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HMRC internal manual

International Manual

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Controlled Foreign Companies: exemptions - the motive test: Application of motive test: examples - holding companies

Example 12

A subsidiary of a United Kingdom group acts as the holding company for various associates. It is funded entirely by equity subscribed for by its UK parent which has borrowed in the UK to fund the subscription. With one exception its income is made up exclusively of dividends from trading subsidiaries that satisfy the exempt activities test. That one exception is that a proportion of its income is in the form of interest from a loan to one of its subsidiaries. This income causes it to fail the exempt activities test. The facts show that:

  • one of the main reasons for the existence of the company is to act as a holding company and to provide finance to its subsidiaries; but
  • the company has, within the meaning of ICTA88/SCH25/PARA19, achieved a reduction in UK tax by a diversion of profits from the UK; and
  • the achievement of that reduction is another main reason for its existence.

This is on the basis that:

  1. it is reasonable to suppose that, in the absence of the holding company (and any other related, non-United Kingdom company that could perform the same function as the holding company), the whole of the holding company’s receipts would have been received by a United Kingdom person (most likely the UK parent);
  2. had that happened, that UK person would have been liable to UK tax on the profits arising out of those receipts; and
  3. one of the main reasons why the holding company exists to receive its receipts is because, if they were to be received by a UK group company, that UK company would have to pay such UK tax.

The diversion of profits leg of the motive test is therefore failed.

Example 13

The facts are the same as in Example 12 except that the United Kingdom parent has not borrowed to fund its equity subscription in the holding company. It has funded it by way of a rights issue to its shareholders. Since the method by which the UK parent has funded its subscription is entirely irrelevant for the purposes of the motive test, this makes no difference to the analysis we are required to make. The answer is precisely the same; the diversion of profits leg of the motive test is failed.

Example 14

A holding company resident in a tax shelter acts as a pure conduit for the payment of dividends from trading companies all of which are resident in normal rate countries. 100% of such dividends are immediately passed to the United Kingdom on receipt. It has no other income. The holding company, however, fails the exempt activities test because it has neither premises nor employees in the tax shelter. The facts show that:

  • one of the main reasons for the existence of the company is to act as a holding company and to pass on dividends paid to it by its subsidiaries;
  • another main reason for the company’s existence is to avoid the need to pay a withholding tax in the subsidiaries’ countries of residence which would be due were dividends from the company’s subsidiaries to be paid directly to the UK but not if paid to the company;
  • because of the absence of withholding taxes, the amount of DTR available to set against the liability on the dividends is less than would have been available had the dividends been paid direct to the UK.

As noted in INTM255240 and INTM255300, the controlled foreign company has, within the meaning of ICTA88/SCH25/PARA19, achieved a reduction in UK tax by a diversion of profits from the United Kingdom but the questions remains as to whether achievement of that reduction is another main reason for its existence.

In the unusual circumstances and particular facts of this specific case (and without hypothesising alternative scenarios), the absence of the withholding tax that would otherwise have been payable (and creditable against UK tax) cancels the ICTA88/SCH25/PARA19 ‘reduction in tax’ leaving, in the round, no net loss of tax to the UK. In such circumstances, achieving the ICTA88/SCH25/PARA19 reduction in tax is not a main reason for the controlled foreign company’s existence so the motive test is satisfied.

(Health warning: ‘Brass plate’ companies like this rarely satisfy the conditions of the diversion of profits leg of the motive test but on the particular facts of this case, that leg is passed. That said, this example should not be taken as a general indication that conduit companies will always satisfy the conditions of the motive test. As noted above, even where 100% of the receipts are always passed on immediately, most conduit companies will, within the meaning of ICTA88/SCH25/PARA19, achieve a reduction in UK tax by a diversion of profits from the UK. They will only satisfy the conditions of the motive test if (as in the above example), as a matter of fact, the achievement of that reduction is not one of the main reasons for the conduit’s existence.)

Example 15

A United Kingdom group has a broadly autonomous south east Asian trading sub-group which consists solely of trading subsidiaries carrying out their operations exclusively in that region. It is headed by an intermediate holding company resident in Hong Kong.

The facts show that:

  • the intermediate holding company plays a mixed role of holding, management and finance company for the sub-group;
  • it has staff based in its permanent premises in Hong Kong with sufficient authority and expertise to make all of the material decisions regarding the operations of the trading sub-group, including the provision of both debt and equity funding which it provides out of its own resources (made up exclusively of income earned on arm’s length terms on such funding); and
  • the only reason for setting up the controlled foreign company in Hong Kong as opposed to the United Kingdom was the need for a holding/finance/management company located in the region where these decisions are made.

These facts demonstrate that, whilst the existence of the holding company achieves a reduction in UK tax by a diversion of profits from the UK within the meaning of ICTA88/SCH25/PARA19, that achievement (and the payment of the lower rate of tax chargeable in Hong Kong) was only incidental to the commercially-driven reason for its location in Hong Kong rather than being another main reason for the controlled foreign company’s existence.

The company therefore satisfies the diversion of profits leg of the motive test.