Advanced Taxation Session 16: Controlled Foreign Companies, Exit Charges, and the Dividend Exemption

Session 16 Learning Objectives and Competency Framework

• Learning Objectives: By combining this session with the follow-up in the Learning Journal, students will be able to advise on:

  • How Controlled Foreign Company (CFC) rules affect UK companies.

  • Exit charges arising when a company migrates tax residence outside the UK.

  • Whether dividends received by companies are exempt from UK Corporation Tax, including planning aspects.

• Competency Statement References (Framework for Taxation):

  • International Issues (2.1): Demonstrate awareness of the foreign profits regime, including the Dividend Exemption (Applied level).

  • Residence Migration: Demonstrate knowledge of the Corporation Tax implications of a company changing residence out of the UK (Applied level).

  • CFC Rules: Discuss and apply the rules for Controlled Foreign Companies (CFC) and the interaction of double tax relief (Integrates level).

Controlled Foreign Companies (CFC): Part 1 Objectives and Definitions

• Objectives of the CFC Rules:

  • Designed to prevent UK resident companies from conducting activities outside the UK to take advantage of lower tax rates in foreign territories.

  • The regime specifically applies to income profits only.

  • Key Principle: Overseas activities are not taxed in the UK unless there is an "artificial reduction" of the UK tax base.

  • Legislation: The rules are contained in Part 9A of TIOPA 2010.

  • Targeting: Where a CFC charge applies, it is proportionate, targeting only profits artificially diverted from the UK. The legislation uses "gateways" to identify these circumstances.

• Definition of a CFC (s371AA(3) TIOPA 2010):

  • A company is a CFC in an accounting period if:

    1. It is non-UK resident.

    2. It is controlled by "persons" resident in the UK.

  • CFC status may need to be reported on the CT600 form of any UK corporate shareholder.

• Determining Residence (s371TB TIOPA 2010):

  • Step 1: The territory in which the CFC is liable to tax by reason of domicile, residence, or place of management.

  • Step 2: If the above is not applicable, the territory in which the CFC was incorporated.

• Definition of Control:

  • Control is achieved in two ways:

    1. Economic Control: The $50\%$ test.

    2. Legal Control: Holding of shares, voting power, or any similar power enabling UK persons to ensure the company's affairs are conducted in accordance with their wishes.

  • Aggregation: Ownership of all associated enterprises must be aggregated to any UK persons to determine if ownership exceeds $50\%$.

  • Broad Scope: The definition is widely drafted to catch companies controlled by any number of UK resident shareholders. All UK resident shareholders (individual and corporate) are considered.

• Control Example 1:

  • Structure: Antrim Ltd (UK) holds $30\%$, Armagh Ltd (UK) holds $35\%$, Mr. Tyrone (UK) holds $15\%$, and Spain SA (Non-UK) holds $20\%$.

  • Result: Isle of Man Ltd satisfies the control test under s.371RB TIOPA 2010 ($50\%$ test) because it is controlled by three UK resident taxpayers totaling $80\%$ ($30+35+15$). Even though Antrim Ltd only holds $30\%$, it must declare the CFC on its CT600.

• Control Example 2:

  • Structure: Antrim Ltd (UK) holds $10\%$, Armagh Ltd (UK) holds $30\%$, Mr. Tyrone (UK) holds $9\%$, and Spain SA (Non-UK) holds $51\%$.

  • Result: Isle of Man Ltd does not satisfy the control test as UK resident taxpayers total only $49\%$.

CFC Part 2: Overview and Entity-Based Exemptions

• Two-Step Process for CFC Regime:

  • Step 1: Establish if the foreign company is a CFC (non-UK resident and UK controlled).

  • Step 2: Establish if a CFC charge applies via specific tests (Exemptions or Gateways).

  • Chargeable Company Definition: A UK resident company is chargeable if at least $25\%$ of the CFC chargeable profits are apportioned to it.

• Entity-Based Exemptions: If any of these are met, there is no CFC charge for the period (though reporting may still be required):

  1. Exempt Period Exemption: No CFC charge for the first $12$ months after a non-resident company comes under UK control, allowing time for reorganisation.

  2. Excluded Territories Exemption: Applies to CFCs resident in specific territories listed by HMRC.

  3. Low Profits Exemption:

     • Accounting profits/assumed taxable total profits are under $£50,000$.

     • OR Accounting profits/assumed taxable total profits are under $£500,000$ and non-trading income is under $£50,000$.

  4. Low Profit Margin Exemption: Applies if the CFC’s accounting profits (before interest) are not more than $10\%$ of the CFC’s relevant operating expenditure.

  5. Tax Exemption: No charge where the local tax amount paid by the CFC is at least $75\%$ of the corresponding UK tax that would have been paid.

• Gateway Tests:

  • If no entity-based exemptions apply, consider the CFC charge gateways. Only profits passing through the gateways are liable to UK tax.

  • Gateways must be applied separately to each category of profit (trading vs. non-trading).

  • Initial Charge Gateway (Chapter 3): Introduced to reduce compliance burdens. If profits do not pass this gateway, there is no CFC charge.

  • Initial Gateway Conditions for Chapter 4 Trading Profits: If any of the following four conditions are met, there is no CFC charge:

    1. The CFC does not have UK tax minimisation as a main purpose.

    2. The CFC does not have any UK managed assets.

    3. If there are UK managed assets or risks, the CFC has the capability to ensure its business remains commercially effective.

    4. The CFC’s assumed total profits consist solely of non-trading profits and/or property business profits.

CFC Part 3: Main Charge Gateways and Implications

• Main Charge Gateways (Chapters 4-8):

  • Chapter 4: Profits attributable to UK activities.

  • Chapter 5: Non-trading finance profits.

