INTM208350 - Controlled Foreign Companies: exemptions - the motive test
Application of motive test: examples - holding companies
Example 12
A subsidiary of a United Kingdom group acts as the holding company for various associates. It is funded entirely by equity subscribed for by its United Kingdom parent which has borrowed in the United Kingdom to fund the subscription. With one exception its income is made up exclusively of dividends from trading subsidiaries that satisfy the exempt activities test. That one exception is that a proportion of its income is in the form of interest from a loan to one of its subsidiaries. This income causes it to fail the exempt activities test. The facts show that:
- one of the main reasons for the existence of the company is to act as a holding company and to provide finance to its subsidiaries; but
- the company has, within the meaning of ICTA88/SCH25/PARA19, achieved a reduction in United Kingdom tax by a diversion of profits from the United Kingdom; and
- the achievement of that reduction is another main reason for its existence.
This is on the basis that:
- it is reasonable to suppose that, in the absence of the holding company (and any other related, non-United Kingdom company that could perform the same function as the holding company), the whole of the holding company’s receipts would have been received by a United Kingdom person (most likely the United Kingdom parent);
- had that happened, that United Kingdom person would have been liable to United Kingdom tax on the profits arising out of those receipts; and
- one of the main reasons why the holding company exists to receive its receipts is because, if they were to be received by a United Kingdom group company, that United Kingdom company would have to pay such United Kingdom tax.
The diversion of profits leg of the motive test is therefore failed.
Example 13
The facts are the same as in Example 12 except that the United Kingdom parent has not borrowed to fund its equity subscription in the holding company. It has funded it by way of a rights issue to its shareholders. Since the method by which the United Kingdom parent has funded its subscription is entirely irrelevant for the purposes of the motive test, this makes no difference to the analysis we are required to make. The answer is precisely the same; the diversion of profits leg of the motive test is failed.
Example 14
A holding company resident in a tax shelter acts as a pure conduit for the payment of dividends from trading companies all of which are resident in normal rate countries. 100% of such dividends are immediately passed to the United Kingdom on receipt. It has no other income. The holding company, however, fails the exempt activities test because it has neither premises nor employees in the tax shelter. The facts show that:
- one of the main reasons for the existence of the company is to act as a holding company and to pass on dividends paid to it by its subsidiaries;
- another main reason for the company’s existence is to avoid the need to pay a withholding tax in the subsidiaries’ countries of residence which would be due were dividends from the company’s subsidiaries to be paid directly to the United Kingdom but not if paid to the company;
- because of the absence of withholding taxes, the amount of DTR available to set against the Case V liability on the dividends is less than would have been available had the dividends been paid direct to the United Kingdom.
As noted in
INTM208090 and
INTM208150, the controlled foreign
company has, within the meaning of ICTA88/SCH25/PARA19, achieved a
reduction in United Kingdom tax by a diversion of profits from the
United Kingdom but the questions remains as to whether achievement
of that reduction is another main reason for its existence.
In the unusual circumstances and particular facts of this
specific case (and without hypothesising alternative scenarios),
the absence of the withholding tax that would otherwise have been
payable (and creditable against United Kingdom tax) cancels the
ICTA88/SCH25/PARA19 'reduction in tax' leaving, in the round, no
net loss of tax to the United Kingdom. In such circumstances,
achieving the ICTA88/SCH25/PARA19 reduction in tax is not a main
reason for the controlled foreign company’s existence so the
motive test is satisfied.
(
Health warning: 'Brass plate' companies like this
rarely satisfy the conditions of the diversion of profits leg of
the motive test but on the particular facts of this case, that leg
is passed. That said, this example should not be taken as a general
indication that conduit companies will always satisfy the
conditions of the motive test. As noted above, even where 100% of
the receipts are always passed on immediately, most conduit
companies will, within the meaning of ICTA88/SCH25/PARA19, achieve
a reduction in United Kingdom tax by a diversion of profits from
the United Kingdom. They will only satisfy the conditions of the
motive test if (as in the above example),
as a matter of fact, the achievement of that
reduction is not one of the main reasons for the conduit’s
existence.)
Example 15
A United Kingdom group has a broadly autonomous south east Asian
trading sub-group which consists solely of trading subsidiaries
carrying out their operations exclusively in that region. It is
headed by an intermediate holding company resident in Hong Kong.
The facts show that:
- the intermediate holding company plays a mixed role of holding, management and finance company for the sub-group;
- it has staff based in its permanent premises in Hong Kong with sufficient authority and expertise to make all of the material decisions regarding the operations of the trading sub- group, including the provision of both debt and equity funding which it provides out of its own resources (made up exclusively of income earned on arm’s length terms on such funding); and
- the only reason for setting up the controlled foreign company in Hong Kong as opposed to the United Kingdom was the need for a holding/finance/management company located in the region where these decisions are made.
These facts demonstrate that, whilst the existence of the
holding company achieves a reduction in United Kingdom tax by a
diversion of profits from the United Kingdom within the meaning of
ICTA88/SCH25/PARA19, that achievement (and the payment of the lower
rate of tax chargeable in Hong Kong) was only incidental to the
commercially-driven reason for its location in Hong Kong rather
than being another main reason for the controlled foreign
company’s existence.
The company therefore satisfies the diversion of profits leg
of the motive test.
