Commission: UK's CFC rules partly contravened state aid rules

The finance company exemption from the UK's controlled foreign company (CFC) rules partly contravened EU state aid rules and the UK must require repayment from groups that benefited, the European Commission has decided.

"The EU Commission's decision would have created significant uncertainty for businesses at any time, but in light of the current uncertainty regarding Brexit there is even less clarity for affected businesses," said Peter Morley, a corporate tax expert at Pinsent Masons, the law firm behind Out-Law.com.

The finance company exemption applied between 2013 and 2018. It allowed a full or 75% exemption from UK tax for financing income received by an offshore subsidiary from another foreign group company. The exemption enabled multinational groups to have a non-UK finance company making intra-group loans to other non-UK companies without incurring a significant UK tax charge.

The Commission said that the exemption contravened EU law to the extent that it applied to financing income where the lending activities which were most relevant to managing the financing activities were based in the UK.

However, the Commission said that the exemption was justified where the loans were financed with funds or assets deriving from capital contributions from the UK but there were no UK activities involved in generating the finance profits. It said the exemption was justified in that instance because it "avoids complex and disproportionately burdensome intra-group tracing exercises" to assess the exact percentage of profits funded with UK assets.

The UK's CFC rules are designed to prevent UK companies diverting profits to a subsidiary based in a low or no tax jurisdiction to avoid UK tax. They operate by reallocating certain profits made by offshore subsidiaries back to the UK parent so that they are subject to UK corporation tax.  

The Commission opened an in depth investigation into the exemption in October 2017. It was removed from the UK rules from 1 January 2019 when the CFC rules were amended to comply with the EU Anti-Tax Avoidance Directive (ATAD).

The Commission says that the UK should reassess the tax liability of UK companies that benefitted from the aspect of the group financing exemption that has been ruled unlawful and recover from each group the tax saved as a result of the exemption.

"The practical impact of the Commission’s ruling is that that in accordance with current EU law, the unlawful state aid needs to be repaid. This could mean significant cash payments of tax being made by some taxpayers who benefitted from the group financing exemption whilst it was in force," Peter Morley said.

"Businesses which are hoping that Brexit will make this go away will be disappointed. The enforcement details will depend on the final Brexit arrangements. As it currently stands, state aid law will be incorporated into UK domestic law and come under the remit of the Competition and Markets Authority (CMA), which will take over enforcement from the Commission. What the CMA will do remains to be seen, but they may well seek to enforce the payments and could do so under guise of blaming the EU," he said.

Reuters reports that BBA Aviation, Chemring, Daily Mail & General, Diageo, Euromoney, Inchcape, London Stock Exchange, Meggitt, Smith & Nephew and WPP are some of the companies which have mentioned the state aid investigation in their accounts.

Last year the Scottish Court of Session decided that a quarry operator was required to pay over £1m to the UK government by way of recovery of unlawful state aid as a result of an aggregates levy exemption which was ruled unlawful by the European Commission

The Commission has also investigated tax rulings given to multinationals and has previously ruled against rulings given to Apple, Amazon, Starbucks, Fiat and Engie.  The Commission says that as a result of these decisions, Ireland recovered €14.3 billion from Apple, Luxembourg recovered €282.7 million from Amazon and €23.1 million from Fiat and the Netherlands recovered €25.7 million from Starbucks. The recovery procedure is still ongoing in relation to around €120 million from Engie.

The Commission is still investigating tax rulings from the Netherlands to one of the groups operating the business of IKEA, and to Nike.