INTM180020 - Foreign entity classification for UK tax purposes: How HMRC arrives at a general view of foreign entities

INTM180030 includes a list of foreign entities and undertakings where we have provided a general view as to whether they can be described as “transparent” or “opaque” within the meaning explained at INTM180010. This list is intended to provide HMRC officers and customers with a general view as to whether the members will be liable to UK tax on the profits, income or gains of the entities or only on any distributions made by the entities. INTM180040 however explains how our view of a specific entity may vary and how we would reach a definitive view.

To reach a general view, we take into account the following factors:

1. Does the foreign entity have a legal existence separate from that of the persons who have an interest in it?
2. Does the entity issue shares in its capital or something else which serves the same function as shares in capital (for these purposes, “shares” should be interpreted in line with CTA10/S1117(1) to include any other interest of a member in a company- see CTM00513 and below for further guidance)?
3. Is the business carried on by the entity itself or jointly by the persons who have an interest in it that is separate and distinct from the entity?
4. Are the persons who have an interest in the entity entitled to share in its profits as they arise; or does the amount of profits to which they are entitled depend on a decision of the entity in accordance with its constitution, usually made by its directors (or their equivalents), or members collectively, after the profits have been measured (a distribution)?
5. Who is responsible for debts incurred as a result of the carrying on of the business: the entity or the persons who have an interest in it?
6. Do the assets used for carrying on the business belong beneficially to the entity or to the persons who have an interest in it?

Note that the above factors may be relevant when coming to a definitive view on how a particular statutory provision applies in a particular situation (as at INTM180040). However, the extent to which each factor may be relevant will depend on what exactly the statutory question to answer is.

Some of those factors may point in one direction; others may point in another. An overall conclusion is reached from looking at all the factors together, though some have more significance than others.

These factors overlap. For example, as part of considering factor 4, it is useful to consider the extent to which the entity displays what some commentators call ‘entity shielding’, which refers to the protection of the entity assets from members and their creditors. If it displays strong entity shielding, that would indicate that the members are not entitled to the profits which correlate to the assets in the balance sheet as they arise.

To shield assets in this manner, the entity will need a separate legal existence (factor 1) with the ability to carry on business as an entity distinct from the members jointly or in common (factor 3) . Business assets will generally belong to the entity (factor 6), supporting their shielding or partitioning away from members and their creditors. If the entity is responsible for the debts (factor 5), that would be a pointer that it carries on the business itself, and strong entity shielding will often be a feature associated with members’ limited liability.

A consequence of entity shielding is that members’ interests are not directly in the assets of the entity, but in the entity itself. This interest in the entity is likely to serve the same function as share capital in a UK-registered company (factor 2).

Share capital in a UK-registered company is what the members contribute and under UK company law reflects a nominal value, although the shares may be issued at a premium. The shares issued will reflect members’ proportionate interests in the share capital according to nominal value (although the actual value of the shares will usually be different from the capital contributed as the actual value will usually reflect undistributed profits or the discounted value of the expected dividend stream rather than entitlement to assets in liquidation). 

However, the important point here is that the share capital concept reflects not UK company law formalities but members’ ownership interests in what has been called the “corpus” of the company (see Rae v Lazard (1963) 41 TC 1).

When considering whether a foreign entity issues something similar to share capital in a UK-registered company, it is therefore important to remember that whilst foreign company law may be significantly different from UK company law (for example, there may be no nominal capital), it may still issue something that serves the same purpose of reflecting members’ ownership interests in the “corpus” of the entity. See CTM00515-6 for further guidance.

In considering the factors above it is also important to remember that we look at the foreign commercial law under which the entity is formed and at the internal constitution of the entity. How the entity is classified for tax purposes in any other country is not relevant.