Section 36: Schedule 16: Controlled Foreign Companies
Summary
1.Section 36 provides for the amendment of the Controlled Foreign Company (CFC) rules in Chapter 4 of Part 17 of the Income and Corporation Taxes Act 1988 (ICTA). The detailed amendments are in Schedule 16.
2.Part 1 of the Schedule repeals the exemption from the CFC rules for overseas companies which pay most of their profits back to shareholders in the United Kingdom. Part 2 of the Schedule provides for the amendment of the special rules for holding companies in the exempt activities exemption. It removes the rules providing exemption for ‘superior holding companies’ and ‘non-local holding companies’. The exemption will in future only relate to the third category, local holding companies.
3.Parts 1 and 2 have effect in relation to a CFC’s accounting periods beginning on or after 1 July 2009. Provision is made to split accounting periods which straddle this date.
4.Part 3 of the Schedule contains an amendment consequential to the legislation in Schedule 15, Finance Act 2009. It provides for the chargeable profits of a CFC to be reduced in certain circumstances to avoid double taxation.
5.The changes introduced by this Section are part of the package of measures being introduced as a result of the Government’s review of the taxation of foreign profits.
Details of the Section
6.The Section provides that Schedule 16 has effect to amend the CFC rules.
Details of the Schedule
Part 1 – Abolition of Acceptable Distribution Policy Exemption
7.Paragraph 1 removes the reference to the acceptable distribution policy (ADP) exemption in section 748 of ICTA which lists the circumstances in which the CFC charging provision in section 747 of ICTA will be disapplied and repeals the ADP rules in Part 1 of Schedule 25 of ICTA.
8.Paragraph 2 makes consequential changes to ICTA.
9.Paragraphs 3 and 4 amend the rules in Schedule 29 to the Finance Act 2002 concerning the calculation of gains and losses arising to a CFC from intangible assets and carry the effect through to the legislation in Corporation Tax Act 2009.
10.Paragraph 5 makes consequential changes to the relevant Finance Acts.
11.Paragraph 6 states that Part 1 of the Schedule has effect in relation to a CFC’s accounting periods beginning on or after 1 July 2009.
12.Paragraph 7 sets out that where a CFC has an accounting period which straddles 1 July 2009 it is to be treated as split into two separate accounting periods in order to facilitate the repeal of the ADP exemption.
13.The first of these periods will begin on the first day of the straddling period and end on 30 June 2009; the second will begin on 1 July 2009 and end on the last day of the straddling period. The CFC’s chargeable profits and creditable tax should be apportioned between the two periods on a just and reasonable basis.
14.Paragraph 8(1) makes it clear that the amendments do not affect the application of either:
the rules in sections 801, 801C and 803A of ICTA concerning the treatment of dividends paid in pursuit of an ADP; or
the ADP exemption in Part 1 of Schedule 25 to ICTA
in relation to dividends paid on or after 1 July 2009 for periods ending before that date in pursuit of an ADP.
15.Sub-paragraphs (2) and (3) set out a transitional provision which applies where the CFC paid a dividend in the second of the two deemed accounting periods created by paragraph 7. It ensures that the current rules governing how dividends are attributed to accounting periods continue to work appropriately. It does this by saying that the relevant provisions of section 799 of ICTA will have effect as if the reference in it to the last period for which accounts of the CFC were made up were a reference to the first of the two deemed accounting periods provided for by paragraph 7.
16.The purpose of paragraphs 7 and 8 is to ensure that the ADP exemption remains available to profits accruing prior to 1 July 2009. A CFC which pays a dividend on or after 1 July 2009 for an accounting period ending before that date may still qualify for the ADP exemption for that period if the conditions currently in Part 1 of Schedule 25 are fulfilled.
17.Paragraph 9 states that ‘accounting period’, ‘chargeable profits’, ‘controlled foreign company’ and ‘creditable tax’ take the meaning given to them for the purposes of the CFC rules.
Part 2 – Amendment of Exempt Activities Exemption
18.Part 2 of the Schedule provides for the amendment of the special rules for holding companies in the exempt activities exemption. They remove the rules providing exemption for ‘superior holding companies’ and ‘non-local holding companies’. The exemption will thereafter only relate to the third category, local holding companies.
