INTM208210 - Controlled Foreign Companies: exemptions - the motive test

Application of motive test: United Kingdom takeover of overseas group - 'period of grace'

It will often be the case that when a United Kingdom group takes over an overseas group, it will inherit overseas companies that will not satisfy the criteria of the objectively-based exemptions. Indeed, some of the subsidiaries may well have been set up wholly or mainly to avoid tax. It is highly unlikely, however, that such subsidiaries will have been set up to avoid United Kingdom tax - since they will have been controlled by non-United Kingdom persons that will not have been subject to United Kingdom taxation under the United Kingdom’s controlled foreign companies rules or, indeed, more generally.

Whilst, once under United Kingdom control, most of these subsidiaries will achieve a reduction in United Kingdom tax by a diversion of profits within the meaning of ICTA88/SCH25/PARA19, most will not, initially at least, have as one of the main reasons for their continued existence the achievement of that reduction. They will therefore initially pass the diversion of profits leg of the motive test.

As with any other case, the question of whether such a controlled foreign company passes the motive test will be a question of fact. As a matter of administrative practice, however, HM Revenue and Customs will, on receipt of a satisfactory clearance application (see INTM214120 and following pages), accept that the motive test is satisfied in the case of newly acquired overseas subsidiaries up to the end of the first full (i.e. 12 months) accounting period following acquisition. This is commonly known as a 'period of grace' clearance.

Thereafter, the main reasons for the continued existence of the company are very likely to change. It will be under the control of United Kingdom persons. The motives of those from whom the United Kingdom group acquired the company will no longer be relevant. By then, the achievement of a reduction in tax by a diversion of profits in accordance with ICTA88/SCH25/PARA19 may well have become one of the main reasons for its continued existence. Indeed, merely allowing the company to continue to exist may be enough to fail the motive test.

It should be noted that the 'period of grace' clearance will apply only to:

• controlled foreign companies that were not previously under United Kingdom control; and
• controlled foreign companies whose main business remains unchanged throughout the relevant period.

So, the clearance will not apply, for example, to an overseas company that, prior to the takeover was part of a United Kingdom sub-group. In such circumstances, it could be the case that the United Kingdom-owned non-United Kingdom subsidiaries have been set up to avoid United Kingdom tax (and they will of course, in any event, already be subject to the United Kingdom’s controlled foreign companies rules).

Similarly, the clearance will not apply to any company whose main business changes following United Kingdom acquisition. This is not least because such a change implies active involvement of the new controller(s) whose motives will thereby have usurped those of the previous controller(s).