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Finance Act 2012

Chapter 11 - The excluded territories exemption

248.Chapter 11, introduced by new section 371KA provides for the “excluded territories exemption” (ETE). If a company is resident and carries on business in one of the countries on the list made under the regulation-making power conferred by Chapter 11, and meets the other conditions of the ETE, then the CFC is excluded from the CFC charge.

249.New section 371KB(1) sets out the four conditions that need to be met for the ETE to apply for a CFC’s accounting period. These are that:

  • the CFC is resident in one of the excluded territories specified in regulations for the accounting period;

  • the total of amounts (if any) of the CFC’s income which falls within Categories A, B, C and D (as set out in new sections 371KE-371KI) is not more than the “threshold” amount for the accounting period (as described in new section 371KD);

  • the IP condition (provided by new section 371KJ) is met; and

  • the CFC is not involved in an arrangement, the main purpose or one of the main purposes of which is to obtain a tax advantage for any person at any time during the accounting period.

250.The categories A to D of income are explained in detail below. In essence there is a limitation on the amount of certain classes of income which the CFC can accrue if it is to qualify for the ETE. This threshold is set by virtue of new section 371KD at 10 per cent of the CFC’s accounting profits excluding transfer pricing adjustments for the accounting period in question, or £50,000 if greater. If income falls into more than one category then it is counted only once for the purposes of the test.

251.New subsection (3) confers a power on HM Revenue and Customs Commissioners to make regulations in connection with requirements of the ETE. The income category and IP conditions may for example be switched off or modified in respect of certain territories in the regulations. Further requirements may also be specified as having to be met for the ETE to apply.

252.To be exempt under the ETE a CFC must have a territory of residence. New section 371KC explains that the rules in Chapter 20 dealing with residency more generally should apply with one exception. This is where it has not been possible to establish a territory of residence under the general rules in Chapter 20 and instead the CFC is treated as resident either in the country in which it is incorporated or, if the CFC is UK incorporated but treated as not resident in the UK under double taxation arrangements, it is treated as resident in the territory of the other party to the relevant arrangements. In these circumstances the CFC will only be eligible for exemption under the ETE if, at all times during the accounting period, the CFC or persons with interests in the CFC are liable to tax under the law of the territory in question on the CFC’s income.

253.New section 371KE provides the basic rules covering Category A income. This category is concerned with income which is either exempt from tax in the territory or subject to a reduced tax rate in specified circumstances which include a tax holiday or other investment incentive and tax repayment schemes.

254.New section 371KF applies where a CFC has a permanent establishment in an excluded territory. The effect is to apply the same Category A income conditions to the income from the permanent establishment as apply to the income from the CFC’s territory

255.New section 371KG covers the basic rule for Category B income. This category is concerned with a CFC’s non-trading income which benefits from a notional deduction for interest expense in the CFC’s territory so that the income is effectively subject to a reduced tax rate, and where that deduction would not be available for such amounts under the corporation tax assumptions in Chapter 19 which apply Part 5 of CTA 2009.

256.New section 371KH sets out the scope of Category C income. This category includes income from a settlement in relation to which the CFC is a settlor or beneficiary and the CFC’s share of any partnership income where the CFC is a partner.

257.New section 371KI provides for Category D income. This category applies in circumstances in which a CFC has related party transactions which result, following the application of transfer pricing rules, in its income being reduced in the CFC’s territory and where there is no corresponding increase in any other territory so that the income is effectively subject to a reduced tax rate. This category also includes income which is taxed at a reduced rate by virtue of any ruling, other decision or arrangement by the territory’s governmental authorities.

258.New section 371KJ sets out the IP condition.

259.New section 371KJ(2)(a) to (d) provide that the IP condition is met unless:

  • the CFC’s assumed total profits for the accounting period include amounts arising from IP (the “exploited IP”);

  • all or parts of the exploited IP were transferred to the CFC by a UK related person at any time during the “relevant period” (defined in new subsection (5) as 6 years before the accounting period) as the accounting period in question and the preceding six accounting periods), or it was otherwise derived, directly or indirectly, out of or from IP held by a UK related person at any time during that period;

  • as a result of the transfer there has been a significant reduction in the value of the IP held by the UK related person; and

  • if only parts of the exploited IP were transferred or derived, the “significance condition” is met.

260.New subsection (3) provides that the significance condition is met if IP which has been transferred or otherwise derived from the UK forms a significant part of the CFC’s total exploited IP, or if the transfer or other derivations of IP from the UK produces CFC profits which are significantly higher than they otherwise would have been.

261.New subsection (4) limits the meaning of references to the transfer or holding of IP by a person related to the CFC where that person is non-UK resident. In such a case the transfer or holding must be of IP which was previously held by that person wholly or partly for the purposes of a UK permanent establishment.

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