How to satisfy the motive test for offshore companies

The Motive Test

was introduced by UK's HMRC because it proved impractical to devise comprehensive objective tests that ensured that all United Kingdom controlled overseas subsidiaries with profits derived from genuine overseas activities were excluded from the controlled foreign companies' charge. However the motive test was included in UK Law which shows that this legislation is targeted at countering tax avoidance. The EU claims that UK's anti-avoidance rules relating to the transfer of assets are excessive in their application and are contrary to EU law relating to the free movement of capital. Until now HMRC and the Treasury have resisted any relaxation of the rules but amendments to CFC rules  were made in the Finance Act 2011 and further changes will be implemented under the Finance Bill 2012/13.

Capital Gains Tax

The changes relating to the capital gains tax rules in section 13 TCGA 1992 will introduce a new test, the business establishment test, to exempt foreign company gains. This will effectively extend the current exemption for assets used in a trade by an offshore company to look at the whole activity. The business establishment test will look at the activities being conducted by the offshore company and determine if a genuine economic activity is being conducted.

To determine this, such matters as staffing, physical presence in the offshore jurisdiction and third party transactional activity will be examined. Any pure investment activity is unlikely to pass this test unless the offshore company can demonstrate that it is actively managing the portfolio and not using agents. AMP & Partners Ltd can assist clients to appoint local directors/business partners and to source suitable office premises. Contact Us  for a free 'no obligation'. consultation.

The proposed test will therefore protect companies that carry out genuine economic activities but will not assist those offshore companies that are merely being used to ring-fence assets.

Income Tax

The consultation document has also addressed changes in the anti-avoidance rules relating to the transfer of assets overseas. Currently the anti-avoidance rules apply where the following conditions are met:

  • There is a transfer of assets overseas to a person not resident in the UK, 
  • and Income becomes payable to the transferee,
  • The transferor has the power to enjoy the income either now or in the future. 

If all three conditions are met then the income arising is treated as the transferor’s income and is taxed accordingly. As these broad conditions most Uk Taxpayers fall under this legislation. One defence against this is the Motive Test  where it can be proven to HMRC that the transfer of the assets was for purely commercial reasons and not for tax avoidance purposes, alone.

In addition to the existing exemption a new exemption is to be introduced. The new exemption will look at the economic circumstances surrounding the transfer in an objective manner and try to identify transactions carried out on an arms-length basis for genuinely commercial purposes.

To meet this test there will be two conditions to satisfy:

  • The first Condition is that the transaction is truly arms-length in character. This can mean connected parties, but the terms of the transaction should be the same as if carried out between independent third parties.
  • The second Condition requires that the transaction is undertaken for significant economic activities that are carried on outside the UK.

This broadly follows the section 13 exemption and will require the overseas activity to be for the provision of goods or services on a commercial basis and with a view to making a profit through employees, agents and contractors that are required to generate profits on that scale The Consultation Document states that the making of investments will not normally be considered as being an “economically significant activity” and therefore is unlikely to satisfy this test.

One final change to the current rules relates to foreign companies resident in the UK for corporation tax purposes. Under the existing rules such companies are deemed to be persons overseas for the purposes of the transfer of assets abroad legislation and therefore lead to anomalies arising. It is proposed that such companies will be outside the legislation and therefore transfers of assets to such companies will no longer be caught within this particular anti-avoidance provision. This is to apply retrospectively from 6 April 2012.

Please Contact Us  to find out further details about how you or your company can meet the criteria for establishing an overseas business.