06. BPT - Corporate anti-avoidance Flashcards
Why are dividends usually exempt?
As the profit it has been paid out of was already subject to CT
If a comp pays a pre-sale div out of distributable reserves (which represent earned profits) it will reduce the value of the company and hence the gain on its disposal
This prevents double taxation and is permissible
When can tax be charged on dividends?
Where a comp pays a div out of untaxed profits, as then it may be attempting to avoid tax by reducing the value of the company and converting a taxable gain into tax free div income
Example of this:
If a comp pays a pre-sale div out of distributable reserves (which represent earned profits) it will reduce the value of the company and hence the gain on its disposal
This prevents double taxation and is permissible
Sparrow Ltd owns 100% of Lark Ltd.
An asset is transferred from L ltd to S Ltd for £12m and has an indexed cost of £2m (assume NBV = indexed cost). S Ltd then sells the share in L ltd to an unconnectedd comp
Explain why this transaction may be covered by the value shifting arrangements and the likely adjustment
On transfer of the asset to S Ltd, an acc profit of £10m would arise, allowing L Ltd to pay a div to Sparrowr Ltd
For tax purposes, the transfer has been made between members of a gain group and therefore will be at a gain of nil
Div will educe the value of L Ltd’s assets, and therefore on the sale of shares in the comp the chargeable gain on disposal would be £10m less than it should be.
Issue here is that the div has been paid out of unpaid taxes
If the disposal of shares in L ltd is covered bt SSE, no value shifting adj will be needed
But if SSE doesn’t apply (e.g. if L Ltd isn’t a trading comp) then a value shifting adj might be made
Adj will be likely to increase the deemed proceeds of the shares by £10m
Describe ‘value shifting’
When comp pays a div, usually CT exempt as paid from post-tax profs
But sometimes comp may pay out of distributable reserves, reducing value of comp and gain on disposal. Prevents double tax and is allowed
But then if they sell the shares, the sale may have to be adjusted for this by ‘just and reasonable amount’. This ‘value shifting’ may create capital gain
If subsequent disp of shares is covered by SSE, no value shifting adj will apply since there is no tax adv to be gained
What is the purpose of depreciatory transactions?
These rules are designed to restrict the loss arising and disposal of subsidiary in certain circumstances
What is a depreciatory transaction?
A transaction prior to the share disposal which reduces the value of the shareholding being disposed of
What are the limiting rules on depreciatory assets?
Depreciatory transaction adjustments can only restrict capital losses
They can’t increase capital gains
Give an example of a of depreciatory transactions?
WhIf there has been a movement of assets around a group at less than MV
S Ltd bought D Ltd for £24m
Since acquisition, the value of D Ltd’s assets have reduced from £24m to £17.6m for genuine commercial reasons.
D Ltd sells to S Ltd for £4.8m a prop with a current MV of £9.6m
S Ltd then sells the shares in D Ltd at their MV of £12.8m
Explain how much
S Ltd has realised a commercial loss of £11.2m on the disposal of the shares in D ltd
Of the total loss of £11.2m, £6.4m represents the decline in value of D Ltds assets attributable to external commercial factors, and £4.8m results from depreciatory transaction whereby S Ltd extracted commercial factors, and £4.8m results from the depreciatory trans whereby S Ltd extracted value from D ltd
Legislation doesn’t allow such distortion by reducing cap losses to the extent that these result from depreciatory transactions.
Therefore, S Ltd’s allowable cap losses restrict on a ‘just and reasonable’ basis to £6.4m
What is a tax haven?
Countries with loss rates of tax
What will a UK comp consider when setting up an overseas subsid?
Will be attracted to countries with low rates of tax (known as tax havens)
What does CFC stand for?
Controlled foreign companies
What anti-avoidance legislation is in place for UK comps considering setting up an overseas subsid?
What else are these rules relevant for?
- Legislation in place to prevent UK comps diverting profits out of UK to countries charging low rates of tax (companies are known as controlled foreign companies (CFC))
Also relevant to profits of overseas Eps if the election has been made to exempt them from UK CT
Give an overview of Controlled Foreign Companies (flowchart)
Is the company a CFC?
No - No CFC charge
Yes - does the comp fall under 1 of the 5 exemptions?
No - no CFC charge
Yes - does the company have profits passing through the gateway?