  • Chapter 6: Trading finance profits.

  • Chapter 7: Captive insurance.

  • Chapter 8: Solo-consolidation.

• Chapter 4 - Profits Attributable to UK Activities:

  • Focuses on profits where contractual arrangements are largely tax-driven.

  • Safe Harbour Exclusion (Trading Profits Exclusion): If all five conditions are met, all trading income is excluded:

    1. Business Premises Condition: CFC must have premises in the foreign territory.

    2. Income Condition: No more than $20\%$ of relevant trading income derives from UK resident persons.

    3. Management Expenditure Condition: UK-related management expenditure is not greater than $20\%$ of total related management expenditure.

    4. IP Condition: No intellectual property has been transferred to the CFC from UK related parties within the previous $6$ years.

    5. Export of Goods Condition: No more than $20\%$ of trading income arises from goods exported from the UK.

• Chapter 5 - Non-trading Finance Profits:

  • Profits from lending brought into charge if:

    • Derived from UK-undertaken activity (e.g., lending decisions).

    • Lending is derived from UK capital investment.

    • Loans are made to UK residents.

  • Exception: Lending incidental to an exempt trade or property business, or holding shares in subsidiaries.

• Chapter 9 - Finance Company Exemption:

  • Provides full or partial exemption for Chapter 5 profits if a claim is made.

  • Applies to loans made to another CFC under common control (Qualifying Loan Relationship).

  • Restriction: No exemption if profits fall within the charge due to Significant People Functions (SPFs) carried on in the UK.

  • Benefits: Facilitates funding overseas growth and tax-efficient circulation of cash.

• Implications of CFC Charge:

  • Taxable profits allocated to "relevant persons" in proportion to shareholdings.

  • Only UK corporate shareholders with an interest greater than $25\%$ are liable for apportionment.

  • Profits are subject to UK Corporation Tax at the relevant rate, minus "Creditable Tax" (local tax paid).

• Summary & Administration:

  • SPFs: Defined as people carrying out fundamental business functions leading to the assumption of risk.

  • Reporting: Via CT600B on the company tax return.

  • Clearance: Companies can apply to HMRC for clearance on various aspects of CFC legislation.

Exit Charges

• Basis of Charge: If a company ceases to be UK resident (migrates), exit charges arise on unrealised capital gains on chargeable assets (Sections 185 and 186 TCGA 1992).

• Deemed Disposal: The company is treated as having disposed of all assets at market value.

• Excluded Assets: Assets remaining within the UK tax charge are excluded, including:

  • UK land.

  • Indirect interests in UK land.

  • Assets situated in the UK held for the purposes of a trade of a UK Permanent Establishment (PE).

  • Note: Substantial Shareholdings Exemption (SSE) cannot qualify for deemed disposals under exit charge rules.

• Other Asset Charges:

  • Intangible Assets: Similar charge under Section 859 CTA 2009.

  • Plant and Machinery: Balancing charges or allowances arise due to the cessation of trade.

  • Stock: Under Section 164(4) CTA 2009, stock is valued at the amount it would have realised in the open market.

• Exit Charge Payment Plan:

  • Available if migrating to an EEA state.

  • Election must be made within $9$ months of the end of the migration accounting period.

  • Deferral: Paid in six equal annual instalments starting on the normal Corporation Tax due date.

  • Interest: Amounts deferred are subject to interest.

  • Trigger Events (Immediate Payment): All outstanding tax becomes due if:

    1. Company becomes insolvent or enters administration.

    2. A liquidator is appointed.

    3. Company ceases to be resident in the EEA.

    4. Failure to pay an instalment within $12$ months of it becoming due.

• Notification Procedure:

  1. Give notice to HMRC of intention to cease UK residence.

  2. Specify migration date.

  3. Provide statement of tax outstanding at the proposed migration date.

  4. Quantify the tax to be included in the payment plan.

• Administration: Migration causes the chargeable accounting period to end. No further returns or payments are due after the final return for the period ending on the migration date.

Dividend Exemption

• General Rule: UK legislation includes important exemptions for dividends received by UK resident companies from UK or overseas companies.

• Augmented Profits: While exempt, dividends from non-group companies must be included in the calculation of augmented profits to determine the Corporation Tax rate and whether instalment payments are required.

• Exemption for Small Companies (s931B CTA 2009): Exempt if all of the following are met:

  1. Payer is resident in the UK or a "Qualifying Territory" (one with a double taxation treaty containing a standard non-discrimination provision).

  2. Payer is NOT a dual resident company.

  3. Distribution is not a non-dividend distribution (Paragraph E or F of s1000(1) CTA 2010).

  4. The dividend has not been allowed as a deduction from taxable profits outside the UK.

  5. The distribution is not part of a tax advantage scheme.

• Exemption for Other Companies (Not Small): Dividends must fall within one of five exempt classes (s931E to s931I CTA 2009):

  1. Distributions from controlled companies (s931E).

  2. Distributions in respect of non-redeemable ordinary shares (s931F).

  3. Distributions in respect of portfolio holdings (s931G).

  4. Dividends derived from transactions not designed to reduce tax (s931H).

  5. Dividends in respect of shares accounted for as liabilities.

• Election to be Taxable: A company can elect (within $2$ years of the end of the accounting period) to make a particular distribution taxable to reduce foreign withholding tax rates via treaty requirements.

• Planning and Anti-Avoidance:

  • Exempt dividends receive no credit for foreign tax; if taxable, credit relief is granted.

  • Care is needed with "pre-acquisition profits" distributed after acquiring control (anti-avoidance for depreciatory transactions).

  • Small companies should consider deferring dividends from non-qualifying territories until the group is no longer "small."

  • Intermediate holding structures should be reviewed to minimize incremental overseas taxes.