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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 - conduit companies

Another example of a holding company that might, in certain circumstances, satisfy the conditions of the motive test is a holding company that acts purely as a conduit (i.e. it exists solely to receive dividends from its subsidiaries which it immediately passes on to its United Kingdom parent). Until relatively recently such companies have not generally been an issue as regards the motive test. This is because they would normally satisfy the conditions of either:

  • the exempt activities test; or, failing that (if, for example, the company was simply a ‘brass plate’ with no employees/premises)
  • the acceptable distribution policy test (‘ADP’), which applied for APs ending on or before 30 June 2009.

There continues to be no real issue with conduit companies so long as they are not ‘brass plates’. Since FA00, however, HMRC has been increasingly asked to comment on whether brass plate conduits satisfy the conditions of the motive test. The reason for this is of course that the rules for double taxation relief were fundamentally changed in FA00. In particular, ‘ADP dividends’ cannot be pooled with other dividends.

This has created a new issue as regards the motive test. On the one hand, genuine conduits immediately pass on the income they receive to their UK parents - which, through the ADP exemption, is something the controlled foreign companies’ rules are, in effect, designed to encourage.

On the other hand, however to exempt ‘brass plate’ conduits under the motive test seems to be flying in the face of the spirit of the controlled foreign companies regime since:

  1. offshore ‘brass plates’ are one of the types of company at which the controlled foreign companies’ rules are aimed and which are specifically excluded from the exempt activities test; and
  2. as noted at the start of this section, the motive test is aimed at sweeping up companies at which the controlled foreign companies’ rules are not intentionally aimed but to which an objective test is impractical to apply - something that is clearly not the case even for ‘brass plate’ conduits.

That said, the legislation does not explicitly direct that one exemption takes precedence over another. Notwithstanding the intended function of the motive test, if a controlled foreign company meets its conditions, those who hold an assessable interest in the controlled foreign company are not precluded from making a claim for relief under that exemption where one of the objective tests is applicable. Perhaps because the motive test was not designed with conduits in mind, however, it is not an easy test to apply to them.

The motive test is concerned with tax-reducing diversions of profits from the United Kingdom (as defined by ICTA88/SCH25/PARA19). At first blush, genuine conduits do not appear to have such a role. Indeed, even though their existence is specifically to divert profits from the UK, they do so only temporarily since they immediately pass on the overseas profits to the UK.

That is not, of course, the whole story, however. Conduits can be used, in conjunction with the double taxation relief (‘DTR’) rules, to repatriate overseas profits in a manner which reduces the UK tax that would otherwise be payable on those (or, importantly, other) overseas profits.

As with any company, all will depend on the facts and it is the statutory wording that needs to be considered. Notwithstanding its specific profit repatriation role, as with most holding companies, it will usually be the case that a conduit will, under the terms of ICTA88/SCH25/PARA19, achieve a reduction in tax by a diversion of profits from the UK since:

  1. it is clearly reasonable to suppose that, in the absence of the conduit (and any other related, non-United Kingdom company that could perform the same function), the whole of the conduit’s receipts would have been received by a United Kingdom person (most likely the United Kingdom parent); that, after all is their ultimate destination; and
  2. had those receipts been received in the United Kingdom, a United Kingdom person would have either been liable for more United Kingdom tax or would have been entitled to less relief (for example, DTR).

As noted above, at first blush, this seems an odd result, especially if, as a matter of fact, the on-payment of the dividends results in a tax liability that is equivalent to (or, theoretically at least, even more than) that which would have arisen had the dividends come straight to the UK instead of via the conduit. The point here, however, is that:

  1. ICTA88/SCH25/PARA19 obliges us to look solely at the conduit’s receipts and to consider whether, if on the basis that in the conduit’s absence it would be reasonable to suppose they’d be received in the United Kingdom, there would consequently have been more United Kingdom tax to pay (or less relief to give). The statute affords no scope for considering what subsequently happened to those receipts; and
  2. the question of course still remains as to whether the achievement of that reduction was a main reason for the existence of the conduit. That will, as ever, be a question of fact - and, in this respect, the subsequent destination of the receipts may be a relevant fact to be taken into account.

Example 14 at INTM255500 provides one instance of where the achievement of the ICTA88/SCH25/PARA19 reduction in UK tax might not have been a main reason for the existence of a conduit.