INTM254380 - Controlled Foreign Companies: definitions

Definitions: lower level of taxation

Introduction
Companies with no territory of residence - ICTA88/S749(5)
Designer rates - ICTA88/S750A
General rule and definition - ICTA88/S750(1) and (2)
Assumptions, treatment of tax paid, etc - ICTA88/S750(3)
Amount of local tax
Tax paid in third countries
Examples
Practical considerations

Introduction

By definition a company cannot be a ‘controlled foreign company’ unless it is subject to a lower level of taxation in the territory in which it is resident (see INTM254400). If this condition does not apply for a particular accounting period then the company is not a controlled foreign company in that period and no apportionment under Chapter IV falls to be made.

Subject to the exception in the next paragraph, the lower level of taxation test requires a comparison to be made between the actual tax paid by a company in its territory of residence (see INTM254400) and the Corporation Tax it would have paid if it had been resident in the United Kingdom. If the former (the local tax) is less than three quarters of the latter then the company is subject to a lower level of taxation.

Companies with no territory of residence - ICTA88/S749(5)

In order to apply the lower level of taxation test it is necessary to establish a company’s territory of residence. The rules for determining the territory of residence are given at INTM254400. The operation of those rules will sometimes result in a company having no territory of residence. Where this is the case, under ICTA88/S749(5) the company is conclusively presumed to be subject to a lower level of taxation and the paragraphs below do not apply. Further information on companies which are not subject to tax by reason of domicile, residence or place of management is given at INTM254400.

Designer rates - ICTA88/S750A

ICTA88/S750A was introduced by FA2000 and applies to controlled foreign companies’ accounting periods beginning on or after 6 October 1999. It ensures that any company enjoying the benefit of a so-called ‘designer rate regime’ will no longer be able to avoid the controlled foreign companies’ rules. These are regimes that allow controlled foreign companies effectively to choose the amount of tax they pay (such that it equates to just above the rate at which the standard lower level of taxation test has been set). Non-resident companies that are paying designer rate tax are deemed by ICTA88/S750A to be subject to a lower level of taxation. Regimes that are to be regarded as designer rate ones are listed in Regulations - see SI2000/3158.

General rule and definition - ICTA88/S750(1) and (2)

The general rule in ICTA88/S750(1) is that a company is subject to a lower level of taxation in its territory of residence if the tax paid under the law of that territory on profits arising in an accounting period (the local tax) is less than three quarters of the ‘corresponding United Kingdom tax’ on those profits.

ICTA88/S750(2) defines ‘corresponding United Kingdom tax’ as the amount of Corporation Tax which would be chargeable in respect of the company’s chargeable profits computed on the basis of -

The small profits rate given by CTA2010/S18 is available for the purposes of computing corresponding United Kingdom tax. (Under ICTA88/SCH24/PARA5 the company is assumed to be neither a member of a group or a consortium for the purposes of any provision of the Taxes Acts, but this does not affect the number of associated companies to be taken into account underCTA2010/S24(3).

Chargeable profits are computed for the purposes of the lower level of taxation test in exactly the same way as they are for the purposes of apportionment under ICTA88/S747(3). Full instructions on the computation of chargeable profits are given at INTM255600 et seq.

The general rule for the lower level of tax test at S750 is modified for periods beginning on or after 2 December 2004 to ensure that low taxed profits are identified in a way consistent with UK tax principles.

S750(1A) prevents UK excluded income from distorting the test by excluding tax arising from income and any expenditure of the company which is brought into account in the calculation of profits arising to the company under the law of the territory of residence but would not be brought into account in determining the chargeable profits of the company under UK rules.

S750(1B) makes a further adjustment to exclude from the test tax arising in the territory of residence that directly or indirectly results in the repayment or credit of tax to a person other than the company originally paying the tax.

Where accounting periods have been manipulated to avoid being subject to the modifications at S750(1A) & (1B) all such accounting periods falling before 2 December 2004 will be subject to these subsections.

