality of looking at different periods for determining whether a loss relief should be available have been eliminated by aligning the periods. Both conditions should be satisfied by reference to the basis period rather than the tax year.