INTM202020 - Controlled Foreign Companies: definitions
ICTA88/S755D (introduced by FA00) provides specific rules, effective from 21 March 2000, for determining whether a company is controlled by persons resident in the United Kingdom for the purposes of Chapter IV. The new test is similar in many ways to the transfer pricing participation and management test in ICTA88/SCH28AA/PARA4. For example:
- it mirrors the well-established meaning of control in CTA2010/S1124 (see 'Control' below);
- it includes specific rules for international joint ventures (see The '40% test - ICTA88/S747(1A)’ below); and
- it includes anti-avoidance rules that attribute to a person, for example, interests, rights and powers held by another person (see ‘Attribution rules - ICTA88/S755D (5) - (9)’ below).
'Control' is defined at ICTA88/S755D(1) and means the power of a person to secure that the affairs of a company are conducted in accordance with his wishes. Where two or more persons have the power to secure that the affairs of a company are conducted in accordance with their wishes, they are treated as having control of it. Such powers in S755D are related to holding shares or to powers conferred by articles of association or other related documents. The definition has been extended with effect for determinations of control on or after 12 March 2008. For information about these changes see ‘Extension of Control’ - ICTA88/S755D(1A)’ below.
The test is not a mechanical one based simply on, for example, shareholding or voting rights. The aim is to establish whether a person (or persons) has the power to ensure that the affairs of a company are conducted in accordance with his (or their) wishes. If such power is exercisable only as a result of share holding, it is to the shareholdings that one would look to determine control but it will not be a simple mechanical or mathematical test.
Assume for example, the following structure:
DRAWING - INTM202020D1
On a purely mathematical basis, UK has only 48.75% of NR2. It nonetheless clearly has the power to secure that the affairs of NR1 are conducted in accordance with its wishes and as NR1 also has control of NR2, UK also clearly has the power to secure that the affairs of NR2 are conducted in accordance with its wishes. NR2 will therefore be a controlled foreign company within the meaning of ICTA88/S755D, by virtue of share holding.
On the other hand, assume a slightly different structure:
DRAWING - INTM202020D2
On a simple mathematical calculation, UK1 has 35% of CFC and UK2 has 25% of CFC, giving a total of 60% which would appear to give control to persons resident in the UK. If, however, one person owned the remaining 65% in the joint venture, that person would on their own on a purely mathematical basis have 65% of the CFC. Clearly, one cannot have 125% of a company and the reason for the additional 25% is that UK2’s shareholding in CFC has effectively been counted twice.
However, simply eliminating double counting will not necessarily produce the right answer. In the above scenario, for example, eliminating the double counting reduces the total shareholding in CFC of UK1 and UK2 to 51.25% (UK2’s 25% + UK1’s 35% x 75% (=26.25%)). Again, this would appear to give control to persons resident in the UK. Yet UK1 and UK2 are clearly not in a position - even together - to secure that the affairs of CFC are conducted in accordance with their wishes. UK1’s minority interest in the joint venture does not confer additional control over CFC. The other shareholder(s) of Joint Venture could prevent that happening - whether or not any of those shareholders themselves is in a position to exercise control. As such, CFC is not controlled by UK persons for the purposes of Chapter IV.
The '40% test' - ICTA88/S747(1A)
A company is also treated as controlled by UK persons if the conditions of the '40% tests' in ICTA88/S755D(3) and (4) are met. That is, where:
- two persons (one UK resident and the other not UK resident) together control a company; and
- the UK person has interests, rights and powers representing at least 40% of the holdings, rights and powers by which the company is controlled; and
- the non-UK person has interests, rights and powers representing at least 40% but not more than 55% of such holdings, rights and powers.
40% in this context means 40% of a situation where more than 50% would give a person control of the company and refers to 40% of all the interests, rights and powers of the kind which gives the two persons in question control of the company. The fact that the test applies only where there are two persons who together control (directly or indirectly) a company does not mean that it does not apply where one of those two persons has the power to control the company on their own. Where, for example, a non-resident person holds 55% of a company and a UK person holds the remaining 45%, the test will be satisfied and the company will be treated as controlled by UK persons.
Extension of Control -ICTA88/S755D(1A)
For determining control at any time on or after 12 March 2008 the definition of control is extended to include control by rights to the majority of:
- any distribution of the company’s income, were such a distribution to be made or
- the proceeds of any sale of the company’s share capital, were such a sale to take place or
- the assets in the event of a winding up of the company.
Attribution rules - ICTA88/S755D(5) - (9)
The rights and powers held by another person that can be attributed to a person are:
- those that a person who (whilst he does not hold them at the relevant time) is either entitled to acquire in the future or which, in the future, he will be entitled to acquire;
- those held by or through nominees and the like; and
- those held by connected persons - where both persons are UK resident.
- where there are three persons (for example, A, B and C) and A is connected to B and B is connected to C but A and C are not connected, so long as each is resident in the UK, any rights and powers of A are to be attributed to C and vice versa;
- where there are more than three persons (from, say, A to Z) where, say, C is connected to D, D to E, E to F and so on, so long as all relevant persons are resident in the UK and there is a chain of connection between them, any rights and powers of any one of them are to be attributed to each other.
As well as the general attribution regarding future entitlements in the first of the above bullets, all of the other attributions also refer to rights and powers that a person who (whilst he does not hold them at the relevant time) is either entitled to acquire in the future or which, in the future, he will be entitled to acquire.
Finally, where the rights and powers a person has - or rights and powers to which he will, in the future, be entitled - can only be exercised jointly with another person, such rights and powers are also to be attributed where appropriate.
The question of whether one person is connected to another is determined in accordance with CTA2010/S1122 - but CTA2010/S1122(4) (which treats, for example, partners in a joint venture as connected with each other by virtue of their respective interests in the joint venture) is disapplied for these purposes. As such, no attribution can be made from one joint venture partner to another under the connected party rules unless there is a connection between the partners other than through the joint venture itself.