On 26 January 2010, HMRC published a discussion document outlining proposed reform of the CFC rules, with the intention of legislating in FA 2011. It is proposed that transfer pricing principles will apply in the new rules in the following way:
- Notional income deemed to arise from the CFC will be imputed to the CFC’s UK corporate shareholders where the CFC is “thickly capitalised” with excess equity;
- The excess equity will be recharacterised as debt with interest being imputed to the UK parent.
CFCs will be covered by the regime unless specifically exempted. Proposals to allow for proportionality include:
- the possible exemption of companies narrowly missing exemption requirements or falling outside of an exemption because of a oneoff commercial transaction;
- the increase of the de minimis threshold;
- the temporary suspension of the regime after a commercial acquisition of a new sub group from a third party;
- a possible exemption for situations where the CFC is established in a country with a similar statutory rate and tax base as the UK;
- Reinsurance and Property subsidiaries may also be exempted, as might group treasury companies.
A new motive test is also proposed, where other exemptions are not available, which will allow a company to demonstrate the non-tax related rationale for a transaction or the role of the overseas subsidiary as a member of the group. The changes proposed may mean that new charges arise under the proposed system which would not have done under the current rules.
Questions arise as to whether the debt to equity ratios to be applied will be reasonable and as to the criteria for artificiality to be applied in the new motive test.
The immediate issue will be whether the provisions protecting commercial arrangements will genuinely protect the commercial or will simply repeat the arm’s length test and thus still fall foul of the Thin Cap judgment. The proposals are not necessarily incompatible with Community law, but the devil is in the detail. Draft legislation is awaited.