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HMRC internal manual

International Manual

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HM Revenue & Customs
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Controlled Foreign Companies: exemptions - Exempt Activities Test ('EAT'): Income treated as not derived from subsidiaries

ICTA88/SCH25/PARA12(5) and (6) and PARA12A(5)

Certain income which a holding or superior holding company receives from its subsidiaries is disqualified from being treated as income derived from a company which it controls in determining whether the holding company satisfies the 90% gross income test (see INTM255000).

Where a holding or superior holding company has income which -

  1. is derived directly from a company which it controls and which is not a holding or superior holding company but is otherwise engaged in exempt activities, and
  2. was, or could have been, paid out of any of that other company’s non-trading income which is derived directly or indirectly from a third company connected or associated with it,

then such income is treated, in relation to the holding company or superior holding company , as if it were not derived directly from companies which it controls.

For the purposes of (b) above ‘non-trading income’ is income which would not be within the charge to Corporation Tax if the company were trading in the United Kingdom.

Example

A is a holding company with a subsidiary B which is mainly engaged in manufacturing but which receives dividends from its own subsidiary C. The accounts of B show the following.

  £
   
Manufacturing profits 70,000
Dividend from C 30,000
Total profits 100,000
Dividend to A 50,000
Transferred to reserves 50,000

In order to determine how much of the dividend of £50,000 paid to A is to be treated as derived from companies which A controls, the dividend must first be matched with the non-trading income which B has derived from connected or associated companies, that is, with the dividend of £30,000 from C. Thus only £20,000 of the dividend will be treated in the hands of A as derived from companies which it controls while the balance will be regarded as derived from other sources.

ICTA88/SCH25/PARA12(5), (6) and PARA12A(5) prevent holding companies from sheltering income which, if received directly, would not count towards the 90% test. In the example above, if C were an investment company held directly by the holding company A, the 90% test would not be satisfied. Where, but for these provisions, a holding company or superior holding company would pass the exempt activities test, the motive test will apply where the 90% test would be satisfied if the non-trading income referred to in ICTA88/SCH25/PARA12(5)(b) were received directly by the holding company or superior holding company.

Therefore if C above were a company carrying on exempt activities or were an exempt trading company, A will be treated under the motive test as though no part of the dividend of £50,000 paid by B fell within ICTA88/SCH25/PARA12(5), notwithstanding that that income is ‘non-trading income’ in the hands of B. This treatment will only apply where the group structure that results in the application of ICTA88/SCH25/PARA12(5) exists for commercial reasons.