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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 - avoidance of United Kingdom or foreign tax

Some holding companies are set up mainly to avoid foreign taxes. This does not mean, however, that such companies will automatically satisfy the motive test.

As made clear in INTM255160, the motive test recognises that there may be more than one main reason for the existence of a controlled foreign company. Whilst many offshore group finance companies do indeed have as one of the main reasons for their existence the reduction of foreign taxes, most also have as a main reason the achievement of a reduction of United Kingdom tax by a diversion of profits from the UK as defined in ICTA88/SCH25/PARA19. So, even if one of the main reasons for the existence of the controlled foreign company is to reduce foreign tax, a motive test claim will only succeed so long as the controlled foreign company is not also being used to reduce UK tax.

In virtually all of the cases that have been seen by HMRC, avoidance of foreign taxes has been a significant factor in the setting up of the controlled foreign company. That is not the test, however. Even if the reduction of foreign tax is the principal motivation behind the existence of the controlled foreign company, if one of the main reasons for existence is also to achieve a reduction in UK tax, the motive test will be failed.

That the group might never have contemplated using a UK company to reduce foreign tax (because UK tax on the receipt of the interest would be broadly similar to the foreign tax saved) does not, within the meaning of ICTA88/SCH25/PARA19, mean that it would not be ‘reasonable to suppose’ that the receipts would accrue to a UK company. Indeed, it is an illustration that one of the main reasons for using an offshore holding company instead of a UK holding company is because of the tax that would be payable were the receipts received in the UK.

Prior to the abolition of ACT, it was, as noted above, quite common for UK groups to use UK companies to achieve this kind of reduction in foreign tax. The abolition of ACT has not prevented UK companies from continuing to use UK companies to reduce foreign tax. What it has done, is to remove the parallel UK tax advantage from so doing. So, in most cases we have seen, the controlled foreign company has tended to be set up to avoid both United Kingdom and foreign tax. The motive test is not concerned with the avoidance of foreign tax. It is, however, concerned with the reduction in UK tax. Where, in addition to reducing foreign tax, the reduction in UK tax is also a main reason for the existence of a controlled foreign company, the motive test will be failed.

Since all motive test claims will depend entirely on their own particular facts, it is not possible to state how the motive test will apply to holding companies per se. That said, there are some generic factors relevant to most holding companies.

As noted in INTM255310, there are two basic questions that need to be answered:

  • could the business of the controlled foreign company have been carried out in the UK?
  • is one of the main reasons it was not carried out in the UK because the tax that would have been payable in the UK would have been greater than the tax paid by the controlled foreign company in the territory in which it is resident?

Like most controlled foreign companies, the business of virtually all holding/group finance companies could quite easily be carried out in the UK. This is, after all, what tended to happen in most cases (at least with group finance companies) before the abolition of ACT in 1997. The answer to the second question depends wholly on the facts. In virtually all of the cases that have been submitted to HMRC, the main reason for locating the holding company outside the UK is because the tax paid on interest received in the territory is significantly less than that which would be payable were the holding company located in the UK. In such circumstances, the motive test will be failed.

So, is it ever possible for a holding company whose main receipt is intra-group interest to pass the motive test? The answer is yes - but, in our experience, only in limited situations. One such situation might be where the controlled foreign company was set up for regulatory reasons or where it acted as a broadly autonomous regional holding company. Examples of holding companies that would (and would not) satisfy the motive test are given at INTM255500.