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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?: Funds derived from shares: Share for share exchanges

A group may make an acquisition of another group by offering newly issued shares to the shareholders of the ‘target’ group. An acquisition effected in this way is referred to as a share for share exchange.

Resources obtained from a shareholding (e.g. by selling the share or from a distribution) are qualifying if the sum received represents an amount obtained by the group in a share for share exchange. For example, the following will (subject to the conditions on share for share exchanges being met) be qualifying resources:

  • a distribution of pre-acquisition profits;
  • a repayment of share capital that existed when the acquisition was made.

Conditions for share for share exchanges to create qualifying resources

The conditions to be satisfied so that funds derived from share for share exchanges can be treated as qualifying resources are provided by TIOPA10/Part 9A/S371IC. The original shareholders must be given shares in the acquiring group in return for their shares in the target group. The shares must be newly issued by a company in the group that is not the 51% subsidiary of any other company. Usually the only company to qualify in this way is the group’s ultimate parent company.

The proportion of resources obtained from a share for share exchange that are qualifying resources are reduced if the acquisition was partly for shares and partly for cash, or if an ‘extraordinary distribution’ was paid to shareholders in connection with the acquisition. In such a case the proportion of the resources from the share for exchange that are qualifying resources is given by the formula:

  100% x B  
  A + B  


  • A = Share value,
  • B = dividend and/or cash

In the first diagram at the link below, a UK group acquires a US group through the following steps:

  • The US Group shares are acquired in exchange for newly issued shares in the UK group. The value of the newly issued shares is 1100.
  • To compensate the existing UK group shareholders, an extraordinary dividend is paid to them immediately before the exchange of shares. The value of the dividend is 100.
  • The dividend is funded as follows, cash reserves of 60, dividends received from foreign subsidiaries of 20 and debt taken on by the company paying the dividend of 20.

The newly acquired shares are transferred to CFC A, which is resident in the Cayman Islands, in return for shares issued by A. A in turn passes the shares to CFC B, which is resident in the US, in return for shares worth 520 and debt of 480.

The group makes a claim under s371IB for the profits derived by CFC A on the qualifying loan relationship of 480. It has to establish what part of the loan of 480 made from CFC A to CFC B is funded out of qualifying resources.

As the loan is funded by the sale of the newly acquired shares in US by CFC A to CFC B the group has to consider s371IC to determine the qualifying proportion.

In the formula in s371IC (5), A is 1100 and B is 100, therefore 11/12 of the funds derived from the shares are qualifying. Therefore 440 out of 480 of the loan qualifies for full exemption.

If the dividend paid to UK’s shareholders had been wholly UK debt funded, subsections 371IB (8) and (9) have no effect. But if the dividend had been funded out of debt of 100 the non-qualifying part must be increased by 100 by these subsections, to match the new debt. Therefore only 380 of the loan from CFC A to CFC B would be treated as being funded out of qualifying resources. And so only X% = 380/480 =79.2% of the non-trading finance profits arising from the loan of 480 would be exempt under s371IB.

A few years after the acquisition of US, CFC A has retained profits of 2000 arising entirely from its loan to CFC B. The US sub—group has increased in value and the group wants to ‘thin out’ the sub-group to increase the US tax deduction for interest. The following steps are taken:

  • CFC A borrows fund of 1000 using a daylight facility provided by a UK resident third party lender
  • CFC A makes a loan of 1200 to CFC B using the retained profits and the borrowed funds
  • CFC B pays a dividend of 1000 to CFC A
  • CFC A repays the daylight facility of 1000

200 out of the 1200 lent by CFC A to CFC B is derived from lending to CFC B. This is a qualifying resource under s371IA (6) (a).

The remaining 1000 is initially funded by the UK daylight facility, but due to the relaxation (see paragraph 140 below) provided by s371IB (9a) and (9b), that debt is ignored in considering any restriction of qualifying resources due to UK debt. But once the temporary loan is repaid, it become necessary to consider the source of funds for the repayment, which is the dividend from CFC B.

This is the ultimate source for the other 1000 of CFC A’s lending and it is derived from a group shareholding, so falls within s371IB (6) (b), subject to subsection (7).

It is therefore necessary to consider the source of the distributed funds. The distributed funds could fall within s371IB (7) (a) if the distribution is sourced from group profits arising in the US, such as post-acquisition profits of the acquired group. They could also fall within s371IB (7) (b) if they are funded out of amounts comprised in the earlier acquisition, although in this case only the proportion established above (i.e. 11/12) would qualify.

The greatest possible proportion is 100% qualifying resources if the funds all derive from the groups US operations post acquisition.

Use this link to view the first diagram

In the second diagram in the link below, Target (T) and its subsidiaries were acquired from unconnected persons in return for an issue of shares by a UK resident parent (UK). One of T’s subsidiaries acquired was finance CFC (F), tax resident in territory F.

Use this link to view the second diagram

In the third diagram in the link below, following the acquisition F issues new shares to T in exchange for shares in X and Y (which are tax resident in territories X and Y respectively). X and Y pay dividends to F out of profits that accrued prior to the acquisition. F used those funds to make a loan to Z1 (tax resident in territory Z). Z uses the loan to part fund an acquisition Z1 from T.

The dividends potentially represent qualifying resources as they are the funds received by F from the qualifying value of relevant pre-acquisition funds or other assets. There is no restriction because the dividends are paid out of profits derived from different territories from that of the ultimate debtor as there would be for dividends qualifying under section 371IB (7) (a) i.e. profits of the CFC group in the relevant territory. This is because the dividends qualify as relevant pre-acquisition funds or assets under section 371IB (7) (b).

Use this link to view the third diagram

A further example is where shares in an unconnected company are acquired in exchange for the issue of new shares worth £100m in the acquiring group’s parent company plus cash of £20m. At the same time an extraordinary dividend is paid to existing shareholders of the acquiring group’s parent company of £5m. Half of these shares are passed to a CFC in return for shares issued by the CFC. The acquired company distributes all of its pre-acquisition profits, the CFC receiving a dividend of £60m. The CFC makes a qualifying loan to another non-UK group company of an amount £30m. There is no other significant investment in the capital of the CFC.

The value of the acquired shares is £120m and so the value of the investment in the CFC is 60. The non-qualifying costs are £20m + £5m = £25m. The qualifying proportion of pre-acquisition profits is therefore reduced by Y% given by the formula in section 371IC (5), where A is £100m and B is the sum of £20m and £5:


                  100% x  100+25 =20%

So, in relation to the loan of £30m the qualifying value of the pre-acquisition profits is reduced by 20% from £30m to £24m. The distribution therefore comprises qualifying resources to the extent of 80% of its value. Therefore the non-trading finance profits from this loan are 80% exempt (i.e. the qualifying resources are £24m).

 A final example is where a UK group A acquires an unconnected UK Group B by issuing new shares A to the shareholders of B. Group B had an existing overseas financing company that had made a number of intra-group loans to non-UK members of group B. The funding of these intra-group loans has come from a variety of sources, mainly equity from the UK. The loans are not treated as being funded out of qualifying resources simply because they have come into group A via a share for share exchange; the requirements are more specific than that. The resources used to create the loan must be derived from amounts that represented value in the share exchange, which would not be the case for an intra-group loan that pre-existed within the acquired group B.