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HMRC internal manual

International Manual

Controlled Foreign Companies: exemptions - Exempt Activities Test ('EAT'): Income requirement of holding companies

ICTA88/SCH25/PARA 6(4) and (4ZA)

For a holding company other than a ‘local holding company’ (see INTM255020 to INTM255050) to satisfy the exempt activities test, at least 90% of its gross income during the accounting period under consideration must:

i) be derived directly either from companies which it controls or from companies which are ‘maximum permitted shareholding companies’ or ‘40/40’ controlled foreign companies in relation to it and which, throughout that period -

  1. are not themselves holding companies (whether local or not) or superior holding companies but otherwise are, in terms of ICTA88/SCH25, engaged in exempt activities or are exempt trading companies; or
  2. are ‘local holding companies’; and

ii) be in the form of ‘qualifying dividends’ (see below) - unless the company in i) above is resident in the same territory as the holding company and the income is received in that territory (i.e. it is not received in an overseas permanent establishment of the holding company).

The term ‘qualifying dividends’ is defined in ICTA88/SCH25/PARA6 (5B) as any dividend other than one for which there is an entitlement to a deduction for tax purposes in the territory of the payer. This would include, for example:

  • ‘hybrid’ dividends that are treated as interest for tax purposes;
  • dividends paid by companies resident in countries where a tax deduction is automatically given - whether or not tax is withheld in the source country; and
  • dividends where (because, for example, of a repurchase agreement - or ‘repo’) an effective tax deduction in respect of the dividend falls to a company other than the payer but where the deduction effectively falls to the payer because it and the other company are members of the same group and, for example, the territory of the payer taxes groups on a consolidated basis.

Exchange gains and losses arising in respect of income derived from controlled companies should be excluded from the ‘gross income’ as being a consequence of the currency in which the transaction is enacted or the currency of account rather than being derived from the controlled company.

It is recognised that there may be occasions where information about the Controlled Foreign Company may not be available or the time it would take to verify beyond any doubt that the Controlled Foreign Company satisfies all of the conditions for the exemption would be disproportionate. In these circumstances, see INTM256620 for further guidance.