The UK’s ‘controlled foreign company’ (“CFC”) rules are directed at companies which artificially divert UK profits to low tax territories or other favourable overseas tax regimes so as to reduce their UK tax liabilities. Broadly, under the current rules, a UK company with a 25% or more interest in a company controlled from the UK and resident in a country with a tax rate on income profits at least 75% lower than the UK’s rate can be taxed on a proportion of that company’s profits.
The UK’s CFC rules have been the subject of scrutiny in recent years, with many arguing that they have contributed to the trend that has seen a growing number of multinational corporate groups – including within the insurance industry - ‘re-domicile’ offshore (especially to Bermuda in the case of insurers).
Reform of the UK’s CFC legislation has been a central feature of the current Coalition Government’s plan to make the UK’s corporate tax rules more competitive and more territorial. Proposals for reforms to the UK’s CFC rules were tabled in November 2010 as part of the Coalition Government’s ‘Corporate Tax Road Map’. An interim programme of reform was implemented by the Finance Act 2011. In June 2011, the Coalition Government published a consultation document setting out detailed proposals for full CFC reform to be introduced in the Finance Bill 2012. Draft legislation was published in December 2011, with further updates and revisions to the draft legislation made subsequently. The Finance Bill 2012 (published on 29 March 2012 and still awaiting Royal Assent) contains legislation to repeal the current CFC legislation and replace it with a new CFC regime.
Many in the insurance industry have been following the changes to the UK’s CFC provisions with extreme interest. The key elements of the new CFC rules can be summarised as follows:
- In very broad terms, it is proposed that a CFC charge will arise only if a foreign company is (i) controlled from the UK, (ii) the CFC has chargeable profits as defined by the so-called “gateway”, and (iii) none of a number of “safe harbours” or (iv) exemptions apply. This approach effectively reorders the current rules, which start from the position of charging all of a CFC’s profits unless an exemption applies.
- A company can be controlled by reference to legal or economic control or by reference to accounting standards. Furthermore, the so-called “control TAAR” means that a company that would not otherwise be a CFC may be treated as a CFC if it is reasonable to suppose that it would be a CFC but for arrangements (one of) the main purpose(s) of which is securing that it is not a CFC.
- The business profits of a foreign subsidiary will generally be outside the scope of the new CFC regime if they meet the specified conditions set out in the “gateway”. The gateway identifies those profits (if any) that are artificially diverted from the UK and which, therefore, pass through the gateway and become subject to the CFC charge. If there are no chargeable profits following application of the gateway, no CFC charge will arise.
- “Safe harbours” for the gateway conditions are provided covering general commercial business, incidental finance income and some sector specific rules. A foreign subsidiary can rely on these safe harbours to show that some or all of its profits are outside the scope of the CFC regime.
- As an alternative to the gateway and safe harbours, the new regime 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.
- The regime includes rules for finance companies which will generally result in an effective tax rate on intra group finance income of one-quarter of the main corporation tax rate. The regime will also provide for full exemption in certain circumstances.
The new CFC rules will be effective for CFCs with accounting periods beginning on or after 1 January 2013.