Out-Law News 4 min. read

Reform of the Controlled Foreign Company (CFC) regime moves a step nearer


New controlled foreign company (CFC) tax rules contained in draft legislation published today will give a more specific definition of which profits are within the scope of the CFC charging regime.

The changes mean that it will no longer be the case that all profits of foreign subsidiaries will be potentially subject to a charge unless an exemption is met. The move will be welcomed by business, a tax law expert said.

 

Following the latest consultation over the summer on the proposals for a new CFC regime, the Government has published its draft legislation for the new CFC regime together with a response document including the policy aims of the CFC reform and key developments in the proposals. The legislation will form part of the Finance Bill 2012.

 

Under current law, a CFC is an overseas company controlled by United Kingdom residents which pays less than three quarters of the tax which it would have paid on its income had it been resident in the UK. The controlled foreign companies' provisions are directed at companies which artificially divert UK profits to low tax territories or other favourable overseas tax regimes to reduce their UK tax liabilities.

 

The business profits of a foreign subsidiary will be outside the scope of the new CFC regime unless they meet the 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 allocated outside the UK, the response to consultation states.

 

'Safe harbours' for the gateway conditions will be provided covering general commercial business, incidental finance income and some sector specific rules. A foreign subsidiary can rely on these safe harbours to show that some or all of its profits are outside the regime's scope.

 

As an alternative to the gateway, the regime will also provide exemptions for CFCs. The exemptions will apply to the CFC as a whole and include an excluded territory exemption and a low profits exemption. The lower level of tax test which currently forms part of the definition of a CFC will function as an exemption in the new regime.

 

"The UK needs CFC rules to help maintain sustainable corporate tax revenues by protecting the tax base against artificial diversion of UK profits to low tax jurisdictions, but there is scope for significant modernisation of the current CFC regime." the response to consultation explains.

 

"The new regime will focus on situations that pose the highest risk of artificial diversion of UK profits. All other situations will either be outside the scope of the regime or exempt, significantly reducing compliance burdens. Where a charge does arise it will be proportionate, targeting only artificially diverted UK profits," according to the response to consultation document.

 

The response document confirms that "the Government remains committed to providing a partial exemption on profits from overseas intra-group financing, which will provide a 5.75% effective UK tax rate by the year 2014". However it does state that the Government is still considering the case for full exemption in limited circumstances.

 

The response to the consultation states 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, then it has shown that all of its business profits are outside the scope of the regime. This precludes the need to look at each foreign subsidiary individually for this purpose."

 

As a result of responses to the previous consultation the proposed rules have changed. One change reported in the response document is that the 'gateway' will now expressly define profits which are within the scope of the regime, rather than treating all profits of foreign subsidiaries as potentially subject to a charge unless an exemption is met.

Concerns were raised during consultation that the territorial business exemptions proposed were too narrowly drawn, according to the response to consultation. It states that these mechanical tests have been "considered further and refined to ensure they are appropriately targeted". Groups not wishing to use the gateway to self assess can, if they prefer, rely on these more mechanical rules. 

"In providing both a Gateway and more mechanical exemptions, the aim is that groups will have little difficulty in self assessing with respect to the majority of their foreign subsidiaries." says the response to consultation.

"These rules are a pragmatic and competitive approach to the treatment of overseas finance income, maintaining protection of the UK tax base and avoiding the need for complex legislation to trace transactions or financial flows." according to the response to the consultation.

"It's good news for business in that HMRC and HM Treasury have listened to taxpayers' concerns, and their adoption of an 'all out unless brought in' approach is most welcome," said Eloise Walker, a corporate tax expert at Pinsent Masons, the law firm behind Out-Law.com. "The devil is in the detail, though, so the fact that we don't have the complete set of draft legislation yet is somewhat disappointing and it is only to be hoped that we have enough time to thrash out the kinks before enactment."

The Government has been consulting on the reform of the UK's CFC rules for a number of years. The UK rules have been severely criticised because of their wide ambit. The aim of the reform is to move towards a more territorial system of taxation that reflects the global reality of modern business. The system will focus more on profits from a UK activity in determining the tax base rather than attributing worldwide income of a group to the UK.

The new regime will apply to individual entities and a CFC charge will only arise on the proportion of overseas profits that have been artificially diverted from the UK. It will operate in a similar way to the current regime by identifying low taxed foreign companies controlled from the UK and then providing a number of exemptions to remove CFCs from the regime that do not give rise to the artificial diversion of UK profits. The exemptions are being significantly modernised to reflect current business practice.

The response to the consultation states that the government welcomes views by 10 February 2012 on the issues raised in the document and the draft legislation. It confirms that further draft legislation covering areas for which legislation has not yet been published will be published in January 2012.

We are processing your request. \n Thank you for your patience. An error occurred. This could be due to inactivity on the page - please try again.