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HMRC internal manual

International Manual

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Arbitrage: practical guidance - examples demonstrating the application of the arbitrage legislation: Example 2 Part 4 - outward investment

Example 2 Part 4 - outward investment

Facts: For the fourth part of the example, we assume that the funds provided by the equity investment did not replace an existing loan, but were retained in the subsidiary as a cash reserve for a brief period before being returned to the UK as a dividend which was used to repay the loan. In the UK, the tax charge on the dividend was eliminated by underlying tax relief (but we assume that it did not carry significant amounts of surplus Double Taxation Relief (Eligible Unrelieved Foreign Tax) (DTR (EUFT)) to set against other dividend income).

Analysis: The scheme did not achieve a commercial purpose, because the funds were not used for investment in the subsidiary’s trade, and were in fact returned to where they started. The scheme is essentially self cancelling and requires no funding. The scheme created a foreign tax advantage, represented by the tax deduction given for the partnership interest.

However the scheme did not reduce the amount of UK tax payable. It created a UK deduction and matching receipt but the overall effect was neutral on the assumption that it required no external funding.

On this analysis it appears that there was a main purpose of achieving a foreign tax advantage, but no main purpose of achieving a UK tax advantage. Therefore Condition C is not met and the legislation does not apply.