An unintended change in tax law may mean that partnership members have missed out on claiming relief against Class 4 National Insurance Contributions for annuities paid to former partners in 2007/08.
An error made in the Income Tax Act 2007 meant that, technically, claims for NIC relief in tax returns for the year 2007/08 were illegal and it is possible that returns and self assessments for that year may not have included claims for NIC relief as a result.
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HMRC has recognised that the repeal was an oversight and it is going to be remedied, probably by the next Finance Act. The amended law will be made retrospective to 6 April 2007, meaning that claims for NIC relief already made for that year will be retrospectively validated and any partnership that did not deduct qualifying annuities for 2007/08 can now do so.
However, the legal window for amendment of the 2007/08 returns will only be open until 31 January 2010. Therefore, partnerships that paid annuities to ex-partners in that year and did not claim NIC relief on the annuity have less than three months in which to make a claim.
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The change was made by the Income Tax Act 2007 (ITA). This was introduced as part of the Tax Law Rewrite Programme, a programme intended to simplify the form of tax law, making it easier to use without changing its meaning. Unfortunately, however, ITA repealed paragraph 3(5) Schedule 2 of the Social Security (Contributions and Benefits) Act 1992, which previously ensured that annuities deductible for income tax purposes would also be deductible when calculating NICs. The result was nonsensical and it was not intended.
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Annuities to ex-partners are generally allowable, but tax and NIC deduction is not automatic. The strict legal position is that the capital value of an annuity should be treated as capital gains tax consideration for the ex-partner’s sale of his or her partnership share. But Revenue & Customs’ statement of practice D12 generally overrides that rule to the extent that the annuity is reasonable recognition of the retired partner’s past contribution of work and effort to the partnership.
Annuities that meet that test will be accepted by HMRC as allowable: the excess over a reasonable sum will not be accepted as being incurred for the purposes of the partnership’s business and will instead be partly disallowed. To the extent that an annuity to a former partner is taxable as a capital gain, the amount of the gain is taxable in full for the year in which the right to receive the annuity arises. This means that, although the rate of tax may be lower, being CGT at 18%, the tax is payable ‘up front’ as a single lump sum instead of being paid annually on the annuity.
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Partnerships that pay annuities need to review their 2007/08 returns to check whether they included a deduction of the annuities paid to former partners in the profit calculation made for Class 4 NIC purposes, because this is the figure that will have been used as the basis for individual partners’ self assessments.
If the partnership statement did not include the annuities, an amendment to the return needs to be filed to enable individual partners to amend their personal returns and so reclaim the overpaid NICs.