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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: Full Exemption - Qualifying Resources: What are Qualifying Resources?: Profits from lending to the territory:

CFC investing its lending profits in other group companies

A CFC may invest its lending profits in other group companies

As an example, a CFC makes a loan L1 to a group company in territory X. The CFC accumulates profits P from this loan. Using the funds P the CFC makes another loan L2 not to territory X.

 L2 is repaid and the CFC uses the funds to make a loan L3 to a group company is territory X.

 The funds making up the loan L2 are not qualifying resources because the borrower is not resident in territory X.

 The funds making up loan L3 are qualifying resources, because they are the profits earned from loan L1. Both L1 and L3 are made to borrowers in territory X. The fact that the profits P were lent to a non-qualifying company does not mean they necessarily lose their character as potential qualifying resources that may be subsequently lent to a group company.

As an alternative to depositing funds from profits of lending in a bank account or with a group treasury company before using those funds for further lending, a CFC may invest those profits in another group company. For example, a financing CFC may invest its profits in redeemable preference shares issued by a UK company as an alternative to upstream lending the profits to the UK. If the shares are redeemed, then the funds from the repayment of the shares may then be used as funding for further loans by the financing CFC with the proviso that the group can demonstrate that the return of the funds solely represents the profits that were originally earned from lending to the relevant territory. If this is the case, then the repaid funds may subsequently be used as qualifying resources.

 

To qualify under section 371IB(6)(a), profits must arise from a loan made to the relevant territory that is used for group business in the relevant territory. For example, profits from a loan to a group company resident in territory X used for the purpose of acquiring shares in a territory Y or for the purpose of lending to other group companies in territories Y and Z will not represent qualifying resources if subsequently used to make loans to group companies resident in territory X. This is because the profits have not been generated from lending that has been used for the purposes of the business of the CFC group in territory X. While in the second example the loans may have been made by a group company resident in territory X, that company may not be the ultimate debtor and the loans have been used to fund group business outside of territory X.

In the link to example one below, CFC A owns CFC B and CFC C that are resident in Germany and CFC D that is resident in Italy. CFC A lends to CFCs B and C in Germany and D in Italy (loans L1 to L3). The loans are all for business purposes of those CFCs in their respective territory of residence.

CFC A subsequently makes a further loan of £37m to CFC B, funded out of £20m of NTFPs received by CFC A in respect of the original loan L1 to CFC B, £15m of NTFPs received by CFC A in respect of the original loan L2 to CFC C and £2m of NTFPs received by CFC Ain respect of the original loan L3 to CFC D.

CFC A also makes a further loan £3m to CFC C funded out of NTFPs received by CFC A in respect of the original loan L3 to CFC D.

CFC B uses the funds to acquire plant and machinery used in the trade of CFC B in Germany (no profits of which pass through the CFC charge gateway). Out of the further loan of £37m, £35m is funded by qualifying resources as defined in section 371IB. This is because £35m is funded out of profits made by CFC A on loans made to relevant members of the CFC group, CFCS B and C – which are connected companies resident in Germany (being the same territory of residence of the ultimate debtor of the new loan of £37m, CFC B). The remaining £2m of the loan is not funded out of qualifying resources as the funds were sourced from the profits of the loan made by CFC A to CFC D in Italy.

CFC C uses the funds from the loan of £3m to acquire share in a French joint venture. The further loan from CFC A to CFC C is not funded out of qualifying resources as the funds were sourced from the profits on the loan made by CFC A to CFC D in Italy. The loan would also not be treated as being funded out of qualifying resources as the loan is not used for the business purposes of CFC C in Germany.

Note that the source of funds for the original loans to CFCs B and C does not need to be tested to establish whether the profits made on those loans by CFC A meet the conditions to be treated as qualifying resources. What is required is that the loans were made to the same territory and used by those CFCs for their business purposes in that country.

Use this link to view example one

In the link to example two below, CFC A and CFC B are both tax resident in the same territory, Luxembourg. CFC C the ultimate debtor in respect of loan 2, is tax resident in another territory, “the relevant territory”.

The dividend from CFC A is funded from lending to CFC C in the relevant territory, but it is not derived from group profits arising in the relevant territory. These are Luxembourg profits.

Although profits from lending to CFC C can qualify under s371IB (6) (a), they do so only if they are used directly by the lending CFC to make a further loan to the same territory. Funds derived from lending into a territory is not a category under s371IB (7) and there is nothing in s371IB (6) (a) that allows direct sources of funding to be considered.

Use this link to view example two