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HMRC internal manual

International Manual

From
HM Revenue & Customs
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Controlled Foreign Companies: The CFC Charge Gateway Chapter 4 - Profits attributable to UK activities: Exclusions - Trading profits: Example

Example of the trading profits exclusion

A CFC carries out manufacturing and distribution activities. It has several factories in its territory of residence, and one factory in the UK.

60% of its manufacturing takes place in its territory of residence.

40% of its manufacturing takes place in the UK.

Of the goods manufactured in the UK, half of them are exported to the CFC’s territory of residence, and the rest are sold in the UK.

Total trading income of the CFC is £100. UK sales make up 40% of the total trading income of the CFC. However, 75% of that UK income arises from the sale of goods manufactured in the CFC’s territory of residence.

10% of the total related management expenditure of the CFC is incurred in relation to individuals carrying out relevant management functions in the UK.

The CFC does hold intellectual property which has been transferred from its UK parent company within the last three years. Whilst this did result in a significant reduction in the value of the IP held by the UK parent company, the transferred IP only generates around 5% of the total income of the CFC.

The CFC clearly meets the business premises condition.

40% of the CFC’s income comes from UK customers. However, 75% of that UK income arises from the sale of goods which are manufactured in the CFC’s territory of residence. That income is disregarded for the purposes of the 20% UK income condition.

TIOPA10/S371DH(3) requires that such income is deducted from the total trading income to arrive at the relevant trading income. This means that the CFC’s relevant trading income is £70, which is the total trading income of £100 less the UK income derived from the sale of goods manufactured in the CFC’s territory of residence (£30).

The trading income derived from UK resident persons is £10 (25% of the UK sales income of £40). As £10 is less than 20% of the CFC’s relevant trading income of £70, the income condition is also met.

As only 10% of total related management expenditure is incurred in the UK, the management expenditure condition is also met.

With regard to the IP condition, there has been a transfer of IP from a related party in the UK within the relevant period (the accounting period and the preceding six years), and this did significantly reduce the value of IP held by the UK transferor. However, the significance condition is not met, because the CFC’s profits are not significantly higher than they would have been absent the transfer - in fact, the transferred IP only generates about 5% of the CFC’s total income. The IP condition is therefore met.

Although 40% of the CFC’s manufacturing takes place in the UK, half of those goods are sold in the UK, and the other half are exported into the CFC’s territory of residence. Therefore, half of these UK goods are not exported at all, and the other half is excluded from the calculation because the goods are exported into the CFC’s territory of residence. The export of goods condition is met because none of the income of the CFC falls within the definition provided by the legislation, notwithstanding that the CFC does export goods from the UK.

The anti-avoidance condition is not engaged because the CFC has not been party to any arrangements which involve a reorganisation of a significant part of the CFC’s business with a main purpose of meeting one or more of the conditions for exclusion.