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HMRC internal manual

International Manual

Controlled Foreign Companies: Reviews: Examples of Controlled Foreign Company avoidance

The design of Chapter IV ICTA 1988 is to counter two main methods of reducing United Kingdom tax

a) the diversion of profits from the United Kingdom tax net to overseas territories - where they will suffer little or no tax,

and

b) the accumulation of profits in overseas territories - where they will suffer little or no tax. These are profits earned abroad which, but for tax reasons, might be expected to flow back to the United Kingdom as taxable dividends.

Here are some examples of these methods.

‘Moneybox’ Companies

A company puts surplus funds into a company in a low tax territory, usually as a subscription for shares. The income from the investment of these funds accumulates free of tax. If the United Kingdom company invested the funds directly, whether in the United Kingdom or abroad, it would pay Corporation Tax on the investment income.

In some cases the Officer may find that the moneybox company has lent the funds back to a United Kingdom member of the group - at interest that qualifies for tax relief in the United Kingdom.

Captive Insurance Companies

A group that has in the past insured its risks with independent insurance companies, or not insured them at all, places its insurance with an offshore subsidiary specially set up. The profits of this captive company are free of tax. The parent company can normally deduct the premiums paid in computing its profits, despite CTA09/S54 and TIOPA10/Part 4. You can also find captive hire purchase or leasing companies.

The captives will invest the premiums and the income from these investments will qualify as trading income of an insurance business.

Sales, Distribution or Service Companies

A company splits off parts of its trade to an overseas company so that the profits from those parts arise in a low tax area. Often the amounts of these profits do not relate to what the overseas company actually does. For example, a company may sell its goods to an overseas company that it controls, instead of selling them directly to the customers abroad. The overseas company then sells the goods to these customers. The company delivers the goods however from the United Kingdom directly to the customers, with only the paperwork being routed through the overseas company. In this way part of the profit on the goods escapes United Kingdom tax.

Patent Holding Companies

A company transfers its rights to patents, trademarks, copyright, licences, etc. to a subsidiary in a low tax territory. In this way the income from the rights suffers less United Kingdom tax.

Dividend Trap Companies

A company with an overseas trading subsidiary sets up a non-resident holding company. The holding company intercepts and accumulates dividends in a low tax territory. The dividends would otherwise come directly to the United Kingdom and suffer tax.

The above list of examples is not exhaustive. Looking at how United Kingdom companies involve themselves with low tax territories may reveal many different methods of escaping tax, some of which Chapter IV may not catch. (See INTM256860 for action to be taken in cases that do escape). It may also be found that the nature of a company in a low tax territory is not clear cut. For example, a company set up to route invoices or to trap dividends may in the end look like a moneybox company because of the investment of its accumulating reserves.