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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?: Conditions A to D: Example 4

A UK headed group holds intellectual property (IP) in two different companies, one resident in the UK (Company Y) and the other in a zero tax territory (Company Z). Company Y holds patents and related IP for products manufactured and marketed by the group around the world. Company Z holds software which is used by one of the group’s businesses across Latin America and which is also licensed to third parties in Spanish and Portuguese speaking countries.

Company X, the UK parent of Companies Y and Z decides to acquire an African business that is quite similar to the group’s Latin American operation. All the work in relation to this is done in the UK by Company X, which also makes the decisions on where in the group the newly acquired IP should be held and, within an outline business plan, sets out in general terms how its value might best be exploited.

Ownership of the newly acquired software is transferred to Company Z as part of the acquisition process, and a number of patents are transferred to Company Y in the UK. Company Z needs to recruit some new staff locally to handle the increased work and its acquisition of the software is funded by additional equity from Company X.

In considering TIOPA10/S371CA, the fact that the exploitation and development of the software is within the parameters of the outline business plan does not of itself necessarily mean that the asset and risks are UK managed. Nonetheless it is concluded that Company X in the UK has managed or controlled the acquisition of assets and the taking on of risks to a significant extent by way of relevant UK activities (detailed planning, decision making, provision of equity funding), under arrangements that would not have been entered into by companies not connected with each other. So Condition B is not met.

Condition C requires that Company Z has the capability to ensure that its business would be commercially effective if its UK managed assets and risks were to stop being UK managed at any time during the AP. It is recognised that the acquisition could not have proceeded without Company X’s involvement and the details of the additional funding and staffing were such that it cannot be concluded that Company Z could have carried on the same business in a commercially effective way without the relevant UK activities. So Condition C is not met.

Condition A will be met unless both subsections (3) and (4) of TIOPA10/S371CA apply. With regard to subsection (3), the possibility of either Company X or Y holding the software will have been considered in putting together the outline business plan as will the UK tax consequences of putting that arrangement in place. As both tax and non-tax issues had to be taken into account in the decision to transfer the software IP to Company Z, subsection (3)(a) is likely to apply. As there was an expectation that Company Z’s business would become more profitable by its owning the new IP, subsection (3)(b) also applies.

In relation to subsection (4), there is expected to be a reduction of the liabilities of at least one of the UK companies through holding the software in Company Z so subsection (4)(a) applies. This is on the assumption that, had the UK group simply acquired the third party intangibles and held on to them in the UK, this would have resulted in additional UK profits and tax. However it is not reasonable to suppose that the arrangement by which Company Z holds the software would not have been made but for that expectation. In this case, there were a number of sound commercial considerations involved in making the relevant arrangements, and sufficient evidence to conclude that the same decisions would have been made if the taxation consequences of all the options had been the same. So Condition A is met.

It is important to note that whilst the facts of this example indicate significant UK involvement in relation to the acquisition, it will often be the case that an acquisition or commercial re-structuring has taken place during an earlier accounting period. It such cases, it may well be the case that the CFC no longer requires or indeed receives UK support for its ongoing activities. Clearly, in such cases, the analysis would be different. In particular, it may well be easier to demonstrate that the CFC could remain commercially effective without UK support. It should be easier for groups to demonstrate that Condition C is met in those later periods. The conditions have to be applied to each accounting period, based on the relevant facts during the accounting period under consideration.