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