No - No CFC charge
Yes - Any UK company holding > 25% must pay CT on their share of the CFC’s profits
Define a CFC
- Resident outside the UK and EITHER
» Under UK control ( > 50% or de facto)
» At least 40% controlled by a UK resident and at least 40% but no more than 55% controlled bye non-UK resident
» UK res comp (alone or together with their associated enterprises)) holds an inv of more than 50% either directly or indirectly
When is a person an associated enterprise
- They hold a 25% inv in the UK comp
- The UK comp has a 25% inv in the person
- Another person has a 25% inv in each of the person and the company
TYU1
Explain whether the following company is a CFC ?
a) Alpha AG is resident for tax purposes in Germany. it is owed as follows: Orange Ltd (UK res comp) 25% Lemon Ltd (UK res comp) 15% Lime Ltd (UK res comp) 25% Pomegranate Ltd (res in Bahamas) 25%
Alpha AG is a CFC because it is 75% owned by UK residents
TYU1
Explain whether the following company is a CFC ?
b) Beta Ltd is resident in Ireland and is owned as follows: Appe GmbH (Swiss resident, 80% owned by Orchard plc (UK resident)) 60% Pear SpA (resident in Italy) 40%
Beta Ltd is a CFC because, although Orchard plc only has a 48% ‘effective’ interest, Orchard plc can control it as a matter of fact
This is because it controls Apple GmbH, which in turn controls Beta Ltd
TYU1
Explain whether the following company is a CFC ?
c) Gamma Ltd is resident in Jersey and is owned as follows
Tiny SA (resident in Jersey) 56% Big plc (resident in UK) 42% Mr Average (resident in Guernsey) 2%
Gamma Ltd is NOT a CFC.
Because although there is a UK SH (Big plc) with a SH of at least 40%, and also a non-UK SH with a shareholding of at leat 40% (Tiny SA), the non-UK SH has a holding of more than 55%
Note:
if Tiny SA’s SH had been 55% or less, Gamma would be a CFC under the 40% test
Describe the following CFC exemption
Low profits
The foreign comps chargeable profits are £50k or less in 12m period
OR
No more than £500k (of which no more than £50k comprises of non-trading profits)
Describe the following CFC exemption:
Low profit margin
The foreign company’s acc profits are no more than 10% of relevant operating expenditure
Operating expenditure for these purposes excludes amount paid to relates parties and COGS (unless those goods are used locally
Describe the following CFC exemption:
Tax exemption
Tax paid in overseas country is at least 75% of the UK CT which would be due if it were a UK res company
What does a CFC charge apply to?
- CFC charge applies to trading profits attributable to UK activities (other types of profs are covered by leg but not in this exam)
What must be determined when carrying out the CFC charge gateway test?
- Must first determine whether the test applies
2. Determine which profit have passed through the gateway (and are therefore subject to apportioned profit rule)
What are the entry conditions which result in profits of a CFC NOT passing through a chargeable gateway?
i. e. CFC profits pass through the gateway UNLESS the comp:
- CFC has not been party to arrangements with a primary purposes of reducing/ eliminating a charge in UK tax
- None of the CFC’s assets or risks are managed from the UK
- the CFC has the ability to manage its own business if any UK management of assets and risks were to stop
What are the entry conditions which result in profits of a CFC NOT passing through a chargeable gateway?
i. e. CFC profits pass through the gateway UNLESS the comp:
- CFC has not been party to arrangements with a primary purposes of reducing/ eliminating a charge in UK tax
- None of the CFC’s assets or risks are managed from the UK
- the CFC has the ability to manage its own business if any UK management of assets and risks were to stop
- All of the CFC’s profits consist solely of non-trading profits and/or property income
If the entry conditions are not met for CFC profits, what is the next step?
So if nt met one of the 5 entry conditions, the CFC profits pass through the ‘charge gateway’ and become chargeable
So must determine what extent the profits have been diverted from the UK
To do this, must analyse its signif persons functions (SPFs) which are relevant to those assets and risks
If any of the relevant SPFs are carried out in the UK, the profits relating to them pass through the gateway and become chargeable in the UK
What does SPF stand for?
And what does it mean?
Signif persons functions
Being a person who is involved in active decision making around a particular asset
What are the consequences of being a CFC?
If a foreign comp is a CFC, there is a potential for a CFC charge
CFC charge will arise if
- no CFC exemptions apply AND
- CFC has chargeable profits falling within the gateway AND
- UK holds at least 25% interest in the CFC
Describe the CFC charge
- Means that all 25% or greater UK corp SH pay CT on their share of the CFC’s profits. Known as apportioned profit rule
CFC charge is at the unified rate of 19% CT. UK comps can’t offset UK losses and surplus expenses against a CFC charge
Credit can be taken for their share of any foreign tax actually paid (known as creditable tax
What % is the CFC charged at?
