United Kingdom Tax Alert

Transcription

1 International Tax United Kingdom Tax Alert 30 November 2010 Discussion document addresses CFC and other corporate tax reforms The U.K. government published a discussion document entitled, Corporate Tax Reform: Delivering a More Competitive System, on 29 November 2010, which advances proposals for reform of the taxation of controlled foreign companies (CFCs) and foreign branches. The document also confirms earlier proposals for the introduction of a patent box regime from 2013 and a general review of R&D tax credits. Contacts Bill Dodwell bdodwell@deloitte.co.uk Joanne Bentley jcbentley@deloitte.co.uk Tim Haden thaden@deloitte.co.uk New CFC regime Wider reform of the CFC rules will be included in Finance Bill 2012 (with interim improvements introduced in the 2011 bill, as discussed further below). The proposed rules would operate on an entity-by-entity basis, with a number of exemptions; only overseas profits that have been artificially diverted from the U.K. would be subject to a CFC charge. This is a move away from the current all good or all bad approach. The discussion document focuses on the difficult areas of monetary assets and IP. Monetary assets: Overseas finance companies would be exempt from a CFC charge if the company is appropriately funded with a mix of debt and equity. The proposed minimum debt-to-equity ratio is 1:2 which, for a 100% equity-funded CFC, effectively excludes 66% of overseas financing income from the scope of a CFC charge. This would result in an effective tax rate of less than 9% in 2012, falling to 8% when the main U.K. corporation tax rate reduces to 24%. The ratio (and other parts of the proposals) will be debated in consultation and finally announced in the Budget on 23 March Anti-avoidance rules would be included to prevent groups recycling money to the U.K. from obtaining a tax advantage and artificially diverting U.K. profits. Such rules presumably would be designed to target upstream loans, but it is unclear whether they might be defined more widely, for example, to prevent loan receivables transferred from the U.K. from using the exemption.

2 Trading companies with finance income would be brought within the CFC charge for the first time. Interest income that is not ancillary or incidental to an entity s trading income would be treated as if it had arisen in a finance company and the same debt-to-equity ratio would be applied to that part of the company. Up to now, the all-or-nothing approach in the CFC legislation has enabled such companies to escape the CFC regime where the trading activities are larger than the finance activities. It would appear that a full exemption for treasury companies may not be proposed, as many businesses often have higher risk financing activities alongside normal treasury operations. Further discussion is proposed on this point, particularly whether these mixed entities should be treated in the same way as a finance company. Separate proposals will be published in spring 2011 for banks and insurance companies. Intellectual property: In general, the government believes that CFC charges should not apply to income from IP held overseas. However, there are three high risk areas where a U.K. tax charge may be considered: IP developed in the U.K. is transferred to a low-tax jurisdiction; or IP is held offshore but is effectively managed in the U.K.; or The IP has been funded by the U.K. and the U.K. does not receive a return on that investment. The proposed CFC rules would allow the U.K. tax authority to: 1. Identify entities that hold IP with a substantial U.K. connection, which would include: IP that was transferred from the U.K. in the last 10 years; IP for which significant amounts of activity to maintain or generate the IP are undertaken in the U.K.; and IP held as an offshore investment. 2. If there is IP with a substantial U.K. connection, determine whether excessive profits have arisen. The government is proposing that a new methodology (with some safe harbors) be developed that seeks to identify excessive profits based on factors such as substance, activity, funding structure and the time since the IP was transferred from the U.K. The detail of this new methodology is unclear (and will be developed during consultation), but the government does not accept that internationally accepted transfer pricing principles are sufficient. Any additional calculations are likely to be highly complex and will be subject to considerable debate. 3. If there are excessive profits, assess whether these have been artificially diverted from the U.K. The proposal is that the excessive profits that the IP company generates would be shared among jurisdictions (including the U.K.) where relevant on a just and reasonable basis.

