Out-Law News | 21 Dec 2017 | 1:45 pm | 3 min. read
The Commission announced in October that it was beginning an investigation into the exemption. The opening decision setting out the Commission's preliminary view that the exemption breaches EU state aid rules was published in the EU Official Journal on 24 November.
Eloise Walker, a tax expert at Pinsent Masons, the law firm behind Out-law.com, said: "Groups which have relied on the finance company exemption are at risk of having tax benefits clawed back plus interest, should the decision go against the UK. However, there are arguments that it is contrary to EU law for the CFC rules to apply at all to genuine group treasury companies. This action by the Commission may result in groups with an EEA based finance company which have benefited significantly from the exemption, mounting a challenge to the application of the CFC rules."
"Any groups with a significant potential exposure should consider whether they need to take any action to protect their position," she said.
The CFC rules are anti-avoidance provisions which reallocate certain profits arising in an offshore subsidiary back to the UK parent company for tax purposes. The rules include an elective regime to exempt, or partially exempt certain non-trade finance profits of CFCs from the charge. The exemption enables multinational groups to have a non-UK finance company making intra-group loans to other non-UK companies without incurring a significant UK tax charge.
The UK's CFC rules were changed in 2013 in an attempt to ensure that they did not breach the EU principle of freedom of establishment, following a case involving Cadbury Schweppes. In that case the Court of Justice of the European Union held that the then rules were too wide and went further than necessary to target 'wholly artificial arrangements' which do not reflect economic reality.
The Commission said that it considers the exemption from UK corporation tax for foreign inter-company finance profits is "a scheme which provides for a selective advantage constituting state aid".
Last year the CJEU decided in the World Duty Free case that a tax measure was selective if it favoured some businesses over other businesses in a comparable factual and legal situation, even if the measure was in principle open to all companies.
The Commission said of the finance exemption: "It seems prima facie selective because the exemption only applies to UK entities controlling a CFC that earns profits from financing foreign group companies and not to UK entities controlling a CFC that earns other finance profits, both of which are in a legally and factually comparable situation in view of the objective of the reference system".
"There seems to be no justification for this treatment by the logic or general scheme of the tax system because the exemption regards profits that the CFC rules themselves define as artificially diverted from the UK and that therefore are within the objective of the reference system," the opening decision says.
The decision summarises the arguments made by the UK in defence of the regime. It explains that the UK does not tax companies on the profits of their subsidiaries, whether they are in the UK or abroad, even when distributed but UK companies can deduct interest expenses incurred on borrowing used to fund investment in subsidiaries, domestic or abroad. A UK company controlling a CFC could therefore capitalise the CFC using funds sourced from UK borrowings and qualifying for UK tax deductions, effectively diverting UK profits to the CFC.
The UK argues that the two group finance exemptions are designed to reflect the fact that not all the funding will be sourced from the UK. A full exemption is available to groups which can show the CFC is not funded at all by debt finance from the UK.
A partial exemption takes out of the CFC charge 75% of the finance income arising on intra-group loans between non-UK members of a UK headquartered group. This assumes that the funding costs incurred by the UK instead of the CFC can reasonably be taken as 25% of the CFC’s non-trade finance profits, avoiding the need for groups to keep records of complex flows of money leading to disproportionate compliance costs for them and HMRC.
The Commission will now conduct a full investigation into the exemptions. The official deadline for making comments to the Commission expires on 24 December. The Commission normally accepts comments after the official deadline, although it will not guarantee to take late submissions into account.
If the Commission decides that the exemption constitutes unlawful state aid, the UK government will be required to recover the benefit of the aid from any groups which have claimed the exemption. The UK can appeal the decision, and affected businesses can intervene.
"The Commission will want to make its decision before the UK leaves the EU. If the decision goes against the UK, Brexit is unlikely to save groups from having to pay up. Compliance with pre-Brexit rulings will almost certainly be part of the Brexit deal," said Eloise Walker.
The Commission has also been investigating tax rulings given to multinationals and has previously ruled against rulings given to Apple, Amazon, Starbucks and Fiat. Earlier this month it announced an investigation into tax rulings from the Netherlands to one of the groups operating the business of IKEA, the furniture retailer.