19.Paragraph 10 amends Part 2 of Schedule 25 to ICTA containing the exempt activities exemption and repeals those elements of it relating to holding companies other than local holding companies. It also removes references to ‘superior holding companies’ from the legislation and repeals the related definition at paragraph 12A.
20.Paragraph 11 makes consequential changes to the relevant Finance Acts.
21.Paragraph 12 states that the changes in Part 2 have effect for the accounting period of a CFC beginning on or after the commencement date. For ‘qualifying holding companies’ the commencement date is 1 July 2011; for all other companies the commencement date is 1 July 2009.
22.Paragraph 13 defines a ‘qualifying holding company’ as a CFC that was an ‘exempt holding company’ for the duration of the last accounting period to end before 1 July 2009 but specifically excluding an accounting period created by Part 2 of this Schedule.
23.An ‘exempt holding company’ is a company which throughout a particular accounting period was engaged in exempt activities under the special rules applying to non-local and superior holding companies.
24.The distinction between qualifying and non-qualifying holding companies is fundamental to the operation of the Schedule. It underlies the mechanism by which transitional relief is provided elsewhere in the Schedule.
25.Paragraph 14 contains rules that apply where a CFC has an accounting period that straddles 1 July 2009. In such circumstances the straddling period shall be treated as split into two deemed accounting periods to facilitate the repeal of the superior and non–local holding company rules.
26.The first deemed period will begin on the first day of the straddling period and end on 30 June 2009; the second will begin on 1 July 2009 and end on the last day of the straddling period. The CFC’s gross income, chargeable profits and creditable tax should be apportioned between the two periods on a time basis according to their respective lengths.
27.Paragraph 15 contains similar rules which apply to a qualifying holding company which has an accounting period which straddles 1 July 2011.
28.The straddling accounting period is again to be treated as split into two deemed accounting periods. The first will begin on the first day of the straddling period and end on 30 June 2011; the second will begin on 1 July 2011 and end on the last day of the straddling period. The CFC’s gross income, chargeable profits and creditable tax should be apportioned between the two periods on a time basis according to their respective length.
29.The rules in paragraphs 14 and 15 are required to ensure that profits accruing in periods straddling 1 July 2009 and 1 July 2011 are treated appropriately. For CFCs which are not qualifying holding companies 1 July 2009 marks the point from which only the local holding company exemption will be available.
30.For a qualifying holding company 1 July 2009 marks the beginning of a two year transitional period in which the superior and non-local holding company rules will continue to be available subject to the provisions of paragraph 17. The transitional period defers the commencement date for qualifying holding companies until 1 July 2011 after which only the local holding company exemption will be available.
31.Paragraph 16 contains the definition of ‘relevant accounting period’, a term employed in paragraph 17. A relevant accounting period is one that falls within the two year transitional period established for qualifying holding companies by the deferred commencement date.
32.Paragraph 17 contains the special rules that apply to a qualifying holding company in the transitional period. They set out that in relation to a relevant accounting period of a qualifying holding company, paragraphs 6(4) and (4A) of Schedule 25 have effect subject to certain specified conditions. These mean that transitional relief is not automatically available to qualifying holding companies where levels of non-qualifying gross income exceed historic flows.
33.Sub-paragraph (2) sets out these criteria. They say that the non-local and superior holding company rules in paragraphs 6(4) or (4A) of Schedule 25 will only apply if the conditions set out in those paragraphs are satisfied, and additional criteria, referred to as conditions A and B, are also met.
34.Sub-paragraph (3) sets out condition A which is that at all ‘material times’ the group of companies of which the CFC was a member must have had the same ultimate parent.
35.Sub-paragraph (4) defines ‘material times’ as at the beginning of 9 December 2008 and all times during the accounting period in question.
36.Sub-paragraph (5) defines Condition B, which is satisfied where the amount X does not exceed amount Y.
