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HMRC internal manual

Employment Income Manual

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Employment income provided through third parties: exclusions: income arising from earmarked sum or asset

Sections 554Q and 554Z17(2) ITEPA 2003

Scenario envisaged by Section 554Q
The exclusion
The listed exclusions
The arm’s length condition
Example
Earlier relevant step before 6 April 2011
Relevant step within Section 554C or 554D

If the specified conditions are met, the earmarking of income arising from a sum or asset that has already been earmarked will not itself give rise to Part 7A income.

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Scenario envisaged by Section 554Q

There are three conditions for Section 554Q to apply. These conditions are bulleted below.

  • A sum of money or asset (‘sum or asset R’) is held by or on behalf of a person (‘P’).
  • Income arises from sum of money or asset R.
  • When the income arises, it

    • is received by or on behalf of P, and
    • is the subject of a relevant step (‘the step under review’) within Section 554B taken by P. See EIM45095 onwards.

Section 554Q can apply to steps within Section 554Z18 (undertakings given by employers etc in relation to retirement benefits etc: earmarking etc). See EIM45150.

But section 554Q cannot apply to steps within Section 554Z19 (undertakings given by employers etc in relation to retirement benefits etc: provision of security). See EIM45155.

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The exclusion

The step under review will not give rise to Part 7A income if four conditions are met. They are bulleted below.

  • Before the income arose, P took a relevant step (‘the earlier relevant step’) within Section 554B of which the subject was sum or asset R.
  • The earlier relevant step either (a) gave rise to Part 7A income or (b) would have given rise to Part 7A income but for one of the listed exclusions.
  • Immediately before the income arose, sum or asset R was still held on:

    • a Section 554B basis (see EIM45095), or
    • if the earlier relevant step was a step within Section 554Z18, the basis mentioned in Section 554Z18(1)(a) or (b).
  • The arm’s length condition is met.

But the arm’s length condition does not need to be met if the step under review is within Section554Z18.

On Section 554Z18 (undertakings given by employers etc in relation to retirement benefits etc: earmarking etc), see EIM45150.

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The listed exclusions

These are the listed exclusions.

  • Section 554Q (income arising from earmarked sum or asset)
  • Section 554R (acquisitions out of earmarked sums or assets) (see EIM45250)
  • Section 554H (earmarking of deferred remuneration) (see EIM45255 onwards)
  • Section 554J (earmarking for employee share schemes: specified vesting date) (see EIM45355 onwards)
  • Section 554K (earmarking for employee share schemes: specified exit events) (see EIM45385 onwards)
  • Section 554L (earmarking for employee share option schemes: specified vesting date) (see EIM45405 onwards)
  • Section 554M (earmarking for employee share option schemes: specified exit events) (see EIM45435 onwards)
  • Section 554T (employee pension contributions) (see EIM45615)

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The arm’s length condition

The arm’s length condition is an anti-avoidance condition. It will be failed if, in essence, the income represents a return from sum or asset R which exceeds the return which might be expected on the assumption that all ‘relevant connected persons’ are acting at arm’s length of each other.

When considering the arm’s length condition, you take into account the type of investments from which the income derives, whether directly or indirectly.

A ‘relevant connected person’ is a person with a connection (direct or indirect) to the arrangement under which the income arises. ‘Connection’ here has its normal English meaning.

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Example

A sum of money has been earmarked for A by being held in a sub-trust. Income arises on this sum and is earmarked for A or A’s family, and Sections 554A and 554B are met.

If the conditions are met, Section 554Q will stop the earmarking of this income from giving rise to Part 7A income.

But Section 554Q will not prevent Part 7A income arising if a relevant step is taken within Section 554C or 554D.

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Earlier relevant step before 6 April 2011

Suppose:

  • the income is the subject of a relevant step within Section 554B, but
  • the earlier relevant step was taken before 6 April 2011.

Then the income needs the shelter of Section 554Q but the second of the conditions focusing on sum or asset R cannot be met, because the earlier relevant step could not possibly have given rise to Part 7A income.

The transitional rule in Schedule 2 paragraph 56 FA 2011 solves this problem. It deems this condition to be met if - supposing the Part 7A rules had been in force when the earlier relevant step was taken - that step would have either (a) given rise to Part 7A income or (b) given rise to Part 7A income but for one of the listed exclusions.

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Relevant step within Section 554C or 554D

If income is the subject of a relevant step within Section 554C or 554D, then Section 554Q cannot stop Part 7A income arising.

So, the full value of relevant steps within Sections 554C and 554D will be chargeable if they are funded by income arising from sum or asset R.