19%
Can the following be offset against a CFC charge?
UK losses
Surplus expenses
NO
What is a transfer price set?
Transactions that take place between connected companies at a price other than MV
This shifts profit from a comp paying higher tax at a higher rate to a comp paying tax at a lower rate
When does transfer pricing legislation apply?
Applies where either profits subject to UK tax are reduced, or losses are increased as a result of transfer price set
Transfer price set = Transactions that take place between connected companies at a price other than MV which shifts profit to lower tax rate
TYU3 Tonetti Ltd, UK Comp, has taxable profits of £200k int eh year to 31 Mar 21
Owns 95% of an overseas subsid, resident in the country of Alanna, where tax rate is 2%. Subsid falls with in the definition of a CFC
The overseas subsid has profits of £500k for the ye 31 Mar 21, 80% of which been artificially diverted from UK and are chargeable under CFC legislation
Show effect of CFC on th CT payable by Tonetti Ltd for yr 31 Mar 21
CT Computation - ye 31 Mar 21
TTP £200k
CT @ 19% = £38k
CFC charge:
UK tax on apportioned profits (19% * 95% * 80% * £500k) = £72.2k
Less creditable tax (2% * 95% * 80% * £500k) (7.6k)
CFC charge = £64.6k
Total CT payable = £38k + £64.6k = £102.6k
When are companies deemed to be connected?
- 1 comp directly/indirectly participates in man, control or capital of the other company
- Third party directly/indirectly participates in management, control or cap of both comps
When is a company ‘large’?
What about when it is in a group?
- At least 250 employees
OR - Revenue > 50m euros and total assets > 43m euro
If a company is member of a group, it is large if the group as a whole breaches these limits
When is a company ‘large’?
What about when it is in a group?
- At least 250 employees
OR - Revenue > 50m euros and total assets > 43m euro
If a company is member of a group, it is large if the group as a whole breaches these limits
What are the rules for transfer pricing of goods and services?
- Transactions should be charged on arm’s length basis
Therefore an adj is required in tax comp of the comp which gained the tax adv, to reflect the prof that should’ve been achieved if the transaction had been carried out at arm’s length
Usually, if transaction is between 2 UK comp, an equal and opposite adj is made on each of their computations
What must be done when there is a disposal of stock other than in trade, or a disposal of intangibles between related/connected parties?
(in relation to transfer pricing)
Transfer pricing may impose an arms’ length value which is less than MV
The amount recognised for CT purposes is never less than MV
But a comp can enter into an Advance Pricing Agreement with HMRC which details how certain complex transactions should be dealt with
What can a company enter into with HMRC if they have particularly complex transactions involving transfer pricing?
a comp can enter into an Advance Pricing Agreement with HMRC which details how certain complex transactions should be dealt with
What 2 transactions does transfer pricing apply to
Transfer of goods/services
Provision of loan finance
What do the rules of transfer pricing apply to for the provision of loan finance?
- Amount loaned
- Rate of interest charged
What is thin capitalisation?
Refers to the amount of loan finance provided to a connected company exceeds the amount a third party would be willing to provide
How do HMRC determine when a company is thinly capitalised?
Gearing and interest cover
What are the implications of thin capitalisation on Interest charged
- Int charge on amount of loan that exceeds an amount a third party would lend isn’t allowable for tax purposes. A disallowance must be made
- A further disallowance may also be required if the level of interest charged on the loan isn’t at arms length, e.g. a tax adv is gained in UK
What does thin capitalisation apply to?
- Loan finance
- Guaranteed loans
How does thin capitalisation apply to guaranteed loans?
- Apply to third party loans which are supported with a guarantee from a group member
Therefore, interest on ‘real’ bank loans may be disallowed in the same way interest on intra-group loans can be disallowed
How does thin capitalisation apply to guaranteed loans?
- Apply to third party loans which are supported with a guarantee from a group member
Therefore, interest on ‘real’ bank loans may be disallowed in the same way interest on intra-group loans can be disallowed
What does DPT stand for?
Diverted profits tax
What do Diverted profits tax (DPT) rules cover and what can they lead to?
- Covers artificial/ contrived arrangements
- may lead to overseas companies paying UK tax simply for doing business in the UK
What is the rate of diverted profits tax and what is it charged on?
25% is charged on taxable diverted profits if DPT applies
When does DPT apply?
And when does it NOT apply?
