Location, location, location (and tax)

THIS YEAR’S Finance Bill includes a number of changes that the government hopes will encourage multinationals to set up operations in the UK and help promote the country’s standing as a competitive holding location for international businesses.

The proposed legislation issued on 29 March includes, in Schedule 20, the latest draft of the new controlled foreign companies (CFC) rules. These provisions are directed at companies that artificially divert UK profits to low-tax territories or other favourable overseas tax regimes to reduce their UK tax liabilities.

Experts believe that the current CFC rules – first introduced in 1984 – have become more and more restrictive and have increasingly failed to reflect the way in which modern business is structured, leading to a number of listed UK groups relocating their headquarters overseas. In response, the government embarked on a reform process in 2008 to create a more modern and competitive regime.

Open gateways

The new CFC rules – which will apply to accounting periods beginning on or after 1 January 2013 – will specifically define those profits which are considered to have been artificially diverted from the UK, using “gateway” provisions. Finance profits, such as interest on a loan or foreign exchange gains, and non-finance – operational business – profits will be dealt with separately. UK groups will be free to choose whether to use the gateway provisions or the entry conditions, safe harbours or exemptions – or a combination of these – to exclude profits.

Where a CFC’s profits fall within the gateway provisions and are not otherwise excluded, they will be apportioned to the UK and taxed on any UK resident company with a 25% assessable interest in the CFC. This will be reduced by a credit for any foreign tax attributable to the apportioned profits and by the offset of relevant UK reliefs.

The new regime will also include a favourable finance company exemption, which will normally result in 75% of the profits from overseas intra-group financing being exempt. This will produce an effective UK tax rate of 5.5% on such profits from 2014 once the corporation tax rate is reduced by 1% to 22% – another attempt by the chancellor to attract more inward investment, which has slipped over recent years.

The UK has dropped from fourth to seventh in the global league table for inflows of inward investment in 2010, according to the UN Conference on Trade and Development. Belgium and Germany have now toppled the UK’s long-standing position as Europe’s leading destination for foreign direct investment.

International standing

However, tax lawyers and accountants believe that the changes to the CFC regime, as well as the 1% cut in corporation tax, will be particularly welcomed by many international businesses and will enhance the UK’s position as a holding company location. Sarah Brock, corporate tax manager at accountants Ward Williams, says that “the revised CFC rules and the cut in corporation tax will help show that the UK is open for business and should help attract more foreign companies”.

Already, PwC says that it has spoken to ten to 15 multinational companies that are considering locating substantial operations to the UK as a result of corporate tax reforms. Following the Budget, pharmaceuticals giant GlaxoSmithKline said that it would invest £500m, create 1,000 jobs and build its first UK factory in 40 years.

Neal Todd, corporate tax partner at law firm Berwin Leighton Paisner, says that the changes to the CFC rules will make the UK “a much more attractive place to have a holding company and should therefore attract more inward investment”.

Michael Bird, international tax director at KPMG, adds that “the finance company exemption represents a real opportunity for UK groups to finance their overseas subsidiaries in a tax-efficient manner”.

He adds, however, that the new CFC rules are not straightforward and groups will need to think about the best approach to excluding profits from a CFC apportionment with a view to minimising the compliance burden.

Gateway provisions and key exemptions

The “gateway” provisions define those profits that are within the scope of the new CFC rules:

• Business profits are caught if the CFC holds assets or bears risks where the related management activities are undertaken in the UK. However, such profits are excluded where any of the entry conditions or trading income safe harbour applies. In addition, property business profits are specifically excluded;

• Non-trading finance profits are caught where they are attributable to UK management activity, arise from funds or other assets invested from the UK or arise on loans and other arrangements with the UK where there is a purpose of reducing any tax liability. However, any “incidental” finance profits in a trading or property company can be excluded;

• If a UK group acquires foreign subsidiaries or a non-UK group moves to the UK, the group will be given a period of time to restructure the foreign subsidiaries so that they fall outside the CFC rules;

• The new CFC regime will apply, broadly, in the same way to exempt foreign branches of UK resident companies as to non-UK resident subsidiaries.