Associated Companies – Who Cares?

The main rate of corporation tax is 23% for the financial year (FY) 2013 (ending 31 March 2014) and is set to fall to 21% for FY 2014 and from 1 April 2015 it is expected that there will be only one rate of corporation tax at 20%. Of course, 2015 is an election year and so whether the latter change is implemented or whether it is reversed following the election remains to be seen.

The difference between the small profits rate at 20% and the main CT rate for FY 2013 at only 3% is perhaps not something to get too excited about; and in future the small profits rate may not exist at all. It has been suggested that, in that case the associated companies’ rules may be abolished, though that seems unlikely. 

The definition of ‘associated company’ is provided by CTA 2010, s 449, under which a company is associated with another company if one company controls the other or both are controlled by the same person or persons. This basic definition is then expanded by various other provisions (within CTA 2010, Pt 10 (Close Companies)). 

However, as can be seen, the associated company test (in s 449 and related provisions) is, in effect, borrowed for the purposes of applying the small profits rate. The test is also relevant in relation to the quarterly instalments regime for payment of corporation tax for companies with profits of (basically) more than £1.5 million per annum, which is perhaps another reason why the associated companies rules are unlikely to be abolished unless – as has also been suggested – the intention is to bring all companies within the quarterly instalments regime from 2015.

The ‘control’ test (in CTA 2010, s 450) operates at two levels. The first is what might be considered the actuality of the situation, i.e. whether a person does in fact exercise control over a company’s affairs whether directly or indirectly. However, this is a difficult test for HMRC to apply in practice. The second level of the test of control is more specific and is couched in terms of a person’s right to the greater part of a company’s

For the purposes of the control test there may attributed to a person, among other things, the rights of their associate(s) and of any company which they and their associates have control.

‘Associate’ in relation to a person is defined by CTA 2010, s 448 and includes a ‘relative’ or ‘partner’ (but see below) as well as trustees/personal representatives which are related to that person in certain circumstances (described by s 448(1)(b)-(d)). A ‘relative’ means a spouse/civil partner, brother/sister and any lineal ancestor or descendant (e.g. father, child, grandchild etc.). However, associates of associates do not count: so while a person’s sister would be an associate of that person, her husband would not.

The attribution of rights of associates has been a somewhat vexed subject over the years. In R v CIR (ex parte Newfields Developments Ltd) [2001] STC 901, N Ltd was controlled by the trustees of a will trust in which the deceased’s widow (W) held a life interest, while L Ltd was controlled by the trustees of a discretionary trust also set up by W’s deceased husband. The trustees of both companies were associates of W within the precise terms of s 448. It was held by the House of Lords that although W herself did not directly own shares in either company, the rights of her associates had to be attributed to here with the effect that she was deemed to control both companies which were therefore associated.

The upshot of Newfields is that apart from the exceptions discussed below, where rights can be attributed to associates under the legislation then the attribution(s) must be made. In claiming small profits rate, and for the purposes of the corporation tax quarterly instalments regime (see below), it is necessary to ascertain whether any associated companies exist, to the best of the directors’ knowledge and belief.

Prior to FA 2011, the requirements of s 451 had already been relaxed by CTA 2010, s 27, as previously enacted, in respect of business partners, who were only to be regarded as associated for small profits rate purposes if they were involved in ‘tax planning arrangements’ affecting the company.

An exception was also made under Extra-Statutory Concession (ESC) C9 in the circumstances described in Example 1, provided that there was no ‘substantial commercial interdependence’ between the companies.

A owns 100% of the issued shares in company X, while his wife B owns 100% of the issued shares in company Y. Since X and Y are relatives as defined by s 448 and are therefore associates, under s 451 A’s rights in X may be attributed to B and vice versa and within the terms of the legislation the companies are therefore associated. 

The ‘substantial commercial interdependence test’ within ESC C9 has now been legislated by substituting the current CTA 2010, s 27 with effect for accounting periods ended on or after 1 April 2011. The factors to be taken into account for this purpose are described by Treasury Order (SI 2011/1784) in terms of financial, economic or organisational interdependence. The HMRC guidance is now set out at CTM03770-03800.

Two companies are financially interdependent if (in particular) one gives financial support to the other or each has a financial interest in each other’s business.

Two companies are economically interdependent where they both ‘seek to realise the same commercial objective’, the activities of one benefits the other, or they have common customers. 

Two companies are organisationally interdependent if they have common management, employees, premises or equipment.

A dictionary definition of ‘interdependence’ is ‘depending upon each other’ and, as the writer recalls, HMRC formerly accepted to some extent that the test was a two-way street. If one company gives financial support to the other, for example, the company giving the support is not dependent on the other company and therefore in plain English the companies are not interdependent. However, as can be seen from the above any such nuance seems to have been lost on the draughtsman of SI 2011/1784.

The legislation in CTA 2010, s 27 and SI 2011/1784 do not attempt to define ‘substantial’. The writer also recalls that the test of substantial was formerly described in the HMRC guidance as being both ‘qualitative’ and ‘quantitative’ which are somewhat subjective terms and appeared to mean whatever the inspector wanted them to mean. In terms of the current guidance HMRC consider that:

‘For substantial commercial interdependence to exist it is not necessary for all three types of links to exist. For example, if there is a sufficient financial link one company will be an associate of another even if no economic or organisational links exist’ (CTM03780).

The test of what degree of interdependence is ‘substantial’ will of course depend upon the precise facts. The HMRC guidance gives several examples of each of the above factors which are somewhat ‘black or white’ but which will inevitably form the basis of HMRC’s approach in practice. 

Don’t forget that CTA 2010, s 27 and SI 2011/1784 relate only to exceptions from the s 451 requirements regarding the attribution of rights of associates (in determining whether two companies are associated) where no substantial commercial interdependence exists. But as can be seen from Example 2 below, two companies may be associated despite there being no such interdependence, under the general test in s 449.

The facts are as in Example 1. However, Company Y is in financial difficulty and A personally makes a substantial loan to Y. This makes A a ‘participator’ in Y and as the company’s share capital is a nominal £100, this entitled him to the greater part of the assets of Y on a winding-up (for the purposes of CTA 2010 s 450(3)(d)). As he is treated as controlling both companies, X and Y are therefore associated.