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CFC Reform Under the Microscope
For UK headquartered multinationals, the most significant aspect of the draft Finance Bill 2012 published in December was the proposals for a revamped Controlled Foreign Company (CFC) regime. This marks the beginning of the end of a reform process that started back in 2007. The result is that the rule book has been completely rewritten in the first significant overhaul to the rules since they were introduced in the mid-1980s. The new regime is expected to be effective when the 2012 Finance Bill receives Royal Assent, probably in July 2012. Taxand UK examines the new tax regime and how multinational companies based in the UK could benefit from the new rules.
The key feature of the new regime is that it seeks to only tax profits of foreign subsidiaries where those profits have been artificially moved from the UK for tax purposes. These profits will now be identified by applying a so-called "Gateway" system. The Gateway deals separately with business profits and finance profits.
Business profits falling within the regime will be those profits arising from arrangements where profits are derived from UK activities that relate to the assets or risks of the foreign subsidiary. Whilst the Gateway approach introduces some complex new concepts which may be difficult to apply, a number of safe-harbours and entity level exemptions will also be available which should serve to simplify matters.
This new approach should help address some of the problems associated with an existing regime that does not really cater adequately for modern business practices adopted by global enterprises. In particular most 'foreign-foreign' trading activities (i.e. those that have no UK connection) should no longer fall within the CFC rules meaning that the UK parent does not have to pay tax on those profits even where they arise in a low tax jurisdiction. The rules should permit organisations to organise their non-UK supply chain activities without attracting some of the adverse tax implications that are encountered under the current regime - particularly in respect of transactions between different parts of the organisation.
Financing profits will fall within the CFC net to the extent that the profits arise from the investment of funds from a UK connected company, or where the profits arise on upstream loans (i.e. from a subsidiary company to its parent); unless there are non-tax benefits to repatriating capital to the UK by way of loan, as opposed to paying a dividend.
Notwithstanding the inclusion of non-trade financing profits in the new CFC regime, the Government has reaffirmed its intention to introduce a new Finance Company Partial Exemption ("FCPE"). This will allow UK groups to debt finance their overseas activities with a UK effective tax rate of 5.75% in respect of the interest income. This will work by only apportioning one quarter of an overseas finance company's profits back to the UK shareholder. Banks and insurance groups, despite initially being excluded from the FCPE when the consultation document was published in June 2011, will now be able to benefit from this exemption. However, the details for how these rules will apply to the financial services sector are not yet finalised.
The Government has already taken some great strides towards its stated objective of increasing the UK's competiveness- most notably through the commitment to reduce the main rate of corporation tax to 23% by April 2014. However, the Government's biggest challenge in the competitiveness stakes is to deliver a CFC regime that is satisfactory to all stakeholders. The apparently contradictory objective of doing so in a way that is taxpayer friendly whilst still protecting the UK tax base. As has been shown in the past, it is difficult to reconcile, but Taxand's initial feeling is that the CFC proposals strike the right balance.
Ultimately however, UK PLC will vote with its feet. The Government will be hoping that the reform will help stem the recent exodus of companies leaving the UK and even encourage some of those groups that have already relocated their corporate seat to come back into the fold. Overall, UK banks have been well catered for in the draft proposals and this should boost competitiveness in the financial services sector.
UK headed groups should review their existing structures in respect of trading and financing to determine the extent to which they will benefit from the new rules.
Non-UK groups, particularly those seeking to invest into Europe, have an increased incentive to consider the UK as a serious contender for the choice of jurisdiction for their intermediate holding companies and for the holding of group financing companies.
Financial services groups should continue to monitor the rules as they develop in advance of the summer and plan accordingly.
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