Foreign tax change put on hold

The UK government has put off plans to change the taxation of foreign profits
regime, which business groups and tax experts say has created a climate of
greater uncertainty that may damage UK business competitiveness.

In letters to the Confederation of British Industry and The Hundred Group of
Finance Directors, Jane Kennedy, the financial secretary to the Treasury, wrote
that replacing the credit system with an exemption for dividends from overseas
subsidiaries in next year’s finance bill could cost too much.

“Although it remains our objective to introduce a dividend exemption, our
estimates show that to do so could impose significant costs on the Exchequer,”
she wrote.

The current Controlled Foreign Companies (CFC) tax regime provides safeguards
to ensure profits from economic activity are properly taxed in the UK. But the
government has admitted that the system needs to be amended because the
mechanisms for relieving double taxation of these profits within the UK and
other countries is cumbersome, particularly for large companies with complex
structures. This has resulted in UK business calling for a tax exemption of
profits made abroad that are repatriated into UK operations. However, the
government is wary that implementing such a regime will result in large scale
tax avoidance.

A technical note on the progress of the consultation with taxpayers on the
foreign profits regime was published at the same time as the letter. It forecast
that, under the present system, the corporate tax paid on foreign dividends
would be £300m in the 2012/2013 fiscal year.

Tax avoidance
The note added that while an exemption would mean taxpayers would not have to
plan to avoid tax on dividends, it would encourage them to move profits into low
tax jurisidictions. While it estimated that this could cost the government
£600m, it said it could be anything between £200m and £1.1bn.

The CBI
and others had urged the Treasury to press ahead with the exemption
ahead of the introduction of extra anti-avoidance rules. But Kennedy has said
that “the fiscal risks are too great” to introduce a dividend exemption in next
year’s Budget without accompanying anti-avoidance measures. Controversial
anti-avoidance proposals affecting the tax treatment of intellectual property
have been dropped.

The Treasury’s technical note says an amended form of this sort of
“controlled companies” regime has not been ruled out, but business appears to
prefer continuing with some form of the existing anti-avoidance rules. The
Treasury also floats the idea of introducing “additional but still limited”
restrictions on interest deductibility.

The Treasury also postponed plans to cut the amount of interest on company
loans that could be deducted from a company’s tax bill and to replace the
controlled foreign companies rules with a controlled companies regime that would
have sought to tax UK taxpayers that received passive income from overseas
units. These proposals were particularly unpopular with companies, such as in
the pharmaceutical and entertainment industries, whose wealth is based on the
value of their intellectual property.

The document questions the assertion by business that an exemption would
trigger the repatriation of billions of pounds to the UK which could be used to
repay debt, so increasing the UK tax take. On the contrary, the Treasury
suggests that businesses would increase their debt because they would use the
exemption to return funds to shareholders.

But tax experts say that the Treasury technical note which confirms the
decision to scrap the proposed changes to the taxation of foreign profits will
lead to a further extended period of uncertainty.

According to
Baker
Tilly’s international tax partner Kevin Phillips, “This could be
seen as the Treasury confirming that it is backing down over its original
proposals for wholesale replacement of the CFC rules and opting instead for
changes to the existing rules.

“However, following the recent Cadbury Schweppes and Vodafone judgments,
there is a huge question mark about the enforceability of these rules in the
case of CFCs resident in the European Union, even after changes from 2007
onwards that were supposed to make the rules compliant with EU law. Therefore,
it’s far from clear to me that relying on changes to the existing rules is a
sound strategy until the ultimate outcome of the Vodafone case is known. Even
then, there’s the possibility of a further case to test whether the 2007 changes
really do now make the legislation EU compliant.”

No movement
However, Peter Cussons, international tax partner at accountants Pricewaterhouse

Coopers, says that while business should continue to lobby the government for
changes in the foreign profits tax regime, the recent announcement is not really
a setback to UK business in the short-term.

“While the government’s delay on implementing these changes is causing
companies some confusion, it is seriously doubtful that any large company would
seek to relocate elsewhere because of the UK’s tax regime. Companies want to
make tax savings where possible, but not usually at the expense of moving
operations.”

In brief
The Treasury’s current views can be summarised as follows:
• The commitment to introduce a foreign dividend exemption is confirmed, but not
before the Finance Bill 2010.
• The proposals for a new income-based CFC regime are effectively to be
scrapped.
• The need to protect the UK tax base alongside the introduction of a foreign
dividend exemption is
reaffirmed, but a willingness to try to achieve this by changes to the existing
entity-based CFC rules instead is now expressed.
• The proposal to cap UK interest deductions is reaffirmed, but with the
possibility of a relaxation for temporarily cash-rich groups.
• The proposal to scrap Treasury consent for certain transactions and replace
this with a more targeted reporting obligation is reaffirmed.
Source: Baker Tilly

Useful links
See the Treasury website at
www.hm-treasury.gov.uk,
then click on ‘consultations and legislation’ and go to ‘Latest live
consultations’