Beta This part of GOV.UK is being rebuilt – find out what this means

HMRC internal manual

International Manual

HM Revenue & Customs
, see all updates

Controlled Foreign Companies: exemptions - the motive test: Application of motive test: overview

In applying the motive test it is important to remember the role played by the motive test in the broad scheme of Chapter IV of the Act. The controlled foreign companies’ legislation is concerned only with the avoidance of United Kingdom tax. However, it achieves its aim of tackling this avoidance by casting a wide net and bringing within its scope all United Kingdom-controlled foreign companies that are subject to less than three-quarters of the tax to which they would be liable were they resident in the UK.

It gets nearer its target by then excluding the vast majority of such companies through a series of objectively based exemptions. Finally, the motive test exemption sweeps up those companies that do not fit within the criteria of those objective tests but which, nonetheless, are not involved in UK tax avoidance.

When the motive test was first mooted during the 3 year consultation period leading up to the introduction of the controlled foreign companies rules in 1984, it was originally intended that there would be a link between the motive test and the other exemptions. The motive test was, at that time, intended to apply ‘having regard to the reasons why’ the other tests were not satisfied. However, following representation’s that such an approach could unfairly prejudice some controlled foreign companies, the focus of the motive test was consequently changed with the result that the terms of the motive test are entirely separate from those of the other exclusions. This separate approach has two main consequences:

  • on the one hand, failure to satisfy the requirements of the other exclusions will not necessarily prejudice a controlled foreign company’s ability to meet the motive test;
  • on the other hand, (apart from a limited and wholly concessionary exception - see below re ‘marginal and isolated failures’), a marginal failure to satisfy the requirements of the other exclusions will not, of itself, necessarily mean that a controlled foreign company will consequently meet the conditions of the motive test.

This is important because the objective tests are not concerned directly with tax avoidance. Many controlled foreign companies that satisfy one or more of the objectively-based exemptions quite clearly involve, to a greater or lesser degree, the avoidance of UK tax. Indeed, in some cases, it is clear that one of the main reasons for the existence of a controlled foreign company that satisfies one of the other exemptions is to achieve a reduction in UK tax. They are excluded from the controlled foreign companies’ rules not because they are not involved in UK tax avoidance but because the genuine commercial nature of their activities, as a general rule, outweighs the tax considerations.

As noted above, to satisfy the motive test, it is not enough that genuine commercial reasons might be more important than tax-related reasons. The test can only be passed if the achievement of a reduction in UK tax by a diversion of profits from the UK is not one of the main reasons for the existence of the company.

That a company would not satisfy the motive test, however, is irrelevant to the question of whether it satisfies the conditions of one of the objective tests. Conversely, in addressing the question of whether a company passes the motive test, it is equally irrelevant whether a company would, if things were just a little different, satisfy one of the other exemptions.