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Controlled foreign companies proposals may not be EU compliant, experts warn

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Detailed proposals for reform of the UK’s controlled foreign companies regime received a broad welcome from tax professionals but some experts warned that the new rules may not be compatible with European law.

Writing in this week’s Tax Journal, Philip Baker QC of Gray’s Inn Tax Chambers said that because the proposals are ‘pushing the envelope’ future challenges ‘may well show incompatible elements’.

Gary Richards, Tax Partner at Berwin Leighton Paisner, said that while the government should be congratulated on the depth of the consultation and its willingness to publish its understanding of EU law, ‘one issue which remains is whether HMRC's view that EU law permits a UK tax charge on artificially diverted profits is right, or whether even these reforms may yet be open to challenge’.

David Gauke: ‘CFC reform will not be a vehicle to allow multinationals to avoid tax in developing countries’

Critics say that the reforms, together with the proposed exemption for foreign branch profits, will increase tax competition.

The development charity ActionAid argues that the new rules increase tax avoidance in developing countries, the Financial Times reported, because they ‘remove an effective deterrent to multinational companies shifting profits into tax havens’.

But the ‘FT verdict’ was the changes are justified because they ‘reflect the reality of the international character of multinationals and intensifying tax competition from smaller states’.

‘CFC reform will not be a vehicle to allow multinationals to avoid tax in developing countries,’ David Gauke, the Exchequer Secretary to the Treasury, said in a speech at an OECD conference. ‘We will continue to support developing countries to create robust and sustainable tax systems and protect their own tax bases.’

‘A very challenging area’

Will Morris, Chairman of the CBI’s Tax Committee, said the CFC consultation ‘will make a serious contribution to the government's pledge to create the most competitive tax system in the G20’.

Reform is needed to improve the UK’s tax competitiveness while ensuring that the UK tax base is adequately protected, the Treasury said in Consultation on Controlled Foreign Companies reform published on 30 June.

‘We want to attract business investment from all over the world to the UK and reverse the recent trend of businesses leaving the UK amid concerns over tax competitiveness,’ Gauke wrote in a foreword.

‘This document is more detailed than many comparable consultations as this is a very challenging area and we want to work with interested parties to get this reform right,’ he added.

The government published proposals last November for new CFC rules to be introduced in Finance Bill 2012, and introduced interim improvements in Finance Bill 2011. It now aims to publish draft legislation in Autumn 2011.

A finance company partial exemption will give rise, in most situations, to an effective UK corporation tax rate on profits from overseas intra-group financing of 5.75% by the year 2014, the Treasury said. In some limited circumstances, the Treasury suggested, it could be appropriate to offer ‘full exemption’ of a finance company’s profits.

‘Cards on the table’

The proposals go some way to dissuading companies from leaving the UK but they are still not as user friendly as CFC regimes in other jurisdictions, Paul Smith, Head of International Tax at Grant Thornton, told Tax Journal.

‘This is cards on the table time for the government,’ said Barry Murphy, tax partner at PwC. ‘The reforms have been much talked about and for the first time we have a chance to assess whether the detailed proposals measure up to government ambitions.

‘It’s a big document, but it’s good that it really opens up the thinking behind the proposals. These are fundamentally important changes and a full debate is needed to ensure that the reforms are effective and practical for business.’

Murphy welcomed the proposed finance company regime. Modernisation of the existing exemptions appears to take into account many of business’s current concerns and issues, he added.

Heather Self, Tax Director at McGrigors, said the consultation process had gone on for ‘far too long’ but there had been an open and collaborative debate. Writing in this week’s Tax Journal, Self said the finance company regime was a ‘genuine step forward’ that would ‘probably lead to significant restructuring of offshore financing arrangements over the next few years’.

Comments are invited by 22 September.

Paul SmithAn opportunity to compete for finance company business

Paul Smith
Head of International Tax, Grant Thornton UK LLP

‘The CFC proposals open up the opportunity for the UK to compete with Benelux countries for finance company business but there will still be a UK tax charge, as only one quarter of any overseas tax can be used to credit against the UK tax charge. As a result, the effective rate of tax on a finance company's profits will be in excess of 5.75%.

‘The proposals state that the government will “consider the limited circumstances in which full exemption might be appropriate”. This would be good for the UK economy but might signal the start of the end of the UK’s role as a global tax policeman.’