Controlled Foreign Companies: Entity Exemptions: Chapter 11 - The Excluded Territories Exemption: The Residence Condition
To be exempt under the excluded territories exemption (ETE), a CFC must be resident in an excluded territory. The list of excluded territories is provided by regulation 3 and Part 1 of the Schedule of the Controlled Foreign Companies (Excluded Territories) Regulations 2012 SI 3024 (The Regulations).
For the purposes of this list, Hong Kong and Macau are not to be regarded as part of China because they have their own taxation systems and independent judicial systems to back them up. On this basis we treat China as a separate territory from Hong Kong or Macau.
TIOPA10/S371KC explains that the rules in Chapter 20 (see INTM242000) that establish where a CFC should be taken to be resident should apply with one exception. This is where it is not possible to establish a territory of residence under the general rule in Chapter 20 (TIOPA10/S371TA(1)(a)) This general rule states that the CFC is taken to be resident in the territory under the law of which the CFC is liable to tax by reason of domicile, residence or place of management). Where this general rule does not apply, the CFC is instead treated as resident either in the territory in which it is incorporated or, if the CFC is UK incorporated but treated as not resident in the UK but resident of another territory under double taxation arrangements, in that other territory. In these circumstances, the CFC will only be eligible for exemption under the ETE if, at all times during the accounting period, the CFC or a person or persons with interests in the CFC are liable to tax under the law of the territory in question on the CFC’s income (TIOPA10/S371KC(3)). For this purpose, the CFC’s income excludes capital profits or losses.
For example, a US Limited Liability Company (LLC) may be eligible for the ETE provided it can be demonstrated that the LLC itself or the interest holders in the LLC are liable to tax on the income of the LLC under the law of the US.
However the ETE will not be available to an entity which is disregarded for tax purposes in its territory of residence in an accounting period if the result is that the entity’s income is not taxed in that territory; an example would be where the participators or persons with interests in the company are not resident in the territory where the entity is incorporated and are therefore not liable to tax on the CFC’s income in the CFC’s territory of residence. All participators/interest holders need to be liable to tax on the profits of the entity in the territory in which the entity is tax resident.
‘Liable to tax’ in this context refers to a person’s general liability to taxation under the law of the CFC’s territory and has a broader meaning than ‘subject to tax’ (see INTM225100) in that in certain circumstances tax may not be paid on all of the CFC’s income, regardless of a person’s general liability, due to a particular exemption for a type of income or similar provision under the law of that territory.