Introduction Details of the Schedule Part 1.Controlled Foreign Companies Chapter 9 - Exemptions for profits from qualifying loan relationships
187.New section 371IA(1) introduces Chapter 9 which provides the rules for full and 75 per cent exemption of certain intra-group non-trading finance profits that would otherwise pass through the CFC charge gateway because they fall within Chapter 5. Chapter 9 applies only to profits that arise from qualifying loan relationships as defined at new section 371IG. The business premises condition at section 371DG must also be met.
188.A chargeable company must make a claim to an Officer of HM Revenue and Customs under new section 371IA(2) in order for Chapter 9 to apply. The effect of the claim, by new subsection (3), is that for the chargeable company only, non-trading finance profits pass through the CFC charge gateway only to the extent that they are not exempt under Chapter 9. Where a claim is made, the rules in Chapter 9 apply to all of the non-trading finance profits arising from qualifying loan relationships of the CFC for the accounting period by virtue of section 371CB(8). New section 371IA(9) excludes from Chapter 9, in the same way as they are excluded from Chapter 5, any non-trading finance profits where they:
	arise from the investment of funds held by the CFC for trading purposes;
	arise from the investment of funds held by the CFC for the purposes of a property business;
	fall within Chapter 8 (solo consolidation); and
	arise from a relevant finance lease.
189.The finance company full and 75 per cent exemptions are given by way of an adjustment that is made to a CFC’s chargeable profits and creditable tax for an accounting period at step 2 of section 371BB(1).
190.New subsection (5) provides that profits are exempted firstly by applying either the qualifying resources rule or the 75 per cent exemption rule at new sections 371IB and 371ID respectively and then by applying the matched interest rule at new section 371IE, if relevant.
191.New subsection (10) explains that a loan relationship for Chapter 9 purposes is limited to a loan relationship that is a money debt arising from a transaction for the lending of money as defined at section 302(1) of CTA 2009. It will not include any other arrangement treated as a loan relationship such that the associated credits and debits would otherwise fall to be dealt with under Part 5 of CTA of 2009.
192.New section 371IB sets out the rules to be applied to establish the extent to which profits from a qualifying loan relationship will be exempt where it is funded out of qualifying resources. The section will apply in respect of a loan relationship only if the company’s Chapter 9 claim states that it is to apply. It is not possible to make a claim under this section for full exemption in respect of part of a qualifying loan relationship and a claim under new section 371ID for 75 per cent exemption in respect of the remainder.
193.New section 371IB(2) provides that X per cent of the profits of a qualifying loan relationship are exempt if the chargeable company (C) is able to demonstrate that at least X per cent of the qualifying loan relationship was funded out of qualifying resources and that the ultimate debtor was resident in the same territory at all times during the relevant period. It is possible that the amount so funded may vary throughout that period.
194.For example, a £100m loan is funded at the beginning of an accounting period entirely out of qualifying resources and this loan is increased to £200m half way through the year with the balance of the loan being funded out of non qualifying resources. Throughout the relevant accounting period the percentage of the loan funded from qualifying resources is 100 per cent for the first 6 months and 50 per cent for the second 6 months so that over the year the percentage of profits that are exempt should be 75 per cent (assuming the loan is equally profitable at all times). C’s claim should therefore specify X to be 75 per cent. In the second accounting period if the loan remains at £200m throughout the accounting period C’s claim should specify X to be 50 per cent.
195.A relevant period is defined by new subsection (4) as the accounting period, or if a loan is only outstanding for part of that accounting period that shorter period.
196.Qualifying resources are a source of funds that place no demands on group resources outside the ultimate debtor’s territory of residence (the ‘relevant territory’). They are defined at new subsections (6) and (7) as:
	profits earned by the CFC from lending to connected companies within the relevant territory that are used for the purposes of the business being carried on in that territory;
	profits that have been earned in the relevant territory by members of the CFC group;
	the qualifying value of relevant pre-acquisition sums or other assets (as defined in new section 371IC); or
	funds that arise from ordinary non-redeemable shares issued by the parent company in the group to persons who are not members of the CFC group. The parent company must be a company that is not a 75 per cent subsidiary of another company.
197.Funds in all but the first of the above four categories may be derived directly or indirectly from the sources listed above, but must be received by the CFC in relation to shares it holds in, or shares it has issued to other group companies.
198.New subsections (8) and (9) limit sums that will be qualifying resources for Chapter 9 purposes where the associated qualifying loan relationship has been put in place as part of an arrangement under which a member of the CFC group takes on debt in the UK. These subsections are targeted at circumstances where the arrangement results in an increase in net debt or net interest expense in the UK group.
199.New subsection (10) gives definitions for the purposes of the section and new section 371IC. Subsection (10)(c) states that the relevant territory is the territory where the ultimate debtor (of the qualifying loan relationship) is resident. This means that to the extent they are qualifying resources by virtue of subsection (6)(a) or subsections (6)(b) and (7)(a) together, those qualifying resources have to be derived from the same territory in which the borrower (in respect of the qualifying loan relationship) is resident. Subsection (10)(d) and (e) provide further limitations to qualifying resources in those cases, so that:
	loans made to persons outside the relevant territory are not treated as being for the purpose of the business carried on in that relevant territory; and
	profits earned outside of the relevant territory that are distributed to or arise to a company resident in the relevant territory are not treated as earned in the relevant territory.
