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United Kingdom: Controlled Foreign Companies (CFC) Regime

01 October 2013   (0 Comments)
Posted by: Author: Smith & Williamson (Smith & Williamson)
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Author:  Smith & Williamson (Smith & Williamson)

Does your UK resident business hold a controlling interest in an overseas group with controlled foreign companies? If so, and the business acts as a UK holding company, it may be able to benefit from partial (75%) or full exemption from UK CFC tax charges on certain non-trade finance profits.

Background

The UK has recently updated its controlled foreign company (CFC) regime so that it is more clearly focussed on artificial diversion of profits from the UK. The reform has also introduced the ability to ensure that certain overseas finance profits can be accumulated subject to a UK tax rate of 25% of the normal corporation tax rate or be fully exempt. This latter feature is an attractive tax consideration for locating a holding company structure in the UK.

The feature of the CFC regime allowing full or partial exemption of certain finance income is intended to encourage UK based groups to provide tax efficient finance to overseas subsidiaries.

The new legislation is a fundamental change to the previous CFC rules and applies for accounting periods of a CFC beginning on or after 1 January 2013, but may be revised as part of the OECD project on Base Erosion and Profit Shifting.

When considering any international tax issues it is always appropriate to consider the tax consequences in all affected jurisdictions. In relation to the idea highlighted in this note it would be necessary to consider if there are restrictions on the tax deductibility of interest charges in a jurisdiction where that interest charge gives rise to interest income subject to the favourably tax regime of the UK.

Summary of provisions

A company subject to UK corporation tax that has an interest in a foreign company has an interest in a 'controlled foreign company' if that company is:

  • resident outside the United Kingdom;
  • controlled by persons resident in the United Kingdom; and
  • subject to a lower level of taxation in its territory of residence than it would be subject to in the United Kingdom.

Under the new CFC regime a CFC charge arises to a UK resident company with an interest in the CFC that gives it an apportionment of at least 25% of the CFC's profits that are chargeable under the CFC regime. Profits are within the CFC charge if they are not exempt and they pass through the CFC charge gateway. A CFC's profits will be exempt from a CFC charge if they come within one of the following categories:

  • The profits are from an excluded territory (those with acceptable tax rates and systems) and meet certain other conditions.
  • The profits are below a deminimis level of £50,000, or are no more than £500,000 if non-trade income is no greater than £50,000.
  • The CFC's accounting profits for an accounting period are no more than 10% of the CFC's relevant operating expenditure.
  • The CFC's territory of residence meets certain conditions and the local tax on CFC profits is at least equal to 75% of what would otherwise be the corresponding UK tax. 

Income subject to the CFC charge (that passes through the CFC charge gateway) includes profits within one of the following categories:

  • Business profits (excluding non-trade finance and property business profits) attributable to UK activities. This covers profits arising from assets which the CFC has (or has had), where there are any UK 'Significant People Functions' (SPF), subject to certain exclusions. 
  • Non trade finance profits:
    • related to assets & risks with UK SPFs not within the above category or;
    •  arising from certain UK funding or;
    • arising on loans to UK connected companies and certain other entities or;
    • arising from finance leases entered into for tax purposes that involve UK connected lessees. 
  • Trade finance profits attributable to certain elements of the CFC's capital, subject to exceptions. 
  • Captive insurance business profits that either arise from insurance of connected UK businesses, or which are UK based and have no significant non-tax motive.
  • Certain banking finance profits.
  • Non trade finance profits meeting certain conditions that can be partially exempt or exempt.

The last of these categories may be seen as an incentive to locate holding companies in the UK, as qualifying finance profits of a subsidiary which is a CFC may be either exempt from UK tax or charged to tax at a rate of only 25% of the main rate of Corporation Tax (i.e. an effective rate of 5.75% for profits chargeable between April 2013 and March 2014, expected to fall to an effective rate of 5% from April 2015).

This article first appeared in Mondaq.com 


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