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International Manual

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Controlled Foreign Companies: The CFC Charge Gateway Chapter 6 - Trading Financial Profits: Interaction with Chapter 9

Interaction with Chapter 9

Chapter 6 contains specific provisions at TIOPA10/S371FB and S371FC, which deal with the interaction of Chapter 9 with Chapter 6. Chapter 9 contains the conditions in relation to the full and partial exemption from a Chapter 5 charge on a CFC’s non-trading finance profits. These exemptions are available to the extent that the CFC’s non-trading finance profits arise from a ‘qualifying loan relationship’ (defined at TIOPA10/S371IG - see INTM217000).

Chapter 6 contains rules which ensure that if a CFC that falls within Chapter 6 (i.e. a CFC whose assumed total profits include trading finance profits) is the ultimate debtor in relation to a qualifying loan relationship, the excess free capital or excess free assets of that CFC are adjusted to take account of the qualifying loan relationship for which full or partial exemption has been applied under Chapter 9.

In a straightforward situation if a CFC under the rules of Chapter 9 makes a qualifying loan to another connected CFC which has trading financial profits in Chapter 6 and the income on this qualifying loan is exempted by a certain proportion by Chapter 9, then the same proportion of this qualifying loan is treated as free capital or excess free assets in the CFC that has trading financial profits.

CFC - Qualifying loan relationship adjustment

TIOPA10/S371FB applies where a CFC within Chapter 6 (a CFC with trading finance profits) is the ultimate debtor (debtor CFC) in relation to a qualifying loan relationship of another CFC (creditor CFC). ‘Ultimate debtor’ and ‘qualifying loan relationship’ are defined and explained within the Chapter 9 guidance (See INTM216000).

Whilst Chapter 9 may exempt some or all of the non-trading finance profits which arise to the creditor CFC from a qualifying loan relationship, the Chapter 6 adjustment is calculated in terms of the loan capital outstanding (the “principal outstanding”).

TIOPA10/S371FB(2) and S371FB(3) provide the calculation to determine the percentage of the ‘qualifying loan relationship’ profit which is exempt under Chapter 9. This percentage (E%), is then applied to the principal outstanding. The resulting amount is added to the free capital or free assets of the debtor CFC. E% is calculated by using the following formula:

E% = (100% x EP)/P

  • ‘EP’ is the total amount of profits of the qualifying loan relationship which is exempt.
  • ‘P’ is the total amount of the profits of the qualifying loan relationship.

TIOPA10/S371FB(4) and S371FB(5) provide that for the purposes of calculating E%:

  • where the accounting periods of the creditor and debtor CFC do not match, the profits and consequently the loan capital are apportioned pro rata;
  • profits of a qualifying loan relationship for the creditor CFC’s accounting periods falling wholly or partly in the accounting periods of the debtor CFC are to be considered;
  • the profits of the qualifying loan relationship for an accounting period of the creditor CFC are to be determined in accordance with Chapter 9;
  • the section 371FB(5) calculation has to be undertaken for each chargeable company which makes a Chapter 9 claim and the ultimate debtor is within Chapter 6.

TIOPA10/S371FB(5) uses a two-step approach to determine the amount of exempt profits under Chapter 9, and then apportion those exempt profits to each chargeable company in accordance with the allocation rules (See INTM194000).

The application of the percentage P% (determined by TIOPA10/S371BC(3) see INTM194400) ensures that the exempt qualifying loan relationship adjustment for Chapter 6 matches the percentage of profits allocated to each chargeable company. The adjustments for shares held as trading assets and companies carrying on BLAGAB (see INTM194800) are disregarded for the purposes of TIOPA10/371FB.

The effect of TIOPA10/S371FB(5) is to ensure that where there are several chargeable companies, or if the chargeable company has less than 100% of the profits of the CFC apportioned to it, the amount of exempt profits of the qualifying loan relationship to be considered under Chapter 6 is reduced accordingly.

Example

Consider the diagram below. As UK Co has a relevant interest in the Chapter 9 CFC, it would only be subject to a potential CFC charge on £70m (70% of the £100m QLR (qualifying loan relationship)). Assuming the QLR is subject to partial exemption (see INTM218600), then 75% of the profits arising on that £70m QLR will be exempt (those arising on £52.5m of the loan). The £52.5m will be added to the free capital or free assets (where appropriate) when assessing the capitalisation position of the Chapter 6 CFC.