Assumptions, treatment of tax paid, etc - ICTA88/S750(3)

The assumptions and computational adjustments required under ICTA88/S750(3) for the calculation of the corresponding United Kingdom tax of a company are as follows:

  • It should be assumed that an apportionment falls to be made for the accounting period in question.
  • No double taxation relief should be given in respect of the tax paid by the company in its territory of residence (the local tax). Taxes paid in other territories will however qualify for credit in the normal way.
  • The amount of the corresponding United Kingdom tax should be reduced by:
    1. any Income Tax deducted from payments received by the company which would qualify for set-off under CTA10/S967
  2. any Income Tax or Corporation Tax actually charged in respect of the company’s chargeable profits; for example, Corporation Tax on the profits of a trade carried on through a permanent establishment in the United Kingdom.

The amount of a reduction in accordance with (a) or (b) above is the amount of the final liability, net of any sum repaid or repayable to the company.

Amount of local tax

The local tax taken into account for the purposes of the lower level of taxation test is the tax actually paid under the local law on the company’s profits, exclusive of chargeable gains. Accordingly, it is restricted to taxes which qualify for tax credit relief against United Kingdom taxes on income under the normal double taxation rules. Taxes on capital profits, or taxes computed on some basis other than profits such as indirect taxes or taxes on insurance premiums, are excluded from local tax. See INTM256690 for an example where subsequent adjustments to local tax affect the lower level of taxation test.

Tax paid in third countries

Relief for third country taxes suffered is given against both the local tax and the corresponding United Kingdom tax. The former will take account of third country taxes according to the method of double taxation relief (credit or exemption) which applies in the territory of residence. The latter is reduced by double taxation relief for third country tax under the normal rules in Part 2 TIOPA 2010, following on the assumption in ICTA88/SCH24 that the company is resident in the United Kingdom.

Examples

These examples illustrate the working of the lower level of taxation test.

Example 1

A foreign company resident in country X has chargeable profits of £100,000 in the accounting period to 31 March. The company pays £14,000 tax in respect of those profits in country X and in addition pays £10,000 tax in country Y where it trades through a permanent establishment. The £14,000 tax paid in country X is net of tax relief given by country X for the tax paid in country Y. The comparison to be made in accordance with ICTA/S750(1) is as follows:

Corresponding United Kingdom tax:

- £ -
£100,000 @ 30% 30,000 -
less tax paid in country Y 10,000 -
- 20,000 (A)
Local tax (tax paid in country X) 14,000 (B)

As (B) is less than three quarters of (A), the company is subject to a lower level of taxation in its territory of residence.

Example 2

The facts are as in Example 1 except that in addition the company pays Corporation Tax of £5,000 in respect of a permanent establishment in the United Kingdom through which it trades. The computation of its corresponding United Kingdom tax is now as follows:

- £ £
£100,000 @ 30% - 30,000
less tax paid in country Y 10,000 -
Corporation Tax paid 5,000 15,000
- - 15,000

As the local tax of £14,000 is more than three quarters of the corresponding United Kingdom tax, the company is not subject to a lower level of taxation.

Example 3

The facts are as in Example 1, except that the tax paid in country X is nil and the tax paid in country Y is £25,000. The computation of the corresponding United Kingdom tax is now as follows:

- £
£100,000 @ 30% 30,000
less tax paid in country Y 25,000
- 5,000

The local tax of nil is less than three-quarters of the corresponding United Kingdom tax and the company is subject to a lower level of taxation.

This example emphasises that the comparison to be made is between the corresponding United Kingdom liability and the tax paid in the territory of residence rather than the total taxes paid by the company abroad. Even if it is subject to relatively high rates of tax world-wide a company may still be subject to a lower level of tax in its territory of residence.

It is assumed in the above examples that no restriction is required under TIOPA10/S42 in respect of the tax paid in country Y.

Practical considerations

It will often be clear from the accounts of a non-resident company that it is subject to a lower level of tax and it may not be necessary to compute its corresponding United Kingdom liability to confirm the position. However, where accounts show a significant tax charge, it should not be assumed automatically that the company is not subject to a lower level of tax. For example, the charge may include a provision for a deferred tax liability, may be an estimate which proves to be much larger than the final liability, or may include amounts which are not taxes on profits similar in nature to Income or Corporation Tax.