200.New subsections (10)(a), (11) and (12) define “the CFC group”. This consists of the CFC together with companies that it is connected with from time to time. It also includes companies that existed before the CFC existed (or before it was part of the group), provided that they were at that time connected with all UK resident companies that now control the CFC.
201.The qualifying value of relevant pre-acquisition funds (if there are any) is determined by new section 371IC. This is the value of funds or other assets represented by the consideration given for shares in a company (referred to as the “target company”) acquired by a CFC from persons who are not members of the group. The acquisition must take place by way of shares issued in exchange to those persons who are not members of the group by the parent company in the group. Qualifying resources will include the distribution of pre-acquisition profits to the CFC or the repayment of share capital by the target company.
202.New section 371IC(4) provides that where the issue of shares by the parent company represents only part of the consideration given for the acquisition or the parent company pays a special dividend (or otherwise makes an extraordinary distribution) to the parent company’s shareholders as part of the arrangements then only that part of the value in the company acquired represented by the issue of shares will be qualifying value. New subsection (5) provides the formula that determines the amount of qualifying value where other such consideration has been given.
203.Where new debt is taken on in the UK as part of the arrangement that creates the qualifying resources then section 371IB(8) and (9) provide that the qualifying loan relationship will be treated as derived from non-qualifying resources in at least the amount of the new debt.
204.New section 371ID applies to a qualifying loan relationship where a claim has not been made under section 371IB that full exemption should apply to the profits from all or part of that qualifying loan relationship. It provides that 75 per cent of the profits of the qualifying loan relationship shall be exempt.
205.The matched interest rule in new section 371IE applies when:
	there remain profits (called “the leftover profits”) that are not exempt after the application of sections 371IB or ID; and
	(apart from the application of this section) profits under Chapters 5, 6 or 9 have been apportioned to a UK group company resulting in that company having a finance income amount (section 314A); and
	the UK members of the group have in aggregate a surplus of net finance income over net finance expenses.
The matched interest rule use terms from the worldwide debt cap rules in Part 7.
206.New section 371IE(2) provides that all of the leftover profits will be exempt if the tested income amount (TIA) exceeds the tested expense amount (TEA).
207.New subsection (3) provides that a percentage of the leftover profits will become exempt if the CFC charge causes the TIA to exceed the TEA. The excess is referred to in new subsection (4) as “E”.
208.The TIA may be increased by a CFC charge (“I”) or the TEA may be reduced by a CFC charge (“R”). The calculation to determine the exempt percentage is set out in new subsection (4) by reference to the amounts E, I and R.
209.New subsections (9) to (14) provide modifications to the worldwide debt cap rules in Part 7 for the purposes of applying this section. It requires that a calculation of TIA and TEA be made for a UK group, if one has not already been made. This includes banking and insurance groups and groups that are not large groups. Subsection (9) provides a limitation that excludes debits, credits and other amounts that arise from banking or insurance business in determining what the finance income amount would be for any company and what the TIA and TEA would be.
210.New section 371IF sets out the steps for calculating the CFC’s “qualifying loan relationship profits”. The section operates by applying the following steps to each qualifying loan relationship:
	Step 1 is to determine the credits from the qualifying loan relationship (which is defined at new section 371IG) that are brought into account for the purposes of determining the CFC’s non-trading finance profits for the accounting period. The amount determined is “the Step 1 credits”;
	Step 2 is to add to or subtract from the Step 1 credits such debits or credits as arise from derivative contracts or other arrangements that are a hedge of interest rate or FOREX risk relating to the qualifying loan relationship. The amount determined is “the Step 2 credits”;
	Steps 3 to 5 are further steps for bringing into account debits and credits (so far as not reflected in the Step 2 credits) for the purposes of determining the CFC’s non-trading finance profits for the accounting period. This is done by subtraction from or addition to the Step 2 credits of a just and reasonable proportion of debits or credits to give the CFC’s qualifying loan relationship profits for the qualifying loan relationship in question.
211.New section 371IG(1) sets out the conditions for a loan relationship of a CFC to be treated as a qualifying loan relationship. These are where in relation to the qualifying loan relationship:
	the CFC is the creditor;
	“the ultimate debtor” is a “qualifying company” (which is defined in new section 371IG(8); and
	new section 371IH does not apply to treat the loan as non-qualifying.
212.New section 371IG(2) provides that the ultimate debtor is the immediate debtor in relation to a qualifying loan relationship unless new subsection (3) applies.
213.New subsections (3) to (6) establish who the ultimate debtor is where a loan is used (directly or indirectly) to fund another loan. They provide that the ultimate debtor will be a person (“P”) if:
	the loan to the debtor of the CFC is made for the purposes of funding a loan to P;
	the loan to P is not used for the purposes of funding a loan to any other person; and
	the loan to P gives rise to a loan relationship in relation to which P is the debtor.
