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CFC reform: creating the right conditions for growth

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David GaukeFor three years before this government came to office, I shadowed my current ministerial role.

During this time I heard time and again, both from businesses and tax professionals, that in recent years the UK’s tax system had ceased to be the asset that it once was.

In May last year, as a new government faced with the enormous challenge of restoring Britain’s worst public finances in peacetime history, we were clear that to achieve the private sector led recovery the country needs, we had to show that Britain has an attractive tax system and is open for business.

A key part of this is our ambition to create the most competitive corporate tax regime in the G20.

Reducing the main rate of corporation tax to 23% by 2014, the lowest rate in the G7, is only part of this.

Multinational businesses have frequently identified reform of the UK’s Controlled Foreign Companies (CFC) rules as a key priority to improve the UK’s tax competitiveness, and ensure it remains an attractive location for business.

Consulting on competitiveness

In June, the government published its Consultation on Controlled Foreign Companies (CFC) reform, setting out the objectives of the new regime and proposals for its operation.

Our priority now is to work with business over the coming months to minimise complexity in all of these exemptions

These respond to continuing consultation with business and set out possible solutions to the issues raised during this process.

The government is working towards draft legislation in the autumn.

We will, of course, continue to consult through this process to ensure that the new rules deliver the government’s objectives as effectively as possible.

Although consultation on these reforms has been a long process, by following the government’s new approach to tax policy, with its focus on certainty and stability, we have made significant progress over recent months.

We will continue this throughout the consultation, in order to achieve our commitment to deliver the new rules in Finance Bill 2012.

The consultation process is designed to allow the government to work in partnership with business to get this much-needed reform right so that it contributes to greater certainty and stability in the corporate tax system.

The proposals set out in the June paper are deliberately detailed, a pre-condition in this case for government and business to work together effectively to ensure that the new CFC rules work across different businesses and sectors, as well as for the government.

The government has received some positive feedback from business and commentators during this process.

However, we recognise that there is still work to be done to make sure that we achieve our aim of enabling the large majority of CFCs that undertake genuine commercial activity to be exempted from the rules as simply as possible.

Since June, officials have been working hard with businesses, advisers, industry bodies and other interested parties, listening to their feedback on the proposals.

A key focus of this is ensuring that the exemptions are simpler to apply and any conditions are appropriately defined and targeted.

I recognise that consultation can be resource intensive for taxpayers and practitioners.

However, government and business have a shared objective to improve the competitiveness of the UK tax system and I remain convinced that we can only do this in partnership.

Overview of the proposals

In common with many other countries, the UK uses CFC rules to maintain sustainable corporate tax revenues by protecting against artificial diversion of profits to low tax jurisdictions.

However, there is scope for significant modernisation of the rules to reflect the way businesses operate in a globalised economy.

Our proposals aim to strike the right balance between improving the competitiveness of the UK’s regime and ensuring that businesses pay their fair share of tax.

Our more territorial approach to corporation tax means the regime will be targeted at situations that pose the highest risk of artificial diversion of profits from the UK and a reduction in the scope of the rules to exempt foreign to foreign transactions.

Another key feature of the new rules is their proportional approach, so that where a CFC charge arises, it will apply to only the proportion of profits that have been artificially diverted from the UK.

The regime includes an internationally competitive partial exemption for finance companies that will normally result in a 5.75% tax charge on overseas financing profits by 2014.

In order to minimise compliance burdens, it is intended that the rules will allow the exemptions to be applied flexibly by businesses.

Some will prefer to use one of the more mechanical exemptions and others the general purpose exemption (GPE) which looks at whether profits of a CFC are commensurate with its activities on a case-by-case basis.

Our priority now is to work with business over the coming months to minimise complexity in all of these exemptions.

Officials are looking in particular at the excluded country and territorial business exemptions and are working to provide more clarity on how the GPE will operate so that only those more complex and high risk situations will require the detailed calculations proposed.

One further aspect of this work is to design rules that operate for business and HMRC in a clear and consistent way.

The government will also be looking at transitional issues and recognises that flexibility may be required in moving from the current regime to the new one.

Next steps

Although we recognise that there is work to do on the detail, the recent announcements of groups considering returning to the UK tell us that the reforms are moving in the right direction.

We must build on this by getting the final legislation right, and I would strongly encourage businesses to continue to engage with these proposals to ensure that they achieve the desired aims.

We are committed to legislating new CFC rules in 2012, a challenging timetable but achievable by working together with business.

David Gauke, Exchequer Secretary to the Treasury

The formal consultation is open until 22 September 2011 and draft legislation will be published in the autumn.

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