ANNEX 1:: MINOR CHANGES IN THE LAW MADE BY THE BILL This change is adverse to some taxpayers and favourable to others in principle. But it is expected to have no practical effect as it is in line with current practice.
Change 101: Accrued income profits: variable rate securities: transfers after the securities’ last interest period: sections 579, 617, 630, 636, 639, 640, 641, 667, 669 and 747 and Schedule 1 (section 119 of TCGA and section 161 of FA 1998)
This change relates to the clarification of when accrued income scheme profits on transfers of variable rate securities arise where the settlement day for the transfer occurs after the end of the securities’ last interest period and consequential changes.
Normally securities pay their last interest on their redemption day. So settlement on the transfer of securities will only occur outside an interest period in exceptional circumstances. There are two particular cases where the settlement day occurs after the end of the securities’ last interest period. One is where securities with a variable rate of interest (“variable rate securities”) are transferred, including securities which pay their last interest some time before redemption day. (The other is securities transferred with unrealised interest.)
Section 717 of ICTA deals with variable rate securities. The provisions about their transfer are not straightforward. Since section 717(7) of ICTA provides that the securities are treated as being transferred with accrued interest if they would not otherwise be so treated, it is clear how transfers which are settled in an interest period are dealt with: they fall within the main accrued income scheme regime and so the rule in section 714(2) of ICTA will apply. But it is not so clear what happens where the settlement day occurs after the end of the securities’ last interest period.
In the case of a transfer that is treated as taking place at redemption under section 717(8) of ICTA, section 712(4) of ICTA provides that the settlement day is the day of the transfer (that is, the day of the redemption). Where the last interest period ends before redemption, so that the settlement day occurs after the end of the securities’ last interest period, section 717(11) of ICTA, as applied by section 717(10) of ICTA, treats a further period lasting up to the settlement (redemption) day as an interest period of the security (“the artificial interest period”). Section 713(2)(a) of ICTA then operates so that the transferor is treated as entitled to a sum in the artificial interest period in which the settlement day falls. The rule in section 714(2) of ICTA then applies by reference to the artificial interest period. This has the result that the accrued income profits on redemption are taxed in the tax year in which the settlement (redemption) day falls.
However, section 717(10) of ICTA says nothing explicit about section 717(11) of ICTA applying to ordinary transfers (as distinct from transfers that are deemed to occur on redemptions) where the settlement day occurs after the end of the last interest period but before the date of redemption. Consequently, it is not clear how they should be dealt with. But in practice, HMRC interpret section 717(11) of ICTA as applying in all cases where the settlement day in fact falls after the end of the last interest period, so as to add an artificial interest period up to the settlement day for any transfer after the final interest period of a variable rate security. Then section 713(2)(a) of ICTA can again operate by reference to the artificial interest period, with the result that the accrued income profits are taxed in the tax year in which the settlement day falls.
Section 617(3) gives effect to that interpretation by providing that profits on all transfers of variable rate securities are treated as made in the tax year in which the settlement day falls where the settlement day is after the end of the last interest period.
Section 630 deals with transfers of variable rate securities where the settlement day falls outside an interest period. It deals with all such transfers, rather than restricting its application to transfers on redemption. Section 630 (1) and (2) therefore also gives effect to that interpretation in determining whether the transferor is treated as making accrued income profits without distinguishing a transfer to which section 717(11) of ICTA applied.
As explained in part (A) of this note, in the case of the redemption of variable rate securities where the settlement day for the transfer occurs after the end of the securities’ last interest period, section 717(10) and (11) of ICTA create a further artificial interest period and in practice this is taken to extend to all transfers and not just redemptions.
The settlement day for the purposes of section 721 of ICTA is the day on which the securities are transferred by the personal representatives to the legatee (see section 712(4) of ICTA). This is unlikely to coincide with the redemption day, but in practice it would be treated as falling within the artificial interest period.
As a consequence of the change explained in part (A), section 636, which rewrites the exemption for transfers to legatees in section 721 of ICTA, makes special provision at subsection (3) so that transfers to legatees of variable rate securities after the end of the only or last interest period of the securities are covered by the exemption, even though they will no longer occur in the artificial interest period and so will not fall within section 636(2).
