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HMRC internal manual

Savings and Investment Manual

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Annual payments: examples

Examples of annual payments

Example 1

Peter carries on a trade as a software developer and software consultant. In the course of the trade, he develops a suite of computer programs in which there is commercial interest. He sets up a company, of which he and his wife Teresa are directors, to exploit and market the software.

Peter enters into a licensing agreement granting the company a 25-year licence on the source code and intellectual property rights in the software, in exchange for a licence fee paid quarterly. The agreement does not require him to further develop or maintain the software, or supply technical advice to users - this is all done by the company.

The licence fees received by Peter are agreed to form part of the income of his trade as a software developer, and are included in the amount he returns as trading profits. However, Peter dies, and under the terms of his will, the intellectual property and the benefit of the licence agreement pass to Teresa.

Teresa does not carry on a trade of her own, and any work she does in connection with the software is done in her capacity as a director of the company. In her hands, the licence fees are annual payments. This is because the company is legally obliged under the licensing agreement to pay them, they are recurrent, and - in particular - they represent pure income profit to Teresa. She does not have to do anything to earn them, and does not have to set outgoings against them.

The company is now making annual payments, and must deduct income tax at the basic rate from the licence fee payments and account for it on form CT61Z (see SAIM9000 onwards).

Teresa must enter the annual payments received in a tax year as ‘other taxable income’ on her self assessment return (not as taxed interest). If she is liable to tax only at the basic rate, she has no more tax to pay on the sums she receives.

Example 2

Vivienne, a UK resident, travels to the US to negotiate with a boat-building company, and buys an ocean-going yacht from them for $2.6 million. In order to clinch the deal, the salesman makes an offer (later confirmed in writing by the company) to pay Vivienne $60,000 a year for the next 5 years. Although the payments are expressed as a contribution towards the running costs of the yacht, there is no obligation on Vivienne to spend them in any particular way. She accepts the offer.

The agreement constitutes a legally enforceable contract, even though it is only documented informally. The payments are made in consideration of Vivienne’s purchase of the boat. Once she has made the purchase, however, she does not have to do anything further in order to receive the payments (see the discussion of conditions and counter-stipulations at SAIM8040). They are therefore annual payments.

Since the payments do not originate in the UK, Vivienne does not receive them with income tax taken off, and she must pay tax at both basic and higher rates on the income (although she can claim relief for any US withholding tax).

Example 3

William signs up for a credit card offering a ‘cashback’ feature. Twice a year, the issuer credits to the card an amount equal to 1% of the payments William has made in the previous 6 months. Such credits are not annual payments. Each payment is contingent on his having charged amounts to the credit card in the previous period. In essence, each payment represents a one-off rebate of amounts that William has paid to the card issuer. Any future cashback received will be dependent on the cardholder making more purchases with the card and no further cashback will be received if there are no future card transactions.

Example 4

Tariq, a carpenter, requires £12,000 to build a workshop on to his house, for the purposes of his trade. His uncle, Mohammed, agrees to advance him the funds, but for religious reasons he does not wish to make an interest-bearing loan to Tariq. They therefore enter into a murabaha contract (see CFM3361). Under the agreement, Mohammed buys commodities for £12,000 and sells them to Tariq, who immediately sells the commodities back into the market for £12,000, thus realising the necessary funds. However, under the terms of his purchase from Mohammed, he is granted ‘credit terms’, paying 48 monthly instalments of £275, a total of £13,200.

The arrangement does not fall within the alternative finance arrangement covered by the legislation in FA05/S47, because Mohammed is not a ‘financial institution’. Mohammed does not habitually deal in commodities: while it is possible for an isolated transaction of purchase and resale to be a trading transaction (see BIM20230) and each case must be judged on its own merits, the return of £1,200 which he derives from the transaction is unlikely to be a trading profit.

If it is not trading income, the £300 received by Mohammed each year, which is over and above ‘repayment’ of the capital sum advanced, will be an annual payment - it is pure income profit in Mohammed’s hands, of a similar nature to interest.