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HMRC internal manual

International Manual

Controlled Foreign Companies: exemptions - the motive test: Application of motive test: United Kingdom takeover of overseas group - ‘period of grace’

It will often be the case that when a United Kingdom group takes over an overseas group, it will inherit overseas companies that will not satisfy the criteria of the objectively-based exemptions. Indeed, some of the subsidiaries may well have been set up wholly or mainly to avoid tax. It is highly unlikely, however, that such subsidiaries will have been set up to avoid UK tax - since they will have been controlled by non-UK persons that will not have been subject to UK taxation under the UK’s controlled foreign companies rules or, indeed, more generally.

Whilst, once under UK control, most of these subsidiaries will achieve a reduction in UK tax by a diversion of profits within the meaning of ICTA88/SCH25/PARA19, most will not, initially at least, have as one of the main reasons for their continued existence the achievement of that reduction. They will therefore initially pass the diversion of profits leg of the motive test.

As with any other case, the question of whether such a controlled foreign company passes the motive test will be a question of fact. As a matter of administrative practice, however, HMRC will, on receipt of a satisfactory clearance application (see INTM256720 and following pages), accept that the motive test is satisfied in the case of newly acquired overseas subsidiaries up to the end of the first full (i.e. 12 months) accounting period following acquisition. This is commonly known as a ‘period of grace’ clearance.

Thereafter, the main reasons for the continued existence of the company are very likely to change. It will be under the control of UK persons. The motives of those from whom the UK group acquired the company will no longer be relevant. By then, the achievement of a reduction in tax by a diversion of profits in accordance with ICTA88/SCH25/PARA19 may well have become one of the main reasons for its continued existence. Indeed, merely allowing the company to continue to exist may be enough to fail the motive test.

It should be noted that the ‘period of grace’ clearance will apply only to:

  • controlled foreign companies that were not previously under UK control; and
  • controlled foreign companies whose main business remains unchanged throughout the relevant period.

So, the clearance will not apply, for example, to an overseas company that, prior to the takeover was part of a UK sub-group. In such circumstances, it could be the case that the UK-owned non-United Kingdom subsidiaries have been set up to avoid UK tax (and they will of course, in any event, already be subject to the UK’s controlled foreign companies rules).

Similarly, the clearance will not apply to any company whose main business changes following UK acquisition. This is not least because such a change implies active involvement of the new controller(s) whose motives will thereby have usurped those of the previous controller(s).