Controlled foreign companies (CFC) reform publication of draft legislation. 6 December 2011

Transcription

1 Controlled foreign companies (CFC) reform publication of draft legislation 6 December 2011

2 On 6 December 2011, the Government published draft legislation introducing a new CFC regime which will be included in Finance Bill A paper has also been published which provides details of the key developments in the proposals as a result of the June 2011 consultation and an overview of the responses to the questions raised in the consultation. Concerns had been raised by business that the proposed mechanical exemptions were too narrowly drawn and that the general purpose exemption was too complex and would need to be applied to too many cases. In response, the proposals have been reshaped around a Gateway which will specifically define those profits that are within the scope of the new CFC regime. The draft legislation and supplementary paper can be found here. Summary of proposals Overall framework Under the new CFC regime, to the extent that a CFC s chargeable profits are within the Gateway and are not otherwise excluded, they will be apportioned to the UK and taxed on any UK resident company with a 25% assessable interest in the CFC. The CFC charge will be reduced by a credit for any foreign tax attributable to the apportioned profits and by the offset of relevant UK reliefs. The definition of control will follow the mechanical approach under the existing CFC rules, but will also incorporate an accounting based condition which will treat a person as controlling a company where the person is the parent undertaking of the company in accordance with FRS 2, whether or not there is a requirement to prepare consolidated accounts. There will also be an anti-avoidance provision to prevent arrangements with a main purpose of securing that a company does not otherwise fall within the definition of control. 40% joint ventures will remain within the definition of control. Protected cell companies will be caught by the new regime as each cell will be treated as if it were a non-resident company. The Gateway will specifically identify circumstances where there has been an artificial diversion of UK profits. It will deal separately with finance profits and non-finance, or business, profits. If profits are not within the Gateway, they will be excluded. Groups will be free to choose whether to use the Gateway or the more mechanical safe harbours and entitylevel exemptions, or a combination of these, to exclude profits. Finance profits which are not otherwise excluded will be fully taxable, unless the finance company partial exemption (as it is commonly known) applies. All CFCs must be resident in an overseas territory to apply the Gateway, safe harbours and entity-level exemptions. As the focus of the Gateway and safe harbours will be on UK management activity, there are no specific local management requirements. The Gateway Business profits Business profits will be within the scope of the new regime to the extent that they arise in a CFC due to arrangements that separate ownership of an asset or bearing of a risk outside the UK from the significant people functions ( SPFs ) involved with the exploitation of the asset or with management of the risk in the UK. However, such profits will be caught only where all of the following conditions are met: Artificiality condition the majority of profits from the assets/risks are connected with UK activity by reference to SPFs. Non-tax value condition the separation of assets/risks from activity does not give rise to any substantial non-tax value. Independent companies arrangements condition the arrangement which creates the separation of assets/risks from activity would not have been entered into between independent companies. Therefore, for example, business profits derived from assets/risks which are managed wholly or mainly outside the UK will be excluded. Finance profits Non-trading finance profits will be caught to the extent that: the profits are attributable to UK based SPFs (referred to as key entrepreneurial risk taking functions in financial cases); the profits arise from the investment of capital directly or indirectly from a UK connected company; or the profits arise on upstream loans, unless there is a substantial non-tax benefit to returning capital to the UK in this way, as opposed to a dividend or other distribution. Trading finance profits of a bank or insurance company will also be caught if attributable to excess capital and there has been an investment of capital directly or indirectly from a UK connected company. Work is continuing with the banking and insurance sectors to establish how the concepts of excess capital should be implemented in practice. 2

