Nichola Ross Martin's Tax Consultancy

Associated companies: a summary of the new tests as found in section 27 Corporation Tax Act 2010, as inserted by s55 FA 2011

From 1 April 2011 the associated companies rules for corporation tax have been amended by the 2011 Finance Act: section 27 CTA 2010 has been rewritten and Extra Statutory Concession C9 is no longer operative.

The changes completely remodel and extend the attribution rules for the purposes of working out who is in control of a company when determining whether a company has associates for the purposes of small compaies relief for corporation tax.  

When companies are associated their profits are taxed as if they were a single entity: each company's profit band for corporation tax purposes is reduced by dividing it by the number of its associates plus one. There is no corresponding relief for losses.

A company is associated with another company when one has control of the other or both are under the control of the same person or persons (section 449 CTA 2010). 

A close company may be under the control of up to five participators, where any two or more persons together satisfy any of the conditions of control they are treated as having control of a company.

A person is treated as having control if he is able to possess or is entitled to acquire the greater part of:

• The share capital or issued share capital.
• The voting power.
• The income distributed to shareholders, assuming that all income was so distributed.
• The assets distributed in the event of winding up: this test often results in a loan creditor having control of a company.

There is no order or ranking to the tests. The test that creates the greatest number of associated companies in the period under review is used. 

Where there are a number of participators, it is possible when comparing the different tests to have a number of different controlling combinations.   

Rules old and new: the parts that are not changing

The default position is always that where two or more companies are under the “direct” control of one person or the same identical group of persons they will be associated. By "direct" we mean before attributing the rights of any individual's relatives or partners.

Old rules accounting periods ending 31 March 2011 

Control is determined by considering both “indirect” as well as direct control.

Indirect control takes into account the rights of an individual’s associates and attributing them to him. 

Associates include blood relatives and business partners, however:

• ESC C9 provides a further exception, providing that there is no substantial commercial interdependence between companies; for the purpose of attribution, the definition of “relative” is limited to include only spouses or children who are minors, and
• Old S27 CTA 2010 (prior to the 2011 Finance Act changes) provides a further exception; the rights of an individual’s business partner are not attributed to him provided that there are no relevant "tax planning arrangements" in place involving the partner and company. A tax planning arrangement is an arrangement designed to avoid the associated company rules.

New rules: all change from 1 April 2011 

The direct control test remains the default, and it is not necessary to attribute the rights of an individual's associates unless one company has a relationship of “substantial commercial interdependence” with another company.

Alternatively put: where there is substantial commercial interdependence between the companies the control tests are extended to consider indirect control this means that:

• The rights of all the individual's associates are attributed to him.
• The concessionary treatement in ESC C9 no longer applies and
• as section 27 CTA 2010 is completely rewritten, there are no longer special rules for business partners.

These new rules apply to accounting periods ending on or after 1 April 2011.

Where a company finds that it is adversely affected by the new measures it may elect for them to only apply to accounting periods starting on or after 1 April 2011. 

Substantial commercial interdependence 

Substantial commercial interdependence is determined by taking the following factors into account:

The degree to which the companies are:

• Financially interdependent,
• Economically interdependent, or
• Organisationally interdependent.

Financial interdependence

This is where:

• one company gives financial support  (directly or indirectly)  to the other, or
• each has a financial interest in the affairs of the same business.

Key points to note:

• Companies are financially interdependent where one makes a loan or provides a guarantee on behalf of another.
• Intercompany loans will general provide first hand evidence of financial interdependence.
• A very short term or temporary loan is unlikely to indicate financial interdependence.
• Loans or guarantees may be made on a personal basis by the shareholder or director of one company to the shareholder or director of another company or between family members. Even though these may be used for the purposes of the individual's company this should not always create financial interdependence between any two companies.
• A company may be controlled by virtue of the interests of a loan creditor; this can be confusing when the financial interdependence tests cross over. 

For example:

Mrs Y and Mrs Z are partners in a law firm. Mrs Y owns 100% of Y Limited and Mrs Z owns 100% of Z Limited. Y Limited has lent Z Limited a sizable loan in order to keep it afloat.

Are the two companies associated? 

• Under the rules to 31 March 2011, s27(3): there were no relevant tax planning arrangements so it was unnecessary to attribute the rights of business partners. s450(3)(d): there was what appears to be a significant loan relationship, Y Limited may control Z Limited as a loan creditorm however, ESC C9: this will only associate the two companies where there is a past or present connection between the two companies. This issue probably requires closer inspection in order to drawn a conclusion.
• Under the rules from 1 April 2011, however the two companies are associated because Z Limited is financially interdependent on Y Limited. 

Economic interdependence

This is where:

• the companies seek to realise the same economic objective,
• the activities of one benefit the other, or
• the companies have common customers.

Organisational interdependence

This is where the companies share common:

• management; or
• employees; or
• premises; or
• equipment.

Further planning points

• The substantial commercial interdepence test will mean that a husband and wife may now be able operate separate companies (this was impossible pre 1 April 2011 as husband's and wife's interests were always attributed to each other).
• The relationship between any two or more companies, will need to be reviewed annually and each case considered according to its own facts.
• Where the relationship or transactions are made on an arm's length basis there is unlikely to be any economic interdependence, however, if one company is the entirely dependent on the actions of another, then there may be substantial interdependence despite the fact that transactions are at arm's length.
• Where there is commercial interdependence through "an act of circumstance" HMRC agree that it may be disproportionate to link the two companies.

Election to disapply the substantial commercial interdependence test

Companies may elect to apply the substantial commercial interdependence test to accounting periods starting on or after 1 April 2011.

The thinking is that the majority of companies will benefit under the new rules, however, this allows fair treatment for those that do not. 

The new rules in a nutshell 

• If there is no substantial commercial interdependence between companies you need only consider direct control (no need to attribute the rights of an individual's associates).
• If there is substantial commercial interdependence then you must apply indirect control tests (attribution).
• The old ESC C9 and s27 exceptions for relatives or business partners are removed.
• These new rules apply to accounting periods ending on or after 1 April 2011.
• Unless adversely affected by the new measures , then elect for them to apply to accounting periods starting on or after 1 April 2011.

Checklists

• Associated companies checklist (new)
• Associated companies checklist (old)

Small print:

The text of revised s27 CTA 2010: Sch 55 FA 2011:

Companies with small profits: associated companies

(1 ) For section 27 of CTA 2010 (meaning of “associated company”: attribution to persons of rights and powers of their partners) substitute—

“27Attribution to persons of rights and powers of their associates

(1)This section applies if—

(a)it is necessary to determine in accordance with section 25(4) and (5) whether a company is an associated company of another company, and

(b)the relationship between the two companies is not one of substantial commercial interdependence.

(2)In the application of section 451 (meaning of “control”: rights to be attributed) for the purposes of the determination, any person to whom rights and duties fall to be attributed under subsections (4) and (5) of that section is to be treated, for the purposes of those subsections, as having no associates.

(3)The Treasury may by order prescribe factors that are to be taken into account in determining whether a relationship between two companies amounts to substantial commercial interdependence for the purposes of this section.”

(2)The amendment made by this section has effect in relation to accounting periods ending on or after 1 April 2011.

(3)But a company may elect that the amendment made by this section is of no effect in relation to an accounting period that begins before that date.

(4)An election under subsection (3) must be made within one year from the end of the accounting period to which it relates.

(5)The first order under section 27(3) of CTA 2010 (as substituted by subsection (1) of this section) may be made so as to have effect in relation to accounting periods ending on or after 1 April 2011.