UK Foreign Profits Reform Receives Cautious Welcome

by Jason Gorringe, Tax-News.com, London

24 April 2009

Tax experts have welcomed the announcement in the UK government budget to implement proposals for a much improved corporate tax regime for foreign profits, although concerns persist with regards to accompanying anti-avoidance measures, especially the worldwide 'debt cap.'

Under the long-awaited reforms, dividends from overseas subsidiaries will normally be received completely free of UK corporation tax, bringing the system in line with many other countries having tax friendly holding company regimes, such as Luxembourg and the Netherlands. This change will apply from July 1, 2009 at the same time as new streamlined reporting requirements for cross border transactions, which will abolish the outdated 'Treasury Consents' rules.

Currently, foreign dividends and other distributions received are chargeable to corporation tax, with credit given for any foreign tax withheld from a dividend and (for shareholdings of 10% or more) for foreign tax charged on the profits out of which the dividend is paid (underlying tax). UK distributions received are generally exempt from corporate tax.

However, the Chancellor has repeatedly stressed that the reforms need to be tax neutral and, accordingly, he has confirmed that a new 'debt cap' restriction will apply from January 1, 2010. The idea of a cap is to restrict the amount of tax deductions available to UK members of the group for finance costs, such as interest, so that this does not exceed the total consolidated finance expense of the worldwide group. The idea behind this proposal is to stop groups offsetting large amounts of debt to the UK and claiming large tax deductions for the associated interest cost.

Additionally, controlled foreign company rules that apply UK corporation tax to the profits of certain low tax subsidiaries will continue in a revised form. The new version of these anti-avoidance provisions, which have been cited as one driver behind the emigration from the UK of a number of high profile UK listed international groups, will be phased in over two years up to July 1, 2011.

Stephen Herring, Senior Tax Partner, at BDO Stoy Hayward comments: "It was essential that the uncertainty over the UK tax treatment of overseas dividends should be resolved and, to that extent, this measure is to be welcomed. It is not unsurprising for the Chancellor to seek to control broadly related interest tax relief as a quid pro quo for exempting dividends, to the extent that the tax free income derives from the debt funding giving rise to the interest expense. However, it is extremely disappointing that the method adopted will be both cumbersome and may, in certain cases, deny relief for wholly commercial financing costs of doing business in the UK."

Herring believes it is "essential" that the government takes steps to shore up the eroding competitiveness of the UK corporate tax system.

"The current 28% corporation tax rate is higher than many competitor European nations and the decision to maintain the current rate represents a lost opportunity to support the UK's status as a location for the emerging business sectors that the Chancellor is aiming to encourage," he argued.

Ian Menzies-Conacher, Chairman of the Chartered Institute of Taxation's Technical Committee, says that while the government is to be congratulated for listening to the concerns of business and tax experts during the drafting of the foreign profits legislation, he expects the devil to be in the detail.

"Until the Finance Bill is published this is unknown," he cautioned. "While the consultation process has been exemplary, the government has been working towards a self-imposed deadline and this may lead to further problems being identified when the legislation is available for study."

Philip Howell, Director of Corporation Tax at PKF anticipates that the changes will have a "positive impact," but shares widespread concerns that more fundamental reforms are needed to restore the UK's tax competitiveness.

"The government needs to improve the attraction of the UK to international businesses in every budget, otherwise the country will no longer be seen as a competitive place for companies to do business," he noted. “Today’s steps get the ball rolling, but there must not be any complacency about developing this further.”

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