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HMRC internal manual

International Manual

HM Revenue & Customs
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Controlled Foreign Companies: guidance relating to superseded legislation

Acceptable Distribution Policy: distribution standard for accounting periods beginning before 28 November 1995


Distribution standard for non-trading companies

For non-trading companies the distribution standard was 90% of the company’s available profits for accounting periods ended before 30 November 1993.

Distribution standard for trading companies

For trading companies, the distribution standard was 50% of the available profits for periods beginning before 28 November 1995.

Definition of a trading company

ICTA88/S756 (1)For accounting periods of controlled foreign companies beginning before 28 November 1995 the distinction between trading and non-trading companies is necessary to ascertain the appropriate distribution standard. A company is a trading company if its business consists wholly or mainly of the carrying on of a trade(s).

In most cases it is clear whether a controlled foreign company is within this definition for an accounting period.

There are, however, exceptional cases where despite carrying on a trade the company cannot be regarded as a ‘trading company’. For example where income from non-trading sources is more than the gross receipts of the trade the business may not consist wholly or mainly of the carrying on of a trade.

Definition of available profits

ICTA88/SCH25/Para2 (1)(d) and (2)Where in an accounting period a trading company has no available profits it cannot pass the acceptable distribution test. This is because one of the criteria for the test is that there must be a distribution ‘of the company’s available profits’. Where this happens chargeable profits rarely exceed the de minimis threshold. However, where they do each case is considered on its merits. The Board will not usually make a direction if company has not reduced the amount available for distribution by manipulation of the profits which would have arisen in the course of its commercial activities.

These are the main steps to take to work out the ‘available profits’.

  • Identify the ‘relevant profits’ of the accounting period for the purposes of ICTA88/S799 – see discussion of capital profits below.
  • Then leave out any excess of capital profits over capital losses – see discussion of capital profits below.
  • It may be necessary to apportion the net result on a time basis. This will happen if the controlled foreign company’s accounting period is not the same as the period for which it makes up accounts.The figure from the steps above is the amount of the ‘available profits’ of the accounting period. This amount may need to be adjusted in any of these circumstances:

The company pays a dividend that it says is out of dividends it has received from another controlled foreign company – see INTM254690.

The Board makes a declaration that the available profits of the accounting period should be taken as the chargeable profits – see discussion of Board’s declaration below.

Non-residents hold part of the share capital of the controlled foreign company – see INTM254710and following pages.

Relevant profits

ICTA88/SCH25/Para3The term ‘relevant profits’ is in ICTA88/S799, though that section does not define its meaning. The meaning was considered in Bowater Paper Corporation Ltd v Murgatroyd (46TC37). The court held that the term meant the commercial profits shown in a company’s accounts which it could legally distribute. It did not mean the profits as adjusted for tax purposes. To decide whether the company can legally distribute it is necessary to look at the law that applies to the company. This may not be United Kingdom law.

The following is a guide to help identify relevant profits:

  • Start with the commercial profits (including realised capital profits). These are for a period as shown in a company’s accounts. They are after deduction of any proper provision for tax liabilities.
  • The law which applies to the company may treat an amount as not available for distribution. In that case the amount is not included in relevant profits. For example, the law of some countries requires companies to transfer a part of their profits to a legal reserve, until the reserve reaches a prescribed amount.
  • Do not leave out an amount simply because the Company’s articles of association (or some similar rule) do not allow distribution.
  • A company may deduct profits or set them aside to use as a general reserve. It may also use profits to issue bonus shares. Profits dealt with in this way are relevant profits.A provision against a future liability can be left out of relevant profits provided that

  • it is a proper deduction in working out commercial profits using accountancy principles,
  • there is a real prospect that the company will incur the liability, and
  • the amount directly relates to the foreseen amount of the liability.A company may make a provision only for reasons of commercial prudence. This should be treated as available for distribution.

Unrealised profits or gains on exchange differences are normally not included. But they are included if they are in fact distributed or the company puts them to a general reserve that is distributable or if the company puts them in its retained profits account.

The above guidelines will not provide clear-cut answers in all cases. BusinessInternational: Outward Investment Team should be consulted if an Inspector has any problems in identifying relevant profits or agreeing the treatment of provisions.

Capital profits

ICTA88/SCH25Para3 (1) and (4)Capital profits’ are profits which arise on the disposal of assets and which are not included in working out the company’s profit or loss of an income nature.

Capital losses’ are interpreted in the same way.

Available profits are computed by taking from the relevant profits any excess of capital profits over capital losses. There is no adjustment for any excess of capital losses over capital profits.

TCGA92/S31 (1) makes a broad distinction between income and capital gains for the purpose of computing capital gains liabilities generally. ICTA88/SCH25/Para3 (4) does the same. There are some items which on first principles would be treated as capital. However, they are treated as income, however, because of a specific statutory provision such as ICTA88/S56 (transactions in deposits). In the same way such items are not treated them as capital for the purposes of ICTA88/SCH25/Para3 (4) and therefore are included in the computation of available profits.

There must be a disposal of assets. Capital profits arising from the revaluation of assets kept by the controlled foreign company are not deducted. In the same way profits arising from the revaluation of a liability are not deducted. This might happen, for example, when a company buys back a debenture. Such profits might be excluded from relevant profits anyway - see the discussion of relevant profits above.

Board’s declaration for non-trading companies

ICTA88/SCH25/PARA3 (2)Prior to FA96 interest was assessed on an arising basis but commercial profits were computed on an accruals basis. The aim of the rule in SCH25/PARA3 (2) was to stop people making use of these different bases.

Non-trading controlled foreign companies could manipulate their accounting dates for periods before 30 November 1993. This could make a big difference between the chargeable profits for a 12 month period and the dividend needed to meet the acceptable distribution test. This is why the Board could declare that a controlled foreign company’s available profits for the period were its chargeable profits. It could do this where the company had an accounting period of less than twelve months. In addition the company’s available profits for that period had to be less than its chargeable profits.