The UK Controlled Foreign Company (CFC) rules exist to prevent multinationals resident in the UK from avoiding UK tax by artificially diverting profits to tax havens and low tax jurisdictions. By definition a controlled foreign company in an accounting period is a company that is resident outside the United Kingdom,controlled by persons resident in the UK, andsubject to a lower level of taxation in its territory of residence. CFC rules kick in when the CFC pays in its tax jurisdiction less than 75% of the tax which it would have paid on its income had it been resident in the UK. Where an overseas company falls within the definition of a CFC and none of the exemptions applies the chargeable profits and creditable tax of the company are apportioned among the persons with an interest in it. The chargeable profits attributable to UK Company’s interests then are assessed for UK corporation tax after deducting any creditable tax. No apportionment is due where the chargeable profits do not exceed £50,000 in an accounting period.
With the government recognizing that the current CFC rules are becoming a major obstacle for multinationals with foreign operations to do business in the UK, and to improve the UK’s attractiveness as a place to do business with, the government has proposed a two-stage reform of the current CFC rules; interim improvements to be introduced in the Finance Bill 2011 and longer term reforms to be introduced in the 2012 Bill.
Interim proposals
The interim improvements likely to be introduced in the Finance Bill 2011 include exemptions for commercially justified activities like:
· intra‑group trading activities where there is minimal UK connection and low risk of artificial diversion of profits;
· those businesses whose main business is exploiting IP with minimal UK connection; and
raising the exemption level for larger enterprises from £50,000 to £200,000, with the chargeable profits to be calculated using an accounts-based test (e.g. GAAP) than the UK tax rules.
A three year exemption for foreign subsidiaries falling within the scope of CFC rules for the first time as a consequence of a reorganisation or a change in UK ownership is also envisaged in the interim proposals.
Wider reforms
The full reforms likely to be introduced in the Finance Bill 2012 will introduce an entity based system with a view to bringing in to CFC charge only that proportion of the profits that have been artificially diverted from the UK. The risk areas that the government has identified include interest income and intellectual property rights.
Interest: A partial ‘finance company’ exemption is proposed to allow groups to manage their overseas financing operations more efficiently without eroding the UK tax base. A CFC charge would apply if the company has excess equity. With the government likely to consider a 1:2 debt-equity ratio what this effectively means is that an all equity company would be required to pay tax on 1/3rd of the profits, being treated as deemed interest.
IP profits: The government believes that CFC protection is needed to ensure that if IP profits are artificially diverted to a low tax jurisdiction the UK can continue to tax those profits. In this regard it intends to target high risk areas namely a) IP transferred out of the UK within the last ten years; b) overseas IP where UK activities contribute to value added; and c) IP held offshore as an investment without a substantial return reaching the UK
Whilst the proposals are likely to be welcomed by large businesses what is uncertain is whether these are going to be EU-compliant!
