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The latest stage in the reform of controlled foreign companies (CFC) rules has been welcomed by tax professionals, after the government announced new legislation for the new Finance Bill.
It will repeal the current arrangements and replace them with a regime that will exclude the business profits of a foreign subsidiary unless they meet the specified conditions, set out in a ‘gateway’, which define what is to be treated for the purposes of the regime as profits artificially diverted from the UK.
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 the safe harbours to show some or all of its profits are outside the scope of the new set-up – which 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.
It has taken five years to arrive at the latest proposals but the time was ‘worth the wait’, remarked Duncan Whitecross, international tax partner at Ernst & Young.
He said the legislation has ‘changed from a “guilty until proven innocent” approach to “innocent until proven guilty”. Although this will have the same coverage and protect the tax base in a similar manner, the new approach will be significantly simpler to operate.’
‘Of particular note is the long anticipated new overseas group finance company regime, which taxes profits at 25% of the UK rate, rather than the full rate,’ Mr Whitecross added. ‘In addition, the case for full exemption for finance profits in certain limited circumstances is still being considered.’
Additional draft legislation will be published in January 2012. Martin Lambert, corporate tax partner at Grant Thornton, said the new rules were ‘certainly not as straightforward as the government intended. UK multinational-based groups will need to consider the new rules carefully [because] the scope… is wider than the previous rules’.
However, Mr Lambert said there were ‘some very helpful new rules, such as an exemption from the CFC rules for income of an offshore finance company, which will benefit UK groups expanding overseas’.
In relation to the UK’s banking sector, Peter Maybrey, financial services partner at PricewaterhouseCoopers, said the new regime would significantly enhance its competitiveness.
‘It is encouraging that the proposals for taxing profits of foreign subsidiaries appear to largely treat banks on a level playing field with other sectors: for example, allowing banking groups to benefit from the new foreign financing partial exemption,’ he said.
He continued: ‘Under the proposals, profits of foreign banking subsidiaries will only be subject to UK tax where they are derived from activities carried out in, or directed from, the UK or from excess capital provided from the UK.
‘The news that the government intends to continue to work with the banking industry to develop a capitalisation condition should considerably reduce the compliance burden for banking groups.’
