The European Commission ("EC") has issued a press release, confirming that the UK's exemption for certain finance profits of Controlled Foreign Companies ("CFCs") partially constitutes illegal State aid that must be recovered. The EC has concluded that the exemption:
- does not constitute illegal State aid where all of the significant people functions generating the CFC's finance profits are located outside of the UK, even if the CFC is funded directly or indirectly with capital from the UK; but
- does constitute illegal State aid where the CFC's finance profits are generated from significant people functions in the UK.
We expect the publication of the non-confidential version of the decision by the EC will provide further detail and insight. However, once the decision has been received by the UK Government this will start the 4 month window in which they must theoretically recoup the illegal State aid from taxpayers.
As part of its investigation into whether the finance company exemption in Chapter 9 Part 9A TIOPA 2010 constitutes illegal State aid, the EC has been considering two key tests in the UK legislation which determine whether a CFC's finance profits are subject to a CFC charge (but for the finance company exemption). See our previous tax alert for additional background to the investigation.
The first test provides that a CFC's finance profits are subject to a charge if and to the extent that they derive directly or indirectly from UK capital. Where this is the case, the EC has concluded that the finance company exemption is justified on the basis that it avoids "complex and disproportionately burdensome" tracing exercises that would otherwise be required to determine the amount of CFC profits that are funded with UK capital. The EC therefore concludes that, in these circumstances, the finance company exemption is a "proxy" rule and does not constitute State aid.
The second test provides that a CFC's finance profits are subject to a CFC charge if and to the extent that significant people functions in the UK have contributed to the generation of those profits. In this case, the EC concludes that the finance company exemption is not justified because determining whether such financing income derives from UK significant people functions is not particularly burdensome or complex. Therefore, no "proxy" rule is justified and the exemption does constitute State aid.
What does this mean for UK multinationals?
All multinationals who currently or have previously relied on the finance company exemption in Chapter 9 Part 9A TIOPA 2010 should be actively reviewing their position. As discussed in our last alert there are a number of potential defences that multinationals may want to consider in arguing that either the finance company exemption is not State aid or to otherwise challenge a recovery.
Following the press release yesterday, multinationals should examine in greater detail the circumstances in which the finance company exemption has been claimed to determine whether the CFC's finance profits directly or indirectly derive from UK capital or whether UK significant people functions contributed to the generation of those profits (or both).
For finance profits that fall into both categories, the EC press release was not entirely clear on how taxpayers should calculate the amount of the illegal State aid. It is possible that the EC has take the position that, provided that some of the significant people functions generating the finance profits are located in the UK, then all of those profits are subject to a CFC charge with no apportionment to the significant people functions outside of the UK. This would seem to be a very odd result and would give rise to a "cliff edge" for CFCs whose profits fall within both categories, and would lack coherence.
Whilst the publication of the EC's full decision will provide additional insight, taxpayers who have claimed the finance company exemption should now be carefully analysing the circumstances in which it was claimed.
In theory, the UK Government will have four months to make an effective recovery from the date of receipt of the full decision from the EC. However, given the complexity in calculating the amount to be recovered, we expect that this may in practice take longer.
The receipt of the full decision by the UK Government will also set the clock running on any appeal by the government to the General Court (EGC). However, for taxpayers this clock will start running from the date of publication of the decision in the Official Journal of the European Union (or earlier if the decision is formally notified to a taxpayer by the EC).