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HMRC internal manual

International Manual

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HM Revenue & Customs
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Controlled Foreign Companies: exemptions - the motive test: Application of motive test: holding companies - background

When proposals to introduce controlled foreign companies’ rules were first announced in 1981, the intention had been to not have an automatic exemption for holding companies

In a consultative document entitled ‘Taxation of International Business’ which was issued in December 1982 the Inland Revenue stated:

‘It is intended that, in applying the motive test to holding companies, its conditions should be regarded as satisfied where the main purpose of the company is -

  1. receiving dividends and interest from their overseas subsidiaries as a mere staging post in the course of the process of reinvestment of the profits concerned in the trading operations of the overseas subsidiaries concerned, or
  2. holding of funds outside the source country for the purpose of reinvestment in that country because of rigorous exchange controls, inflation, exchange fluctuations or political instability and the risk of expropriation.’

[‘Overseas subsidiaries’ in (a) means non-United Kingdom subsidiaries.]

Following consultation, it was decided that an automatic exemption for certain holding companies was appropriate and when the legislation was introduced in 1984, the exemption was included as part of the exempt activities test (see INTM254800 and following pages). However, it was recognised that there might, in theory at least, be some companies to which the December 1982 announcement might apply but which might not satisfy the conditions of the exempt activities test. When guidance on the controlled foreign companies’ legislation was issued in 1985, therefore, it was announced that the 1982 interpretation of the motive test would continue to be valid.

It is difficult, if not impossible, to reconcile the statutory wording of the motive test with the December 1982 ‘staging post’ interpretation. For a number of years, however, there was little difficulty in practice as United Kingdom companies tended to use offshore companies mainly to act as ‘staging posts’ for the recycling of dividends rather than interest. Issues surrounding the utilisation of surplus advance corporation tax (‘ACT’) tended to lead them to use United Kingdom companies to act as ‘staging posts’ for the recycling of interest. In practice, therefore, the controlled foreign companies’ staging post interpretation had only limited application.

The problem came to a head, however, following the abolition of ACT in 1997. Abolition led a number of companies to seek to take advantage of the automatic exemption under the exempt activities test or the staging post interpretation of the motive test to avoid significant amounts of United Kingdom tax. So, in FA00, the automatic exemption was revised and the ‘staging post’ interpretation of the motive test withdrawn for controlled foreign companies’ accounting periods beginning on or after 21 March 2000.

Naturally, the motive test still applies to holding companies just as it applies to any other type of company. It can now be satisfied, however, only if, on the facts, the statutory conditions set out in section ICTA88/S748(3)(b) and ICTA88/SCH25/PARA19 are satisfied.

Since March 2000, we have had a number of queries about how the motive test (or more specifically, the diversion of profits leg of the test) applies to holding companies - especially with regard to those that act not only as a holding company but as a group finance company and where the major element of their profits is intra-group interest.

Two major issues have tended to crop up in this context:

  • the example quoted by the Inland Revenue in its 21 March 2000 press release about the changes to the exempt activities test and ‘staging post’ interpretation of the motive test; and
  • the question of whether holding companies have been set up to avoid foreign or United Kingdom tax.