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Tax Exemption For A Controlled Foreign Company (CFC)

The Controlled Foreign Company (CFC) regime must be considered where an overseas company is controlled from the UK. The legislation can be quite daunting for the uninitiated as it contains 22 different, and highly detailed, Chapters.

Given the complexity of the CFC legislation, it is easy to get bogged down in the detail, and this edition of Tax Connect seeks to provide outline guidance on a sensible approach to applying the series of different gateways, safe harbours and exemptions contained within the legislation.

Who could the CFC legislation apply to?

In simple terms, the CFC legislation applies to all companies that are resident outside the UK that are controlled by UK residents.

The definition of control is widely drawn and examples of situations where the legislation could apply include:

Where a CFC has been identified, and a UK company has a relevant interest of 25% or more in that CFC, a UK tax charge can arise on that company but only if the profits pass through a CFC charge ‘gateway’.

Standing at the outer gateway

The CFC charge gateways are designed to identify profits that have been artificially diverted from the UK. Only if profits pass through the gateways will they be subject to a CFC charge, and there are a number of ways in which a UK company can obtain complete exclusion from such a charge arising.

To visualise the manner in which the gateways work, imagine an outer gate with five locks in it, behind which there are a number of inner gates each with one lock. Profits will only be assessed under the CFC regime if the gates cannot be locked to prevent the profits from passing through them.

Locking the outer gate via entity-level exemptions

There are five entity-level exemptions, only one of which has to be met, to lock the outer gate and provide a complete exclusion from a CFC charge. In general terms, subject to specific anti-avoidance provisions, the exemptions are as follows:

Standing at the inner gates

Where none of the entity exemptions apply, it is necessary to proceed to the inner gates. The gates that need to be considered will depend on the nature of the CFC profits, and are classified as follows:

To determine if any of the Chapter 4 to 8 internal gates are passed through, the conditions and requirements laid out in Chapter 3 should be considered. The difficulty here is that these are to some extent subjective in nature, and the outcome will not always be clear.

However, for companies that have general profits within the Chapter 4 gateway (most trading companies), there are various ‘safe harbour’ provisions, and an initial approach would be consider these ahead of the more subjective Chapter 3 tests.

The Chapter 4 safe harbour provisions offer a full exclusion from a CFC charge provided all five conditions can be satisfied in order to confirm that there is not a significant UK connection.

These conditions can be briefly summarised as follows:

If the safe harbour provisions cannot be applied, it would usually be worthwhile making a clearance application to HMRC to confirm their view on the conditions and requirements laid out in Chapter 3. This is likely to be preferable to undertaking the detailed and subjective assessment that applies when profits of the CFC pass through the inner gates.

Passing through the inner gates

If a company has reached this stage, and cannot lock the inner gates, the profits of the CFC will need to be carefully assessed. A CFC charge can only arise to the extent that the profits of the CFC that pass through the inner gates are classified as ‘chargeable profits’.

Making this assessment will require carrying out a functional and factual analysis of each CFC’s activities, and considering this against the specific measures included within each gateway test.

For instance, both Chapter 4 and 5 require identification of the location of the Significant People Functions (SPFs) in relation to the management of the assets and risks of the CFC.

For some groups, it may be that it is judged that there are no chargeable profits or, for companies with non-trading profits, that it is possible to claim a partial or full exemption. Where there is material doubt or difficulty in making this assessment, it is possible to submit a clearance letter to HMRC to obtain certainty of position.

CFC analysis and reporting

As highlighted all CFCs must now be separately tested against the various exemptions, safe harbours and gateway provisions. This will require obtaining a variety of information about each CFC so that the appropriate analysis can be carried out, and documentation drawn up, to support the conclusions that are reached.

This analysis will be important for the completion of the UK tax return, and the CFC supplementary pages (CT600B) of the corporation tax return will need to be completed unless a CFC satisfies the Tax Exemption, the Excluded Territories Exemption or the Low Profit Margin Exemption.

Further information

Please contact your usual Menzies tax team representative or e-mail taxconnect@menzies.co.uk

Read the update in full here.