IR34 9 March 1999 LOOPHOLE CLOSED IN CONTROLLED FOREIGN COMPANY RULES A loophole in the anti-avoidance rules for controlled foreign companies (CFCs) will be closed with effect from today, protecting the UK tax base. The measure will put a stop to an avoidance scheme used to exploit an anomaly in one of the CFC exemptions. Companies will no longer be able to avoid CFC tax by routing UK dividends through a CFC. The Chancellor's announcement reflects the Government's determination to crack down on tax avoidance, and builds on changes introduced last year to improve the fairness and effectiveness of the CFC rules. DETAILS Background 1. The CFC rules are designed to stop UK companies avoiding tax in this country by diverting income to subsidiaries (CFCs) in tax havens and preferential regimes. The rules work by making UK companies pay an amount of CFC tax equal to any tax that would otherwise be avoided. 2. There are a number of exemptions. One of these is where a CFC pays to the UK a dividend equal to at least 90 per cent of its profits. This is called pursuing an acceptable distribution policy (ADP). The Avoidance Scheme 3. Some UK companies have entered into arrangements which are designed to enable their CFCs to satisfy the ADP exemption without paying any of their low- taxed profits to the UK. 4. The arrangements typically involve a UK multinational transferring ownership of one of its normally taxed UK subsidiaries to one of its CFCs (which has undistributed, low-taxed, profits). Dividends from the UK subsidiary are then routed through the CFC to the UK parent. 5. The way the CFC rules are currently written means that the UK dividend which is routed through the CFC: - does not normally count towards working out how large a dividend the CFC has to pay to the UK to satisfy the ADP exemption; but - does count towards demonstrating that the required amount has been paid; and as a result the CFC is able to satisfy the ADP exemption without paying any of its low-taxed profits to the UK. 6. The UK parent pays no tax on the dividend which is routed through the CFC because it is entitled to double taxation relief for the UK tax paid on the UK profits giving rise to the dividend. Closing the Loophole 7. Dividends which a CFC pays to the UK will no longer count towards satisfying the ADP if they are paid out of UK dividends (or other distributions) which do not count towards computing the chargeable profits of the CFC. The change will apply to dividends paid by CFCs on or after today for accounting periods ending on or after today. 8. A copy of the clause that will be included in the Finance Bill is attached to this press release. NOTES FOR EDITORS 1. A CFC is a company which is not resident in the UK (but which is controlled by individuals or companies who are) and which is subject to a level of taxation less than three quarters of what it would have paid had it been resident in the UK. Subject to various exemptions, the difference between the UK tax it would have paid and the overseas tax it has paid can be charged on UK companies with an interest of at least 10 per cent (25 per cent under self-assessment) in the CFC. 2. The rules require that a CFC's chargeable profits should be computed as if it were resident in the UK. Dividends (and other distributions) which a UK company receives from another UK company do not normally count towards chargeable profits. This means that UK dividends (and other distributions) received by a CFC do not normally count towards working out how large a dividend the CFC must pay to satisfy the ADP exemption. 3. The yield from the measure is estimated at #20m for 2001-2002 and #50m for 2002-2003. INLAND REVENUE PRESS OFFICE Media enquiries to: 0171 438 6692/6706/7327 (Out of hours: 0860 359544) Non-media enquiries to: 0171 438 6420/6425 (Office hours only) Inland Revenue information is on the Internet: www.inlandrevenue.gov.uk # = pounds sterling FINANCE BILL CLAUSE -(1) In Schedule 25 to the Taxes Act 1988 (cases where section 747(3) does not apply), after sub-paragraph (1A) of paragraph 2 (acceptable distribution policy) there shall be inserted the following sub-paragraph- "(1B) A dividend paid by a company shall not fall within sub-paragraph (1)(d) above if, and to the extent that, the profits which are the relevant profits in relation to the dividend derive from dividends or other distributions paid to the company at any time which are dividends or other distributions- (a) to which section 208 applied; or (b) to which that section would have applied if the company had been resident in the United Kingdom at that time. Subsections (3) and (4) of section 799 (double taxation relief: computation of underlying tax) apply for the purposes of this sub-paragraph as they apply for the purposes of subsection (1) of that section." (2) Subsection (1) above applies for the purpose of determining whether dividends paid on or after 9 March 1999 for accounting periods ending on or after that date fall within sub-paragraph (1)(d) of paragraph 2 of that Schedule.