Controlled foreign companies

Britain as the place for international businesses

Corporate Tax Reform – updating the controlled foreign company (CFC) regime

When George Osborne delivered Budget 2011, he said: “I want Britain to be the place international businesses go to, not the place they leave.” The modernisation of our CFC rules is vitally important to the overall corporate tax reform strategy. The Government’s aim is to make the UK the most competitive tax regime in the G20 and, as a result, keep home-grown business and attract inward investment, delivering growth in the UK economy.

The package of CFC reforms set out in this draft legislation will transform the UK tax landscape. A number of detailed points are still to be resolved, but it’s a package that both UK-based multinational companies (MNCs) and inward investors will welcome. The key will be making sure that, on a practical level, those rules will be easy to apply.

A complete rewrite of the existing regime

The draft legislation published on 6 December 2011 overhauls our current CFC regime and introduces a whole new approach to dealing with the overseas subsidiaries of UK companies for tax purposes. Improvement and modernisation of these rules is fundamental to the Government’s ability to make good its commitment to deliver a competitive tax regime and we’re pleased to see positive movement towards this goal. These proposals contain a number of pleasant surprises as well as some welcome attempts to address some of the shortcomings of the previous proposals.

Most significantly, this package introduces an entirely new concept of a gateway test with the aim of filtering out a large number of companies from the CFC regime entirely. It also introduces safe harbours which are intended to offer companies a more straightforward means of exempting overseas profits even where the gateway is failed. The Government also reaffirmed its intent to introduce a new low rate finance company exemption – and are intending to consult on whether this can be further improved. There is also an update on the shape of the remaining exemptions and how these sit within the CFC overall rules.

There’s good news for banks and insurance groups as they’re now to be included in the finance company rules and will have updated exemptions. This is a boost for the competitiveness of the UK’s banking sector and has the potential to make the UK a more attractive location for banks to be headquartered.

But we’re still in a period of consultation, which closes on 10 February 2012. There are various details that are still under consideration and there is the real possibility of further improvements before the final changes are enacted.

Broadly speaking, under the UK’s current CFC regime, UK companies with subsidiaries in low tax jurisdictions could face a tax charge in respect of profits arising in such subsidiaries unless one of a limited number of exemptions is available. There are a wide variety of modern commercial activities which don’t fall into any of the available exemptions and, where available, claiming an exemption (or otherwise demonstrating that profits are outside the regime) can often cause a undue burden for your business.

All of the old exemptions have been removed and a new set are being introduced. More fundamentally, certain aspects of the regime represent a complete departure from the old approach and will require a change of your mindset and your approach to tax management.

• Gateway test – Most significant is the brand new gateway test. This has been introduced in response to calls from business for the compliance and administrative burden of the CFC regime to be reduced. While companies will undoubtedly welcome this approach in broad terms, we’re still evaluating how much of a burden the detailed provisions will actually be to apply in practice. An important component of this test is an understanding of the significant people functions (SPFs) of the entity concerned. This will be a new concept for many of those concerned and one on which there’s little practical guidance at present. So, the practical benefits will need to be evaluated as business gets to grips with these new rules.
• Safe harbour – Another major change proposed today is the new concept of safe harbour tests. Again, these are intended to allow more business activities to be exempt from the CFC rules altogether.
• - The new FCPE allows UK-based businesses to lend to overseas subsidiaries with a low rate of 5.75% by 2014. This is a positive step, enabling UK-based businesses to lend to overseas subsidiaries tax efficiently for the first time. Where UK based businesses are in a net cash position, proposals are being considered as to whether to allow them to lend to overseas subsidiaries with no UK tax pick-up. This new exemption is good news for business. It’s also been confirmed that banks and insurers will be able to benefit from this regime, although some of the detail surrounding this is yet to be clarified – again a positive change from the Government.

Where these don’t apply, there are still the other specific exemptions. There are fewer than before and despite the inclusion of a new commercial activities exemption may be seen as narrower in breadth. The removal of the motive test with no new equivalent is likely to cause concern for some businesses. With a mechanical set of exemptions it is almost inevitable that some ‘catch all’ or safety net will be required.

The new exemptions do include the requirement that income be streamed and tested separately. This requirement will present an additional layer of complexity, but one that is arguably softened by the introduction of the gateway test. There are anti-avoidance rules included in the new safe harbours and exemptions dealing specifically with intellectual property (IP) transfers out of the UK. The impact of this will have to be evaluated by different businesses.

Impact on your current structure and tax strategy

If your group has foreign operations you’ll need to understand these changes, and evaluate the impact they have on both your current structure and your tax strategy.

If you’re a UK-based MNC, you’ll want to re-evaluate your tax strategy to consider whether it remains ‘fit for purpose’. The new gateway test should result in a whole new approach to CFCs, management, and the FCPE is a great catalyst for UK businesses to re-examine and potentially improve their financing strategy.

For inward investors, these improvements (taken together with other attractive features of the UK tax regime such as our capital gains tax exemption, zero dividend withholding tax and stable interest deductibility rules), make the UK an attractive location for a holding company, principal or IP hub.