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HMRC internal manual

International Manual

HM Revenue & Customs
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Controlled Foreign Companies: exemptions - the motive test: The transaction leg of the motive test: motive element

ICTA88/S748 (3) (a) and ICTA88/SCH25/PARA18

There is only one question to be answered for the second element of the transaction leg of the motive test:

Was the main purpose, or one of the main purposes, of the transaction(s) to achieve that reduction in United Kingdom tax?

Even if the definition of what is meant by a transaction that achieves a more than minimal reduction in United Kingdom tax is met with regard to any transaction, the transaction leg of the motive test will still be satisfied, unless it was the main purpose or one of the main purposes of the transaction to achieve that more than minimal reduction. The purposes which have to be considered are those of -

  1. the controlled foreign company concerned; and
  2. any person who had an interest (see INTM255900) in the company at any time during the relevant accounting period.

Others’ motives are not relevant to the transaction leg of the motive test. If a client makes use of the services of a controlled foreign company in order to reduce his own tax liability and his intentions are unknown to the company and its owners, it clearly cannot be their purpose to achieve that reduction. Furthermore, even where a client’s intentions are known, the motive test cannot be failed unless the reduction is achieved by means of a transaction (or transactions) the results of which are reflected in the profits of the controlled foreign company.

The extending of commercial services to a client in the normal course of business in return for a fee would not itself achieve a reduction in the client’s tax. By contrast, the direct participation by a controlled foreign company in a scheme to reduce the tax of a third party would result in failure of the test if transactions which formed part of the scheme were reflected in the company’s profits. This would remain true even if the scheme failed to achieve its purpose.

Whether, and the extent to which, tax considerations underlay a transaction is a question of fact and all relevant facts and circumstances have to be considered. In practice, if a transaction achieves a reduction of UK tax, it will normally be reasonable to infer that the reduction was anticipated. If the reduction is substantial, it is likely that this was one of the main purposes of the transaction. It would be unusual for a group of companies to undertake any substantial transactions without careful consideration of all the financial implications including the tax consequences.

That raises the question as to when a purpose is not a main purpose. The answer to that is: when the purpose is merely incidental to the main purpose. For example, the main purpose of the purchase by a UK company of goods from an overseas associate might be to obtain those goods in order to resell them at a profit in the United Kingdom. Clearly the tax relief available against the resale proceeds in respect of that purchase falls within the definition in ICTA88/SCH25/PARA16 and ICTA88/SCH25/PARA 17 of a transaction that achieves a reduction in UK tax. Equally, clearly, the tax relief is of crucial importance to the UK company.

That importance does not necessarily, however, make obtaining that tax relief a main purpose of the transaction. It may be merely incidental to the main purpose. It is a question of fact and degree. Whether the goods are purchased at an arm’s length price will, for example, be a factor. If the price is not at arm’s length, that might indicate that tax relief was more than an incidental purpose.

An important point with regard to the motive element is that the test is not concerned with the sole or t h e main purpose. It recognises that many transactions have more than one purpose and, indeed, more than one main purpose. So, while there may be sound commercial reasons for undertaking a particular transaction, that does not necessarily mean that the test is thereby satisfied.

Even if there is a genuine commercial purpose underlying a transaction, that transaction will still fail the motive element of the transaction leg if achieving a reduction in UK tax (as defined) was also one of the main purposes of the transaction. Regardless of the commercial considerations, only if achieving the reduction in UK tax was not one of the main purposes of the transaction will the motive element of the transaction leg be satisfied.