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HMRC internal manual

Employment Income Manual

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Employment income provided through third parties: transition: relevant step within Section 554C or 554D giving rise to Part 7A income: relevant step within Section 554B before 6 April 2011 already taxed

Schedule 2 paragraph 59 FA 2011

Conditions applying to the relevant steps
Tax compliance conditions
Value condition
Reduction
Settlement credit

There is the possibility of double taxation if what is effectively the same amount is:

first taxed as earnings from the employment in relation to a step taken before 6 April 2011, and

then taxed again under Part 7A ITEPA 2003.

This could happen if there is a third party arrangement which results in employment income being taxed both as earnings from the employment and under Part 7A.

There are special rules to stop this double taxation by reducing the value of the relevant step to take account (to summarise) of the amount taxed.

In summary, these special rules apply if:

  • a relevant step within (what is now) Section 554B is taken before 6 April 2011,
  • a relevant step within Section 554C or 554D is taken giving rise to Part 7A income, and
  • specified conditions are met.

It is necessary to meet:

  • conditions applying to the relevant steps,
  • a tax compliance condition, and
  • the value condition.

If all the conditions are met, Part 7A income is reduced.

For a worked example of these rules, see EIM45940.

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Conditions applying to the relevant steps

The relevant steps must meet three conditions.

  • A relevant step within Section 554B (‘the pre-6 April 2011 step’) was taken in a tax year before 6 April 2011 (‘the pre-6 April 2011 tax year’). See EIM45095.

This transaction did not give rise to any Part 7A income but it was still a relevant step within (what is now) Section 554B.

  • A relevant step (‘the chargeable step’) within Section 554C or 554D is taken and would apart from these special rules - give rise to Part 7A income. See EIM45060 onwards.
  • The chargeable step gives rise to Part 7A income.

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Tax compliance conditions

There are two tax compliance conditions. One of these alternative conditions must be met.

The two conditions are very similar. The second condition does not necessarily involve an agreement with HMRC. The first condition does.

This is the first tax compliance condition. It is laid down in Schedule 2 paragraph 59(1)(d)(i) and (e)(i) FA2011. There are three parts to this condition and they must all be satisfied.

  • Before the chargeable step is taken, an agreement was made between HMRC and:

    • A,
    • B, or
    • both A and B.
  • It was agreed that the pre-6 April 2011 step was to be treated as giving rise to earnings within Section 62 ITEPA 2003 (see EIM00511) of A from A’s employment with B for the pre-6 April 2011 tax year.
  • Before the chargeable step is taken, A or B has paid (or otherwise accounted for) any tax which A or B is required to pay (or otherwise account for) as a consequence of this agreement.

This is the second tax compliance condition. It is laid down in Schedule 2 paragraph59(1)(d)(ii) and (e)(ii) FA2011. There are two parts to this condition and they must both be satisfied.

  • Before the chargeable step is taken, the tax payable by A for the pre-6 April 2011 was otherwise decided on the basis that the pre-6 April 2011 step was to be treated as giving rise to earnings within section 62 ITEPA 2003 (see EIM00511) of A from A’s employment with B for the pre6April2011 tax year.
  • Before the chargeable step is taken, A or B has paid (or otherwise accounted for) any tax which A or B is required to pay (or otherwise account for) as a consequence of this decision.

Note that both these conditions refer to tax which ‘A or B has paid (or otherwise accounted for)’. Therefore, neither condition will be met if there is merely:

  • a tax liability which has not been settled, or
  • a potential tax liability.

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Value condition

To see whether the value condition is met, you take three steps.

Step 1. Calculate the value of the chargeable step after any reductions under:

* Section 554Z4 (residence issues see [EIM45720](https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim45720)),
* Section 554Z5 (overlap with earlier relevant step see [EIM45725](https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim45725)),
* Section 554Z6 (overlap with certain earnings see [EIM45735](https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim45735)),
* Section 554Z7 (exercise price of share options see [EIM45740](https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim45740) onwards), and
* Section 554Z8 (cases where consideration given for relevant step see [EIM45755](https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim45755) onwards).

Step 2. Determine, on a just and reasonable basis, the extent to which the result of Step 1 represents the earnings treated as arising from the pre-6 April 2011 step under the tax compliance condition. If it represents those earnings to any extent, then the value condition is met. Go to Step 3.

Step 3. Determine, on a just and reasonable basis, the extent to which the value calculated at Step 1 represents any return on those earnings. If it represents such a return to any extent, then the value condition is met but only to that extent.

In Step 3, the return can be income or capital, direct or indirect, realised or unrealised.

In Step 3, exclude any return so far as it is reasonable to suppose that the return exceeds the return which might have been expected on the assumption that all relevant connected persons are acting at arm’s length of each other. In other words, the amount that meets the value condition will exclude contrived or uncommercial returns on the original earnings.

A ‘relevant connected person’ is a person with a connection (direct or indirect) to the arrangement under which the return arises (Schedule 2 paragraph 59(4) FA 2011). ‘Connection’ here has its normal English meaning.

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Reduction

You reduce the value of the chargeable step by an amount which reflects the extent to which that value represents (or still represents):

  • the earnings treated as arising from the pre-6 April 2011 step under the tax compliance condition, or
  • any return on those earnings.

You calculate this reduction on the same basis as in Steps 2 and 3 of the value condition.

You make this reduction after any reductions under Sections 554Z4 to 554Z8. It cannot reduce the value of the chargeable step beyond nil.

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Settlement credit

This reduction is often called the ‘settlement credit’.

But remember that it is a reduction in the amount of Part 7A income, calculated by reference to other income.

This reduction will as a result reduce the income tax liability on the Part 7A income (unless, of course, this income would in any case have been covered by other allowances or reliefs).

But Schedule 2 paragraph 59 FA 2011 does not require a comparison between tax on the Part7A income and tax on the other income. So, the ‘settlement credit’ does not give credit for tax against tax. Instead, it reduces the value of the Part 7A ‘chargeable step.’