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HMRC internal manual

International Manual

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HM Revenue & Customs
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Controlled Foreign Companies: exemptions - excluded countries: Application of non-local source income rules to permanent establishment income: examples

It may help to have a copy of SI1998/3081 to hand when working through these examples.Example 1

  Total Controlled Foreign Company income   PE income
(included)          
           
  Sales 500,000      
  Purchases 300,000      
  Net Sales   200,000   20,000
  Plus        
  Non-local interest 50,000   2,000  
  Non-local royalties 25,000      
      275,000   22,000
  Less        
  Costs 75,000   2,500  
      200,000   19,500
  • Regulation 6(3) does not apply. But non-local interest is greater than 10% of net permanent establishment profits.
  • The non-local source income for the controlled foreign company is therefore:
  Interest 48,000 regulation 5(3)(b)
       
  Royalties 25,000 regulation 5(3)(c)
  PE 2,000 regulation 5(3)(e)

Example 2

A company resident in territory A has a permanent establishment in territory B. Territory A operates an exemption method. The head office in A makes a loan to the permanent establishment in B on which B pays interest. The interest is liable to tax in territory A. The test is satisfied.

The facts are as above but territory A operates a credit method of taxation. The interest paid by the permanent establishment to the head office in territory A is not allowed as a deduction against the taxable profits of the company except to the extent that it represents interest paid by the company to another person. In computing the company’s profits for tax in territory A the interest paid by the permanent establishment is not therefore allowed. The test is satisfied.

Example 3

  Total Controlled Foreign Company income   PE income (included)  
         
Sales 500,000      
Purchases 300,000      
Net Sales   200,000   20,000
Plus        
Non-local interest 50,000   10,000  
Non-local royalties 25,000      
    275,000   30,000
Less        
Costs 75,000   25,000  
    200,000   5,000
  • Under regulation 6(3), 10,000 gross interest exceeds 5,000 net permanent establishment profits and therefore 10,000 is substituted for 5,000 when looking at the controlled foreign company’s non-local source income.
  • The non-local source income for the controlled foreign company is therefore:
  Interest 40,000 regulation 5(3)(b)
       
  Royalties 25,000 regulation 5(3)(c)
  PE 10,000 regulation 5(3)(e)