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HMRC internal manual

International Manual

From
HM Revenue & Customs
Updated
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INTM236250 - Controlled Foreign Companies: Control: Legal and economic control: Economic control

TIOPA10/S371RB(2)

A person controls a company ‘economically’ if it is reasonable to suppose that the person would receive (whether directly or indirectly) the majority of one or more of the following:

  • the disposal proceeds in the event of a disposal of the whole of the company’s share capital;
  • the income on a distribution if the whole of the company’s income was distributed; or
  • the company’s assets on a winding up or other circumstances;

whether at the time of the disposal, distribution or winding up, or at any later time.

The term “indirectly” means that a UK person can control a CFC where one or more non-UK resident companies or entities are interposed between the CFC and those persons.

For example if company A, resident in the UK, owns 100% of the ordinary shares in non-UK resident company B, which in turn owns 100% of the ordinary shares in non-UK resident company C, if B were to sell its shares in C then it is reasonable to suppose that A would then or later receive the proceeds of the sale.

The interpretation of a person receiving any proceeds, amounts or assets is extended to include references to the proceeds, amounts or assets being applied directly or indirectly for their benefit.

For example, company A, resident in the UK, owns 100% of the ordinary shares in non-UK resident company B, which in turn owns 100% of the ordinary shares in non-UK resident company C. If B sells its shares in C and use the proceeds to settle a debt that A owes then it is reasonable to suppose that the proceeds have been applied for the benefit of A.

As with legal control, if two or more persons taken together have economic control, those persons will be taken to control the company.

Application of Economic Control to Banks

As part of their business of lending money to companies, banks will generally have recourse to the company’s shares or assets in the event of a default on the loan. The CFC rules are not intended to apply to companies that come to be owned by banks because of a default on a loan and the banks intend to sell on those companies as soon as is economically feasible. Therefore the economic test of control does not apply in such circumstances. However, the rules are not disapplied in the case of a bank’s subsidiaries held to undertake the wider group’s business. Neither would the rules be disapplied if a bank decided to retain the shares or assets of a company so it formed part of the bank’s business structure. In neither case would the bank be considered to be acting in the ordinary course of its banking business.

A “relevant bank” is defined as a bank carrying on a banking business which is regulated in its territory of residence. The economic control test does not apply to only those cases where the bank has lent money in the ordinary course of its business to the company for which control is being tested. In this context money lent in a bank’s ordinary course of business means loans or short-term possession of shares or securities arising on any default of such a loan but not transactions whereby where a bank has other financial contracts with a CFC, for example derivatives.

“Banking business” is defined at INTM248100. It means the business of:

  • banking, deposit-taking, money-lending or debt-factoring; or
  • any activity similar to an activity described in the first bullet point.

Share capital held by a “relevant bank” and rights to distributions or assets on a winding up held by a “relevant bank” are not included in the whole of the company’s share capital, distributable income and assets on a winding up when determining the amount that it is reasonable to suppose a person would receive under the economic control tests. So if a relevant bank owns 2 of the 100 ordinary issued shares in a non-UK resident company, those 2 shares are ignored in testing for economic control. The test of whether a person would receive a majority of the proceeds of a disposal of the whole of the shares would be by reference to 98 shares rather than 100 and so a person owning 50 shares would receive a majority of the proceeds if those 98 shares were sold.

However if the person held 50 shares but 2 shares were held by the person as a relevant bank these shares would be ignored both in terms of the person’s shareholding and the issued shareholding of the non-UK resident company. In these circumstances, under the economic control tests, the person would be taken to hold 48 shares out of a total of 98 shares in the non-UK resident company and would not receive a majority of the disposal proceeds if those 98 shares were sold.

The extension of the definition of whether a person receives any proceeds, amounts or assets also extends to the consideration of the receipt of any proceeds, amounts or assets that are ignored for the bank economic control tests. This means there will be an obligation on any other shareholder of a CFC to consider whether any other shareholder of the CFC is a relevant bank in order to calculate their percentage of income or assets under the economic control tests. In practice it will be reasonable for a shareholder to take a risk-assessment approach to this obligation as, in most cases, it will be clear that the disallowance for relevant banks will not apply.