Controlled Foreign Companies: Entity Exemptions: Chapter 11 - The Excluded Territories Exemption: Meaning of accounting profits: Restricted income - Category A
A CFC’s Category A income consists of any gross amounts (see INTM224950) of any relevant income to which subsections (3), (4) or (5) of TIOPA10/S371KE apply. “Relevant income” means any income of the CFC that:
- is brought into account in determining its accounting profits for the accounting period; or
- is not brought into account but arises in the accounting period.
TIOPA10/S371KE provides the basic rules covering what comprises Category A income. Category A income is any income in respect of which the CFC is taking advantage of a tax exemption, a tax holiday, a tax refund scheme or any similar arrangement.
A tax exemption covers rules permitting certain income arising to a company resident in that particular territory to be exempt from tax in part or in whole. This does not however apply to any exemption for company distributions whether any such distributions would be exempt in accordance with Part 9A CTA 2009 or not.
Category A income could comprise non-local source investment income or income arising in a permanent establishment of the CFC (but see INTM224965) that is exempt under the law of the CFC’s territory of residence. However it will not include income of a CFC that is part of a fiscal unity or included in a consolidated tax return whereby intra-group transactions are netted off against each other and a single member of the consolidated group pays the overall tax liability. This is because in these circumstances income of the CFC is considered to be chargeable under the law of territory in which the CFC is resident.
Tax holidays (sometimes referred to as tax subsidies or tax incentives) can cover either a full exemption on income arising in a CFC (or an extension or renewal of an original holiday) or a reduction in the rate of tax given to investors in a territory in order to encourage investment in that territory. The latter type of tax holiday may take the form of a reduced rate of tax on the whole of the investor’s relevant income or any part of it.
Such tax holidays are commonly given by developing territories and generally arise to CFCs set up in Special Economic Zones (or equivalent areas) where foreign investment in specific sectors such as data processing or manufacturing is targeted and encouraged through exemption or reduced headline rates of tax.
Category A income does not include tax incentives given as deductions; for example, research and development allowances or accelerated depreciation on intellectual property or patents. Although this type of tax incentive could be seen as existing mainly in order to encourage investment in a territory, they will normally reduce the effective rate of tax on those profits rather than the headline rate of tax and TIOPA10/S371KE(4) is referable to a reduction in the headline rate of tax.
A “tax refund scheme or other similar arrangement” includes any tax law or rule that entitles the CFC, its shareholders, interest-holders, or any connected parties directly or indirectly to a full or partial refund of the tax paid by the CFC on its profits (otherwise than as a result of loss relief). An example of a tax refund scheme would be the rules in Malta that allow a repayment to be made to a company’s shareholders, so reducing the effective corporation tax rate from the headline rate of 35% to a rate in-between 0% and a maximum of 6.25%.