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HMRC internal manual

International Manual

Controlled Foreign Companies: exemptions - the motive test: The transaction leg of the motive test: reduction in United Kingdom tax?

ICTA88/SCH25/PARA17 makes it clear that a transaction achieves a reduction in United Kingdom tax if, but for that transaction, any person (whether or not he is connected or associated with the controlled foreign company) -

  • would have been liable to such tax; or
  • would have been liable to a greater amount of such tax; or
  • would not have been entitled to a relief or would have been entitled to a smaller amount of relief; or
  • would not have been entitled to a repayment of tax or would have been entitled to a smaller repayment.

It is necessary therefore to determine what would have been the tax position if a transaction had not been carried out. For example, a captive insurance company may carry out transactions necessary to insure risks of UK associates. If the transactions had not been carried out the insurance premiums involved would not have been paid to it and could not therefore have qualified for deduction in computing the associates’ profits for tax purposes.

It should be noted that ICTA88/SCH25/PARA17 is simply part of the definition of what is meant by a transaction that achieves a reduction in UK tax. The definition is based on comparing the tax position resulting from carrying out the transaction with the tax position that would have resulted had that particular transaction not taken place. In this context, all the statute directs is that an assumption is to be made that a transaction did not take place. It does not direct that any further assumptions are to be made. So, for example, there is no scope for considering hypothetical transactions which might have taken place instead of the actual transaction. Such an interpretation would imply reading into the statute words that are not there.

Taking the example of the captive insurance company mentioned above, this means that the argument that UK associates might have paid premiums to another insurer and obtained deductions for amounts similar to the premiums paid to the captive, cannot be used as an argument that a reduction in taxes has not occurred.

Tax consequences which are remote from the transaction should not, however, be regarded as resulting from it. If, for example, a controlled foreign company gives tax planning advice to an unconnected UK resident but the only transaction reflected in its profits is the receipt of a fee for that service, it would not thereby fail the motive test even if the client acted on the advice and achieved a reduction in his tax liabilities. If on the other hand the controlled foreign company was a direct participant in a transaction or series of transactions designed to reduce the client’s liabilities, its position under the motive test is likely to be prejudiced.

ICTA88/SCH25/PARA17 (2) makes it clear that it is only reductions in United Kingdom income tax, corporation tax or capital gains tax that are relevant. Transactions that result solely in reductions in foreign taxes are not taken into account.