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HMRC internal manual

International Manual

HM Revenue & Customs
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Controlled Foreign Companies: exemptions - the motive test: Application of motive test: holding companies - 21 March 2000 example

This example stated that:

‘the current exemption distorts the way some overseas investments are structured, and is leading to a loss of United Kingdom tax. For instance, a UK company wanting to put additional funds into a subsidiary in the United States will commonly borrow in the UK, put the borrowed money into a low tax subsidiary (e.g. in the International Financial Services Centre in Dublin Docks) in the form of share capital, and the low tax subsidiary will then lend the money to the United States. In this example, the tax effect would be:

* a tax deduction at 30% in the United Kingdom (for the interest onthe United Kingdom loan)
* a tax deduction at 34% in the US (for the interest on the loan from Dublin Docks)
* a tax charge at 10% in Dublin Docks (on the interest from the US).

In other words, the group would get 2 lots of deduction at normal tax rates, and a single charge at a low rate.’

A number of companies have suggested that this demonstrates that the policy behind the change to the exempt activities test and the withdrawal of the ‘staging post’ interpretation of the motive test was to tackle these so-called ‘double dips’ (i.e. the achievement of a tax deduction in two countries for what is, in effect, the same interest payment). As such, some companies believe that the motive test should continue to apply to controlled foreign companies that are not being used to achieve a ‘double dip’.

This is not so. Clearly ‘double dips’ were (and are) a concern but, as is evident from the preceding explanation of how the motive test works, only one element of this kind of ‘double dip’ (the sheltering of the interest receipt) has any relevance to the motive test. The ‘double dip’ example was simply an illustration of the avoidance UK groups had begun to indulge in post-ACT since it reduced tax on two fronts - the UK interest deduction (irrelevant to the motive test unless the borrowing in the UK is from the controlled foreign company) and the diversion of the interest receipt (central to the motive test).

It does not matter, in the context of the motive test, if the structure is used to achieve a ‘double dip’. All that matters is whether one of the main reasons for the existence of the controlled foreign company is to achieve a reduction in UK tax by a diversion of profits from the UK as defined in ICTA88/SCH25/PARA19.