Applies if EITHER of the 2 following scenarios arise
- Non-UK resident companies - arrangements exist to avoid having a UK PE
- UK resident companies - transactions lacking economic substance
But DPT DOESN’T apply if both parties involved are SMEs
When does DPT not apply?
If both parties involved are SMEs
When does DPT not apply?
If both parties involved are SMEs
For DPT apply regarding the first rule:
Non-UK resident companies Arrangements to avoid a UK PE
What are the requirements for DPT to apply?
- A non-resident company is carrying out a trade
- A UK resident person (the ‘avoided PE’) is carrying out activities in the UK in connection with the supplies to UK customers
- It is reasonable to assume that the arrangements are set up to ensure that the foreign comp is not carrying on trade through a UK PE
- The ‘mismatch condition’ or ‘tax avoidance condition’ is met
Note: there is an exception to the rule if total sales revenue from all supplies of g/s to UK cust doesn’t exceed £10m or TOTAL expenses relating to UK activity doesn’t exceed £1m
For DPT apply regarding the second rule:
UK resident companies - transactions take place which lack economic substance
What are the requirements for DPT to apply?
For DPT to apply:
- There are arrangements between a UK comp/PE and a connected party
- The arrangement causes an ‘effect mismatch outcome’ between the 2 parties
Define the mismatch condition and what does it relate to?
Relates to DPT’s first rule
- Arrangements in place between 2 parties
- There is an ‘effective tax mismatch’ outcome as a result of the arrangement (the reduction in one party’s liability is greater than the increase in the other party’s total liability to tax)
- The effective mismatch condition doesn’t apply if the increase in 1 comp’s tax payable is at least 80% of the reduction in the other party’s tax
- The arrangement has ‘insufficient economic substance’
» The value of the reduction in tax outweighs the value of any other tax outweighs the value of any other non-tax financial benefits achieved
» It is reasonable to assume that 1 party was involved to achieve a tax reduction
Define the tax avoidance condition and what does it relate to?
Relates to DPT’s first rule
- Arrangements in place where the main purpose/ one of the main purposes was to eliminate or reduce a charge to CT
What is DPT charged on?
- If DPT arises as a result of an arrangement in place to avoid a UK PE, the 25% tax is charged on ‘notional PE profits’
- These are the profits that would have been chargeable had the non-UK resident company carried on the trade through a UK PE
- If DPT arise as a result of a transaction by a UK resident company lacking economic substance; the taxable diverted profits are based on the necessary, transfer pricing adjustment plus any UK taxable income
When must HRMC be notified if DPT may apply?
Must notify HMRC within 3 months of the end of the acc period that DPT may apply
Who determines whether DPT applies?
Must notify HMRC within 3 months of the end of the acc period that DPT may apply
And HMRC determines if a DPT liability arises and includes an estimate of taxable diverted profits if necessary
How long does the company have to make representations for DPT?
Company has 30 days to make representations
What does HMRC issue if DPT applies?
HMRC issues a charging notice if DPT applies
When must DPT be paid by?
Within 30 days of charging notice
What is the review period for DPT?
All charging notices must be reviewed by HMRC within 15 months (which is known as the review period)
What changes can be made during the review period of a DPT charge?
During first 12m of the review period, the comp can amend the CT return to bring profits into the charge to CT and thus reduce the profits subject to DPT charge
What is the aim of hybrid mismatch arrangements for DPT charges?
Aims to either achieve a double deduction or deduction by one entity with no corresponding income in the other
When does hybrid mismatch often arise?
Often arises in cross-border transactions by exploiting the differences in tax treatment between different countries
How are hybrid mismatches counteracted? (i.e. how are they dealt with)
- In cases of double deduction (relief for expense claimed in 2 comps) the deduction will be disallowed in the country of the parent company
- In cases of deduction/ non-inclusion (relief for expense claimed in 1 comp but corresponding income is exempt in another comp) the deduction will be disallowed
During ye 31 Mar 21, A Inc, a large comp resident in Utopia (a tax haven) bought goods from an unconnected comp to sell to UK customers via M Ltd, a UK comp within the same group.
For tax purposes, A Inc, ensures that M Ltd never concludes these contracts with UK customers, although some support services are offered to customers.
