Sale of income by individual in exchange for capital

Selling future income streams for a lump sum payment has recently gained popularity. This allows individuals to access funds based on their future earning potential. However, it is important for those considering this option to understand the tax implications and navigate the complexities. This article provides an overview of the key considerations and potential tax consequences of selling income for capital.

Income Tax Treatment: When an individual sells future income for a capital sum, the transaction may be characterized as a “reverse premium.” A reverse premium arises when an individual receives an upfront lump sum payment in return for agreeing to make future income payments. The tax treatment of this arrangement depends on the nature of the transaction and the circumstances under which it takes place.

Normal Trade Receipts: If the Sale of future income forms part of an individual’s regular trading activities, the amount received will generally be treated as a trade receipt and taxed as income. For instance, a consultant selling their future consultancy income for an upfront capital sum would be subject to income tax, as the transaction forms part of their normal trading activities.

Non-Trading Receipts: If the Sale of future income is not part of an individual’s normal trading activities, the amount received will be treated as a non-trading receipt and taxed as income. For example, this might apply in cases where an individual sells rights to future royalties from creative works, such as a book.

Capital Gains Tax Treatment: In certain instances, the Sale of future income may be regarded as a disposal of an asset, which could result in capital gains tax implications. If the rights sold are deemed an asset, the transaction may be subject to capital gains tax. For example, selling future royalties from a book could incur capital gains tax if the rights to those royalties qualify as an asset.

Tax Relief and Allowances: Individuals may be eligible to claim tax relief or allowances on specific costs incurred while selling future income. For example, relief may be available for legal and professional fees associated with the transaction. Moreover, certain allowances, such as the annual exempt amount, could be utilized to offset capital gains tax liability.

The Sale of income in exchange for capital can entail complex tax implications. Therefore, it is crucial for individuals to carefully consider the nature of the transaction and the specific circumstances under which it occurs to determine the appropriate tax treatment. While this article offers a valuable framework for understanding the implications of selling income for capital, consulting a tax professional is highly recommended to ensure compliance with all applicable rules and regulations.

Sale of Future Consultancy Income: Suppose a management consultant, Jane, anticipates earning £300,000 in consulting fees over the next three years. She decides to sell her future income to an investment firm in exchange for an upfront capital payment of £250,000. In this scenario, the transaction is part of Jane’s normal trading activities as she sells her future consulting services. For tax purposes, the £250,000 would be considered a trade receipt and subject to income tax. Jane must include this amount in her taxable income for the year she received the payment. Depending on her tax bracket and other sources of income, Jane would be required to pay income tax on the £250,000 at her marginal tax rate.

Sale of Future Royalties from a Book: Consider an author, David, who has written a book expected to generate £100,000 in royalties over the next five years. David decides to sell the rights to these future royalties to a publishing company for an upfront capital sum of £80,000. In this case, the transaction is not part of David’s normal trading activities, as he sells the rights to future royalties rather than his services. For tax purposes, the £80,000 would be considered a non-trading receipt and subject to income tax. David would need to report this amount as part of his taxable income for the year he received the payment. He would pay income tax on the £80,000 at his marginal tax rate.

Additionally, since David is selling the rights to the royalties, the transaction could be viewed as a disposal of an asset, which may have capital gains tax implications. If there is a gain between the original cost of the asset (the rights to the royalties) and the £80,000 he received, David would be required to pay capital gains tax on the difference. He could use his annual exempt amount to offset a portion of the capital gains tax liability if available.

If you need help to plan your taxes, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.