Chapter 6 Corporate anti-avoidance

Question 1

1.1 Controlled foreign companies.

Answer 1

This is anti-avoidance legislation to prevent UK companies diverting profits out of the UK to countries with lower tax rates. The rules also are relevant to the profits of overseas PEs if the election has been made to exempt them from UK CT.

Question 2

1.2 CFC overview

Answer 2

• Is the company a CFC? If no, then there is no CFC charge, if yes
• Does the company fall under one of the five exemptions? No, then no charge, if yes
• Does the company have profits passing through the gateway? No, then no charge, if yes
• Any UK company holding more than 25% must pay CT on their share of the CFC’s profits.

Question 3

1.3 Definition.

Answer 3

A CFC is a company resident outside the UK and either:
- Under UK control (more than 50% or de facto), or
- At least 40% controlled by a UK resident and at least 40% but no more than 55% controlled by a non-UK resident, or
- A UK resident company (alone or together with their associated enterprises) holds an investment of more than 50% either directly or indirectly.
A person is an associated enterprise if they hold a 25% investment in the UK company, or the UK company has a 25% investment in the person, or another person has a 25% investment in each of the person and the company.

Question 4

1.4 CFC exemptions

Answer 4

The apportioned profit rule is not applied if any of the following tests are met:
- Exempt period: first 12 months of the company under the control of UK residents. This is only for companies which have been purchased, and not newly incorporated. To qualify for this exemption in the subsequent accounting period, the company must be within the scope of the CFC legislation but not liable to a CFC charge.
- Excluded territories: HMRC provide a list of approved territories where rates of tax are sufficiently high to avoid a CFC charge arising.
- Low profits: the foreign company’s chargeable profits are £50,000 or less in a 12-month period or no more than £500,000 (of which no more than £50,000 comprises non-trading profits)
- Low profit margin: the foreign company’s accounting profits are no more than 10% of relevant operating expenditure. Op expenditure excludes amounts paid to related parties and cost of goods sold, unless those goods are used locally.
- Tax exemption: the tax paid in the overseas country is at least 75% of the UK CT which would be due if it were a UK resident company.

Question 5

1.5 Chargeable profits – CFC charge gateway

Answer 5

The CFC charge applies to trading profits attributable to UK activities. For the gateway test we must determine whether the test applies, and then determine which profits have passed through the gateway.

Question 6

1.6 Gateway – Profits attributable to UK activities

Answer 6

Unless a company meets any of the following entry conditions, the profits of a CFC will pass through the charge gateway and become chargeable profits:
- The CFC has not been party to arrangements with a primary purpose of reducing/ eliminating a charge to tax in the UK, or
- None of the CFC’s assets or risks are managed from the UK, or
- The CFC has the ability to manage its own business if any UK management of assets and risks were to stop, or
- All of the CFC’s profits consist solely of non-trading profits and/or property income.
If the entry conditions are not met, the company determines which profits have been diverted from the UK. The CFC must analyse its significant people functions which are relevant to those assets and risks being those individuals who are involved in active decision making around a particular asset.
If any of the SPFs are carried out in the UK, the profits relating to them pass through the gateway and become chargeable in the UK.

Question 7

1.7 Consequences of being a CFC

Answer 7

If a foreign company is a CFC, there is the potential for a CFC charge. A CFC charge will arise if:
- No CFC exemptions apply, and
- The CFC has chargeable profits falling within the gateway, and
- A UK company holds at least a 25% interest in the CFC.
The CFC charge if relevant means all 25% or greater UK corporate shareholders pay CT on their share of the CFC profits. This is known as the apportionment profit rule. The CFC charge is at the main rate of UK and UK companies cannot offset UK losses and surplus expenses against a CFC charge. Credit can be taken for their share of any foreign tax actually paid – creditable tax.

Question 8

1.8 Permanent establishments and the anti-diversion rule

Answer 8

To ensure no tax advantage to trading through a PE and claiming the exemption election. A charge will apply to:
Profits that would pass through the trading profits gateway if generated by an overseas subsidiary if none of the CFC exemptions apply. Equivalent exemptions apply here as to those for companies, with the exception of the exempt period exemption which does not apply to PEs.