A Inc, generates income of approx £15m in sales to UK customers, w related costs of £4m
Explain whether DPT applies to this arrangement
- It appears that arrangements are in aplace to avoid having a UK PE
- M Ltd is taking on the role of the ‘avoided PE’ by carrying on an activity in UK in connection w the supply of goods by A Inc, a non-UK res company
Reasonable to assume that activity of M Ltd is designed to ensure the non-UK comp doesn’t carry on a trade in UK for CT purposes. i.e. A Inc ensures that M Ltd never concludes a contract on its behalf, and so the tax avoidance condition (and possibly the mismatch condition) is fulfilled
As Apricot Inc is not an SME and income generated exceeds £10m and costs exceed £1m, DPR will apply to the taxable diverted profits
UK Ltd owns 100% of Oversea Inc, a country resident in Overseasandia (tax rate of 3%)
In Overseaslandia, div income is tax exempt, but interest income is taxable
Overseas Inc lent £4m to UK Ltd in 2018 at rate of 7%, which is an arms length rate of interest
In the UK, this is treated as a debt instrument, where Overseaslandia the payments of the loan are treated as div income
Explain the adjustments UK Ltd are likely to have to make their taxable profits in the ye 31 Mar 21
This is an example of deduction/ non-inclusion under the hybrid mismatch rules
As the div income isn’t taxable in Overseaslandia, no deduction will be allowable for the interest payable to the UK
UK Ltd is likely to need to increase their taxable profits by £280k, being the interest payable in the ye 31 Mar 21
UK Ltd owns 100% of Oversea Inc, a country resident in Overseasandia (tax rate of 3%)
In Overseaslandia, div income is tax exempt, but interest income is taxable
Overseas Inc lent £4m to UK Ltd in 2018 at rate of 7%, which is an arms length rate of interest
In the UK, this is treated as a debt instrument, where Overseaslandia the payments of the loan are treated as div income
Explain the adjustments UK Ltd are likely to have to make their taxable profits in the ye 31 Mar 21
This is an example of deduction/ non-inclusion under the hybrid mismatch rules
As the div income isn’t taxable in Overseaslandia, no deduction will be allowable for the interest payable to the UK
UK Ltd is likely to need to increase their taxable profits by £280k, being the interest payable in the ye 31 Mar 21
What are the different corporate interest restrictions (CIR) rules?
- Net tax-interest expense
- Interest allowance and interest capacity using
» Fixed ratio method for interest allowance
» Group ratio method
Why were the Corporate interest restriction (CIR) rules developed?
Developed as a result of the BEPS project
There is a limit to the interest costs deductible in the UK for companies in a large group
When do the corporate interest restriction apply?
The rules apply where a worldwide group has a net tax-interest expense > £2m
A worldwide group can include groups with companies only in the UK, or a group with companies resident in other countries
What is a corporate interest restriction?
- The net interest deductible in the K can’t exceed interest capacity
- The interest capacity is made up of the current year interest allowance and spare capacity bfwd from the previous 5 years
- Loss restriction rules in respect of carried forward losses apply after the corp interest restriction
Which applies first - loss restriction rules or corporate interest restrictions?
- Loss restriction rules in respect of carried forward losses apply after the corp interest restriction
Who must interest allowance be calculated for?
Must be calculated for groups with a net tax-interest expense > £2m
How is Net tax-interest expense calculated?
UK companies net tax-interest income less UK companies net tax-interest expense
When is the net tax-interest expense limited to the interest capacity?
When the net interest expense exceeds £2m
Any excess is disallowed
How do you determine what the interest capacity is?
- the curent period interest allowance - unused interest allowance from previous 5 years
How is the interest allowance for the current period calculated?
Using 1 of 2 methods:
- Fixed ratio method (default basis)
- Group ratio method (if election is made)
How does the fixed ratio method work for calculating the interest allowance?
Interest allowance is the lower of :
» 30% of the group’s aggregate tax-EBITDA
OR
» The fixed ratio debt cap or ‘ANGIE’ (net interest of the worldwide group adjusted for tax)
If the interest capacity is greater than the group’s net interest expense, no restriction is required
Explain the group ratio method for calculating the interest allowance?
- An election can be made to apply group ratio method if this gives a higher interest allowance
- Interest allowance is the lower of
» Group ratio % (calc as an av of the profits for the group but this will be given in exam) of the aggregate tax-EBITDA of the worldwide group AND
» The group ratio debt cap (qualifying net group interest expense) - If the interest capacity is greater than the group’s net interest expense, no restriction is required
Describe the following admin for interest allowances
- What must be filed if there is a restriction in the period, and when must it be filed?
How is the disallowed amount calculated when there is a group?
- Group should appoint a reporting company
- An interest restriction return is filed if there is a restriction in the period
- The report should be filed 12m from the end of the reporting company’s period of account
- The disallowed amount is calculated for the group as a whole but can then be allocated to UK group companies
