UK Tax Haven Legislation

Most highly developed countries with free economy do not mind their residents working and earning abroad. A genuine trader is free to operate where he wishes. Naturally he is expected to bring his foreign profits home and pay taxes to the domestic state treasury. When he does work abroad but doesn’t bring money back there appear doubts whether he is a genuine trader or his only intention is to avoid domestic taxation. The purpose of controlled foreign corporation regulations in any country is to prevent residents from reducing their home tax liabilities by means of diverting profits to low-tax jurisdictions.

UK introduced its Controlled Foreign Companies Regulations in 1984. Part XVII of Chapter IV ICTA 1988 charges UK resident companies to tax in respect of the income of certain controlled foreign companies in which they have interest. It targets mainly UK companies having foreign subsidiaries in low-tax areas, who do not wish to repatriate any profits on a regular basis thus trying to save on the UK tax liability. It is also known as Haven Legislation or Tax Haven Legislation.

It’s being constantly developed and updated and is rather complex. The latter is due to the fact that the right of the government to levy taxes is restricted to the worldwide income of local entities, incorporated and/or resident under its jurisdiction, and/or local source income of foreign entities.

Status of Controlled Foreign Company

A company is recognized to be a Controlled Foreign Company (CFC) for the purposes of the Haven Legislation if it is residing outside the United Kingdom, but controlled by persons resident in the United Kingdom (individuals or companies), and subject to a lower level of taxation in its territory of residence.

Meaning of “control” is well established and “control” test is far not a mechanical one based only on shareholding and voting rights figures. It means the power of a person to arrange that business of the company is being conducted in accordance with his wishes, and finally encounters many tricks like holding through nominee people or related persons, sophisticated joint venture schemes etc.

Lower level of taxation is defined by less than 3/4 of the tax, which would be payable on the same income of a resident in the United Kingdom.

The company may not necessarily be a CFC in each accounting period. If the according test rules do not prove it to be a CFC in a given period, it is excluded from the tax charge requirements.

Tax on CFC Income

The general scheme requires a computation of the CFC profits (excluding capital gains) on the lines of Corporation Tax profits, an apportionment of those profits among shareholders or those having an interest in the CFC, and self-assessment to tax by those UK resident corporate shareholders (not individuals) that have been apportioned 25% or more of the profits. The apportioned amount is used to check if associates have a relevant interest in a controlled company, i.e. if it fits the 25% threshold. When calculating the tax due double taxation relief is given, as well as tax allowances that the UK company is entitled.

Exclusions of CFCs from Charge to Tax

Apportionment of profits is not due if during the accounting period in question the company satisfies one of the statutory exclusions. The Treasury, however, reserves the right to designate any jurisdiction as having a specific status, when any CFC from such jurisdiction would automatically fall within the requirement to apportion profits and charge to tax accordingly.

Other than that the exclusions are as follows.

  • Excluded countries regulations. If a company is resident in a territory listed in the list of excluded countries and satisfies the income and gains requirement if falls within the excluded countries exemption. “Income and gains requirement” states that at least 90% of the company’s profits should be from local sources.
  • Acceptable distribution policy (ADP). If a CFC pays out dividends of 90% or more of the net chargeable profits to its UK resident associates within 18 months of the end of the accounting period, it may fall within the ADP exemption. There are certain rules to be observed in computation of profits for the further distribution of dividends.
  • The exempt activities exemption. To meet the exempt activities test a CFC must have a business establishment in the territory of residence, with its business effectively managed in there, and with its main business at NO time consisting of certain defined activities (e.g. investment business, dealing in goods to/from associated persons and some more.
  • Public quotation condition. A CFC trading its shares on a recognized stock exchange and having 35% of its shares hold by the public falls within this exemption category. There’s only one limitation that voting power of principal members should not exceed 85%.
  • De minimis exclusion. If CFC’s chargeable profits are £50,000 or less in the accounting period in question it meets de minimis exclusion test.
  • Motive test. A CFC can satisfy the motive test if it shows that by means of transferring transactions into another jurisdiction it achieved an insignificant reduction in the UK tax or it was not the main purpose nor the main reason to get a tax reduction.

Practical Notes

To define whether a foreign subsidiary is a CFC the total interest of both corporate and individual UK resident shareholders of this company is counted, but apportionment of the profits is required only to those corporate shareholders (not individual) having at least 25% of interest. In practice this is mostly the case of the foreign subsidiaries wholly owned by the UK resident companies.

International holding companies experience difficulties to meet any of charge exemption tests.

Sources