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HMRC internal manual

International Manual

Controlled Foreign Companies: The CFC Charge Gateway Chapter 3 - Determining which (if any) of Chapters 4 to 8 apply: Does Chapter 4 apply?: contents

INTM197250 - HMRC governance

INTM197300 - Conditions A to D

Chapter 4 will apply for a CFC’s accounting period unless any one or more of four conditions (A to D) is met. Conditions A to C focus in a similar way to Chapter 4 on the CFC’s assets and the risks that it bears, from which it may derive profits that have been artificially diverted from the UK. Condition D is met when a CFC’s assumed total profits (see INTM239200) consist only of non-trading finance profits and/or property business profits.

The combined effect of these conditions is that Chapter 4 will apply to and bring overseas trading profits within the scope of the CFC charge in relatively few circumstances. This will be where the CFC is diverting profits from the UK by means of a separation of assets and risks from the underlying activity that supports the group’s holding of those assets, or that necessarily goes with its bearing of that risk.

Transfer pricing legislation (see INTM420000) is the primary remedy to inappropriate division of profit between companies within a group of companies. Chapter 4 applies where transfer pricing cannot remedy such inappropriate division. This will be in situations where individual transactions are correctly priced but the circumstances are such that profit attaches to foreign owned assets or risks that have been artificially separated from UK activity. In such cases, it will also be important to consider whether the CFC has a permanent establishment in the UK (see INTM261000). This may need to include consideration of whether the activities of another person in the UK on behalf of the CFC constitute those of a dependent agent.

Conditions A to C in Chapter 3 are designed to provide high- level tests of whether any separation between UK activity and assets and risks that would lead to an inappropriate allocation of profits away from the UK has occurred. The arrangement by which a CFC’s holds assets or bears risks will be treated as giving rise to such a separation only where the arrangement is tax motivated; where the management of the asset or risk is carried on to any significant extent in the UK; or where the CFC would be incapable of the effective management of its business without that intra-group support.

It follows that profits will not come within the scope of the CFC charge unless:

  • UK activity generates profit through the group’s holding of assets or bearing of risks, but those assets and risks are held outside the UK, and
  • that UK activity is not performed by a PE of the CFC through which the CFC carries on a trade, and
  • a transfer pricing adjustment is not an available or appropriate remedy.

The Chapter 3 filter reflects this by providing that Chapter 4 does not need to be considered if the CFC meets any one of the following three conditions.

  • A main purpose condition (Condition A - INTM197310).
  • A UK managed assets or risks condition (Condition B - INTM197320).
  • A capability condition (Condition C - INTM197330).

Also if the CFC’s assumed total profits consist only of non-trading finance profits and/or property business profits (Condition D - INTM197340) Chapter 4 does not need to be considered.

In a high-risk situation where assets are held, and/or risks borne, by a CFC but the activity necessary to support the assets and/or risks appears to be carried out in the UK and a self-assessment under either Condition A, B or C has been made, it will be necessary to consider these returns more closely. For example, if a CFC carrying on captive insurance business has been self-assessed as meeting Conditions A, B or C you should review the arrangements whereby it holds assets and bears risks in the accounting period. This is because such arrangements are frequently put in place in order to primarily achieve a UK tax advantage and there is often UK activity connection with the insurance business.

Chapter 4 Exclusions

It should be noted that even if none of Conditions A to D are met and Chapter 4 must be considered, it does not follow that there will be a CFC charge. All that follows from failing all of these conditions is that Chapter 4 needs to be considered. A further exclusion in Chapter 4 may then exempt the income from the CFC charge, for example, the trading profits safe harbour may apply (See INTM200800). If a group wishes to consider the exclusions within Chapter 4 without considering Chapter 3 it is entitled to do so. There is no reason why the group must consider Chapter 3 first.