Annex 1: Minor changes in the law made by the Act: Change 108: Beneficiaries’ income from estates in administration: removal of the requirement for interest to be annual and a charge on residue to be deductible in calculating the residuary income of the estate: section 666
This change removes the requirements for interest to be annual and a charge on residue in order to be deductible from the aggregate income of the estate in calculating the residuary income of the estate.
The deductions that are allowable in ascertaining the amount of the residuary income of an estate for a tax year are set out in section 697(1)(a) and (b) of ICTA. Section 697(1)(a) of ICTA refers to “the amount of any annual interest, annuity or other annual payment [for the year] which is a charge on residue …”. There is a definition of “charges on residue” in section 701(6) of ICTA which is adapted for Scotland in section 702(d) of ICTA.
So far as the requirement for the interest to be annual is concerned, historically tax legislation has distinguished between short interest (which was not usually deductible) and annual or yearly interest (which was usually deductible). FA 1969 abolished the general relief for interest paid by taxpayers. However, specific provision was made for relief to continue to be allowed in respect of interest on borrowings for certain purposes. Annual or yearly interest continued to be significant as there was a requirement that tax was deducted from certain payments of yearly interest. But under the law as it applies before the commencement of this Act, interest, whether short or annual, may be deducted as an expense in computing the profit or loss of a trade for tax purposes if incurred wholly and exclusively for business purposes. (This is subject to certain restrictions on the deduction of annual interest paid to a person not resident in the United Kingdom and there is still a requirement to deduct tax in certain circumstances in relation to annual interest under section 349(2) of ICTA. For example, where the payment is to a person whose usual place of abode is outside the United Kingdom.)
So far as deductions in calculating residuary income of an estate are concerned, there is no reason, in principle, why short interest paid by the personal representatives should not be deductible. The historic distinction between short interest and annual interest no longer applies in tax legislation generally so it is difficult to justify here.
The other requirement in section 697(1)(a) of ICTA is that the payment of annual interest must be a charge on residue. “Charges on residue” are defined in section 701(6) of ICTA as certain specified liabilities properly payable out of the estate, as well as interest payable in respect of them. The definition is wide enough to include all interest ever likely to be paid by personal representatives, so the requirement that the payment is a charge on residue is otiose for interest.
Therefore, section 666(2)(a) of this Act, which rewrites section 697(1)(a) of ICTA, omits the requirements for interest to be annual and a charge on residue before it can be deducted from the aggregate income of the estate to calculate the residuary income of the estate. As a consequence, all interest paid by the personal representatives will be deductible, except for interest on unpaid inheritance tax which is expressly disallowed by section 233(3) of the Inheritance Tax Act 1984.
Since tax is treated as having been paid at the basic rate on this income, any reduction in the income taken to be available to beneficiaries as a result of this change will have the result that beneficiaries who pay tax at rates above the basic rate will pay less tax, but those not liable to income tax, or liable to tax only at rates below the basic rate, may not be able to reclaim so much tax.
This change is adverse to some taxpayers and is favourable to others in principle and in practice. But the numbers affected and the amounts involved are likely to be small.