Controlled foreign companies

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Controlled foreign companies

A company which is resident in the UK

who wishes to set up an overseas company will be attracted to overseas countries which have low rates of tax; these countries are called tax havens, because the company’s profits will be taxed at a lower rate.

  • If a UK company has an overseas subsidiary the normal treatment is that the UK company will not pay UK corporation tax on the overseas dividend remitted to the UK.

  • This basically means that a UK resident company will set up a subsidiary in a tax haven and have the subsidiary’s profits charged tax at a low rate, and then remit dividends to the parent company in the UK, which are tax free.

However

if the overseas company qualifies as a controlled foreign company then special rules will apply to the taxing of the overseas company’s Taxable total profits.

Controlled foreign company definition

The controlled foreign company rules apply to owners of non-UK resident companies where UK profits have been artificially diverted out of the UK corporation tax net, as explained above.

A company is a CFC if it satisfies all of the following conditions:

  1. Condition 1
     
    – A foreign resident company controlled from the UK

  2. Condition 2
     
    – It is a foreign company resident overseas (ie resident outside of the UK)

A company is controlled by persons resident in the UK if:

  1. A UK person or persons controls the company (>50%)

  2. It is at least 40% held by a UK resident and at least 40% but no more than 55% by a non-UK resident (the term ‘person/persons’ includes companies

CFC Charge

If it is established that a foreign company is a CFC it may be necessary for any UK resident company who owns at least 25% of the shares in the foreign company to pay a CFC charge (additional corporation tax) to HMRC.

  • This charge will be in respect of the chargeable profits of the foreign company (chargeable profits are defined as income profits but not chargeable gains, calculated using UK tax rules which have been artificially diverted out of the UK corporation tax net).

Calculation of the CFC Charge:

[% x Chargeable profits of the CFC x C.T. Rate] – Foreign tax suffered on the chargeable profits

Illustration:

A Ltd., a UK company with taxable profits of £280,000 for the year to 31 March 2024, holds 90% of an overseas subsidiary resident in Nemo Land. 

The subsidiary falls within the definition of  CFC. 

The overseas subsidiary has £600,000 of profits for the period. 75% of which are caught by the CFC legislation and stand to be charged. 

The tax payable in Nemo Land is 5%

  • How much C.T. will A Ltd. have to pay?

Solution

UK C.T. Computation:

Taxable total profits £280,000

C.T. 25% = £70,000
Extra tax on CFC Profits:
(75%*£600,000*90%)*25% = £112,500
Less:
DTR (5%*(75%*£600,000*90%)) = (£20,250)

Total UK C.T. Payable £92,250

When can the CFC Charge be avoided?

The CFC charge can be avoided by a UK resident company if:

  1. The foreign company did not have any chargeable profits (income profits but not chargeable gains, calculated using UK tax rules which have been artificially diverted out of the UK corporation tax net), or

  2. The foreign company satisfies one of the exemptions listed below applies.

Exemptions

Avoiding the CFC charge:

  1. Low profits exemption
     
    – This exemption applies if the foreign company’s profits do not exceed £500,000 and its non-trading income does not exceed £50,000. 

    For example, if the foreign company profits are £499,000 and it only has other income of £45,000 – then the CFC Charge will not apply.

  2. Low profit margin exemption

    -    This exemption applies if the foreign company’s accounting profits are less than 10% of its allowable expenditure. 

    For example, if the foreign company’s allowable expenditure is £100,000 and the accounting profits are £9,000, then the CFC Charge will not apply.

  3. Excluded territory exemption

    - This exemption applies if the foreign company is resident in a country which is specifically listed as an excluded territory.

  4. Tax rate is sufficiently high exemption 

    - This exemption applies if the foreign company pays corporation tax overseas at a rate which is at least 75% of the amount of tax that would have been paid if the company had been UK resident.

  5. Exempt period exemption 

    - There is an initial 12 month exemption from the CFC rules. This exemption will initially apply but will not apply in the future. 

    For example, the first 12 months of the foreign company coming under control of a UK resident will be exempt from a CFC Charge.

Note

Make sure that you spot this in the exam, if there is a UK resident company with a subsidiary overseas in a country with a low tax rate, it’s likely that it will be a CFC.

Illustration

K Ltd., a UK resident company, has two wholly owned subsidiaries.

  1. B Inc. resident in Fishy Land where the C.T. Rate is 7%. This is an investment company and has taxable profits of £30,000 per annum

  2. C Inc. is resident in Hogwarts Land where the C.T. Rate is 19%. It has trading profits of £2,000,000 per annum.

  3. K Ltd pays UK corporation tax at the rate of 25%

On which of these companies will the CFC Charge arise?

Solution:

  1. Taxable profits are below £50,000 – therefore this is exempt and there will be no CFC Charge

  2. C.T. Rate is above 75% of the U.K. C.T. rate – therefore this is exempt and there will be no CFC Charge

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