Foreign Permanent Establishments of UK Companies: anti-diversion rule: motive test: condition B
This applies for relevant periods beginning before 1 January 2013.
CTA09/S18H: Condition B
Condition B of the motive test in CTA09/S18H(6) is based on the diversion of profits leg of the existing CFC motive test. It will apply to permanent establishments which are used to reduce UK tax but which may not be undertaking transactions directly with the UK. This condition therefore focuses on whether the diversion of profits from the UK is one of the main reasons for the company carrying on its business through that PE.
This condition is met if it was not the main reason, or one of the main reasons, for the company carrying on business through the PE to achieve a reduction in UK tax by a diversion of profits from the UK. A reduction in UK tax, by a diversion of UK profits is considered to be achieved if it is reasonable to make the supposition set out in S18H(8). Three questions need to be considered:
In the absence of the business being carried on via the PE, and if there were no related companies, would it be reasonable to suppose that the whole or a substantial part of those receipts reflected in the profits attributable to the PE would have been received by any of the following: the company otherwise than through the PE, another UK resident company which is a non-electing company, or an individual resident in the UK?
In answering the above question, a number of statutory terms need to be considered further.
What is a related company?
The meaning of related company is set out at S18H(9). A company is ‘related’ to a controlled foreign company if:
- it is resident outside the UK, or is UK resident and has an effective S18A election,
- it is connected with, or is an associate (CTA10/S882) of, the company, and
- it fulfils, or could fulfil, directly or indirectly, the same functions as those of the permanent establishment.
The ‘related company’ provision in the context of this test precludes any argument that in the absence of the permanent establishment, it would be reasonable to suppose that its receipts would be received by another overseas subsidiary or foreign PE capable of fulfilling the same function as the PE deemed not to exist, rather than by a UK person. It does this by deeming such companies or PEs not to exist for the purposes of the statutory supposition.
If PE and all related companies are deemed not to exist what becomes of the PE’s receipts?
The statutory questions within CTA09/S18H(8), are similar to those raised within the motive test diversion of profits leg within the CFC regime. How they apply and are interpreted are similar and are set out in detail within the guidance at INTM255270 - INTM255290. It is therefore unnecessary to duplicate them in detail here. In summary, and in line with the CFC regime’s diversion of profits leg motive test, the PE exemption regime:
- creates a fictional scenario, where the PE is deemed not to exist,
- has the effect, within the above scenario, that it will nearly always be reasonable to suppose that the PE’s receipts would be received by the company (otherwise than through the PE) or by one of the other UK residents specified in S18H(8)(a),
- requires an assumption that there are no non-UK group companies that could perform the same function as the PE i.e. the only likely recipient therefore becomes a UK group company,
- requires an assumption, where it is reasonable to make it, that a UK company is created in situations where no other UK group company that could perform the same function as the PE exists.
It will only be in exceptional circumstances that a UK person could not have received the PE’s receipts i.e. where a UK company or individual is prevented from carrying out business in that territory.
If the requirements of S18H(8)(a) are met, the second main question within condition B falls to be addressed.
Would (disregarding S18G(2)) the UK person have paid more, or been entitled to less relief from, UK tax?
It is necessary to determine what would have been the tax position if the PE’s receipts had been received by a UK person and to compare that with the actual position where the receipts are received by the PE. In most instances, of course, the receipts would have been taxable had they been received by a UK person and therefore the UK person would have paid more UK tax, or would have been entitled to less relief from UK tax.
Other than in exceptional circumstances it will therefore nearly always be the case that, in accordance with the statutory definition, the existence of a PE achieves a reduction in UK tax by way of a diversion of profits from the UK. However, even though this test is wide in its application, so that achieving a reduction in UK tax will occur in most situations, the motive element of the test then needs to be considered and Condition B will still be satisfied where one of the main reasons for carrying on the business through a PE is not to reduce UK tax through a diversion of profits.
There is a third question within condition B.
Was it the main reason, or one of the main reasons, for the company carrying on the business through the PE to achieve a reduction in UK tax and diversion of profits from the UK?
The reasons for the PE’s existence and which of those reasons constitute a main reason are questions of fact. In practice, if the existence of a PE achieves more than a negligible saving of tax, it would normally be reasonable to infer that the tax saving was one of the reasons for bringing the PE into, or keeping it in, existence. If the tax saving is substantial, it would be reasonable to infer that it was a main reason for the PE’s existence.
As with condition A, the motive element is not concerned with the sole or a single main reason for the existence of the PE. It similarly recognises that many (probably all) PEs exist for a variety of reasons and, indeed, that there may be more than one main reason why a company carries on business through the PE. While there may be sound commercial reasons underlying the establishment of a PE, that does not necessarily mean that the test is thereby satisfied.
Even if there is a genuine commercial reason underlying the establishment of a PE, the motive element of condition B will still be satisfied if achieving a reduction in UK tax by a diversion of profits from the UK is also one of the main reasons for the company carrying on business through the PE. Regardless of the commercial considerations, only if achieving the reduction in UK tax by a diversion of profits from the UK is not one of the main reasons for the existence of the PE, will the motive part of the leg be satisfied.