Use this link to view diagram showing qualifying loan relationship

Example: application of section 371FB

CFC A has trading finance profits so falls within Chapter 6. CFC A receives a loan of £200m from a connected CFC B (a group finance company). CFC B makes a qualifying loan relationship profit of £10m in the accounting period from this loan. There is no repayment of the loan during the accounting period.

Both CFCs have a 31 December accounting date and are 100% subsidiaries of a UK parent company.

The UK parent makes a successful claim for partial exemption under Chapter 9 for the £200m CFC B loan (CFC A is the ultimate debtor). 75% of the profits of the qualifying loan relationship are now exempt.

TIOPA10/S371FB(2) and TIOPA10/S371FB (3) apply as follows in calculating E%:

EP = exempt profits of qualifying loan relationship = £7.5m

P = total profits of qualifying loan relationship = £10m

E% = 75% (100% x 7.5/10)

This results in £150m (being 75% of the principal outstanding during the accounting period - 75% of £200m) being added to the free capital or free assets of CFC A for the purposes of determining the step 1 or step 2 amounts.

Example: non-matching accounting periods

The facts as in the previous example, except that CFC A has an accounting date of 31 December and CFC B has an accounting date of 31 March.

TIOPA/S371FB(4) applies here to ensure the profits are apportioned correctly, where the accounting period of the creditor CFC (CFC B) only falls partly within the accounting period of the debtor CFC (CFC A).

  • CFC A’s accounting period runs from 1 January 2014 to 31 December 2014.
  • CFC B’s accounting period runs from 1 April 2014 to 31 March 2015.
  • The loan is made on 1 April 2014.

Profits on the qualifying loan relationship for CFC B, for accounting period ended 31 March 2015, are £10m. As 9/12 of the accounting period of CFC B falls within the accounting period of CFC A, 9/12 of the profit of £10m are included in the section 371FB(3) calculation of E%.

Regulation 1: citation, commencement and effect. This simply states that the regulations come into force on 1 January 2013, and have effect for accounting periods beginning on or after 1 January 2013.

  • 9/12 of £10m = £7.5m, of which £5.625m would be exempt
  • Section 371FB(3) calculation E% = 75% (100 x 5.625/7.5)

Although this is the same percentage as in example 1 above, TIOPA10/S371FB(2) refers to E% of the principal outstanding during the accounting period. In this case 75% of £200m = £150m is added to CFC A’s free capital or free assets for the period from 1 April 2014 to 31 December 2014.

Permanent Establishments - Qualifying Loan Relationship adjustment

TIOPA10/371FC applies where a CFC is the ultimate debtor of a qualifying loan relationship which comprises a loan from an exempt permanent establishment (following an election under CTA09/S18A) of a UK resident company. Its application mirrors the treatment of TIOPA10/S371FB, so as to ensure there is parity whether a qualifying loan relationship is made from either a CFC or an exempt permanent establishment.

So, where non-trading finance profits arising on a qualifying loan relationship are included in the relevant profits amount or relevant losses amount for an exempt permanent establishment for the purposes of CTA09/S18A, the amount of corresponding qualifying loan relationship will be added to the free capital (or free assets as appropriate) for Chapter 6 purposes, in a similar way as loans that are treated as qualifying loan relationships from CFCs are added.

There is no TIOPA10/SS371FC equivalent to the formula in S371FB for loans from foreign PEs, because they are not able to access full exemption for their qualifying loan relationship profits (see INTM286400).

Example

UK company C makes a CTA09/S18A election, which covers its branch operating in Switzerland.

The Swiss branch makes a loan to CFC D carrying on banking business.

Company C makes a Chapter 9 claim, as applied via 18HE CTA09/S19HE, in respect of the loan made by its Swiss branch. The loan is a qualifying loan relationship so 75% of the profits within the branch are now exempt from UK corporation tax (25% of the loan relationship profits remain within the charge to UK corporation tax).

TIOPA10/S371FC ensures that 75% of the principal outstanding is added to the free capital of CFC D. This ensures that the level of exemption applied to the profits of the loan under CTA09/S18A matches the proportion of the loan added to the free capital of CFC D.