Reform of UK Controlled Foreign Company Regime
The target date for implementation of the new regime is 2011 and the key premise of the new proposals is that the CFC regime should only tax profits of foreign subsidiaries to the extent that there has been an artificial diversion of profits from the UK. This represents a major shift from the heavily criticised controlled company proposals first put forward by the UK Government in 2007 which would have taxed all intellectual property and passive income in the UK.
Taxand UK outlines the latest proposals, highlights the remaining uncertainties and comments on the likely response of UK-based multinationals.
Overview of Proposed Regime
It is proposed that the new regime will operate on an entity basis and the stated objective is to target the artificial diversion of profits from the UK and not to seek to tax profits that are genuinely earned in foreign subsidiaries. In practice this is to be achieved by designing a number of objective tests to exclude companies from the regime where there is considered to be a low risk of artificial diversion of UK profits. In addition, there will be a wider motive test and special provisions will be included in respect of finance companies and intellectual property.
The exemptions under consideration include:
- High tax exemption – this would exclude companies that operate in jurisdictions with similar statutory tax rates and tax bases to the UK and it is anticipated that a white list of good jurisdictions would be developed.
- Trading activities – companies that undertake genuine trading activities will be exempted from the regime and for these purposes trading activities may include certain intra-group transactions, genuine offshore group treasury operations, certain offshore financing operations and the active management of intellectual property, as discussed below.
- De-minimis test – under the current regime companies with taxable profits of less than £50,000 are excluded. It is proposed that this limit, which was set in 1998, will be increased and further consideration is to be given to the appropriate level.
- Motive test – where the other exemptions are not available there will be a re-designed motive test to exclude situations where a subsidiary that is properly established overseas is not engaged in activities intended to artificially divert UK profits. There will be a move away from the current default presumption that all activities that could have been undertaken in the UK would have been carried on in the UK, had it not been for the tax advantages of the foreign location.
In addition to the above generic exemptions, the Government recognises that exemptions may be appropriate for certain specific activities such as the re-insurance of non-UK risks and the holding of non-UK property.
Treasury and Financing
It is proposed that group treasury companies, which are essentially fully debt funded and earning a small turn on interest flows, will be exempt under the new regime. In relation to offshore financing activities, it is proposed that an exemption will be available subject to the company being financed with an appropriate mix of debt and equity.
Consideration is being given to exempting offshore companies which actively manage intellectual property with little or no UK involvement, subject to satisfying an appropriate substance test based on expertise. Where offshore companies hold but do not actively manage intellectual property, there may be an exemption where there is no UK connection either through management activity or funding.
The latest proposals should be broadly welcomed by UK-based multinationals and are clearly a significant improvement on the controlled company proposals first proposed in 2007. In particular, it is encouraging that the exempt activities regime is likely to be more relaxed, especially in relation to intra-group activities, financing and intellectual property.
However, much of the detail of the new regime remains outstanding and the following matters in particular require further consideration:
- Artificial diversion of UK profits – how will the new more generous motive based regime achieve certainty and consistency in practice?
- Substance – what level of substance will be required in overseas jurisdictions to meet the objective exemptions?
- EU considerations – how will the new motive test be applied in a manner that is consistent with the European Court of Justice ruling in the Cadbury case such as to avoid uncertainty arising from further litigation?
- Finance company debt/equity restriction – how will this be drafted and how in practice will it impact on the use of financing to mitigate foreign tax?
If the above matters are successfully resolved, the new regime has the potential to significantly increase the desirability of the UK as a holding company location for multinational groups.
Your Taxand contacts for further queries are:
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