Question 9

2.1 Transfer pricing

Answer 9

Transactions can take place between connected companies at a price other than market value in order to shift profits and pay less tax. Transfer pricing legislation applies where either profit subject to UK tax are reduced or losses are increased as a result of a transfer price set. The rules cover transactions between two UK companies, or between a UK company and a non-UK company.

Question 10

2.2 Who do the rules apply to?

Answer 10

The rules apply to connected companies, and large companies. Companies are connected where one company directly or indirectly participates in the management, control or capital of the other company, or a third party directly or indirectly participates in the management or control of both companies.
A company is large if it has at least 250 employees, or revenue above 50m euros and total asset above 43m euros. If a company is a member of a group, it is large if the group as a whole breach the limits.

Question 11

2.3 Transfer pricing – goods and services

Answer 11

The rule for transfer pricing is that transactions should be charged on an arm’s length basis. An adjustment is required in the tax computation of the company which has gained the tax advantage, to reflect the profit that would have been achieved if the transaction had been carried out at arm’s length.
Normally if the transaction is between two UK companies an equal and opposite adjustment will be made in the other company’s computation. When there is a disposal of stock other than in trade, or a disposal of intangibles between related/connected parties, transfer pricing may impose an arm’s length value which is less than market value. The amount recognised for CT purposes is however, never less than market value.
A company can enter into an advance pricing agreement with HMRC which details how certain complex transactions should be dealt with.

Question 12

2.4 Transfer pricing – provision of loan finance

Answer 12

The transfer pricing rules also apply to the provision of loan finance between large companies. The rules apply to the amount loaned, and rate of interest charged.

Question 13

2.5 Thin capitalisation

Answer 13

This refers to when the amount of debt finance in a company’s accounts exceeds what would be there in the absence of connected party lending. HMRC use gearing and interest cover ratios is help them assess when a company is thinly capitalised. The implication:
- Interest charged on the amount of loan that exceeds an amount that a third party would lend, is not allowable for tax purposes and a disallowance must be made.
- A further disallowance may also be required if the level of interest charged on a loan is not at arm’s length, such that a tax advantage is obtained in the UK.
This also applies 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.

Question 14

3.1 Diverted profits tax.

Answer 14

The DPT rules cover artificial/contrived arrangements and may lead to overseas companies paying UK tax simply for doing business in the UK. If it applies, 25% is charged on taxable diverted profits (increase to 31% from FY2023). DPT applies if either of the following scenarios arises:
- Non-UK resident companies: arrangements exist to avoid having a UK PE
- UK resident companies: transactions lacking economic substance.
The DPT does not apply if both parties involved are SMEs.

Question 15

3.2 The first rule: non-UK companies’ arrangements to avoid a UK PE

Answer 15

For DPT to apply the requirements are: a non-resident company is carrying out a trade, a person 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 company is not carrying on trade through a UK PE and the mismatch condition or the tax avoidance condition is met.

Question 16

3.3 The second rule: UK resident companies – transactions take place which lack economic substance.

Answer 16

For DPT to apply here there are arrangements between a UK company/PE and a connected party, and the arrangement causes an effective tax mismatch outcome between the two parties.

Question 17

3.4 The conditions

Answer 17

Mismatch condition:
- Arrangements in place between the two parties
- There is an effective tax mismatch outcome as a result of the arrangement.
- The effective tax mismatch condition does not apply if the increase in one company’s tax payable is at least 80% of the reduction in other party’s tax.
- The arrangement has insufficient economic substance: the value of the reduction in tax outweighs the value of any other non-tax benefits achieved, or it is reasonable to assume that one party was involved to secure a tax reduction.
The tax avoidance condition is where arrangements in place where the main purpose is to eliminate or reduce a charge to CT.

Question 18

3.5 What is DPT charged on?

Answer 18

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 arises 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.