214.For the purposes of the ultimate debtor rule a part of a loan is treated as a separate loan. This means that where a loan from a CFC to A is used partly for the purposes of A’s trade and partly to fund a loan to B then there will be 2 loans with 2 ultimate debtors, A and B.
215.New subsection (7) disapplies subsections (4) and (5) in respect of a loan to a CFC whose main business is banking or insurance, the loan is used in the ordinary course of that business and P is not a UK resident qualifying company. In that case the CFC is treated as the ultimate debtor.
216.New subsection (8) defines a qualifying company as a company which is connected with the CFC and is controlled by the UK resident person(s) who control the CFC.
217.New section 371IH(1) sets out the circumstances under which a loan cannot be a qualifying loan relationship where the ultimate debtor is a non-UK resident company. These are where some or all of the ultimate debtor’s debits are:
	being brought into account for the purposes of determining the profits attributable to a UK PE of the debtor under Part 2 of CTA 2009; or
	being brought into account for the purposes of determining the profits attributable to a UK property business of the CFC under Part 3 of the Income Tax (Trading and Other Income) Act 2005.
218.New section 371IH(2) provides that a loan cannot be a qualifying loan relationship where the ultimate debtor is a UK resident company unless all the company’s debits are taken into account for the purposes of determining the profits attributable to a PE of the ultimate debtor and an election is made under section 18A of CTA 2009 in relation to the ultimate debtor.
219.New subsection (3) provides that a loan relationship cannot be a qualifying loan relationship where:
	the ultimate debtor is itself a CFC to which Chapters 3 to 8 or Chapter 12 apply in an accounting period and some or all of the debits of the CFC are being brought into account for the purposes of those chapters; and
	as a result there is no CFC charge for the accounting period, or the charge is otherwise reduced.
220.New subsection (4) provides that the references to debits in subsections (1) to (3) are to the debits from the loan to the ultimate debtor, and where loan A is used wholly or partly to fund loan B (as provided for by section 371IG (4) and (5)) the debits are those of loan B.
221.New subsection (5) provides that a loan relationship cannot be a qualifying loan relationship where it is an arrangement, or connected to an arrangement, the main purpose or one of the main purposes of which is to provide, directly or indirectly, funding for a loan relationship or a quasi loan relationship to a person from the ultimate debtor. A quasi loan relationship is an arrangement intended to produce for any person a return by reference to the time value of money. For example, consider a case where a loan is made by the CFC to another non-UK resident company and that company, by an arrangement that is not limited by other parts of this section, arranges for a loan to be made (using the funds from the first loan) by another person to a UK resident company connected with the CFC. The main purpose of the arrangement is for the CFC to make a loan to the UK resident connected company. The loan by the CFC is not a qualifying loan relationship.
222.By virtue of new subsection (6), subsection (5) does not apply where the main business of the ultimate debtor is banking or insurance business and the funding for the loan or arrangement would be provided in the ordinary course of that business.
223.New subsection (7) provide that a creditor relationship of a CFC cannot be a qualifying loan relationship if:
	the main business of the ultimate debtor is banking or insurance business; and
	the creditor relationship is, or is connected to, an arrangement the main purpose, or one of the main purposes, of which is for the ultimate debtor to provide funding for a loan or arrangement in order to obtain a tax advantage for themselves.
224.New subsections (8) and (9) provide that a creditor relationship of a CFC cannot be a qualifying loan relationship where it is made to any extent (other than a negligible one):
	from UK funds (other than a loan) received directly or indirectly from a UK resident company which has a main business of banking or insurance as its trade; or
	where the loan relationship was created as part of an arrangement which created new debt in the UK for a UK-resident company (apart from the ultimate debtor) which has a main business of banking or insurance as its trade for the purposes of Part 3 of CTA 2009.
225.New subsections (10) and (11) provide that a loan cannot be a qualifying loan relationship where third party debt of a non-UK group company is repaid (in whole or in part), and effectively replaced with new UK debt as part of an arrangement the main purpose or one of the main purposes of which is to obtain a tax advantage for any person. The section only applies where the relevant UK funds or other assets are funded by a loan made to a UK connected company by a UK resident person not connected with the UK company or by a non UK resident person. Consider for example a case where a UK group company A borrows £100m, which in turn is used to buy shares issued by a connected CFC B, which in turn makes a loan of £100m to an overseas group company C, which in turn repays existing external debt of £100m. The arrangement has created two loans where before there was only one, with the interest on one of the loans being sheltered by B. The arrangement has a main purpose of obtaining a tax advantage for UK company A and so the loan to company C is not a qualifying loan relationship.
226.New section 371II confers on HMRC Commissioners the power to make regulations to amend the definitions of qualifying loan relationship, ultimate debtor and qualifying resources.
227.New section 371IJ provides that a Chapter 9 claim must be made in the chargeable company’s tax return for the period and sets out the time limits for the claim and for varying or withdrawing that claim. A later claim may be made, varied or withdrawn if allowed by an Officer of HM Revenue and Customs. A claim may also be varied or withdrawn outside of the usual time limits where there are changes to the TIA and TEA, provided that claim is made within 12 months of such a change and the claim is made to take account of that change (and not for another purpose).