Controlled Foreign Companies: The CFC Charge Gateway Chapter 9 - Exemptions for profits from Qualifying Loan Relationships: Full Exemption - Qualifying Resources: Funds derived from shares:Profits derived from group operations in the relevant territory
Profits derived from group operations in the relevant territory
There is no exhaustive definition of what represents profits derived from group operations in the relevant territory. However, TIOPA10/Part 9A/S371IB(10)(d) and (e) specifically exclude certain profits that do not in substance arise from group operations in the territory from this category of qualifying resources. The specific exclusions are:
- profits that are derived from lending outside the territory,
- distributions received from third countries, and
- profits earned in permanent establishments in third countries.
In the link to example one below, there is a QLR from CFC A to CFC B funded partially out of dividends paid to CFC A from CFC C and partly from dividends received from the CFC B. The relevant territory is the territory where CFC C is tax resident as that is the territory of the ultimate debtor. To the extent the QLR is funded from the dividend paid by CFC C, the QLR will be treated as funded out of qualifying resources.
The dividend received from CFC B will also be qualifying resources under section 371IB (6) (b) and 371IB (7) (a) because all the profits out of which the dividend is paid are profits of the business of the CFC group in the same territory that CFC C, the ultimate debtor, is tax resident in.
In the link to example two below, both CFC C and CFC E are resident in the same territory. The loan of £1bn from CFC B to CFC C is funded out of qualifying resources if the group can demonstrate that the loan has ultimately been funded from the dividend of £1bn paid by CFC. Provided the chain of funding can be properly evidenced, it doesn’t matter if the funds pass through companies that are not resident in the relevant territory.
In the link to example three below, O/S Trading declares a dividend, but rather than borrowing to pay a cash dividend, the dividend is left on inter-company account, creating an intra-group loan receivable. An intra-group debt created in this way can be a QLR as it is a debt brought into being by an instrument and so is a loan relationship that falls within section 302 CTA 2009. The intra-group loan receivable is then distributed by O/S Holding to the UK parent, who in turn contributes that loan receivable to Finance CFC in return for an issue of shares. So the final outcome is a loan from Finance CFC to O/S Trading to fund a dividend.
The loan is funded out of qualifying resources as the loan to O/S Trading is funded out of profits of the business of the CFC group in the relevant territory.
Profits derived from group operations in the relevant territory are not limited to the provision of goods or services in that territory. Profits may well be derived from customers in other territories. For example a service company in the relevant territory may provide legal services for a number of group companies in other territories and so the company is trading with customers in those territories, rather than trading in those territories. Where the company is trading in another territory, the profits from that activity are not derived from group operations in the relevant territory. If the company is trading in another territory, it will generally do so through a permanent establishment in that other territory (in which the case the limitation in section 371IB(10)(e) will apply), but there may be instances where a company trades in another territory without creating a permanent establishment. While this would be unusual, profits earned from such trading are not profits derived from group operations in the relevant territory.
Profits derived from group operations in the relevant territory can include both realised and unrealised profits in respect of the increased value of assets held in that territory. Not all territories will allow a company to make distributions out of unrealised profits but it is possible in the US in certain circumstances.
Profits derived from group operations in the relevant territory do not include share capital, or amounts that are equivalent to share capital, so for example a distribution by a US company that is paid in respect of a contribution of capital made by a UK resident company (e.g. a repayment of share capital) will be excluded because the profits are not derived from US profits.
However, if a US holding company holds shares in other US group companies and the value of those companies increases because of the profits they have earned, including unrealised profits in the form of increases in the value of assets held in the US (for example warehouses used by the US business), a distribution made possible by such increases in value is indirectly derived from US profits and so may be profits derived from group operations in that territory. Put another way, profits are not prevented from being the direct or indirect source of amounts within section 371IB(6)(b) solely because they are unrealised profits, but of course they must in other respects represent profits of the CFC group in the relevant territory in order to meet the condition in section 371IB(7)(a)
So funds derived from shares may be qualifying resources if they directly or indirectly represent amounts derived from any of those three cases. It is therefore necessary to undertake an investigation into the original source for the funds.
A CFC may borrow to fund a loan temporarily, but if the arrangement for the creation of the loan includes the repayment of that temporary loan (i.e. the intention at the outset was for the loan to be funded from a specific source but temporary funding was needed while the permanent funds were appropriated), the funds used to repay the temporary borrowing are in substance used to fund the CFC’s loan and so it is the nature of these funds that will determine whether the loan is a qualifying loan. Note however where the temporary loan is UK debt, the rules provided by sections 371IB(8), (9) and (9A) may place a restriction on an amount that be considered to be qualifying resources.