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CFCs To Benefit From New UK Tax Regime

by Robert Lee,, London

08 December 2011

A major overhaul of the UK's controlled foreign company (CFC) rules has been warmly welcomed by tax experts, who conclude that the proposed new regime will go a long way towards changing the negative perceptions of the UK's corporate tax regime among multinational businesses.

The legislation, mostly included in the December 6 draft Finance Bill, will introduce new rules to replace the existing regime. According to the government, the changes will better reflect the way that businesses operate in a globalized economy and strike the right balance between making the corporate tax system more competitive and protecting the UK corporate tax base.

The consultation on a series of detailed proposals for the new CFC regime was launched in late June and closed on September 22. The government received 73 representations from a range of interested parties, including 43 UK and foreign headed groups, 16 representative bodies, 10 professional services, consultancy and law firms, two Non-Governmental Organizations and two individuals.

In its response to the consultation, which forms a large part of the legislative process, the government argues that the UK needs CFC rules to help maintain sustainable corporate tax revenues by protecting the tax base against the artificial diversion of UK profits to low tax jurisdictions. As the document sets out, the aim of the proposed new system is to target only such transactions, meaning that the regime will focus on situations that pose the highest risk of artificial diversion. As a result, all other situations will either be outside the scope of the regime or exempt, with the aim of significantly reducing compliance burdens. Where a charge does arise it will be proportionate, targeting only artificially diverted UK profits.

The major innovation in the legislation is the provision of a ‘Gateway’ system, which will specifically identify circumstances where artificial diversion has taken place. This is broadly defined as an instance where there is a significant mismatch between key business activities undertaken in the UK and the profits arising from those activities which are allocated outside the UK. Business profits within the Gateway, including ‘foreign to foreign’ profits, will be outside the scope of the new regime.

The legislation also confirms the government's commitment to providing a partial exemption on profits from overseas intra-group financing. The rules will provide a 5.75% effective UK tax rate by 2014. The government believes its rules offer a pragmatic and competitive approach to the treatment of overseas finance income, while maintaining protection of the UK tax base and avoiding the need for complex legislation to trace transactions or financial flows. The case for full exemption in limited circumstances is under consideration.

In addition, the legislation will give groups the opportunity to choose how they self-assess. They will be able to focus either on whether foreign subsidiaries are excluded from the regime by the Gateway or whether they meet the conditions of a more mechanical exemption. The government says that one consequence of the Gateway is that if a group establishes that all of the profits arising from its UK activities (other than its finance profits) are allocated to the UK, it will have shown that all of its business profits are outside the scope of the regime. This therefore precludes the need to look at each foreign subsidiary individually for this purpose.

The government's intention is that it will henceforth be straightforward for groups to establish that the majority of their foreign subsidiaries are outside the scope of the new CFC regime or exempt from it. Consequently, business profits arising in a foreign subsidiary will only be subject to the regime if they are derived from UK activities that relate to the assets or risks of the foreign subsidiary.

According to Ernst and Young, the changes show that the government has turned the country's CFC rules on their head in order to drive competitiveness. International tax partner Duncan Whitecross said the legislation had altered the UK's approach to CFCs from ‘guilty until proven innocent’ to ‘innocent until proven guilty’. Whitecross added: “The proposals mark an important step towards realizing the Coalition’s ambition of making the UK one of the most competitive corporate tax regimes in the G20 by making the UK a more attractive headquarter location. It should help to attract further inward investment and stop any more groups leaving - it may even attract some back!"

Stella Amiss, international tax partner at PwC noted that the rules were better than had been expected, arguing that they represent a potential game changer for the UK in its efforts to attract international business. Amiss believes that the Gateway "will significantly reduce the compliance and administrative burden for corporate UK for those companies that pass the test", but warned that "the mechanics for getting through may not be straight forward and those that fail the test could face a tougher and more complex regime than they had before. In this sense, compliance may be harder for smaller and mid-sized firms who are less geared up to dealing with complex tax law." Nonetheless, Amiss's conclusion is that the rules represent a "a very positive direction of travel".

The Finance Bill also confirmed the government's plans to reduce the headline rate of corporate tax to 24% in 2013 and to 23% in 2014.

Launching the legislation, David Gauke, Exchequer Secretary to the Treasury, said: “This is the second year we have published draft tax legislation, and the government’s more open, predictable and simple approach to tax policy making is working well. By confirming intended tax changes ahead of publication, we are giving greater certainty and stability to taxpayers and businesses than they have had in the past. Furthermore, the consultation responses we are publishing today demonstrate the government’s commitment to listening to the views of those affected by changes to the tax system.”

TAGS: compliance | tax | business | tax compliance | fiscal policy | law | corporation tax | United Kingdom | group taxation | treasury management | corporate headquarters | multinationals | controlled foreign corporations (CFC) | legislation | tax planning | tax reform

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