PBR changes CFC rules

In its pre-Budget report, the government announced it will be introducing an exemption from tax for most foreign dividends received in the UK by large- and medium-sized groups. This will be included in the finance bill 2009 and is aimed at increasing the tax competitiveness of the UK. Draft legislation was due to be published in December.

Coupled with the substantial shareholdings exemption, no withholding tax on dividends and one of the widest treaty networks, the proposals on the face of it increase the attractiveness of the UK for international groups, says accounting firm Mazars. However, it adds, the new rules only apply to large- and medium-sized groups, so unless some form of opt-in is available, smaller multinational groups might be at a disadvantage.

Among the key changes are:
• The existing controlled foreign company (CFC) rules will be reformed, but it looks as if the rules will continue to tax foreign entities as opposed to passive income.
• Owing to the complexities involved in striking a balance between protecting revenue in the UK and reflecting modern business practices, the overall reform of the CFC rules is not expected until at least finance bill 2011. However, there will be some more immediate changes in finance bill 2009.
• The holding company exemptions in the exempt activities test are to be repealed with a 24-month transitional period. It is unclear at this stage how this change will impact on existing group structures where local holding companies in foreign jurisdictions are often used to provide finance for the subsidiaries in that territory.
• The acceptable distribution policy (ADP) rules will be repealed. A CFC can currently avoid having its profits apportioned to the UK company which owns it by paying an ADP instead.
• The current exclusion of chargeable gains from the CFC regime may well continue, but this is yet to be confirmed.

Clamp down
In addition, there will be a strengthening of the existing “unallowable purpose” rule for loan relationships and derivatives to cover schemes and arrangements to clamp down on what the government perceives to be unacceptable tax avoidance.

The government’s changes to the tax regime have been broadly welcomed by accountants. Bill Dodwell, head of tax policy at Deloitte, says, “the Chancellor has accepted that it is appropriate to move UK taxation onto a territorial system ­ that is, only taxing UK source profits. It is thought that it may take up to two years before the new system is legislated.

“This is a good result for the consultative process, set in train in July 2008. The plan to move UK taxation onto a territorial basis will help make our tax system attractive to UK-headquartered groups. However, while we accept there is an economic case for restricting interest deductions, we are concerned that this proposal is complex and will prove unfair in some cases. We hope that further debate will lead to changes.”

Useful links
For Mazars’ views, see http://tinyurl.com/maz-pbr