INTM217550 - Controlled Foreign Companies: The CFC Charge Gateway Chapter 9 - Exemptions for profits from Qualifying Loan Relationships: What is Excluded from the definition of a Qualifying Loan Relationship: Section 371IH(7)(8)&(9)

There is a specific restriction in relation to CFCs which make loans from funds provided by a UK resident connected company whose main business is either banking or insurance. That company does not have to be a qualifying company (i.e. it does not have to be controlled by the same UK resident person that controls the CFC), it is enough that the UK bank or insurance company is connected to the CFC. The restriction applies where the UK resident connected company provides the funds (directly or indirectly) to the CFC other than by way of a loan (e.g. by shares or capital contribution) or the funds are provided by way of arrangement that gives rise to a deduction for the UK resident connected company (apart from the ultimate debtor) in the calculation of its trading profits..

The restriction is provided by TIOPA10/Part 9A/S371IH(8) and (9) which prevent a creditor loan relationship of a CFC from being a qualifying loan relationship (“QLR” - INTM217000) where it is:

  • sourced to more than a negligible extent from relevant UK funds (other than a loan) derived from a UK resident connected company which has a main business of banking or insurance; or
  • where the loan relationship was created as part of an arrangement which gives rise to a taxable Case I deduction for a UK resident connected bank or insurance company (apart from the ultimate debtor). This would include for example interest on a loan.

The restriction in section 371IH(8) is not limited by any rule that specifies the source of the funds provided to the CFC by the UK resident bank or insurance company. So a structure used by the UK resident company to source and differentiate funds which doesn’t give rise to a direct taxable deduction will not prevent the application of the restriction in sub-section (8).

Example 1

A CFC has received capital investment of £100m from a UK connected company undertaking banking activity and those funds have been used to provide the funding for loans of £500m made by the CFC. £250m has been lent to a UK resident group company (and so is not a QLR) and £250m has been lent to another CFC. Absent section 371IH (8), the latter loan would be a QLR. The restriction provided by section 371IH (8) means the loan of £250m to the other CFC will not be a QLR because more than a negligible part of the loan is funded by a UK connected bank. This is the case even though at least some of the loan has been funded from another source.

Example 2

A UK resident bank makes an equity investment of £100m in a UK resident subsidiary, which in turn makes an equity investment in a CFC (which is also connected to the UK bank). The CFC uses the investment to part fund a loan of £500m made to another CFC. As the loan is funded to more than a negligible extent out of funds that have indirectly been provided from a UK connected bank, the loan is not a QLR.

As with section 371IG(7) the rules in sections 371IH(6) to (8) could potentially apply to a group treasury company within a non- financial services group whose activities fall within the definition of banking business. In many cases the majority of group financing transactions may originate from funds raised by the group treasury company or from transactions routed through it. Whether the treasury company (which might be a UK resident company or a CFC) is treated as trading is a matter of fact to be considered on a case by case basis.

Example 3

A US CFC pays a dividend to an offshore holding company and the funds are placed on deposit with the UK treasury company (in line with treasury policy). The funds are later returned to the offshore holding company, which makes an equity investment into another CFC, which in turn uses the funds to make a loan to a US CFC. The UK treasury company is considered to be carrying on a trade.

The initial deposit of funds with the UK treasury company by the offshore holding company may fall within the incidental finance income safe harbour for holding companies at sections 371CC and 371CD in which case the ultimate debtor rules in sections 371 IG and IH are not considered (as the profits will not pass through the CFC charge gateway by way of Chapter 5). Where however the NTFPs arising on the loan exceed the safe harbour then Section 371IG (7) will apply to treat the UK treasury company as the ultimate debtor. However provided the treasury company uses the funds in the ordinary course of its banking business and does not on-lend or enter into arragements outlined in section 371IH (5) (a) or (b) to obtain a tax advantage, section 371 IG (7) will not apply.

The loan from the CFC to the US CFC will not be caught by section 371IH (8) as the funds were simply deposited in the UK treasury company for a short period of time before the funds are used by the holding company to make another investment. In such a case we would treat the loan as not being made out of funds as a result of an arrangement within Section 371IH (8) (b), unless there are circumstances that indicate the funds originated from a different source than the original deposit within the treasury company.