UK: CFC Reform Consultation (Tax Newsletter, Summer 2011)

Last Updated: 11 November 2011
Article by John Watson, Alexander Cox, Paul Miller, Richard Palmer and Simon Swann

The Treasury has published the most detailed proposals yet for the reform of the controlled foreign company (CFC) rules. The Treasury indicated at a recent open day that the new rules would be expected to apply to accounting periods of companies commencing on or after Royal Assent to the Finance Act 2012 (July/August 2012).

The proposed new CFC rules are to operate in a similar way to the existing regime; by identifying low taxed foreign companies controlled from the UK and then applying a number of exemptions. While the new exemptions have clear parallels with those currently in operation, they will be refocused on key areas of risk (mainly IP and monetary assets) and - most importantly - will adopt a proportionate approach such that a CFC charge will only arise on the proportion of profits in a given entity deemed to have been artificially diverted. In particular, the "general purpose" exemption for CFCs that can demonstrate no artificial diversion takes the place of the old motive test, but without a default assumption that profits would have arisen in the UK.

While there are likely to be many cases at the margins where it will be difficult to determine the extent to which profits should be attributable to the UK, it is helpful that the structure of the regime is similar to the existing rules and a non-statutory clearance procedure is proposed to give certainty in borderline cases.

Defining a CFC

The Treasury is looking at a number of options on how best to define "control" in this context:

  • by principle, i.e. that, in substance, the person has economic rights or actual control over the assets or income of the company;
  • by relying on the rules for group consolidation used for accounting purposes; or
  • using similar rules to the present ones, i.e. the ability to ensure that an overseas company's affairs are conducted in accordance with the wishes of a UK person.

As currently, only an entity with profits taxed at a lower effective rate than if it were resident in the UK will be caught (clearly, this decreases as the UK corporation tax rate reduces over the next few years). It is intended to retain the "lower level of tax" test threshold at 75 per cent of the UK corporation tax that would have been suffered, and companies would not be obliged to apply this test if it is easier to claim one of the exemptions instead.

Exemptions

The exemptions exclude from the regime those CFCs which appear to pose a low risk to the UK tax base and the main exceptions are set out below:

Low profits exemption. Effectively a de minimis, the options suggested are a £500,000 threshold with further limits on investment income, permitting a certain percentage of turnover or retaining the existing £200,000 limit.

Excluded countries exemption. Equivalent to the "white list", this operates as a proxy for performing a "lower level of tax" calculation. It would apply to CFCs meeting certain conditions, including a local management condition, and located in jurisdictions with tax regimes with broadly similar rates and bases to the UK. The scope of this exemption has not yet been further clarified.

Temporary period exemption for up to three years where an overseas subsidiary comes within the scope of the CFC regime as a consequence of a reorganisation or change to UK ownership, as per the amendments recently enacted in the Finance Act 2011.

Territorial business exemptions (TBEs) designed to be a safe harbour for genuine overseas trading operations. This would comprise three separate exemptions for CFCs:

  • with low operating margins;
  • carrying on manufacturing trades (other than those involving an IP hub); and
  • carrying on commercial activities where there is a low risk of artificial diversion of profits from the UK. Around 20 per cent of the CFC's activities will be permitted to be certain investment activities such as holding and managing shares and securities other than those of group companies, and some leasing.

Incidental finance income from the working capital needs of the business would be exempt, but because the CFC charge will now be calculated on a mixed entity/income stream approach on a proportionate basis, it will no longer be possible to "swamp" finance income with trading income.

It is proposed that there would be a local management condition for the TBEs such that the CFC must be controlled and managed by sufficient staff of the necessary expertise and seniority.

Finance company partial exemption for overseas financing that would lead to an effective rate of 5.75 per cent on profits from overseas intra-group finance income by the year 2014, i.e. a quarter of what would normally be payable. This equates to a deemed 1:3 debt:equity ratio on an assumed wholly equity funded finance company. This would also apply to finance income that represents the structural surplus cash reinvested within a group to the extent that it exceeds amounts incidental to the CFC's business.

The Government would prefer this to be calculated on an apportionment basis under which the CFC would undertake a UK chargeable profits calculation, rather than an imputation basis deeming excess equity funding to be a loan from the UK. The details of the interaction between this apportionment and debt cap rules is currently unclear.

The Government is also considering a full exemption in limited circumstances.

General purpose exemption. This will consider the facts and circumstances of a CFC to assess whether profits are commensurate with the CFC's own activities or have been artificially diverted. It is proposed that assets and risk would be attributed to the CFC in a similar manner to the OECD guidelines on attributing profits to permanent establishments. Indicators of profits which had been artificially diverted would include (i) transaction diversion, e.g. a transaction giving rise to a UK deduction that would not have arisen had the transaction been at arm's length and (ii) diversion through transfer of assets, e.g. the separation of an intangible asset, previously in the UK, from the active decision-making regarding the risks inherent in the asset ownership.

This exemption would have to be considered for CFCs with high-risk IP, but could also be used as a fall-back either where a CFC falls within none of the previous exemptions (most likely to be available where another exemption is failed only marginally) or where only a proportion of its income is otherwise exempt, e.g. under the partial exemption for finance companies. The Government intends to publish guidance on the operation of this exemption. Concern was expressed at the open day that the complexity of the other exemptions would lead to widespread reliance upon this exemption.

Sector-specific rules will apply to leasing companies, insurers and banks where monetary assets are an intrinsic part of their trade. Please speak to your usual Ashurst contact if you would like more detailed information on these at this stage.

Specific rules for IP

The TBEs can be used to exempt CFCs involved in the exploitation of IP that do not pose a significant risk to the UK tax base. This will cover:

  • IP income related to the holding and exploitation of foreign IP which has not been transferred from the UK, nor has significant economic connection with the UK;
  • local IP that is integral to a genuine overseas manufacturing trade; and
  • IP royalty income that is incidental/ancillary to the trade.

More complex cases, where IP has been transferred out of the UK within the last six years or there is a significant UK connection such as the effective management or development of the IP in the UK, will need to be dealt with by the general purpose exemption.

The consultation document contains a long list of factors to consider in determining whether the profits arising in a CFC following the transfer to it of UK IP are artificially diverted. These include:

  • insufficient genuine commercial substance in the transferee;
  • UK IP is transferred without the transfer of the functions needed to continue to develop/exploit the IP;
  • significant sales in the UK;
  • value-adding activities connected with the IP are performed in the UK rather than the CFC's territory of residence;
  • in the case of a brand, it is geographically sensitive and its integral value is in the UK; and
  • the UK borrows to fund third party acquisitions of IP by the CFC.

Foreign branches

The Finance Act 2011 contains an opt-in exemption for the taxation of foreign branches of UK companies. To ensure that tax treatment of exempt foreign branches is aligned with that of foreign subsidiaries as far as possible, the new CFC rules provide that, when a company elects into exemption, it must consider whether any of its branches are subject to a lower level of tax and, if so, whether those branches meet any of the CFC exemptions. If a CFC exemption is met, the branch profits will be exempt but, otherwise, the branch profits (or an appropriate proportion) will remain chargeable to UK tax.

Credit relief will be available for any foreign tax paid on profits which are subject to UK tax.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.