Question 19

3.6 Administration

Answer 19

The DPT is not a self-assessed tax, but companies are responsible for informing HMRC they fall within the charge.
- Must notify HMRC within three months of the end of the AP that DPT applies.
- HMRC determines if a DPT arises and includes an estimate of taxable diverted profits if necessary.
- Company has 30 days to make representations.
- HMRC issues a charging notice if DPT applies.
- DPT must be paid within 30 days of charging notice.
- All charging notices must be reviewed by HMRC within 15 months.
- During the first 12 months of the review period the company can amend the CT return to bring profits into the charge to CT and thus reduce the profits subject to the DPT charge

Question 20

4.1 Hybrid mismatch

Answer 20

Arise in cross-border transactions by exploiting the differences in tax treatment between different countries. They usually lead to a tax advantage, either by relief being claimed for the same expense twice, or by deduction for an allowable expense when no corresponding income is taxable.
These arrangements should be counteracted, this is usually dealt with as follows:
- Double deduction (relief for same expense claimed in two group companies) the deduction will be disallowed in the country of the parent company.
- In cases of deduction/non-inclusion (relief for expense claimed in one company but corresponding income is exempt in another country) the deduction will be disallowed.

Question 21

5.1 CIR

Answer 21

There is a limit to the interest costs deductible in the UK for companies in a large group. The rules apply where a worldwide group has a net-interest expense bigger than £2 million. The net interest deductible in the UK cannot exceed interest capacity. This is made up of the current year interest allowance and spare capacity brought forward from the previous five years. The loss restriction rules in respect of carried forward losses apply after the CIR.

Question 22

5.2 Net tax-interest expense

Answer 22

The disallowance is only relevant for groups with a net tax-interest income in the UK of more than £2 million. The first step is to calculate this: UK companies net tax-interest income less UK companies net tax-interest expense.

Question 23

5.3 Interest allowance and interest capacity

Answer 23

Need to consider how much interest expense needs to be disallowed. Under the CIR the maximum deduction for interest expense in the UK is limited to the interest capacity. Interest capacity equals the current period interest allowance plus any unused interest allowance from the previous five years.
The interest allowance is calculating using one of the following methods. Fixed ratio method (default basis) or the group ratio method (if election is made). If the group’s net tax-interest expense is more than the interest capacity the excess is disallowed.

Question 24

5.4 Fixed ratio method

Answer 24

The interest allowance is the lower of:
- 30% of the group’s aggregate tax-EBITDA, or
- The fixed ratio debt cap or ANGIE (net interest payable of the worldwide group as adjusted for tax)

Question 25

5.5 Group ratio method

Answer 25

The interest allowance is the lower of:
- Group ratio % 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.

Question 26

5.6 Administration

Answer 26

The group should appoint a reporting company. An interest restriction return is filed, due date is 12 months 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.

Question 27

6.1 Value shifting

Answer 27

If prior to a sale of a company, the company pays a dividend out of distributable reserves it will reduce the value of the company and hence the gain on disposal, and the dividends to the parent company will be exempt.
Value shifting rules apply when a company pays a dividend out of profits that have not been taxed before a share disposal. The consideration on the sale of the share may be adjusted by a just and reasonable amount. A value shifting adjustment can therefore increase or create a capital gain on the disposal of shares in a company or reduce an allowable loss. The rules apply if:
- A company is disposing of shares in another company, and
- Arrangements are entered into, to materially reduce the value of those shares, and
- The main purpose for entering into the arrangement was to reduce to avoid tax.
If the shares are covered by SSE, no value shifting adjustments are needed.

Question 28

6.2 Depreciatory transactions

Answer 28

These rules are designed to restrict the loss arising on the disposal of a subsidiary in certain circumstances. The loss is restricted on a ‘just and reasonable’ basis if there is a sale of shares in a company in a gains group, and the value of the shares is reduced by an asset transfer below market value prior to the sale of the shares.
Depreciatory transaction adjustments can only restrict capital losses, they cannot increase capital gains.