Out-Law News 2 min. read

New controlled foreign company rules will come into force from January 2013, Government says


New rules governing when foreign companies controlled from the UK will be exempt from tax will apply to companies with accounting periods beginning on or after 1 January 2013, the Government has announced.

The change is contained in the Treasury's update to its draft legislation (73-page / 711KB PDF) on the tax treatment of controlled foreign companies (CFCs). It was previously proposed that the new rules would come into force for accounting periods beginning on or after the date that the Finance Bill 2012 receives Royal Assent.

The updated draft also sets out further proposals on the finance company rules (allowing a full exemption for finance profits in certain circumstances), the application of the rules to exempt foreign branches, the temporary period of exemption and how the rules will apply to the financial sector

The changes to the CFC tax rules mean that all profits of foreign subsidiaries will no longer be potentially subject to a charge unless an exemption is met. A charge will only arise on the proportion of overseas profits that have been 'artificially diverted' from the UK.

A CFC is an overseas company controlled by UK residents which pays less than three quarters of the tax which it would have paid on its income if it had been resident in the UK. The rules are intended to capture companies which artificially divert UK profits to low tax territories or other favourable overseas tax regimes to reduce their UK tax liabilities. Low taxed foreign companies controlled from the UK but that do not give rise to the artificial diversion of UK profits are removed from the regime by reference to a number of exceptions, which are being significantly modernised to reflect current business practice.

Under the new rules, business profits of a foreign subsidiary will be outside the scope of the CFC regime unless they meet specified conditions set out in a 'gateway'. These conditions define what is to be treated for the purposes of the regime as profits artificially diverted from the UK. In broad terms this will be where there is a significant mismatch between key business activities undertaken in the UK and the profits arising from those activities which are located outside the UK.

The rules provide 'safe harbours' covering general commercial business, incidental finance income and some sector-specific rules. A foreign subsidiary can rely on these to show that some or all of its profits are outside the scope of the regime.

The Treasury said that respondents to its consultation had already raised concerns around the "excessive compliance burdens" surrounding the new regime, particularly concerning the gateway in its current legislative form.

"The intention is to ensure that groups and their foreign subsidiaries can more readily identify whether or not they are within the scope of the rules. In response to this feedback the Government is considering proposals to achieve this, including developing the Gateway to provide clear entry conditions which work on a qualitative basis and allow ground to be able to assess, in a straightforward manner, that a foreign subsidiary is outside the scope of the rules," it said in an update.

The consultation remains open until 10 February 2012.

"It is encouraging to see that HMRC and the Treasury are still listening closely to taxpayers' concerns over the draft legislation and that progress is moving in the right direction. We still, however, do not know the full picture for reform and businesses may struggle with the 10 February deadline for responses to this most recent draft legislation," said John Christian, a corporate tax expert at Pinsent Masons, the law firm behind Out-Law.com.

The new proposal that the CFC rules should apply to accounting periods beginning on or after 1 January 2013 would benefit groups with a December year end, he added, as "they will have more time to review the new rules and determine how the new Gateway test and revised exemptions will apply to their group".

The current CFC rules have been severely criticised because of their wide ambit and the consulting on reform of the regime for a number of years. The aim of the reform is to move towards a more territorial system of taxation that reflects the global reality of modern business.

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