3 4. Investment IP would be treated as if it were a monetary asset. For investment IP, rather than trying to trace how offshore IP is funded, the government is proposing the same approach as with monetary assets (i.e. there would be a deemed U.K. charge based on an imposed debt-to-equity ratio of 1:2, which results in the IP income being taxed at 8%-9%). We assume that this will be available as a backstop for more active companies if it gives a better result than the calculations in steps 1-3. Although this represents a more targeted approach to IP, it has the potential to be complex and requires a new concept of excessive profits to be defined. It will be important that this is developed during the consultation period. Additionally, there is no comment as to how the proposals would operate in an EU context. Two proposals from the January 2010 discussion document have been excluded from the consultation following discussions with business. These are the earn-out charge when IP leaves the U.K. and the actively managed exemption, which has been dropped due to fears that this would force economic activity out of the country. These are welcome relaxations. Comments are invited by 22 February CFC interim improvements Further details on the interim improvements to the existing CFC regime have been published for consultation and will be legislated in Finance Bill Draft legislation is expected on 9 December. Four main changes are proposed: 1. Intragroup activities: A new exemption is proposed for companies with intra-group transactions that meet the following conditions: The CFC must have a business establishment in its territory of residence; The CFC s business does not include to a substantial extent investment business ( substantial is likely to be defined as more than 10%); Less than 5% of the CFC s gross income is in the form of finance income or income from IP; and No more than 10% of the CFC s gross income or expenditure arises from a U.K. connection. This exemption represents a limited relaxation of the exempt activities test. It may be helpful for groups with, for example, intra-group service companies that do not have transactions with the U.K., provided there is no IP involved. 2. IP with no U.K. connection: A limited exemption is proposed for CFCs, the main business of which is the exploitation of IP. This is helpful, but only where there is little or no involvement of the

4 U.K. (which includes the IP not being held in the U.K. in the last 10 years). 3. Extension to period of grace : HMRC guidance currently provides a temporary CFC exemption for certain companies that are acquired by U.K. groups following an acquisition or reorganization, known as a period of grace. The government proposes that this practice be introduced as a statutory exemption and extended from 24 months to three years. The exemption would not be lost when a CFC restructures so long as the restructuring does not erode the U.K. tax base. 4. De minimis exemption: The de minimis CFC exemption would be increased from GBP 50,000 to GBP 200,000 for large groups. The basis of calculation would change from groups having to calculate the CFC s profits under U.K. taxation principles to being able to use their accounting profit with adjustments in line with the transfer pricing rules. There would also be anti-avoidance measures. Other matters: Transitional rules for superior and non-local holding companies introduced in FA 2009 would be extended until Intellectual property (patent box regime) The government s priority for reform of IP taxation is to support high value, successful commercialization of IP with strong links to R&D and manufacturing in the U.K. The government s view is that brand names and trademarks have a weaker or more variable link to R&D and hightech manufacturing -- and a special regime for all IP would be expensive. In line with earlier announcements, there would be a new tax regime for patents: a 10% tax rate on net profits would apply as from 1 April Profits can arise from both patent royalty income and embedded income in the price of patented products. The government will consult on the identification and quantification of embedded income. It currently favors a formulaic approach, which it believes will be simpler and provide greater certainty, rather than apply the arm s length principle. It is intended that the regime would apply to patents first commercialized, rather than first granted, after 29 November Although the document does not refer to the place of patent registration, it is thought likely that the regime would apply only to U.K. and EU patents. The government is inviting comments by 22 February 2011; there will be further consultation in spring R&D tax credits As part of the IP review, the government also is consulting on R&D tax credits for small- and medium-size enterprises and the large company R&D scheme. As the government announced it would in the June 2010 Budget, the discussion document considers the Dyson Review, which

5 raised concerns that the schemes may not be sufficiently well targeted and made two specific proposals: to refocus the schemes on high-tech companies, small businesses and new start-ups and to improve the ease with which the R&D tax credit can be claimed. It is clear from the current document that the government does not intend to restrict R&D tax credits to specific sectors. Areas for consultation include the definition of R&D, whether there should be a statutory definition of production, costs that should be eligible for relief, whether relief for internal use software should be limited or excluded and whether the claims process could be improved (e.g. by a pre-clearance procedure). Again, responses are sought by 22 February Foreign branch taxation Draft legislation and explanatory notes will be published on 9 December for inclusion in Finance Bill 2011 and the key features are expected to be as follows: An irrevocable opt-in regime that would apply to the trading branches of most U.K. companies. Companies that opt in would not be able to take relief in respect of foreign branch losses. This all-or-nothing approach could mean that some companies may struggle to determine whether an election should be made. The exemption would generally apply to trading branches in all countries and territories, including those with which the U.K. has no tax treaty. However, it would not cover non-treaty branches of small companies. Chargeable gains would be exempt by reference to the relevant treaty or to the OECD model treaty. There would be transitional rules to effectively claw back relief already given for foreign branch losses, depending on whether prior losses are large (as yet undefined). When a company opted into the regime, each of its branches potentially would be subject to anti-diversion rules. Pending the wider CFC reform in 2012, the government intends to include in Finance Bill 2011 a CFC-type regime for foreign branches, with a motive test, a lower level-of-taxation test and a de minimis level of profits as the available carve-outs. Responses are invited by 9 February Conclusion For many businesses, this is a welcome document, aimed at supporting international activities. More detail will be forthcoming from the consultation over the next few months, prior to the new regime being introduced in Business has the opportunity to influence the changes, through representations, either directly, or through Deloitte.

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