This part of GOV.UK is being rebuilt – find out what beta means

HMRC internal manual

International Manual

Interaction with Other Legislation: Income Chargeable to S720 or S727 ITA 2007

The pages describe the interaction between the Profit Fragmentation legislation, and the Transfer of Assets Abroad (TOAA) legislation which can be found at Chapter 2 Part 13 of The Income Tax Act 2007 (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 S720 or S727 ITA 2007 of the TOAA legislation. In these circumstances S720 or S727 ITA 2007 should take precedence over the Profit Fragmentation legislation for the reasons that follow.

Paragraph 7 of the Profit Fragmentation legislation sets out the adjustments required in relation to the Profit Fragmentation arrangements. These adjustments are to be made in order to counteract any tax advantages arising from the Profit Fragmentation arrangements that remain after the application of other provisions.

Where S720 or S727 ITA 2007 has charged tax on the income such that any tax advantages arising from the Profit Fragmentation arrangements have been fully counteracted the Profit Fragmentation legislation will not apply. This is because if the individual did have Profit Fragmentation Arrangements as per the definition in paragraph 2, and S720 or 727 ITA 2007 are applied then no later adjustments will be required under paragraph 7 of the Profit Fragmentation legislation as the tax advantage will be counteracted.

If the tax advantage is only partially counteracted by the application of S720 or S727 ITA 2007 then adjustments should be made under paragraph 7 of the Profit Fragmentation legislation to counteract any remaining tax advantage. This could apply in circumstances where a resident party has incurred an expense reducing their taxable profits as a result of a payment to the overseas party. Part of the corresponding receipt is considered income in the accounts of the overseas party and is chargeable to S720 or 727 ITA 2007 on a UK resident individual, but part is treated for example as capital in the overseas party’s accounts – Profit Fragmentation would still apply to correct the remaining tax advantage.

If the arrangements include a settlor interested trust and income arises to the settlement S624 Income Tax (Trading and Other income) Act 2005 (ITTOIA) may apply to counteract any tax advantage that arises under the Profit Fragmentation rules in the same way as S720 or S727 ITA 2007.

If an arrangement is covered by the Finance Act 2018 changes, such that there is relevant foreign income, this income is potentially caught by s731 ITA 2007. For information regarding the interaction of s731 ITA 2007 and the Profit Fragmentation arrangements please see 7.1.2 below.

For the purpose of these examples we refer solely to S720 ITA 2007, but if the capital sum conditions are in point this could be read as S727 ITA 2007, and the same conclusions would follow.

 

Example A - An individual makes a provision to transfer value via a UK resident company to an overseas company owned by an overseas trust in which the individual is settlor and beneficiary.

J, a UK resident and domiciled individual, owns all of the share capital in a UK resident company which makes a payment of £150,000 to an overseas company.  The overseas company is owned by an overseas trust of which J is both the settlor and beneficiary. Following enquiries it transpires that the payment is made for services provided by the overseas company though the payments being made are inflated. The value of the services if they had been undertaken at arm’s length are £100,000 not £150,000 though full amount of this receipt is treated as income in the overseas company’s accounts. It is assumed for the purpose of this example that no other legislation applies.

The conditions for the application of TOAA are met and the profits of the overseas company will be assessable on J under S720 ITA 2007.  The conditions to be Profit Fragmentation arrangements are also met.

Assuming for the purpose of this example that the overseas company incurred no deductible expenditure the full amount of the £150,000 will be treated as income arising to J and they will be charged to tax on the full amount under S720 ITA 2007. This means that UK income tax has been paid on the full amount of the income and therefore there is no tax advantage as a result of the Profit Fragmentation arrangements.

 

Example B - An individual makes a provision to transfer value to an overseas company for the benefit of a connected person in circumstances when the conditions for s720 ITA 2007 are met.

A UK resident and domiciled individual (A) makes a payment of £150,000 to an overseas company which is owned by an overseas trust the settlor and beneficiary of which is another UK resident and domiciled individual (B). A and B are connected persons who pay income tax at the additional rate of income tax. The payment relates to services that are provided to him by the overseas company. 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, as we assume for the purpose of this example are the conditions for S720 ITA 2007 to apply.

The full amount of the £150,000 will be charged treated as income arising to B and they will be charged to tax on the full amount. This means that UK tax has been paid on the full amount of the income and therefore there is no tax advantage as a result of the Profit Fragmentation arrangements.

 

Example C- An individual makes a provision to transfer value directly to an overseas company owned by an overseas trust of which the individual is settlor and beneficiary.

A UK resident and domiciled individual makes a payment of £150,000 for services provided to him by an overseas company which is owned by an overseas trust of which he is the settlor and beneficiary. The 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 the full amount of this receipt is treated as income in the overseas company’s accounts.

The conditions to be Profit Fragmentation arrangements are met, as are the conditions for S720 ITA 2007 to apply.

Assuming for the purposes of this example that the overseas company incurred no expenditure in respect of the services provided the full amount of the £150,000 will be charged treated as arising to the UK resident individual under S720 ITA 07 and they will be charged to tax on the full amount. This means that UK tax has been paid on the full amount of the income and therefore there is no tax advantage as a result of the Profit Fragmentation arrangements.