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HMRC internal manual

International Manual

Controlled Foreign Companies: Entity Exemptions: Chapter 11 - The Excluded Territories Exemption: Meaning of accounting profits: Restricted income - Category D

TIOPA10/S371KI provides for Category D income. This category applies in circumstances in which a CFC has related party transactions which result, following the application of transfer pricing rules, in its income being reduced in the CFC’s territory and where there is no corresponding increase in any other territory so that the income is effectively subject to a reduced tax rate. This category also includes income which is taxed at a reduced rate by virtue of any ruling, other decision or arrangement by the territory’s governmental authorities.

An example of what Category D is targeted at is Dutch informal capital rulings. This is an approach based on “reverse” transfer pricing in that the Dutch fiscal authorities accept that some of the profits in a Dutch CFC are not attributable to the activities of that company, but rather the result of support from overseas connected parties (other group companies). This is often described as the Dutch CFC receiving benefits from an affiliated party because that other party has not been adequately compensated as they would have been at arm’s length. Those benefits are eliminated by means of a unilateral transfer pricing adjustment in favour of the Dutch CFC i.e. its profits are reduced for tax purposes to an arm’s length amount.

This adjustment for non-arm’s length related party transactions is treated as an informal capital contribution from the parent company of the group. The Dutch CFC can then claim a deduction for that informal capital contribution. There is no Dutch legislative rule to point to, but there is a clear and well-established mechanism, which is best described as either an informal capital contribution ruling or a unilateral transfer pricing adjustment.

An example of income which is taxed at a reduced rate by virtue of any ruling or other decision or arrangement by the territory’s governmental authorities is when a tax holiday with a reduced headline tax rate or a reduced rate of headline tax on specified non-local source investment income is agreed by ruling or extra-statutory concession rather than under the law of the territory in which the CFC is resident. A reduced rate of tax in this context refers to a reduction in the headline rate of tax on the income rather than a reduction in the effective rate of tax through a deduction against gross income.