3 Captive insurance business For captives resident in an EEA state, profits arising from insurance business will be caught to the extent that they derive directly or indirectly from insurance contracts with connected UK companies or UK branches of connected foreign companies where the insured party does not have a significant UK non-tax motive for entering into the contract. For captives resident outside the EEA, profits from all UK connected insurance contracts will be caught. Profits derived from foreign insurance contracts will be exempt. Solo consolidation Where a CFC is solo consolidated with a UK resident regulated financial company, profits will be caught to the extent that they exceed the amount that would be attributed to the CFC if it were a foreign permanent establishment ( PE ) of the regulated company (subject to specific anti-avoidance). This helps to achieve consistency between the regulatory and tax position. Safe harbours The safe harbours will exclude certain profits of a CFC from the scope of the new CFC regime: Trading income safe harbour This will exclude trading income of a CFC provided: the CFC has a business premises in its territory of residence which are, or are intended to be, occupied and used with a reasonable degree of permanence and from which the CFC s operations in that territory are wholly or mainly carried on; no more than 20% of the CFC s trading income is from the UK (excluding income from sales in the UK of goods produced by the CFC in its territory of residence) the limit is only 10% for banks, but excludes interest received from UK connected companies; no more than 20% of the CFC s expenditure relating to the management of its combined assets/risks is incurred in the UK if this condition is failed but the other conditions here are met, it is still possible for the income arising from an individual asset/risk to be excluded where no more than 50% of the expenditure relating to the management of that asset/risk is incurred in the UK; the CFC does not exploit IP transferred to it by UK related persons in the relevant accounting period or previous 6 years, or derived from IP held by UK related persons during that period, where such IP forms a significant part of the CFC s total IP or generates significant additional profits there is a transfer or derivation for these purposes, where the value of the IP held by the related person is significantly reduced from what it would otherwise have been; and no more than 20% of the CFC s trading income arises from goods exported from the UK, excluding goods exported to its territory of residence. An anti-avoidance provision will prevent this safe harbour applying where a group enters into arrangements to organise any part of its business with a main purpose of securing that one or more of the above conditions is met. Property safe harbour All profits from a property business will be excluded. Incidental finance income safe harbour A CFC s non-trading finance profits will be excluded provided they do not exceed 5% of its profits before interest and tax arising from an exempt trade or property business. If this test is failed, non-trading finance profits will still be excluded to the extent that they arise from funds held for the purpose of an exempt trade or property business which is carried on by the CFC. However, the legislation includes specified circumstances in which such finance profits will not be excluded (e.g. where they arise from funds held with a view to acquiring or developing land or paying dividends more than 12 months after the end of the relevant accounting period or acquiring shares or making capital contributions). Where a substantial part of a CFC s business is the holding of shares or securities in 51% subsidiaries, non-trading finance profits will be excluded provided that the holding company and its 51% subsidiaries, together, have non-trading finance profits that do not exceed 5% of the holding company s exempt distribution income. Banking and insurance safe harbours The legislation contains powers to make regulations for safe harbours to exempt trading finance profits of CFCs carrying on banking and insurance business. Regulations have yet to be published as work is continuing with the banking and insurance sectors to formulate appropriate safe harbours. 3

4 Entity-level exemptions The entity-level exemptions will exclude all of a CFC s profits from the scope of the new CFC regime: Low profits exemption This exemption, based on the low profits exemption included in Finance Act 2011, will apply where a CFC s profits do not exceed 500,000 and its non-trading income is not more than 50,000 and also where its profits do not exceed 50,000 irrespective of the amount of investment income (with all these amounts reduced pro rata for accounting periods of less than 12 months). The measure of profits will be the CFC s accounting profits subject to certain adjustments or, alternatively, its total chargeable profits. Anti-avoidance provisions will prevent exploitation of the exemption (e.g. through fragmentation or manipulation of profits) and the exemption will not apply to managed service companies that provide the services of a UK individual for another UK resident. Low profit margin exemption This exemption will apply where a CFC s profits do not exceed 10% of its operating expenditure, excluding related party expenditure and the cost of goods acquired for resale, other than goods imported by the CFC into its territory of residence. The measure of profits will be the CFC s accounting profits before any deduction for interest and subject to certain adjustments. Excluded territories exemption This exemption will apply to a CFC which is resident in a territory with a headline tax rate of greater than 75% of the UK main corporation tax rate (a list of the excluded territories is included in draft regulations) and where the total of the income falling into the following categories does not exceed the greater of 10% of the CFC s accounting profits and 50,000 (reduced pro rata for accounting periods of less than 12 months): income that is (i) exempt from tax (other than distributions) in the CFC s territory, (ii) taxed at a reduced rate locally as a result of an investment incentive scheme or (iii) taxed locally but where any related persons are entitled to a repayment of the tax or a payment in respect of a credit for tax where such income would otherwise include income from a PE of the CFC established in another excluded territory, it is to be excluded unless it consists of income that is treated in one of these ways in the territory in which the PE is established; non-local source non-trading income for which the local tax paid is less than 75% of the UK corresponding tax on that income where such income would otherwise include income from a PE of the CFC established in another excluded territory, it is to be excluded unless it consists of income that is low-taxed in the territory in which the PE is established; income sheltered in a partnership of which the CFC is a partner or a trust in relation to which the CFC is a settlor or beneficiary; and income which is unilaterally reduced for local tax purposes on the basis that the CFC would have earned less profit if it had been an independent company or taxed locally at a reduced rate by virtue of a ruling or similar decision by a governmental authority in the CFC s territory of residence. The exemption will not apply if a CFC exploits IP transferred to it by UK related persons in the previous 6 years, or derived from IP held by UK related persons during that period, where such IP forms a significant part of the CFC s total IP or generates significant additional profits. An anti-avoidance provision will prevent the exemption from applying where the CFC is involved in an arrangement which has a main purpose of achieving a UK tax advantage for any person. Luxembourg insurance companies will also be specifically excluded. Temporary period exemption It remains the Government s intention to offer a time limited exemption as part of the new CFC regime, but the scope of the exemption is still under consideration and so it has not been included in the draft legislation at this stage. Tax exemption This exemption will apply where the local tax paid by a CFC on its profits is not less than 75% of the corresponding UK tax on those profits (effectively recasting the lower level of taxation test in the existing CFC rules as an exemption). The exemption will not apply where there are designer rate tax provisions, to be specified in regulations, which effectively allow the CFC to determine the local tax charge. Finance company partial exemption ( FCPE ) Where the FCPE applies, only one-quarter of a CFC s non-trading finance profits derived from qualifying loans will be subject to a CFC charge (although a credit will only be allowed for one-quarter of any foreign tax). This will result in such profits being taxed at a UK effective tax rate of 5.75% by

