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CFC Reform Provides Interim Improvements for UK Multinationals

20 Jan 2011

There has been much controversy in the UK over recent years about the controlled foreign company ("CFC") rules and the taxation of foreign profits in general. Multinational companies that migrate out of the UK often cite the CFC rules as a reason for leaving. The regime has been progressively tightened for the last 25 years but in April 2011 the rules will be relaxed for the first time. Taxand UK comments on the proposed changes to the controlled foreign company regime.

The Government is hoping to impress businesses with its reform of the controlled foreign company rules. The reform is set to take place in two stages with interim improvements to the regime in April 2011 and a full reform in April 2012. The UK is currently in the process of moving towards a more territorial approach to taxation.

The two major areas for full reform are financing and the holding of intellectual property (IP).

From April 2012 it should be possible to hold a financing company under UK ownership without a CFC charge provided that the company is sufficiently debt capitalised. The Government is currently looking at a minimum debt to equity ratio of 1:2 which would give an effective rate of UK tax of around 8% or 9% on the financing activity as a whole.

The thinking is slightly further behind on the reforms in relation to IP. The approach may be to first identify entities that hold IP with a UK connection and then assess whether excess profits have arisen and what proportion of them should be taxed.

In the meantime, the package of interim improvements to be introduced in April this year will include:

  • an exemption for a CFC carrying on intra-group trading activities where there is minimal connection with the UK and little risk that UK profits have been artificially diverted
  • an exemption for a CFC with a main business of IP exploitation where the IP and the CFC have minimal connection with the UK
  • an exemption which runs for three years for foreign subsidiaries that, as a consequence of a reorganisation or change to UK ownership, come within the scope of the CFC regime for the first time
  • raising the threshold of the de minimis exemption (most likely to ?200,000)
  • deferral of the withdrawal of the exemption for certain holding companies

It had been feared that the relatively generous regime for deductions for interest payable allowed by the UK (the UK allows deductions when a UK company borrows to equity finance an offshore subsidiary) would be restricted as part of the reform. The Government has confirmed that this will not be the case.

Taxand's Take

This is excellent news and marks a step change in the way the UK approaches its corporate tax base. The new CFC regime will be much improved and should afford opportunities for UK based multinationals to perform a sensible level of international tax planning activity.

Your Taxand contacts for further queries are:
Kevin Hindley
T. +44 20 7715 5235

Dafydd Williams
T. +44 20 7072 3215

Taxand's Take Author