INTM197760 - Controlled Foreign Companies: The CFC Charge Gateway Chapter 3 - Determining which (if any) of Chapters 4 to 8 apply: Does Chapter 5 apply?: What is excluded from non-trading finance profits?: Incidental non-trading finance profits - the 5% rule
A CFC’s non-trading finance profits will not pass through the Chapter 5 charge gateway if certain requirements are met. Broadly, these requirements exclude from charge, incidental non-trading finance profits that are no more than 5% of trading profit and/or property business profit or 5% of exempt distribution income, creating a safe harbour.
If the CFC’s non-trading finance profits are no more than 5% of the following amounts:
- if the CFC has trading profits and/or property business profits, the total of those profits determined before deduction of interest or any tax or duty (its EBIT figure);
- if the CFC has exempt distribution income, the total of its exempt distribution income,
- if it has both types of income in the first and second bullet points, the total of both,
then the 5% safe harbour rule will exclude the CFC’s non-trading finance profits from consideration under Chapter 5.
If the CFC has exempt distribution income a substantial part of its business must be the holding of shares or securities in companies which are its 51% subsidiaries throughout the accounting period.
Indicators that the holding of shares or securities will be a substantial part of a CFC’s business in the accounting period include circumstances where;
- more than 20% of the CFC’s gross income is represented by exempt distribution income from its 51% subsidiaries, or
- more than 20% of the net asset value in the CFC’s balance sheet is represented by the investment in its 51% subsidiaries.
“Exempt distribution income” is defined by as any dividends or other distributions which are excluded from the assumed total profits of the CFC because they would be exempt under Part 9A of CTA09, the distribution exemption.
“Securities” is not defined, and should be interpreted in accordance with its ordinary meaning of a debt or claim that is secured (i.e. the subject of a legally enforceable document).
Where a CFC meets the requirements above then none of the CFC’s non-trading finance profits will need to be considered under Chapter 5 and similarly a claim under Chapter 9 will not be required. Whilst a business cash pool or float’s cash needs will vary, 5% has been chosen on the basis that it will cover most cash-flow situations and be generous for many. Where a business consistently has a cash pool requirement in excess of 5% then the incidental rule as described in INTM197750 will need to be considered.
An example of the calculation of the 5% rule is demonstrated at INTM197780.
Anti-avoidance
In order to prevent non-trading finance profits being accumulated amongst different companies within a group chain and manipulating the 5 per cent exclusion, further rules apply if the CFC has exempt distribution income in an accounting period.
If at any time during the accounting period a 51% subsidiary of the CFC is also a CFC (“the CFC subsidiary”) and the CFC subsidiary has “relevant non-trading finance profits”, the CFC subsidiary’s “relevant non-trading finance profits” are to be added to the non-trading finance profits of the CFC for the purpose of testing the 5% limit.
Relevant non-trading finance profits
The CFC subsidiary’s “relevant non-trading finance profits” is defined with reference to whether it has an accounting period that is the same as, or falls wholly within that of the CFC, on the one hand, or, on the other hand, it has an accounting period which otherwise overlaps with that of the CFC.
When a CFC subsidiary whose accounting period either matches or falls entirely within the accounting period of the holding company CFC, the relevant non-trading finance profits are its non-trading finance profits for the relevant period, to the extent that they are exempt from Chapter 5 by virtue of TIOPA10/S371CC or TIOPA10/371CD.
When a CFC subsidiary whose accounting period overlaps with the accounting period of the holding company CFC, the relevant non-trade financing profits are a just and reasonable proportion of its non-trading finance profits for that period again to the extent that by virtue of TIOPA10/S371CC or TIOPA10/S371CD, Chapter 5 does not apply to the CFC subsidiary for the relevant period.
If the CFC subsidiary has non-trading finance profits which are exempt from Chapter 5 by virtue of either of the Chapter 3 exclusions (see INTM197750), or by virtue of the entity level exemptions contained in Chapters 10 to 14, then those non-trading finance profits would not fall within the CFC subsidiary’s relevant non-trading finance profits.
Any trading profits that pass through the CFC charge gateway for the accounting period are excluded from the definition of trading profits for the purposes of TIOPA10/S371CC.
An example of the interaction of these rules is demonstrated at INTM197790.
The consequences of failing the TIOPA10/S371CC 5% safe harbour rule
Where the safe harbour is failed then a mixed activity CFC (i.e. one that has both exempt business income and exempt distribution income) would need to consider the application of the further 5% rule in INTM197770. However, where the CFC has only exempt distribution income and has failed the 5% safe harbour then all of its non-trading finance profits will need to be considered under Chapter 5 unless it makes a claim in respect of qualifying loan relationship profits under Chapter 9 (the exempt finance profits regime).