5 It is necessary to identify the ultimate debtor in relation to each loan made by a CFC. Thus, where a loan is made by the CFC for the purpose of funding a loan to be made by the borrowing company, it is necessary to look through that and any subsequent borrowing company until there is a person whose purpose for the funds is other than on-lending. A loan made by a CFC will be a qualifying loan where the ultimate debtor is a connected company, other than where the ultimate debtor: is a non-resident company which uses the loan for the purposes of a trade carried on through a PE in the UK; is a UK resident company unless the loan is used for the purposes of an exempt foreign PE; uses the loan for the purposes of a trade it carries on (though it is understood that this is only intended to apply where the ultimate debtor is a company engaged in banking or insurance activity, although the draft legislation is currently wider than this); or is a CFC which satisfies the low profits exemption or has or would have a CFC charge which is reduced or extinguished by debits in respect of the loan. In order to qualify, a CFC will also need to have a business premises in its territory of residence (as set out above), but there will be no specific local management requirements. The profits to be apportioned will include foreign exchange differences. However, the results of arrangements entered into to hedge the foreign exchange exposure on qualifying loans will also be included. Expenses will be deductible in arriving at the qualifying profits on a just and reasonable basis. The Government is considering whether the total CFC charge in respect of all of a group s CFCs which qualify for the FCPE may be limited to the aggregate net borrowing costs of the UK members of the group (which would result in a full exemption from UK tax where there are no net UK borrowing costs). Consideration is also being given to the case for full exemption in other limited circumstances, subject to the need to deliver an affordable regime. Who is affected? The new CFC regime will apply to both non-uk resident companies which are controlled from the UK and exempt foreign PEs of UK resident companies. Timing The new CFC regime will apply, at the earliest, for accounting periods beginning on or after the date on which Finance Act 2012 receives Royal Assent. Comments are invited on the draft legislation by 10 February The remaining draft legislation is to be published in January Our view The draft legislation reflects a fundamental shift in the Government s approach to the CFC rules. Up to now the rules have worked on the basis that all foreign profits are to be included, unless they qualify for a specific exemption. The new approach is to define those profits which are within the scope, using the Gateway, with safe harbours and exemptions there as an alternative way to exclude profits. This may sound like semantics, but it marks a fundamental change of mind set at HMRC and is to be welcomed. In practice, groups will be free to choose whether to use the Gateway or the more mechanical safe harbours and exemptions, or a combination of these, to exclude profits. A flowchart illustrating how the new CFC regime might be applied is set out on the next page. With the new approach, there is an inevitable trade-off in terms of increased complexity and the new legislation is complex but it is hoped that, with detailed guidance, the compliance burden can be minimised. The exclusion of all property income from the new CFC regime, on the basis that property generally poses a low risk of artificial diversion of profits, is to be welcomed. This includes UK rents presumably because of the small rate differential between corporation and income tax. There is no longer an intention to have a specific exemption covering leasing businesses as the Gateway and trading income safe harbour will now be available. The key issues for those groups outside the financial sector are as follows: The Gateway relies on identifying, broadly, the business decision makers in relation to a CFC s assets/risks. To the extent that more than 50% of these are in the UK there can potentially be a CFC charge. Groups should start to consider to what extent decision making of their overseas businesses is in the UK. The key to this part of the new rules working in practice is going to be some sensible guidance on the sort of evidence that taxpayers will be required to assemble. This is likely to be developed between now and the final legislation being enacted, so there will be an opportunity to input into this process. 5

