INTM208250 - Controlled Foreign Companies: exemptions - the motive test
Application of motive test: holding companies - conduit companies
Another example of a holding company that might, in certain circumstances, satisfy the conditions of the motive test is a holding company that acts purely as a conduit (i.e. it exists solely to receive dividends from its subsidiaries which it immediately passes on to its United Kingdom parent). Until relatively recently such companies have not generally been an issue as regards the motive test. This is because they would normally satisfy the conditions of either:
- the exempt activities test; or, failing that (if, for example, the company was simply a 'brass plate' with no employees/premises)
- the acceptable distribution policy test ('ADP').
There continues to be no real issue with conduit companies so
long as they are not 'brass plates'. Since FA00, however, HM
Revenue and Customs has been increasingly asked to comment on
whether brass plate conduits satisfy the conditions of the motive
test. The reason for this is of course that the rules for double
taxation relief were fundamentally changed in FA00. In particular,
'ADP dividends' cannot be pooled with other dividends.
This has created a new issue as regards the motive test. On
the one hand, genuine conduits immediately pass on the income they
receive to their United Kingdom parents - which, through the ADP
exemption, is something the controlled foreign companies' rules
are, in effect, designed to encourage.
On the other hand, however to exempt 'brass plate' conduits
under the motive test seems to be flying in the face of the spirit
of the controlled foreign companies regime since:
- offshore 'brass plates' are one of the types of company at
which the controlled foreign companies' rules are aimed and which
are specifically excluded from the exempt activities test; and
- as noted at the start of this section, the motive test is aimed
at sweeping up companies at which the controlled foreign companies'
rules are not intentionally aimed but to which an objective test is
impractical to apply - something that is clearly not the case even
for 'brass plate' conduits (where the ADP is the applicable
exemption).
That said, the legislation does not explicitly direct that one
exemption takes precedence over another. Notwithstanding the
intended function of the motive test, if a controlled foreign
company meets its conditions, those who hold an assessable interest
in the controlled foreign company are not precluded from making a
claim for relief under that exemption where one of the objective
tests is applicable. Perhaps because the motive test was not
designed with conduits in mind, however, it is not an easy test to
apply to them.
The motive test is concerned with tax-reducing diversions of
profits from the United Kingdom (as defined by
ICTA88/SCH25/PARA19). At first blush, genuine conduits do not
appear to have such a role. Indeed, even though their existence is
specifically to divert profits from the United Kingdom, they do so
only temporarily since they immediately pass on the overseas
profits to the United Kingdom.
That is not, of course, the whole story, however. Conduits
can be used, in conjunction with the double taxation relief ('DTR')
rules, to repatriate overseas profits in a manner which reduces the
United Kingdom tax that would otherwise be payable on those (or,
importantly, other) overseas profits.
As with any company, all will depend on the facts and it is
the statutory wording that needs to be considered. Notwithstanding
its specific profit repatriation role, as with most holding
companies, it will usually be the case that a conduit will, under
the terms of ICTA88/SCH25/PARA19, achieve a reduction in tax by a
diversion of profits from the United Kingdom since:
- it is clearly reasonable to suppose that, in the absence of the
conduit (and any other related, non-United Kingdom company that
could perform the same function), the whole of the conduit’s
receipts would have been received by a United Kingdom person (most
likely the United Kingdom parent); that, after all is their
ultimate destination; and
- had those receipts been received in the United Kingdom, a
United Kingdom person would have either been liable for more United
Kingdom tax or would have been entitled to less relief (for
example, DTR).
As noted above, at first blush, this seems an odd result, especially if, as a matter of fact, the on-payment of the dividends results in a tax liability that is equivalent to (or, theoretically at least, even more than) that which would have arisen had the dividends come straight to the United Kingdom instead of via the conduit. The point here, however, is that:
- ICTA88/SCH25/PARA19 obliges us to look solely at the
conduit’s receipts and to consider whether, if on the basis
that in the conduit’s absence it would be reasonable to
suppose they’d be received in the United Kingdom, there would
consequently have been more United Kingdom tax to pay (or less
relief to give). The statute affords no scope for considering what
subsequently happened to those receipts; and
- the question of course still remains as to whether the
achievement of that reduction was a main reason for the existence
of the conduit. That will, as ever, be a question of fact - and, in
this respect, the subsequent destination of the receipts may be a
relevant fact to be taken into account.
Example 14 at INTM208350 provides one instance of where the achievement of the ICTA88/SCH25/PARA19 reduction in United Kingdom tax might not have been a main reason for the existence of a conduit.
