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Interim corporate tax changes finalised

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23rd Mar 2011
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Anne Fairpo summarises the final Budget 2011 adjustments to foreign company taxation rules.

The changes on controlled foreign companies (CFCs) seem to have been going on forever. In reality, they’ve been debated since June 2007 - long enough in tax terms, which sometimes feel like dog years.

The latest batch of changes to be included in Finance Bill will be the first proper new legislation on the topic for many years. The FA 2009 changes don’t count, as they were just tinkering to deal with issues from dividend exemption. The legislation has been around in draft for some time, although FB11 will have some changes to the draft to “ensure that the improvements delivered the desired outcome”, which sounds like code for adding in some anti-avoidance measures, although the Budget note suggests that they may be trying to be helpful as well.

The interim changes bring in two new exemptions: for trading CFCs; and intellectual property holdings’ CFCs, in each case where there is minimal UK connection (meaning funding and transactions).

The FB11 interim changes will have effect for accounting periods beginning on or after 1 January 2011; 1 April 2011 was the suggested date at the last HMRC open day.  The extension to the transitional rules will ensure that the three-year temporary exemption (‘grace period’) is also available to previously UK-headed groups if they return to the UK. This seems to be a clear invitation/plea to the likes of WPP and other groups that have effectively migrated their holding companies since 2007.
 
The changes that had the usual suspects foaming at the mouth over tax heists and thundering about losses to the UK Exchequer is a trailer for next year: 2012 will see full reform of CFCs, following 2011’s interim changes.

One significant measure of the full reform will be a partial exemption for certain finance companies.  The Guardian (in an article by George Monbiot) got very het up about the possibility of an 8% tax rate for UK parents of offshore finance companies.  The Budget revised the proposals, and the finance company exemption is now likely to mean a 5.75% tax rate for UK parents of finance CFCs. 

Predictably, there has already been doom and gloom, even before the follow-up article that the Guardian will no doubt publish, about this being an invitation to drain funds out of the UK. What appears to escape notice is that companies are not actually obliged to set up, or remain in the UK. It’s not impossible to leave the UK - as has been amply demonstrated over the last few years.  Companies answer to shareholders, and shareholders don’t seem to like to see a tax line on the accounts, so the larger groups do something about it (and smaller groups probably aren’t going to be running overseas treasury functions).

Finance operations are highly mobile and relatively easy to move, and the UK is not even close to being the only place with a decent banking infrastructure. In commercial reality, it’s not a question of charging 5.75% instead of (eventually) 23%: it’s a hope that we get 5.75% instead of the 0% we’ll get if overseas groups set up their European holding operations elsewhere and UK headquartered groups decide that we’re too expensive and move their holding operations elsewhere. 

It’s also probably a good idea to wait and see the small print when the consultation paper is released in May - it could be that this measure will turn out to be similar to the interim exemptions, aimed at foreign-foreign transactions.
HMRC info/impact note: Interim CFC Reform
 
Foreign branches
Finance Bill 2011 will include the rules on an opt-in exemption from corporation tax on the profits of foreign branches of UK companies.

The foreign branches tax exemption has been discussed for a year or so now, following protest from the banks and insurance companies that they were unable to benefit from the dividend exemption rules (banks and insurance companies usually operate through branches because of regulatory capital level requirements). 

The original - simple - proposal that the profits and losses of foreign branches be exempt from UK tax has been replaced with a decidedly not simple set of rules, thanks to lobbying by oil/gas industries and others who wanted still to be able to use branch losses and, in part, from the government’s decision to make the exemption more generous than similar exemptions in other countries. 

Most countries with a branch profits/loss exemption limit the exemption to branches in countries with which they have a tax treaty: the UK exemption will be for all branches of large companies - small companies are limited to treaty countries.  This means that the UK rules will also include fairly substantial anti-diversion/anti-avoidance rules. 

Opting into the exemption will mean a transitional run-off period of at least six years, to mop up existing losses in the branch; that adds to the rules and complexity.

The Budget noted that some changes have been made to the draft legislation published late last year to:

  • allow life insurance companies to benefit from exemption (they were previously excluded - the lobbyists are earning their money on this exemption);
  • ensure that the transitional rule is workable for business (for a given value of “workable”); and
  • ensure that the anti-diversion rules are more targeted and proportionate (the foreign branches rules will have something similar to the CFC rules, to try to minimise the prospects of a flood of profits out of the UK).

HMRC info/impact note: Taxation of Foreign Branches

Investment trust companies
Investment trust companies (ITCs) are companies meeting specific criteria (in Chapter 24, Part 4, CTA 2010), which are exempt from tax on capital gains.  The tax rules for these companies are not wholly clear (there’s a surprise) and trading transactions can cause problems for the company’s tax status in some circumstances.
As part of the general buff-up and overhaul of the UK corporate tax system, the government has been consulting on the tax treatment of ITCs, looking at various points, including attempting to give more certainty as to which transactions are investment and which are trading.
FB11 will include the draft legislation published at the end of last year which, apparently, didn’t generate any further comment.  Some (inevitable) “minor technical changes” will appear in FB11 nevertheless, and it’s not the end of the story - the FB11 rules only provide a new definition of an ITC, including giving HMRC powers to approve a company as an ITC. 
Everything else is being delegated, with FB11 giving the Treasury powers to make regulations setting out the rules of the regime - those regulations will appear sometime in April.   This doesn’t seem consistent with the tax policy framework that indicates that the majority of changes to tax law should be by way of primary legislation - the rules will be more than administrative matters, if they are to deal with distinguishing between investment and trading, for example.
Corporate capital gains
Legislation will be introduced in Finance Bill 2011 to simplify the rules for the calculation of chargeable gains degrouping charges for companies.  This has already been the subject of consultation, and HMRC issued draft guidance in January on the changes.
Key points are:
  • Changes to the rules on capital losses following a change in ownership
  • Revision of s31 TCGA on value-shifting
  • Changes to de-grouping transactions following an intra-group transfer 
This last point seems to have thrown up some further problems, and the Budget changes are aimed at dealing with those, particularly:
  • companies leaving a group in consequence of a share for share exchange to which section 127 TCGA 1992 applies; and
  • unintended consequences for a few Real Estate Investment Trust (REIT) groups where there are minority investors in a company that leaves the REIT group.
Unsurprisingly, Finance Bill 2011 will also include an anti-avoidance measure on degrouping, to deal with a planning technique which tried to exploit a possible hole in the law around connected groups. 

The latest changes ensure a de-grouping charge when the transferee company first joins a connected group (connected by control, as in s179(2B)), which doesn’t trigger the degrouping charge, then either:

  • the transferee leaves the second group, or
  • the two groups cease to be connected.
Note that this is, again, phrased as removing “any doubt” - HMRC is trying hard not to confirm that the planning might have worked before - and the impact on the Exchequer is marked as nil, since the government doesn’t want to admit that it might have worked.  As usual with anti-avoidance, the change applies to companies leaving a group on/after Budget Day 2011.
HMRC info/impact note: Preventing Avoidance: Corporate Gains Degrouping Charge
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