6 It appears likely that, in most cases, non-trading finance profits will be within the Gateway. This could lead to a significantly increased compliance burden as every foreign company will need to be reviewed to see if it has more than an incidental amount of such profits. This will require ongoing monitoring, particularly in the event that we move out of a low interest rate environment. As anticipated, the FCPE will give groups an opportunity to finance overseas subsidiaries in a tax-efficient manner. There is also flexibility in that it will apply to mixed activity companies, as well as standalone finance companies. The Government is considering whether in certain circumstances a full exemption can be given although there seems to be concern over the cost of this. Compliance for smaller groups should be considerably simplified by the increased limits in the low profits exemption. At the detailed level there are many other changes (e.g. the new accounting based condition in the control test could potentially result in additional companies being treated as CFCs and Singapore is no longer on the list of excluded territories) and groups will need to work through the new rules for their own specific circumstances. Within the financial services sector, the position is less clear. A number of areas, such as defining the safe harbours for exempt trading finance profits of CFCs carrying out banking or insurance activity, will require further work. It still seems to be the case at this stage that the FCPE will not be extended to those CFCs engaged in banking or insurance activity, although there may well be further industry lobbying on this point. Insurers who have relied upon the use of protected cell companies will need to reconsider and, potentially, restructure their operations going forward. Additionally, insurers with CFCs that had previously relied upon a single exemption, in the form of the exempt activities test, are likely to need to work through a number of provisions before they can conclude that no apportionment is required. We very much welcome the fact that the Government has listened to the response to the June 2011 consultation. The new proposals are a definite improvement on the current position and with sensible guidance we believe can be made to work well in practice. For more information contact Simon Palmer Tel. +44 (0) simon.palmer@kpmg.co.uk Robin Walduck Tel. +44 (0) robin.walduck@kpmg.co.uk Michael Bird Tel. +44 (0) michael.bird@kpmg.co.uk Alastair Munro Tel. +44 (0) alastair.munro@kpmg.co.uk Nothing in this article should be considered to be investment advice. The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG LLP (UK). The information contained is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 6

7 Are the profits of a non-resident company subject to apportionment? All profits CFC rules do Is the company controlled by The entity-level exemptions, not apply No persons resident in the UK? safe harbours and Gateway can be applied in any order Yes or combination to exclude profits. Exclude all Do any of the entity-level profits Yes exemptions apply? (note 1) Business profits No Finance profits Exclude Exclude Does the Does the incidental Incidental nonproperty property safe finance profits safe trading finance income Yes Yes Yes (or to harbour apply? harbour apply? profits the extent it does) Yes Exclude Does the trading Does the banking or Exclude trading trading income safe insurance safe income Yes Yes finance harbour apply? harbour apply? profits Exclude Are profits within Are profits within Exclude relevant relevant business the business profits the finance profits finance No (or to the No (or to the profits Gateway? extent they Gateway? extent they profits are not) are not) Yes (or to the Yes (or to the extent they are) extent they are) Does the finance company partial Yes (or to exemption apply? the extent it does) No (or to the extent it does not) Remaining Any remaining One-quarter of nonbusiness profits finance profits trading finance profits are subject to are subject to from qualifying loans apportionment apportionment are subject to apportionment (note 2) Notes 1. Low profits exemption, low profit margin exemption, excluded territories exemption, temporary period exemption (subject to further consideration) and tax exemption. 2. The Government is still considering whether in certain circumstances there could be reduced charge or full exemption. 7