UK: Taxation Of Foreign Profits Reform - Enhancing UK Competitiveness?

Last Updated: 22 April 2009
Article by Deloitte Tax Group

Most Read Contributor in UK, August 2017

Today's Budget announcement that the Government will introduce the foreign profits reform package in Finance Bill 2009 is the latest development in more than two years of discussion and consultation on this topic. The Government's stated aim of this reform is to enhance and support the competitiveness of the UK tax system. The key question is does the reform package announced meet this aim?

The Government has described the package of foreign profits reform as 'balanced and affordable' so it is clear this is not intended to represent a tax saving. Therefore, in order for the package to enhance UK competitiveness, reform should offer compliance savings. It is, however, not clear this will be achieved under the current package.

Dividend Exemption

Today's announcement states that an exemption from corporation tax will apply to dividends received on or after 1 July 2009. The exemption is extended to apply to all companies where the level of shareholding is 10 per cent or more. This is a positive development in terms of UK competitiveness. Many multinational businesses are expected to benefit from the introduction of exemption, even though for many this will not result in lower actual cash taxes, but will reduce their compliance burden, and extending exemption to include small businesses (who were not offered exemption in the original announcement at the November Pre-Budget report) is a welcome development. However, recent EU case law already supports the position that dividends from EU subsidiaries are not currently taxable in the UK anyway and it must be remembered that the corollary of the fact that many foreign dividends will become tax exempt in corporate hands is that the current blanket exemption for UK-UK dividends is being removed.

Most domestic dividends should still remain exempt under one of the available exempt classes and today's press notice states that 'the vast majority of distributions are expected to be exempt'. However, extra thought will have to be given to UK-UK dividend flows in the future to be certain of the exemption and some technical difficulties with the earlier draft legislation might leave those receiving dividends from UK or foreign associates (between 10% and 50%) relying on a motive clearance from HMRC. For these provisions to truly reduce compliance obligations detailed guidance should be published which sets out when the motive test is not satisfied.

Adding dividend exemption to the existing UK exemption from tax on disposals of qualifying shareholdings (the substantial shareholding exemption) and the UK's lack of domestic withholding tax on dividend payments are all positive indicators of the competitiveness of the UK tax system, especially in relation to attracting foreign investment. However, there are some negative elements to this equation.

Interest Restriction - the Worldwide Debt Cap

One of the most competitive features of the UK tax system in the past has been the lack of any general limitations on the tax deductibility of interest. The UK does have rules to limit interest deductions in certain circumstances including transfer pricing/thin capitalisation and the anti-arbitrage rules but has not previously had a general rule to restrict deductions for corporate interest in the UK. The announcement today that the worldwide debt cap will apply to interest deductions of large groups for accounting periods beginning on or after 1 January 2010 changes this landscape.

The proposals for the debt cap as amended by the update published by HMRC on 7 April 2009 for the change to the proposed mechanics are an improvement on the complex and wide-ranging proposals originally published for consultation by HMRC in December 2008. For example, the revised mechanics for calculating the 'available amount' based on the gross consolidated interest costs of the group (rather than net of interest income as had previously been proposed) will assist those groups who have external debt but also have surplus cash in their business. Basing the calculation of the 'tested amount' on each entity rather than analysing each individual loan relationship should also simplify the test. These are welcome developments. Unfortunately the provisions remain very complex and represent a major compliance burden for groups even if they will have no ultimate disallowance of interest. In addition the positive steps forward in design are accompanied by proposals for a targeted anti-avoidance rule (TAAR) which will aim to prevent back to back arrangements to manipulate the available or tested amounts. The drafting of the TAAR will clearly be crucial and it is likely that this will introduce uncertainty into the calculation.

The policy design of the debt cap is to target situations where the UK has more debt borrowed from other group members than the worldwide consolidated group has borrowed from third parties. This policy will penalise those groups with debt in the UK borrowed from other group members who do not have significant levels of debt borrowed from third parties at a consolidated level and so are managing their group balance sheet in a conservative manner. Such groups will be at a disadvantage if bidding for a UK project against another investor who has a debt-laden balance sheet. How can this be the right answer - so long as the debt is arm's length in both cases then where is the avoidance mischief which HMRC is so keen to correct? It is important to note that no other territory has attempted to introduce an interest restriction with a similar policy design. The introduction of the debt cap cannot be regarded as a move which will enhance and support UK competitiveness and this aspect of the policy design of the debt cap seems more likely to damage the UK's competitive position than to enhance it.

The original foreign profits package announced at the November Pre-Budget Report included proposals to extend the current anti-avoidance 'unallowable purpose' rule which applies to interest and derivative contracts. Today's announcement has dropped this element of the package, which is a welcome development given the very wide drafting proposed in the December draft legislation, but states this area will be kept under review.

Controlled Foreign Companies

The other potentially negative element when measuring the competitiveness of the UK tax system is the current CFC regime. In the 2008 Pre-Budget Report, the Government announced reform in this area will be the subject of separate consultation running to its own timetable. However, it is not expected that legislation for reform in this area will be introduced before 2011, leaving two years of potential uncertainty over the direction this reform will take.

The Government has said it wants a reformed CFC system to protect against diversion of UK profit and not tax profits genuinely arising overseas, but nobody knows yet what they mean by this. This uncertainty is increased by the question as to whether elements of the current UK tax system, especially the CFC rules, are compliant with the UK's obligations under the EC treaties. In the meantime, the removal of some of the existing CFC exemptions may be regarded as tightening the UK tax net in the intervening period.

Take the example of a UK group which has significant levels of profits earned and located offshore. The introduction of dividend exemption may seem like the ideal opportunity to return those profits back to the UK tax free. However, if there is a possibility under a reformed CFC system for transactions between foreign entities which do not represent diversion of UK profit being regarded as exempt, will repatriated profits be tainted, so that this sort of CFC exemption will not be available in the future if these funds are needed to invest offshore?

This sort of uncertainty is very damaging for groups and makes it difficult for them to appraise the tax impact of investment decisions and to forecast what their effective tax rates and tax capacity may be going forward. Certainty and stability in the tax system is one of the goals of this Government but the possible two year delay UK groups will face over the future of CFC reform does not sit well with that objective. This leads to the question of whether more UK headed groups will choose to relocate elsewhere in the meantime, rather than wait to see what future reform may bring.

One possible solution to this problem could be for the Government to introduce an exemption into the current CFC system for transactions between foreign entities where these do not represent diversion of UK profit. This could be an interim measure to alleviate the pressure on the current CFC rules and to counteract some of the attractions which inversion offers to some UK headed groups. Even confining such an exemption to allowing financing between offshore entities outside the CFC net where this does not represent erosion of the UK tax base would be a welcome development, and would signal the Government's commitment to enhancing the competitiveness of this area of UK taxation.

The Government does have a real opportunity now to demonstrate it is committed to supporting and enhancing the competitiveness of the UK's tax system and to build on the positive step forward which dividend exemption represents. A good example of this is the statement made today that the Government will work with business representatives to consider evidence for changes to the way the tax system encourages the location of innovative activity in the UK. Introducing an incentive based regime to attract IP ownership into the UK could be a really positive development for UK competitiveness. The key to enhancing the UK's competitive position will be what happens with CFC reform and we would urge the Government to do whatever it can to allay the uncertainty over this area in the short term.

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.