The Finance Act 2012 (FA 2012) – Schedule 20 effectively changed the course for CFC rules by inserting a new Part 9A in to the Taxation (International and Other Provisions) Act (TIOPA) 2010. The new rules apply to accounting periods of a CFC commencing on or after 1 January 2013.
In a series of articles we’ll be examining CFC rules in detail. In this part we provide an overview of the CFC rules followed by explaining what a CFC means. Readers should note that the end impact of CFC rules would be that a CFC charge will apply on the CFC profit, and will be payable by the chargeable company, which will be a UK company holding relevant interest.
Broadly, there are three steps involved in determining if a CFC charge applies. There is no particular order in which these steps need to be followed and if an exemption applies at any stage then there is no need to go any further.
Step 1: Check if the foreign company is a CFC. If it is not then simply the rules don’t apply and no need to go any further.
Step 2: If it is indeed the foreign company is a CFC then check if:
a) Any of the entity-level exemptions apply to the CFC?
b) The CFC has any chargeable profits?
c) There is a chargeable UK company?
Step 3: If the final answer is a ‘YES’ to b) and c), and a ‘No’ to a) above, then work out the chargeable profits and apply CFC charge to the chargeable UK company.
Definition of a CFC
Basically, the CFC rules apply to companies (and by extension to exempt foreign branches of UK resident companies) resident outside the UK but controlled by UK resident(s). So in order to define a “CFC” it is important to know if it is non-UK resident and controlled by a UK resident person or persons {(s.371AA(3)}
Determining the ‘residence’ of a company can be complicated by the operation double tax treaty provisions. Therefore, S371TA provides further insight to what is meant by ‘resident’ in such situations, as outlined below:
(a) A CFC is resident in the territory where it is liable to tax by reason of domicile, residence or place of management. A company’s domicile is usually taken to be the territory where it is incorporated.
(b) Where residence cannot be determined on the basis of (a) above and if the company is a UK incorporated one but non-resident due to the operation of a treaty tie-breaker (s18 of CTA 2009) then will be treated as resident in the territory where it is treated as resident by virtue of the double tax treaty;
(c) In all other cases the CFC is resident in the territory where it is incorporated or formed.
‘Control’ is defined to mean the power to secure that the affairs of a company are conducted in accordance with the wishes of the UK resident person or persons obtained through shares or voting power, or by powers in the articles of association or some other document (s.371RB, 371RE). The definition includes a 50% test, a 40% test and then a new FRS 2 accounting test where there is a need to consolidate accounts. Therefore, as a caution it is advisable that a company having an investment of 25% and above in a non-resident company checks if it is caught by this definition.
Normally to ‘control’, more than 50% of the shares, rights and powers with regard to that company are required. However, the definition is extended to catch joint venture situations involving two shareholders each having at least 40% of the holdings, rights and powers over the company. In other words if a UK-resident person A has at least 40% of the interests, rights and powers and a non-UK resident person B with at least 40% but not more than 55% of the interests, rights and powers with regard to the company, then A and B are considered as controlling the company (s 371RC).
Then finally the FRS 2 accounting test of control means if the person is the (potential) CFC’s ‘parent undertaking’ that is required to prepare consolidated financial statements, whether actually prepared or not, and at least 50% of the CFCs chargeable profits would be apportioned to the parent company, then that person controls the CFC (s371RE).
If the company in question fails the CFC test then the CFC rules do not apply. In the next part we will deal with entity (CFC) level exemptions.
