UK corporate tax 'group financing exemption' under EU investigation

Out-Law News | 27 Oct 2017 | 1:18 pm | 2 min. read

The European Commission has opened an investigation into a UK exemption from corporate tax anti-avoidance rules, on the grounds that the rule could be allowing multinationals to pay less UK tax in breach of state aid rules.

The investigation relates to the 'group financing exemption', which partially exempts some offshore financing income from the application of the UK's controlled foreign company (CFC) rules. The CFC rules allow HM Revenue and Customs (HMRC) to reallocate profits arising in an offshore subsidiary back to the UK parent company, where they can be taxed accordingly.

The UK updated its CFC rules in 2013, after the Court of Justice of the European Union (CJEU) ruled that the previous regime prevented companies from establishing genuine business operations elsewhere in the EU. However, the EU is now concerned that the group financing exemption potentially gives preferential treatment to  multinationals operating in the UK which finance a foreign group company via an offshore subsidiary.

"The UK government is between a rock and a hard place: if its CFC rules are too tough, the CJEU will complain that companies can't establish genuine business operations elsewhere," said tax expert Eloise Walker of Pinsent Masons, the law firm behind "But now the EU Commission is saying that the rules should be tougher in relation to finance income."

"Perhaps the Commission and CJEU should make up their minds about what they want," she said.

CFC rules are designed to prevent corporate groups from diverting profits to subsidiaries in low or no-tax jurisdictions as a means of avoiding tax. The UK rules allow a 75% partial exemption from CFC charges for group financing income, including income payments received from loans, in some circumstances where a UK group has a finance company located outside the UK.

According to the Commission, the effect of the exemption is to allow a multinational company which is active in the UK to provide financing to a foreign group company via an offshore subsidiary while paying "little or even no tax" on the profits from these transactions. This is because the offshore subsidiary pays little or no tax on the financing income in the country where it is based, while the offshore subsidiary's financing income is only partially reallocated to the UK to be taxed as a result of the exemption. In contrast, CFC rules reallocate other income arising in offshore subsidiaries of UK parent companies to the UK for taxation purposes.The Commission "has doubts whether this exemption is consistent with the overall objective of the UK CFC rules", according to its press release. It is not questioning the right of the UK to introduce CFC rules in the first place, or to determine the appropriate level of taxation.

"All companies must pay their fair share of tax," said Margrethe Vestager, the EU's competition commissioner.

"Anti-avoidance rules play an important role to achieve this goal. But rules targeting tax avoidance cannot go against their purpose and treat some companies better than others. This is why we will carefully look at an exemption to the UK's anti-tax avoidance rules for certain transactions by multinationals, to make sure it does not breach EU state aid rules," she said.

From 1 January 2019, all EU member states will be required to implement anti-avoidance rules around CFCs. The Anti-Tax Avoidance Directive (ATAD), adopted in July 2016, is designed to ensure consistent implementation of the base erosion and profit shifting (BEPS) measures recommended by the Organisation for Economic Co-operation and Development (OECD) across the EU.

Earlier this month, in the latest of a series of decisions relating to tax rulings given to multinationals, the European Commission announced that tax rulings given by Luxembourg granted "undue tax benefits" to online retailer Amazon of around €250 million in breach of EU state aid rules