INTM610260 - Interaction with Other Legislation: Income Chargeable to S731 ITA 2007

This guidance considers how the Profit Fragmentation legislation will apply to adjustments that are within the scope of both Paragraph 7 of the Profit Fragmentation legislation and S731 ITA 2007 of the TOAA legislation.

Benefit Charge

If Profit Fragmentation legislation is applicable to arrangements under which a benefit charge under S731 ITA 2007 is later raised no relief will be available to set against the amount paid under S731 ITA 2007 to take account of the tax paid under the Profit Fragmentation legislation.

There is no basis on which to give credit relief to the recipient of a benefit who is liable under S731 ITA 2007. Unlike the provisions of S720 and S727 ITA 2007, S731 does not deem particular income of the foreign person to be the income of the UK resident individual receiving the benefit but, rather, seeks to tax the value of a benefit actually received by him, and then only if and to the extent that it can be matched by relevant income.

The relevant income itself is not being taxed as income of the UK resident individual, but the value of the benefit is. In arriving at the net figure for relevant income, deduction is made for any taxes, whether UK or foreign, and any expenses properly incurred against that income under S733(1) ITA 2007. This can include payments made by the overseas person to the resident party to cover the tax liability arising as a result of the Profit Fragmentation legislation.

The double taxation relief available under paragraph 8 of the Profit Fragmentation legislation will not be available in these circumstances as the charge under S731 ITA 2007 is on the benefit that arises and not on income attributed to the UK resident individual.

Example D-The application of the Profit Fragmentation rules when the benefit charge applies.

An overseas trust was settled by P, a UK resident and UK domiciled individual for the benefit of his two adult children. P is excluded from benefiting from the trust. A UK resident company makes a payment of £150,000 to an overseas company which is owned by the overseas trust. Services are provided by the overseas company though the payments being made are inflated. The value that would have been transferred between independent parties acting at arm’s length is £100,000 not £150,000. Though full amount of this receipt is treated as income in the overseas company’s accounts.

The conditions to be Profit Fragmentation arrangements are met so the UK resident company makes an adjustment to reduce their expenses by £50,000 under paragraph 7 of the Profit Fragmentation legislation.

The full amount of the £50,000 will be taxable on the UK resident company at 20% meaning the UK resident company pays £10,000 of tax. The overseas company makes a payment to the UK resident company for £10,000 to allow them to pay the tax due on the adjusted amount.

For the purposes of the transfer of assets legislation the remaining £140,000 will be relevant income under S733 ITA 07. For the purpose of this example it is assumed that there is no other relevant income in the structure. In the following tax year the overseas trustees make a capital distribution of £150,000 to one of P’s children. The relevant income of £140,000 will be matched against the benefit under S733 ITA 07 resulting in a benefits charge on that individual under S731 ITA 2007of £140,000 assessable on the UK resident individual in this later year.

Trust Protections

The ‘trust protections’ are the changes made by Finance Act 2017 and Finance Act 2018 to remove what is referred to as protected foreign source income arising in overseas trusts settled by non-UK domiciled settlors from a charge under S624 Income Tax Trading and Other Income Act 2005 (“ITTOIA 05”), S720 ITA 2007 and S727 ITA 2007 and the protected foreign source income of any underlying companies. Such income is instead brought within the scope of S731 ITA 2007 or S643A ITTOIA 05 so that the settlor and close family members are assessed on the benefits they receive from the trust and its underlying entities to the extent that this can be matched with the protected foreign source income arising within the structure.

Protected foreign source income is defined at S628A ITTOIA 05, S721A and S729A ITA 2007. It is not affected by the Profit Fragmentation legislation for the reasons given below. This means that the trust protections will not be affected by the introduction of the Profit Fragmentation legislation.

Paragraph 2 of the Profit Fragmentation legislation requires that there exists a material provision that results in a transfer of value from the resident party to the overseas party. The value transferred will be a transfer of value generated directly or indirectly from the profits of a business chargeable to UK income tax or corporation tax in the tax year or accounting period of the resident party.

Protected foreign source income (PFSI) as defined at S721A ITA 2007, is foreign source income. As PFSI cannot represent value which derives directly or indirectly from the profits of a business chargeable to UK income tax or corporation tax, paragraph 2(1)(b) of the Profit Fragmentation legislation will not apply.

PFSI cannot be income that the Profit Fragmentation legislation applies to, so there is no interaction between the Profit Fragmentation legislation and the TOAA legislation for this type of income.

A “transfer of value” for the purpose of paragraph 2 of the Profit Fragmentation legislation will not therefore include genuine protected foreign source income chargeable in the UK under S731 ITA 2007.