A further discussion document relating to the proposed reforms of the UK’s controlled foreign companies regime has now been published, as envisaged by the HM Treasury and HM Revenue & Customs representatives at the joint meeting with stakeholders held on 9th November last year (see “Update on the Reform of the UK’s CFC Tax Regime”, 10th November).
The details have yet to be determined, but the proposed general shape of the new regime, as outlined at the 9th November meeting, is confirmed.
The proposed new regime would apply to non-UK companies controlled by UK companies (“CFCs”) on an entity-by-entity basis. As under the current regime, capital gains will be excluded, but may be captured under other anti-avoidance rules.
CFCs may be excluded from the regime if they are subject to similar tax rates and bases to those of the UK. Generally CFCs could also be excluded if they “exist … to undertake genuine trading activities”. (Presumably undertaking other additional activities would prevent the exclusion of the CFC from the regime, perhaps unless they are ancillary or incidental to the trading activity. The proposed operation of the regime in this respect is not yet clear.)
The intention is to develop objective tests to identify CFCs considered to be undertaking “genuine trading activities” rather than artificially diverting profit from the UK, but there is no information in the discussion document as to the form such tests could take. However, with respect to CFCs that are treasury or finance companies or which hold intellectual property (“IP”), there are specific suggestions as to the kind of activities that would be permitted without bringing a CFC into the regime. It is suggested that the banking and insurance sectors would need their own, different rules.
A CFC undertaking short-term cash management and cash pooling, referred to as treasury company activity, appears likely to be outside the regime. A CFC undertaking other financing activity appears likely to be within the regime, perhaps subject to an exemption for CFCs which are not thickly capitalised. “Excess” equity funding could result in deemed UK taxable income. For these purposes, a method of determining the “appropriate” blend of debt and equity funding will need to be developed.
CFCs holding IP also appear likely to fall within the regime unless they undertake active management of the IP “similar to a trading activity” outside of the UK. The performance of decision making and activities relating to the IP in the UK would appear likely to bring such a CFC into the regime, however. Where an IP company is within the regime, not all of its profits would necessarily be taxed in the UK. A proportion of that profit may give rise to deemed UK taxable income, as for finance CFCs.
There is also reference to the possibility of a contingent deferred tax charge on the export of IP from the UK where it is difficult to value at the time of export, compared to commercial “earn-out” arrangements. Later increases in value could be brought into the charge to UK tax.
There is mention of possible exemptions for reinsurance companies managing non-UK risks and property companies managing non-UK properties, and of a de minimis exemption.
Should a CFC fail to satisfy any of the objective tests for exclusion from the regime on the grounds of “genuine trading activity”, it may still be excluded where the failure is “narrow” or due to one-off factors. There would also be a final subjective motive test, which if passed would result in exclusion from the regime. The suggestion is to exclude companies that are “properly established overseas” and “not engaged in activities intended to artificially divert UK profit”. The company would need to demonstrate its “non-tax related commercial rationale” either alone or in its group context.
It seems that a CFC that is within the regime will only give rise to UK taxable income to the extent its income is not incidental or ancillary to a genuine trading activity.
Clearly, the details of the proposed regime have still to be developed. One key issue remains the nature of the objective tests intended to capture the concept of “genuine trading activity”, although we do now have more of an idea as to how the authorities believe the rules should apply to IP and group finance companies. Equally, the meanings of the terms “properly established overseas” and “artificial diversion of profit” need to be carefully approached.
Interested parties are encouraged to participate in the consultation process. The discussion document is available at: http://www.hm-treasury.gov.uk/d/cfc_discussiondoc_260110.pdf