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HMRC internal manual

Savings and Investment Manual

HM Revenue & Customs
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Deduction of tax: annual payments and yearly interest: overview

The obligation to deduct tax: background

A long standing feature of the tax system has been the obligation imposed on persons paying certain types of interest, and annual payments and patent royalties (referred to as ‘charges’ on income) to deduct tax and account for it to the Revenue. See SAIM8000 for more on annual payments. Formerly, interest and charges were not allowable as deductions in computing profits from a given source. For tax purposes the amount of the charge was treated as alienated by the payer and formed part of the payee’s income. In effect the payer accounted for the tax liability of the recipient of the payment by deducting tax and paying it to the Revenue, and the payee received a net payment.

The types of interest and annual payment to which deduction of tax was applied became narrower over the years. For tax years before 2006-07, the rules on the deduction of tax were ICTA88/S348 to S350 and applied to

  • annual payments made ‘out of’ profits or gains brought into charge to income tax (ICTA88/S348);
  • annual payments and ‘annual interest’, ‘not out of’ profits or gains brought into charge to income tax (ICTA88/S349). This applied mainly to companies, which pay corporation tax rather than income tax on their profits.

ICTA88/S348 entitled a person paying an annuity or other annual payment to deduct tax from the payments. For an income tax payer, this meant that deduction of tax was optional, although in practice the payer would pay net. The annual payment was not an allowable deduction from income, and was therefore made out of taxed income. Tax was collected as part of the tax charged on the payer’s income. Other provisions in the Taxes Acts reduced personal reliefs or the availability of losses in cases where the payer only had enough taxable income to cover part of the charge.

Under ICTA88/S349 deduction of tax was mandatory. It required the deduction of tax from annuities, annual payments not made ‘out of’ profits or gains brought into charge for income tax and from payments of ‘annual interest’. These were cases where the payer did not have enough income out of which the payments were made, or to payments made by companies. (See the Company Tax Manual CTM9000 for more on charges paid by companies SAIM20000).

ICTA88/S350 allowed the Revenue to raise an assessment on the payer to recover the tax if they failed to deduct tax at source, as required under ICTA88/S349 or where annual payments under ICTA88/S348 exceeded taxed income.

SAIM9050 has more on the old legislation.

The scope of these sections was further simplified as a consequence of the Tax Law Rewrite project. From 2007-08 onwards, relief for annual payments and patent royalties is now given in Chapter 4 of Part 8 of ITA07, which merges the rules formerly in ICTA88/S348 and S349 into a single tax treatment replacing the former legislation on charges on income with an ordinary deduction from income. The requirement to deduct tax from interest, annual payments, etc. is now part of the rules in Part 15 of ITA07. SAIM9060 has more on the new legislation.