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Finance Act 2012

Chapter 6 – The CFC charge gateway: trading finance profits

161.Chapter 6 determines the trading finance profits for the purpose of the CFC charge gateway. Profits are within this Chapter to the extent they derive from excess capital or in the case of an insurance business from excess free assets. Trading finance profits are defined by new section 371VG(4) and (5). They are profits from trading loan relationships (including amounts within Parts 6 and 7 of CTA 2009 that arise from relationships that are treated as loan relationships), distributions treated as trading income and trading profits from a relevant finance lease as defined at section 371VA.

162.New section 371FA(1) provides the basic rule for determining the profits that fall into this Chapter for an accounting period. There are three steps.

163.Step 1 is to determine if the CFC’s free capital is greater than what it is reasonable to suppose it would be if the CFC was a company which was not a 51 per cent subsidiary of any other company, but carrying on the same business with the same amount of funding. The test will take account therefore of any assets in the form of shareholdings held by the CFC in other companies. The amount of this excess free capital is limited to the extent it derives, directly or indirectly from “UK connected capital contributions” (which is defined in section 371VA).

164.So for example, a UK company A provides capital of 60 to a non-UK intermediate holding company B, which in turn provides capital of 60 to CFC C. Company B also provides, from its own reserves, additional capital of 40 to C, so that C’s total capital is 100. If C was not a 51 per cent subsidiary of A, it would have free capital of 20. C therefore has excess capital of 80, but as only 60 is provided by the UK the amount of excess free capital calculated by step 1 of subsection (1) is limited to 60.

165.Step 2 uses the same approach as step 1, but only applies if the CFC carries on insurance business (as defined in section 371VA). This test requires a comparison of the CFC’s actual level of free assets, against the amount of free assets it would be expected to have if the CFC was not a 51 per cent subsidiary of any other company but was carrying on the same insurance business. The amount of any excess free assets is limited to the extent it derives, directly or indirectly from UK connected capital contributions (which is defined in section 371VA).

166.Where there is either excess free capital as a result of performing step 1, or excess free assets as a result of performing step 2, step 3 determines the profits that fall into Chapter 6 as the amount of trading finance profits that it is reasonable to suppose arise from the use or investment of either or both amounts during the accounting period.

167.New section 371FA(2) defines free capital for the purpose of the test in step 1 as funding that does not give rise to debits that are brought into account in determining the non-trading finance profits or trading finance profits of the CFC. A CFC’s free capital is therefore any funding that does not give rise to a deduction that would be taken into account in calculating those profits.

168.New subsections (3) and (7) define free assets for the purpose of the test in step two as the amount by which the value of the CFC’s assets exceeds its loan capital. The value of an asset is the amount that it reasonable to suppose the CFC would obtain from an unconnected third party if it transferred all its rights in that asset to that person.

169.New subsections (5) and (6) provide for a reduction in the amount of the free assets for the purpose of the test in step 2 to the extent the CFC holds assets under certain circumstances. Those circumstances are that the insurance CFC, for regulatory reasons, is required to hold more assets than it otherwise would because it has provided a guarantee to another company connected with the CFC undertaking insurance business and that guarantee is required for regulatory reasons in order for the company connected with the CFC to carry on insurance business.

170.New section 371FB provides for the free capital or free assets to be increased by an amount of loan capital owed by the CFC to the extent that the profits of the lender (where the lender is a connected CFC) in respect of that loan capital, which is a qualifying loan relationship, are exempt under Chapter 9. New section 371FB(3) provides a calculation that determines if E% of the profits arising from the qualifying loan relationship are exempt for the lender. If so, E% of the qualifying loan relationship is added to the amount of free capital or free assets.

171.New subsection (4) explains what assumptions are to be made in calculating the amount of the profits arising from the qualifying loan relationship. This includes establishing the period over which the profits of the qualifying loan relationship should be tested in subsection (3). New subsection (5) provides the steps to be taken to establish what amount of those profits are exempt profits. Those steps are taken for each chargeable company that makes a claim under Chapter 9 that relates to the accounting period of the CFC that has lent the loan capital.

172.So for example if an insurance company receives a loan, which is a qualifying loan relationship, of 200, with the profits from that loan being 75 per cent exempt in the lender (which is a connected CFC), then the same proportion of the loan should be disregarded as loan capital, so that 150 is treated instead as being included in the free assets. If a bank were to receive the same loan, its free capital would be increased by 150. In both cases the effect would be to increase the amount being tested (free capital or free assets) by 150.

173.New section 371FC gives a similar result to section 371FB where the qualifying loan relationships are made by PEs within Chapter 3A of Part 2 of CTA 2009 to banking or insurance CFCs that are ultimate debtors. The result is that loans that are treated as qualifying loan relationships from PEs will therefore be counted as equity for Chapter 6 purposes in the same way as loans that are treated as qualifying loan relationships from CFCs.

174.New sections 371FD and FE confers a power on the HMRC Commissioners to make regulations setting out conditions under which the third step (and thus Chapter 6) will not apply in relation to the CFC’s trading finance profits to the extent they arise from the CFC’s insurance or banking business (which are defined in section 371VA). The regulations may specifically refer to a territory or to the banking or insurance regulatory requirements of a territory.

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