37.Sub-paragraph (6) identifies amount X as the amount of the CFC’s gross income in the accounting period that is ‘non-qualifying gross income’, defined in Sub-paragraph (9) as gross income which does not help a CFC satisfy the existing non-local and superior holding company rules.
38.This definition builds on the existing statutory term ‘gross income’, used in Schedule 25, which broadly speaking refers to the full amount of any income to which a CFC is entitled during an accounting period before any expenses are deducted.
39.Exemption is available under the existing holding company rules where at least 90 per cent of a holding company’s gross income during the accounting period comes from companies that it controls and which, if not themselves holding companies, are engaged in exempt activities. There are detailed rules setting out what income can qualify as part of the 90 per cent for each of the different types of holding company.
40.Sub-paragraph (7) establishes that amount Y is the highest amount of non-qualifying gross income arising in an earlier reference period or periods. Sub-paragraph (9) specifies that a reference period is an accounting period of the CFC that is any one of its last three accounting periods ending before 9 December 2008, and an accounting period in relation to which the CFC was an exempt holding company. However where there is no reference period the Schedule specifies a default reference period of 12 months ending on 9 December 2008.
41.Sub-paragraph 8 provides for a time apportionment where amounts X and Y arise in periods of differing length to ensure that the comparison between the two amounts is consistent.
42.The effect of paragraph 17 is to limit the amount of non-qualifying gross income in the transitional periods to the highest amount arising in any of up to three earlier reference periods. As is made clear in paragraph 17(2)(a) the existing gross income test must be satisfied so at least 90 per cent of the CFC’s gross income must be qualifying income. However, notwithstanding this, if the amount of non–qualifying gross income in the relevant period exceeds the level set by amount Y then the CFC will fail to qualify for exemption.
43.Paragraph 18 defines ‘ultimate corporate parent’ and ‘group’ for the purposes of paragraph 17(3).
44.Paragraph 19 contains an anti-avoidance rule. It applies where a company alters its accounting date so that a particular period that otherwise would have fallen into an accounting period ending on or after 9 December 2008 instead falls into an accounting period ending before that date.
45.Paragraph 20 states that ‘accounting period’, ‘chargeable profits’, ‘control’, ‘controlled foreign company’, ‘creditable tax’ and ‘gross income’ take the meaning given to them for the purposes of the CFC rules.
Part 3 – Reduction in Chargeable Profits for Certain Financing Income
46.Paragraphs 21 and 22 amend ICTA to take account of the introduction of section 751AA.
47.Paragraph 23 inserts the new section into the CFC rules in ICTA. It applies where an apportionment is to be made under section 747(3) and;
the chargeable profits of the CFC contain an amount of income in respect of payment made by another company, and;
the amount brought into account for corporation tax purposes by the payer is reduced by the rules in Part 3 of Schedule 15.
48.It allows the UK company to which the profits are to be apportioned to apply to the Commissioners for a reduction in the chargeable profits of the CFC. If the Commissioners grant the application those profits are treated as reduced by the specified amount and the CFC’s creditable tax are accordingly reduced on a just and reasonable basis.
49.The purpose of the new provision is to ensure that a restriction of an interest deduction under Schedule 15, Finance Act 2009 cannot interact with the CFC rules so as to cause the affected group to suffer double taxation.
50.Paragraph 24 amends the supplementary provision in section 751B, ICTA to take account of section 751AA.
51.Paragraph 25 specifies that the amendments made in Part 3 have effect in relation to accounting periods of CFCs ending on or after 1 January 2010.
Background Note
52.The CFC legislation is at sections 747 to 756 of and Schedules 24 to 26 to ICTA. It is designed to counter the artificial diversion of profits from the UK by UK resident companies to companies which they control and which are located in low tax territories. It does this, broadly, by apportioning the diverted profits to, and taxing them on, those UK residents with a relevant interest in the non-resident company.
53.The effect of the CFC legislation is limited by a series of exemptions. There are five such exemptions which were designed to exclude from the scope of the rules those CFCs that can be reasonably assumed not to exist so as to artificially divert profits from the UK.
54.The Schedule repeals the ADP exemption and amends the exempt activities exemption to remove the special rules applying to holding companies apart from those applicable to local holding companies.
