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HMRC internal manual

International Manual

Foreign Permanent Establishments of UK Companies: anti-diversion rule: motive test: condition A

This applies for relevant periods beginning before 1 January 2013.

CTA09/S18H: Condition A

Condition A of the motive test in CTA09/S18H(2) is met where a relevant transaction, or one or more transactions at least one of which was a relevant one, achieves a reduction in UK tax and either

  • the reduction was minimal, or
  • it was not the main purpose, or one of the main purposes, of the transaction, or of those transactions taken together, to achieve the reduction.

In determining whether condition A has been satisfied, the following three questions need to be addressed.

Question 1 - Was there a relevant transaction?

The term “relevant transaction” (defined at S18H(3)) specifies the transaction(s) to be taken into account for the purposes of the test. A relevant transaction is a transaction the results of which are reflected in such of the UK company’s profits in the accounting period that are attributable to the permanent establishment i.e. those transactions which are attributed to the PE for the accounting period under consideration.

Question 2 - Did that transaction achieve a reduction in UK tax?

A transaction achieves a reduction in UK tax (being corporation, income and capital gains tax S18H(13)) if, had the transaction not been effected, any person (whether or not he is connected or associated with the UK resident company) -

  • would have been liable to such tax; or
  • would have been liable to a greater amount of such tax; or
  • would not have been entitled to a relief or would have been entitled to a smaller amount of relief; or
  • would not have been entitled to a repayment of tax or would have been entitled to a smaller repayment.

It is therefore necessary to determine what would have been the tax position if the transaction(s) had not been carried out. For example, a PE performing captive insurance activities may carry out transactions necessary to insure risks of UK associates. If the transactions had not been carried out the insurance premiums involved would not have been paid to it and could not therefore have qualified for deduction in computing the associates’ profits for tax purposes. This would mean that the UK associates would either have been liable to a greater amount of corporation tax or a smaller amount of relief.

It should be noted that S18H(4) is simply part of the definition of what is meant by a transaction that achieves a reduction in UK tax. The definition is based on comparing the tax position resulting from carrying out the transaction with the tax position that would have resulted had that particular transaction not taken place. All the statute directs is that an assumption is to be made that a transaction did not take place. It does not direct that any further assumptions are to be made. So, for example, there is no scope for considering hypothetical transactions which might have taken place instead of the actual transaction. Such an interpretation would imply reading into the statute words that are not there.

Take the example of the PE’s captive insurance activities mentioned above: that UK associates may have paid premiums to another insurer if they had not paid premiums to the captive and obtained deductions for amounts similar to the premiums paid to the PE cannot be used as an argument that a reduction in tax has not occurred.

In addition to the above, it should also be noted that tax consequences which are remote from the transaction should not be regarded as resulting from it. If, for example, a PE gives tax planning advice to an unconnected UK resident but the only transaction reflected in its attributed profits is the receipt of a fee for that service, it would not thereby fail condition A even if the client acted on the advice and achieved a reduction in its tax liabilities. If on the other hand the foreign PE was a direct participant in a transaction or series of transactions designed to reduce the client’s liabilities, its position under condition A is likely to be prejudiced.

Question 3 - Was that reduction in UK tax more than minimal?

There is no statutory definition or guidance on what is to be regarded as a minimal reduction in UK tax. Each case should therefore be considered on its facts. Whilst a reduction of UK tax may only represent a small proportion of the total liability, it should not be considered minimal where it represents a substantial amount when viewed in isolation from the wider tax liability. The use of the term minimal assists in the wider context of determining whether reduction of UK tax was one of the main purposes of the transaction(s).

Only if the answer to all of the above three questions is yes, will a transaction achieve a more than minimal reduction in UK tax. If the answer to any of the questions is no, condition A will not be in point and there will be no need to consider the second (motive) element.

Motive element of condition A

Even where the definition of what is meant by a transaction that achieves a more than minimal reduction in UK tax is met, condition A can still be satisfied. This occurs where it can be shown that it was not the main purpose or one of the main purposes of the transaction to achieve that more than minimal reduction in UK tax. We therefore need to consider:

‘Was the main purpose, or one of the main purposes, of the transaction (or of transactions taken together) to achieve that reduction in UK tax?’

The purposes which have to be considered for the purposes of this question are those of

  • the UK resident company concerned, and
  • any person who had an interest in that same company at any time during the relevant accounting period (TA88/S749B applies when determining who has an interest in the company).

The purposes of parties not within the above are therefore not relevant to condition A. For example, if a client makes use of the services of a foreign PE in order to reduce his own tax liability and his intentions are unknown to the UK company and its owners, it is not the client’s purpose to achieve that reduction. Furthermore, even where the client’s intentions are known, the motive element cannot be failed unless the reduction is achieved by means of a transaction (or transactions) the results of which are attributed to the PE.

The extending of commercial services to a client in the normal course of business in return for a fee would not itself achieve a reduction in the client’s tax. By contrast, the direct participation by the PE in a scheme to reduce the tax of a third party would result in failure of the test if transactions which formed part of the scheme were attributed to it and one of the main purposes of the transactions was to achieve a reduction in UK tax. This would remain true even if the scheme failed to achieve its purpose.

Whether, and the extent to which, tax considerations underlay a transaction is a question of fact and all relevant facts and circumstances have to be considered. In practice, if a transaction achieves a reduction of UK tax, it will normally be reasonable to infer that the reduction was anticipated. If the reduction is substantial, it is likely that this was one of the main purposes of the transaction. It would be unusual for a company to undertake substantial transactions without careful consideration of all the financial implications, including the tax consequences.

The motive element will be met if the purpose of achieving a reduction in UK tax is not a main purpose, that is, if the tax reduction purpose is merely incidental to the main purpose. For example, the main purpose of the purchase by a UK company of goods from a foreign PE might be to obtain those goods in order to resell them at a profit in the UK. Clearly the tax relief available against the resale proceeds in respect of that purchase falls within the definition in S18H(4) and is a transaction that achieves a reduction in UK tax. Equally, the tax relief is of crucial importance to the UK company.

That importance does not necessarily, however, make obtaining that tax relief a main purpose of the transaction. It may be merely incidental to the main purpose. It is a question of fact and degree. Whether the goods are purchased at an arm’s length price will, for example, be a factor. If the price is not at arm’s length it might indicate that tax relief was more than an incidental purpose.

An important point with regard to the motive element is that the test is not concerned with the sole purpose or with a single main purpose. It recognises that transactions may have more than one main purpose. While one purpose of a particular transaction may not be to reduce tax that does not necessarily mean that the test is satisfied.

Even if there is a genuine commercial purpose underlying a transaction, that transaction will still fail the motive element of the transaction leg if achieving a reduction in UK tax (as defined) was also one of the main purposes of the transaction. Regardless of the commercial considerations, only if achieving the reduction in UK tax was not one of the main purposes of the transaction will the motive element of the transaction leg be satisfied.