The best intentions

ALTHOUGH there may well be good intentions behind HM Revenue & Custom’s (HMRC) new Controlled Foreign Companies (CFC) legislation, they are almost impossible to discern and there is a danger that it may end up driving jobs out of the country. The rules feel like they have been drafted with the paranoid assumption that all companies are looking to “artificially divert UK income” into low taxed overseas subsidiaries. This is a particularly harsh and incorrect assumption when applied to foreign-owned companies that have come to the UK and have a real business need for offices overseas. These organisations have invested in the UK voluntarily, and are looking to embrace the factors that make the UK such a good place to do business, such as the available pool of talent and an otherwise (largely) competitive tax regime.

The critical issue is the uncertainty over whether legitimate overseas subsidiaries will be charged UK corporation tax on genuine foreign profits. Finance directors scrutinising the rules are likely to find them complex and unclear, and foreign groups considering setting up a UK headquarters may struggle to understand or pass the new rules. This means that multinationals looking at the UK will not be able to accurately predict the size of their tax bill, and this may deter them from setting up a headquarters here.

So why are the tax rules so uncertain? The main challenge revolves around the unfamiliar and unclear concept of Significant People Functions (SPFs), used to describe areas of the business such as day-to-day management. A number of exemptions under the new CFC system dictate that overseas subsidiaries need to employ a certain proportion of SPFs in order to achieve exemptions from UK corporate tax. This works perfectly for huge UK groups, as their local subsidiaries will still be relatively large. It causes problems, however, for smaller or foreign multinationals, as they are more likely to have streamlined overseas offices supported by a centralised UK operation, and therefore have a greater proportion of UK SPFs. Even if the subsidiaries pay an Arm’s Length Charge (a payment at cost plus a profit margin) for the HQ’s services, this will not lead to any exemptions. Employers may find the only way to pass the new rules is to move staff out of the UK into foreign subsidiaries. This will also jeopardise another CFC policy objective: the desire to “provide adequate protection of the UK tax base.”

If jobs leave the UK, the government’s tax income from areas other than corporate tax, such as payroll taxes and VAT receipts, will fall. How can this be a good thing? The irony is that UK holding companies typically pay relatively little corporation tax due to deductions for management expenses, interest expenses and tax exemption on dividends and capital gains.

HMRC needs to understand that foreign-owned companies establishing HQs in the UK are not all looking to artificially divert activity out of the country. Foreign companies genuinely trying to circumvent the UK system could simply keep their HQ in their country of origin (or in another attractive European market), and run a smaller service subsidiary out of the UK instead. More specifically, there needs to be an additional exemption in the new rules. Foreign-owned companies with HQs in the UK which hold, and provide services at Arm’s Length Charge to overseas subsidiaries conducting genuine commercial activities, should be eligible for exemption from the CFC regime, even if the HQ houses the majority of the SPFs. The new rules seem to be saying “come and set up an HQ in the UK but whatever you do don’t employ any people here”. An outflow of jobs from this country is the last thing it needs right now. ?

Tim Branston is director of global taxation at Gazprom Marketing and Trading