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HMRC internal manual

International Manual

Controlled Foreign Companies: The CFC Charge Gateway Chapter 9 - Exemptions for profits from Qualifying Loan Relationships: How do you determine the profits of a Qualifying Loan Relationship: Calculating profits of Qualifying Loan Relationships

Example:

A CFC  has made  a loan to each of two CFCs. Both loans are QLRs.

The first loan is for $500m and is charged at a LIBOR floating rate. During the year the CFC receives interest of $30m (£25m). At the beginning of the year the loan is worth £420m. At the end of the year the loan is worth £405m.

The second loan is for $750m and is charged at a LIBOR floating rate. During the year the CFC receives interest of €42m (£39m). At the beginning of the year the loan is worth £680m. At the end of the year the loan is worth £685m.

The source of the funds for the CFC’s lending activity is equity capital provided by the UK, together with a loan of $250m that has been specifically used to fund the loan of $500m. The loan is charged at a LIBOR floating rate and during the year the CFC pays interest of $12m (£10m). At the beginning of the year the loan is worth £210m. At the end of the year the loan is worth £202m.

The CFC has also entered into the following hedging arrangements:

  • UK parent made a loan of €750m to the CFC and the CFC makes a matching loan of £680m to UK parent. During the year CFC pays €42m (£39m) interest to UK parent and receives £37m interest from the UK parent. When everything nets out, CFC has a sterling loan asset and UK parent has a Euro FOREX risk.

 

  • It  enters into an interest rate swap in respect of half of its $500m loan receivable, swapping floating $ interest for fixed $ interest. The interest rate swap is net paying and during the year the CFC makes net payments of  $1.2m (£1m).

The NTFPs of the CFC are calculated on the basis that they are profits of a UK resident company that is party to loan relationships. The overall profit or deficit from the loan relationships in this example are made up from the following loan relationship debits and credits:

  Non-trading credits Non-trading debts QLR profits s371IF
       
$500m loan receivable      
Interest receivable £25m   Step 1
FOREX   £15M Step 5
€750m loan receivable      
Interest receivable £39m   Step 1
FOREX £5m   Step 1
$250m loan receivable      
Interest payable   £10m Step 5
FOREX £8m   Step 3
€750m hedging loan payable      
Interest payable   £39m Step 2
FOREX   £5m Step 2
£680m hedging loan receivable      
Interest receivable £37m   Step 2
Interest rate swap      
Net payments   £1m Step 2
Totals £114m £70m  
Non-trading profit £44m    

 a) In this example both of the CFCs loan receivables of $500m and €750m are agreed to be QLRs. In order to determine the profits of each QLR we follow the steps in s371IF. First we want to take account of the credits and debits of each QLR. This is step 1.

           $500m QLR                  step 1 credits £25m

            €750m QLR                  step 1 credits £44m

b) Next we take account of all debits and credits from a hedging transaction that hedges the QLR. This is step 2

           $500m QLR                 step 1 credits £25m

           subtract hedging debts                      (£1m)

                                                      Step 2 credits £24m

            €750m QLR                 step 1 credits £44m

           Hedging credits        £37m

           Hedging debts          (£44m)

           Overall debt of £7m to subtract from step 1 credits

                                                    Step 2 credits £37m

c) The calculation takes account of any credits in respect of borrowings used to fund a QLR. This is step 3.

            $500m QLR             step 2 credits £24m

            Funding credits of £8m to add to step 2 credits

                                                  Step 3 credits £32m

            €750m QLR            step 2 credits £37m

            No adjustment under step 3

                                                 Step 3 credits £37m

d) Where any loan borrowed by the CFC used to fund the QLR was itself hedged, then any credits or debits relating to the hedging  relationship are included in the profits. This is step 4. In our example there are no step 4 credits and so:

              $500m QLR         step 4 credits £32m

              €750m QLR         step 4 credits £37m

e) The last step identifies any other borrowing costs of the CFC that are indirectly attributable to the QLR, together with any debits of the QLR or debits of any debtor loan relationships used to fund the QLR. In this example there are no indirect borrowings, but there are adjustments in respect of the QLR FOREX losses and funding expenses directly attributable to one of the QLRs:

              $500m QLR         step 4 credits £32m

              FOREX loss debits (£15m)

              Funding loan debits (£10m)

                                                  Step 5 credits £7m 

              €750m QLR          Step 5 credits £37m

f) The profits of the QLRs of the CFC are therefore £7m in respect of the QLR of $500m and £37m in respect of the QLR of €750m.