Controlled Foreign Companies: Entity Exemptions: Chapter 11 - The Excluded Territories Exemption: Introduction
Chapter 11, introduced by TIOPA10/S371KA, provides for the “excluded territories exemption” (ETE). The ETE is an entity level exemption (see INTM224000). Its purpose is to exempt those CFCs that pose a low risk to the UK corporate tax base of artificial diversion of UK profits partly due to their territory of residence but also by looking at the type of income the CFC can receive and any amounts it may receive from intellectual property (IP) that it holds. These are set out as a number of conditions that must be met in order for the CFC to qualify for the ETE for a specific accounting period.
The ETE works by looking at a CFC’s accounting profits rather than its assumed taxable total profits, and is therefore intended to be relatively easy to apply. It is acceptable for a group to take a risk assessment approach to the application of the ETE. For example, a high level review of a sub-group of companies will normally be sufficient where the sub-group in question is a normal trading sub-group in the USA where the tax department are aware that there are no significant investment or avoidance activities taking place.
The ETE in Chapter 11 is supported by the Controlled Foreign Companies (Excluded Territories) Regulations 2012 SI 3024 (The Regulations). The Regulations provide the list of excluded territories for the purposes of the ETE.
The Regulations set out an extra condition that must be met for the ETE to apply if the CFC carries on insurance business. The extra condition is that none of the insurance business is carried on in Luxembourg (the extra condition). They also provide a simplified ETE that is available for CFCs resident in Australia, Canada, France, Germany, Japan and USA provided alternative conditions are met (the simplified ETE). The simplified ETE is an additional, optional basis for exemption that does not affect entitlement to the ETE provided by Chapter 11.
The ETE is an ‘all or nothing’ entity level exemption in that there are no provisions for partial exemption of income if any of the conditions are failed in contrast to the CFC charge gateway provisions in Chapters 4 to 8. However, there is a threshold (or de minimis) amount of category A to D income, below which failure of the income condition at TIOPA10/S371KB(1)(b) will not be fatal to exemption under the ETE.
If the ETE applies for a CFC’s accounting period, all of its profits are exempted from the CFC charge and there are no corporation tax return reporting requirements in relation to the CFC i.e. it will not be necessary for the UK parent company to report the CFC on the CT600B form. It will therefore be important to have an overall understanding of a group’s overseas structure and to be aware that not all CFCs will be reported on the return made by the UK parent. This is particularly important in view of the fact that the ETE is one of the most widely used exemptions in the CFC regime.
It is recognised that there may be occasions where information about the CFC may not be available, or where the time it would take to verify beyond any doubt that the CFC satisfies all of the conditions for the exemption would be disproportionate.
In such circumstances, it would be reasonable for the self-assessment to be based on a realistic interpretation of the available information. With this in mind, it may be sensible to liaise with groups on setting up procedures and checks in order to reduce the risk of subsequent CFC enquiries. It remains a question of fact whether a CFC qualifies for one or more of the exemptions and groups remain responsible for ensuring that returns are correct and complete.