Controlled Foreign Companies: The CFC Charge Gateway Chapter 4 - Profits attributable to UK activities: Introduction
If none of the entity exemptions in Chapters 10 to 14 apply (see INTM224000) or none of Conditions A to D in Chapter 3 are met (see INTM197300) then Chapter 4 needs to be applied.
By the taking of various steps (“The Steps” see INTM200500), Chapter 4 provides a mechanism for determining the extent to which any of a CFC’s assumed total profits (see INTM239200) pass through the CFC charge gateway (“Chapter 4 profits”) and are thus potentially subject to the CFC charge because of specific UK activities that have allowed the CFC to make those profits.
Non-trading finance profits and property business profits are excluded from the CFC’s assumed total profits for the purposes of this Chapter. Non-trading finance profits are dealt with in Chapter 5 and property business income is outside the scope of the CFC charge.
In order to make the calculation required, Chapter 4 identifies profits from assets that are legally owned by the CFC and profits from risks contractually allocated to the CFC in situations where management of those assets and risks is exercised to a significant extent from the UK.
Profits identified for the CFC charge under this Chapter will arise where the CFC is reliant on the UK in order to take on and manage its assets and risks in a commercially effective way. A CFC’s assets and risks may be managed to some extent outside its territory of residence for a number of reasons apart from tax considerations and like Chapter 3 (see INTM197200), Chapter 4 contains a number of exclusions that recognise this.
The steps taken to determine if a CFC has Chapter 4 profits use specific concepts and terms taken and adapted from the Organisation for Economic Co-operation and Development’s (OECD) 2010 Report on the Attribution of Profits to Permanent Establishments (“the Report”).
The Report sets out the authorised OECD approach for attributing to a part of a single enterprise (a permanent establishment (“PE”) in a foreign territory) the profits that it would have earned at “arm’s length”. This requires a two-step analysis. The analysis under the first step requires the PE to be hypothesised as a separate enterprise with its own assets and risks. The second step is concerned with pricing the “dealings” between the PE and other parts of the enterprise on an arm’s length basis.
The attribution of assets and risks to parts of the single enterprise under the first step is based on a functional and factual analysis that has precedence over where in the enterprise the taxpayer nominates its assets to be held or its risks to be borne. This removes the potential incentive for taxpayers to attribute the economic ownership of assets and risks in ways that would give inappropriate profit allocations for the taxation of PEs in foreign territories.
It is not expected that the situations targeted by the rules in Chapter 4 will be common. Profits identified for the CFC charge under this Chapter will arise where the contractual arrangements are largely driven by tax considerations and the CFC is reliant on the UK in order to take on and manage its assets and risks in a commercially effective way. It is possible for a CFC’s assets and risks to be managed to some extent outside its territory of residence for a number of reasons apart from tax considerations and like Chapter 3 (see INTM197300), Chapter 4 contains a number of exclusions that recognise this.