Controlled Foreign Companies: Introduction to the CFC rules: What Gateway Chapters need to be considered?
What Gateway Chapters need to be considered?
Chapter 3 (see INTM197000) serves as an initial ‘gateway’ that determines whether any of Chapters 4 to 8 need to be considered. If none of Chapters 4 to 8 is engaged by Chapter 3 then there are no chargeable profits.
Chapter 3 describes the types of profit that may fall into each of Chapters 4 to 8. It also sets out other conditions that must be met for those Chapters to apply. If the Chapters do apply, they define profits (if any) that pass through the CFC charge gateway. Chapter 9 can stand in place of Chapter 5 if the chargeable company so elects - it gives partial or full exemption for certain intra group non-trade finance profits and so limiting or eliminating the profits that would otherwise pass through the CFC charge gateway by way of Chapter 5.
Most CFCs will not have to consider further than Chapter 3 in order to establish that the CFC has no chargeable profits. If more than one of Chapters 4 to 8 apply, profits pass through the CFC charge gateway if they fall within any one or more of those Chapters. If profits can pass through the CFC charge gateway under more than one chapter, they are only brought into charge once.
The following diagram illustrates how profits can flow through the CFC charge gateway - in many cases profits will not pass beyond any of the boxes and so no charge will arise. If a CFC qualifies for a CFC exemption, there is no need to consider this gateway.
What profits can pass through the CFC charge gateway?
The initial gateway filter in Chapter 3 may direct that particular profits have to be considered under chapters 4 to 8 (with Chapter 9 modifying certain profits that would otherwise pass through the CFC charge gateway). These chapters consider the following types of profits.
Chapter 4 Profits pass through the CFC charge gateway where they are earned by a CFC in respect of assets its owns or risks it bears, where the majority of the key management functions in relation to those assets or risks is undertaken by UK connected persons and where the arrangements giving rise to those profits wouldn’t occur if the key management function undertaken in the UK were to be undertaken by third parties and where any non-fiscal benefits realised from the arrangements do not represent a substantial (broadly 20%) proportion of the overall benefits provided by the arrangements. Alternatively profits are exempt if the CFC meets a local business premises condition and meets other conditions relating to amount of income derived from the UK, the amount of management undertaken in the UK, the amount of goods exported by the UK to the CFC and whether the profits arise from intellectual property transferred from the UK within the last 6 years. Non-trading finance profits are not considered under Chapter 4. Full details of Chapter 4 can be found at INTM200000.
Chapters 5 and 9 Profits pass through the CFC charge gateway where they are non-trading finance profits earned by CFCs from lending to other members of the multinational group and third parties, where either the funding for the loans is provided from UK capital investment or to the extent that the key management functions relating to the loans and their associated risks are undertaken by UK persons. However the identification of the profits that pass through the CFC charge gateway from lending to non-UK members of the multinational group can involve another step provided by Chapter 9. Through a claim for either partial or full exemption the profits that pass through the CFC charge gateway and subject to apportionment to the UK can be reduced. Full details of Chapter 5 can be found at INTM203000, and Chapter 9 at INTM216000.
Chapter 6: Profits pass through the CFC charge gateway where they are trading finance profits that are derived from the excess capital held by a CFC (measured by reference to the amount of capital that would be held by the CFC if it were an independent company) which has been provided from UK capital investment. Full details on Chapter 6 can be found at INTM207000.
Chapter 7: Profits pass through the CFC charge gateway where they are profits earned by CFCs that undertake captive insurance business and are derived from contracts of insurance written with UK members of the multinational group or written with unconnected UK persons and are linked to the provision of goods or services by a UK member of the group (e.g. a warranty sold when a new television is sold). Where the captive insurance CFC is resident in the EEA, profits are only treated as artificially diverted from the UK (and so subject to apportionment) where the insured party has no significant non-tax reason for buying the insurance. Full details of Chapter 7 can be found at INTM210000.
Chapter 8: Profits pass through the CFC charge gateway where they are profits of a CFC that is the subject of a solo consolidation waiver, or is subject to arrangements that have broadly equivalent regulatory effect. Full details of Chapter 8 can be found at INTM213000
The profits that pass through the CFC charge gateway by way of any of these chapters are profits that have been artificially diverted from the UK.
When is a relevant interest holder a chargeable company?
The general rule is that a relevant interest holder is a chargeable company if its interest, together with interests of connected or associated companies, is at least 25% [see guidance at INTM227000]. In that case, a CFC charge is made of an amount equivalent to the proportion given in Chapter 17.
There are however certain exceptions given for (see INTM194600):
- Managers of offshore funds;
- Participants in offshore funds;
- Companies holding shares as trading assets, or otherwise holding them such that both share value movements and distributions are brought into the computation of their taxable profits.
There is also a special basis of charge for assets that are held for basic life assurance and general annuity business (BLAGAB) purposes.
Impact of the CFC rules on finance profits
Overall, taking account of the gateway and the rest of the CFC legislation, the impact of the regime may be summarised as follows.
Non-trading finance profits
Profits derived from lending (or arrangements equivalent to lending) by CFCs that doesn’t amount to financial trading may be brought within the CFC charge by Chapter 5 if:
- The profits are derived from key management activity (such as lending decisions) undertaken in the UK;
- The lending is derived from UK capital investment or some other UK capital contribution; or
- The loans are made to UK residents.
The above is subject to an exception of lending that is incidental to an exempt trade or property business, or to a business of holding shares in subsidiary companies.
Profits derived from loans may qualify for full or partial exemption under Chapter 9 if the loan is made to another CFC under common control with the lender (referred to as a qualifying loan relationship). Chapter 9 replaces Chapter 5 in the event of a claim made by the chargeable company. A claim will bring all the CFC’s qualifying loan relationships into the Chapter 9 provisions, but profits from other loan relationships continue to be dealt with under Chapter 5.
A claim under Chapter 9 for partial exemption or full exemption does not exempt profits that have been identified as profits artificially diverted from the UK. Rather, a claim under Chapter 9 is the second part of the process to identify particular profits that have been artificially diverted from the UK and pass through the CFC charge gateway and exempt those profits that haven’t been diverted and so haven’t arisen from avoidance.
Where the CFC charge results from capital investment or other capital contributed to the CFC, so much profit as reflects the value of work undertaken by the CFC is excluded from the Chapter 5 charge.
Trading finance profits
If the financial profits arise from trading activity then Chapters 4 and 6 may be relevant.
Chapter 6 applies where there has been UK capital contributed to the CFC but profits are brought into the CFC charge only to the extent that the company holds more capital than it would if were not controlled by any other company.
There are also special rules dealing with captive insurance (Chapter 7) and cases where a foreign company enters into a ‘solo consolidation waiver’ with a UK resident company that carries on a regulated financial trade (Chapter 8). The effect of this waiver is that the foreign company is treated as part of the UK resident.