Controlled Foreign Companies full reform

On 6 December 2011, the Government published draft clauses for legislation to be included in Finance Bill 2012, and other tax updates. The draft clauses will be open to consultation until 10 February 2012.

This included the issue of draft clauses for the full reform of the ‘Controlled Foreign Companies’ rules.

The UK has Controlled Foreign Company (CFC) rules to stop multinationals from avoiding UK tax by diverting profits to tax havens and other preferential tax regimes. The rules contain a motive test to ensure that CFC tax is only ever payable if a company is involved in UK tax avoidance.

Following interim changes to the current rules in 2011, new Controlled Foreign Company (CFC) rules will be introduced in 2012 further to recent consultation by HM Treasury and any UK corporate with overseas subsidiaries may be affected by the changes.

The Government’s stated objective is to deliver a more competitive corporate tax system by making the current CFC rules easier to operate and by modernising aspects of the rules so as to exempt commercially justified activities that both business and HM Revenue & Customs (HMRC) agree do not erode the UK tax base.

The law has already been changed by Finance Act 2011 to provide the following interim changes:

  • introduce an exemption for certain intra group trading transactions where there is little connection with the UK and therefore it is unlikely that UK profits have been artificially diverted;
  • introduce an exemption for CFCs with a main business of intellectual property (IP) exploitation where the IP and the CFC have minimal connection with the UK;
  • introduce a statutory exemption which runs for three years for foreign subsidiaries that, as a consequence of a reorganisation or change to UK ownership, come within the scope of the CFC regime for the first time;
  • amend the conditions of the current de minimis exemption, to increase the limit for large groups from £50,000 to £200,000 profits per annum, and to replace the need to calculate chargeable tax profits with an accounts based test; and
  • extend the transitional rules for superior and non-local holding companies until July 2012.

Further measures have now been covered by clauses included in Finance Bill 2012.

Legislation will be introduced in Finance Bill 2012 to repeal the current legislation and replace it with a new CFC regime, the key elements of which are:

The business profits of a foreign subsidiary will be outside the scope of the new CFC regime unless they meet the specified conditions set out in a “gateway”. These conditions 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 these safe harbours to show that some or all of its profits are outside the regime's scope.
  • As an alternative to the gateway, the 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.

It is likely the rules will have effect for accounting periods beginning on or after the date of Royal Assent to Finance Bill 2012 (which should be late July 2012) but this is subject to further consultation.

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