As a consequence of the change explained in part (A), sections 639, 640 and 641 which rewrite these exclusions make special provision so that transfers by these kinds of transferors, where the settlement day is after the end of the only or last interest period of the securities, are covered by the exclusions, even though they will no longer occur in the artificial interest period.
So, for example, for transfers by individuals section 639(3) provides that in the case of variable rate securities an individual is an excluded transferor if the nominal value of the securities does not exceed £5,000 in the relevant tax year or the previous tax year. Section 639(4)(a) provides that, if the settlement day falls in an interest period, the relevant tax year is the tax year in which the interest period ends. Section 639(4)(b) provides that, if the settlement day does not fall in an interest period, the relevant tax year is the tax year in which the settlement day falls.
(Trustees who are resident or domiciled outside the United Kingdom would normally fall with section 715(1)(f) of ICTA so that section 713 of ICTA does not apply to give amounts that would be taken into account under section 714(2) of ICTA. See section 643 which makes provision equivalent to section 715(1)(f) of ICTA, so that such trustees would normally be an “excluded transferor” or “excluded transferee” for the purposes of Part 12.)
Where an amount of accrued income profits is treated as arising under the settlement for the purposes of Chapter 5 of Part 5 of ITTOIA, the settlor will be charged to tax on the amount of the accrued income profits and not the trustees (had they otherwise been the person liable for tax on those profits).
By virtue of section 717(7) of ICTA, transfers of variable rate securities are treated for the purposes of sections 710 to 727A of ICTA as a transfer with accrued interest. Where the transfer occurs within an interest period, section 713 of ICTA applies (subject to the modification in section 717(9) of ICTA) to provide the amount that falls within section 714(2) of ICTA. As explained in part (A) of this note, in the case of the redemption of variable rate securities if the settlement day for the transfer occurs after the end of the securities’ last interest period, section 717(10) and (11) of ICTA create a further artificial interest period. So, in that case section 713 of ICTA (as modified) applies again to provide an amount falling within section 714(2) of ICTA.
Section 667 treats “qualifying accrued income profits” which trustees are treated as making (or would be treated as making but for the fact that they are resident or domiciled outside the United Kingdom) as income arising under the settlement for the purposes of Chapter 5 of Part 5 of ITTOIA. “Qualifying accrued income profits” include profits treated as made under section 628(5) (profits treated as made in an interest period on a transfer of securities with or without accrued interest), and profits treated as made under section 630(2) (profits treated as made where the settlement day is outside an interest period) in respect of a transfer of variable rate securities. As a consequence of the change explained in part (A), profits treated as made under section 630(2) include profits on all transfers of variable rate securities where the settlement day is outside an interest period. And all such profits are therefore included in “qualifying accrued income profits” as that term is used in section 667.
Sections 579 (manufactured interest on UK securities: allowable deductions: matching) and 747 (amounts corresponding to accrued income scheme profits and related interest) rewrite provisions that use cross reference to profits falling within section 714(2) of ICTA (respectively, paragraph 3(2A)(b) of Schedule 23A to, and section 742(4) of ICTA) similarly to the use made in section 720(6) of ICTA. Those sections therefore use the term “qualifying accrued income profits”, as defined in each of those sections, to refer to profits arising under Part 12. The definitions refer to profits treated as made under section 630(2) in respect of a transfer of variable rate securities. So the change explained in part (A) applies also for the purposes of those sections.
As explained in part (A) of this note, in the case of the redemption of variable rate securities if the settlement day for the transfer occurs after the end of the securities’ last interest period, section 717(10) and (11) of ICTA create a further artificial interest period and in practice this is taken to extend to all transfers and not just redemptions.
As a consequence of the change explained in part (A), this Part makes special provision in section 669 so that unremittable proceeds of transfers of variable rate securities after the end of the only or last interest period of the securities are covered by the relief, even though they will no longer occur in the artificial interest period and so will not fall within section 668(1).