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HMRC internal manual

International Manual

Controlled Foreign Companies: exemptions - Exempt Activities Test ('EAT'): Computation of gross income


The starting point for computing the gross income of a holding or superior holding company is to refer to the total amounts received or receivable in respect of its various sources of income, as shown in the accounts for the accounting period in question (but see below for how to deal with some more unusual circumstances). ‘Income’ excludes capital receipts. No deductions of any nature should be made from these gross receipts subject to the following exceptions.

  1. There should be left out of account so much of the company’s gross receipts as is derived from any activity which, if it were the business in which the company is mainly engaged, it would be such that ICTA88/SCH25/PARA6(2) would apply to the company (see below).
  2. To the extent that the receipts of the company from any other activity include receipts from the proceeds of sale of any description of property or rights, the cost to the company of the purchase of the property or rights is (to the extent that the cost does not exceed the receipts) to be a deduction in calculating the company’s gross income, and no other deduction (for example, for business expenses) is to be made in respect of that activity. The term ‘property or rights’ includes the stock of a trading company with the effect that gross profits of such a company are a deduction in calculating the company’s gross income.

The deductions to be made in accordance with (a) above deal with the situation of a holding company which would be able to satisfy the 90% gross income test (see INTM254960) but for income from trading or any other activity which, if it were the company’s main business, would enable it to satisfy the exempt activities test. The effect of ICTA88/SCH25/PARA12(4) is to exclude the receipts of such an activity from consideration altogether, so that the 90% gross income requirement is applied to the company’s remaining gross receipts. An example of how this operates is shown below.

A holding company (within the definition at ICTA88/SCH25/PARA12(1) has gross receipts as follows

Dividends from exempt activities subsidiaries 70,000
Receipts of retail shop (net of cost of goods) 25,000
Bank interest 5,000

But for ICTA88/SCH25/PARA12(4)(a) only 70% of the company’s gross income would be derived from exempt activities subsidiaries. However, under that provision the gross income from the retail shop is disregarded. The proportion of gross income derived from exempt activities subsidiaries is computed as follows.

70,000 x 100 93 per cent
70,000 + 5,000    

The company accordingly satisfies the 90% gross income test.

Partnerships and Trusts

If the Controlled Foreign Company holds an interest in a partnership our view is that the appropriate share of the gross income of the partnership should be included in the computation of the gross income of the Controlled Foreign Company. This view has been challenged by some avoidance schemes but has been put beyond doubt by adding sub-paragraphs 5C, 5D and 5E to paragraph 6, Schedule 25. Sub-paragraphs 5C and 5D also ensure that income accruing in a trust for which the Controlled Foreign Company is a settlor or a beneficiary is included in gross income. These new sub-paragraphs apply to income accruing on or after 12 March 2008. If the legislation applies and an accounting period of the Controlled Foreign Company straddles 12 March 2008 then that AP is split into the period before and the period on or after 12 March in applying the new legislation.