Controlled Foreign Companies: Entity Exemptions: Chapter 11 - The Excluded Territories Exemption: Simplified ETE
The Controlled Foreign Companies (Excluded Territories) Regulations 2012 SI 3024 modify the excluded territories exemption (ETE) in specified cases. Regulation 4 provides that the income and IP conditions do not have to be met in order for the ETE to apply for a CFC’s accounting period, provided:
- the CFC is resident in one of the territories specified; and
- if it is resident in one of the territories specified by virtue of TIOPA10/S371TA(1)(b), all of its income is subject to tax either in the hands of the CFC or its interest-holders in the territory of residence of the CFC (requirement A - see INTM242200) ; and
- its business is not carried on through a permanent establishment which it has in a territory outside its own territory of residence at any time during the relevant accounting period (requirement B).
If a CFC cannot satisfy the conditions of the simplified ETE that are included in regulation 4, the CFC may nevertheless be able to obtain exemption under the ETE as provided for by Chapter 11.
The territories specified by regulation 4 are:
- Japan, and
- The United States of America.
The territories have been selected on the basis that CFCs in those territories pose less of a risk of artificial diversion of UK profits given the nature and stability of their CT regimes, and so need be subject to fewer conditions. In particular they have been included because their CT regimes are similar to the UK’s with few “blanket” exemptions of income or inducements for foreign investment such as tax holidays or notional interest deductions. However it is important to note that the anti-avoidance condition at TIOPA10/S371KB(1)(d) will still need to be met in order for a CFC to satisfy the conditions of the simplified ETE.
Simplified ETE - Requirement A
TIOPA10/S371TA(1)(b) applies where it is not possible to determine the territory of residence of a CFC by the general rule in TIOPA10/S371TB (i.e. where a CFC is not liable to tax by reason of domicile, residence or place of management in the territory in which it is incorporated or formed).
If this is the case, then the territory of residence is determined under TIOPA10/S371TA(1)(b) as follows:
- if the CFC is incorporated or formed in the UK but is taken to be non-UK resident following application of CTA09/S18 (companies treated as non-UK resident under double taxation agreements), by its territory of residence under the relevant double taxation agreement; or
- otherwise, by the territory in which the CFC is incorporated or formed.
For the purposes of establishing, whether a CFC, its interest-holder or its interest-holders are subject to tax on all of the relevant CFC’s income in the CFC’s territory of residence, capital profits or losses are excluded. Any dividend or other distribution income can be ignored provided the company paying the dividend or other distribution is not entitled to a deduction for tax purposes in its territory of residence.
The meaning of “subject to tax” is more restrictive than “liable to tax” in that profits are only “subject to tax” if they are actually charged under the law of a territory to tax (subject to any deductions for losses, allowances etc.). If the law of a territory exempts a person from liability to tax on those profits or exempts those profits themselves from taxation, then those profits will not be “subject to tax” in that territory.
So the residence requirement for CFCs, where the territory of residence is determined through incorporation or under a double taxation agreement with the UK, is more restrictive with regard to the simplified ETE than it is for the main ETE at TIOPA10/S371KC which only requires such CFCs or persons with interests in the CFC to be “liable to tax” on the CFC’s income. This is because the simplified ETE has fewer conditions to satisfy than the main exemption and, in particular, the various Categories A to D of restricted income at TIOPA10/S371KB(1)(b) will not apply to CFCs that fall within the simplified ETE.
Income of a CFC that is included within a fiscal unity for tax purposes or 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 is considered to be “subject to tax” as the income is chargeable under the law of territory in which the CFC is resident. However where either an entity or intra-group transactions are disregarded or ignored for tax purposes the income arising in the entity or from the intra-group transaction will not be ‘subject to tax’ unless a person or persons with an interest in the CFC are subject to tax on that income under the law of the CFC’s territory.