Controlled Foreign Companies: Entity Exemptions: Chapter 12 - The Low Profits Exemption: Introduction
The low profits exemption provides an entity-level exemption for CFCs that pose little risk of diverting UK profits because their profits are relatively low.
The low profits exemption is subject to a number of safeguards against possible avoidance activity (see INTM225600)
Chapter 12 provides an entity-level exemption for a CFC’s accounting period if either the CFC’s accounting profits or its assumed taxable total profits are no more than £500,000, and the amount of those profits that are non-trading income is no more than £50,000. The cap on non-trading income is included as there is a higher risk that this type of income can be artificially diverted from the UK.
A chargeable company has to list any CFCs relying on this exemption on its corporation tax return.
The Basic Rule
TIOPA10/S371LB sets out the basic rules for applying the low profits exemption to the CFC’s accounting period.
The low profits exemption applies if the CFC’s accounting profits or its assumed taxable total profits are no more than £500,000 for the accounting period and the amount of those profits that are non-trading income is no more than £50,000.
Accounting profits are defined at INTM248200. Broadly, they are the amount of pre-tax profits of the CFC determined in accordance with generally accepted accounting practice.
Accounting profits are then adjusted to include or exclude certain items regardless of what the CFC’s accounts show. One of these adjustments applies the transfer pricing rules at Part 4 of TIOPA10 to the measure of accounting profits if the difference made by the application of the rules is more than £50,000.
An example of this is shown in example 1 of INTM225650.
Some of the further adjustments to accounting profits exclude the following:
- amounts that would be exempt distributions (under Part 9A CTA09) in the hands of the CFC if it were a UK tax resident company,
- property business profits or losses and
- capital profits or losses.
Assumed Taxable Total Profits
The CFC’s assumed taxable total profits are defined at INTM239200 and are computed in broadly the same way as the CFC’s taxable profits would be computed for corporation tax purposes if the CFC were resident in UK.
Non-trading income is defined as any income which is not trading income whilst trading income is defined as income brought into account in determining the CFC’s trading profits for the accounting period in question. Trading profits are then defined as those that are chargeable under Part 3 of CTA09 (trading income). See INTM248100 for further details. Non-trading income in this context refers to a gross rather than a net amount of income. Distributions that are not exempt under Part 9A of CTA09 should be included within non-trading income.
The low profits exemption will also apply if the CFC’s accounting profits or assumed taxable total profits for the accounting period are not more than £50,000 without regard of the cap for non-trading income. This allows easy access to the exemption for loss-making companies. However, any arrangements made which include a main purpose of sheltering significant amounts of non-trading income by losses in a CFC will fall within the definition of an avoidance arrangement that can be countered by Condition A of the anti-avoidance provisions.
For accounting periods of less than twelve months, the numerical thresholds for profits and non-trading income outlined above are proportionately reduced.
The low profits exemption is subject to a number of safeguards against possible avoidance activity.