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This clause makes four changes to improve the
fairness and effectiveness of the anti-avoidance rules for controlled
foreign companies. The changes strengthen the legislation and
update it to take account of developments in the ways multinationals
are structured and do business. UK companies will continue to
be exempt in respect of CFCs that are not involved in UK tax avoidance.
The motive test in the CFC rules means that additional tax will
only be payable in situations where companies are seeking to avoid
UK tax.
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The first change updates the definition of whether
there is sufficient control from the UK for a company to be a
CFC. The clause brings the test more into line with the recently
modernised rules for transfer pricing. In particular, the clause
means that companies that are owned by international joint ventures
in which there is significant UK interest will in certain circumstances
be CFCs.
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The second change deals with companies that pay
tax under so-called designer rate regimes. A number of countries
have introduced such regimes to allow companies to sidestep the
CFC rules. The clause will ensure that a company cannot stay outside
the rules by paying tax under such a regime.
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The third change updates the list which sets out
the types of business that are not automatically excluded from
the CFC rules. To counter the growing use of intra-group service
businesses to shelter income in tax havens and preferential regimes,
the clause adds to the list all types of intra-group service business
not already covered.
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The fourth change amends the automatic exemption
for holding companies. The change will stop the exemption being
used to avoid tax on income that is received to any significant
extent out of the pre-tax profits of subsidiaries.
DETAILS OF THE CLAUSE
Clause 103
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The clause provides for Schedule 31 of the Bill
to have effect.
Schedule 31
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Paragraph 1 provides for amendments to
be made to the CFC rules so that the four changes can be made.
Meaning of "control"
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Paragraphs 2 and 4 provide a new test for
control based on that used for transfer pricing. The new test
includes a "40% test" whereby a company is regarded
as being controlled by UK persons if it is at least 40% controlled
by a UK person and at least 40% controlled by another person.
Designer Rates
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Paragraph 3 provides that companies paying
tax under "designer rate tax provisions" are automatically
treated as if they are subject to a lower level of taxation. It
also provides for Regulations to be made specifying which provisions
are to be regarded as being designer rate tax provisions.
Intra-group service companies
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Paragraphs 5 and 8 extend the list of businesses
that are excluded from the exempt activities test. The extension
covers all types of predominantly intra-group service businesses
that are not already excluded.
Holding Companies
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Paragraph 6 provides that the income test
in the local holding company exemption will only be met if the
company receives the income in the territory in which it is resident.
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Paragraph 7 provides that the income test
for other holding companies will only be met if either: a) the
income is received in the territory in which the company is resident
and the income is from subsidiaries resident in that territory,
or b) the income is in the form of dividends from subsidiaries
resident anywhere.
Commencement
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Paragraph 9 brings the control changes
into effect from 21 March 2000, and the intra-group service company
and holding company changes into effect for CFC accounting periods
beginning on or after that date.
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Paragraph 9 also provides that the designer
rate provisions have effect for CFC accounting periods beginning
on or after 6 October 1999 (the date the Chancellor first announced
his intention to legislate).
BACKGROUND
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A CFC is a company which is not resident in the
United Kingdom (but which is controlled to a significant extent
by persons who are) and which is subject to a level of taxation
of less than three quarters of that which it would have been subject
to had it been resident in the United Kingdom.
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The CFC rules are designed to stop UK companies
avoiding tax in this country by diverting income to CFCs in tax
havens and other preferential regimes. The rules work by requiring
the UK company to pay an amount of CFC tax equal to any tax that
would otherwise be avoided.
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The rules were introduced in 1984, and a number
of changes have been made since then to keep the rules up to date
with the changing face of international business. The present
changes reflect the Government's resolve to ensure that the rules
continue to keep pace with developments in the global economy
and with the ways in which multinationals are structured and do
business.
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The rules contain a number of exemptions. One
of these is the Exempt Activities Test that is being changed by
Paragraphs 5-8 of Schedule 31. The other exemptions are
a motive test, a list of 74 countries in which companies are outside
the CFC rules if they meet certain conditions, a distribution
test, and a public quotation test. CFC tax is only payable if
a company fails all of these tests. The motive test specifically
ensures that CFC tax is only payable if a company is involved
in UK tax avoidance.
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The changes introduced by Schedule 31
will bring the UK’s CFC rules more into line
with those in other countries but the UK is unique in having a
motive test to ensure that the rules only apply in cases of tax
avoidance.
Meaning of "control"
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At present, to be a CFC a company must be
controlled from the UK. Most commonly, this means that more than
50% of the shares must be held in the UK.
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The ways in which multinationals are organised
and structured are becoming ever more varied and complex. For
instance, it is becoming increasingly common for UK companies
to enter into joint ventures with overseas companies. In such
situations, a joint venture company in a tax haven may not be
a CFC as currently defined, as the UK company may not have more
than 50% control.
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In order to keep pace with such developments
in the business world, Paragraphs 2 and 4 of Schedule 31
modernise the CFC control test, broadly in line with a similar
up-dating made in 1998 to the control test used for transfer pricing.
Designer rate tax regimes
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The CFC rules normally only apply to companies
paying less than 75% of the tax they would have paid if they were
resident in the UK. To enable companies to get round CFC rules,
a number of countries have introduced regimes that allow companies
to arrange to pay just the right amount of tax needed in any given
situation to avoid CFC tax. Most commonly, the regimes work by
allowing companies in effect to choose their rate of tax.
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Paragraph 3 of Schedule 31 sets aside
the normal requirement that a company is only within the CFC rules
if it has paid tax at a level less than 75% of that which it would
have paid if resident in the UK.
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The designer rate regimes that will be specified
in the first regulations were named in the Inland Revenue's press
release of 6 October 1999 ("Controlled Foreign Companies - Designer
Rate and Similar Regimes.")
Intra-group service companies
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Subject to certain specific exceptions, CFCs
that are genuinely carrying on a straightforward commercial business
are automatically exempt from the CFC rules. The exemption is
known as the exempt activities test ("EAT").
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Broadly, the EAT works by exempting all trading
companies except specified highly mobile businesses that tended
to be used for tax avoidance at the time the CFC rules were introduced
in 1984. (E.g. invoicing companies and wholesale, distributive
and financial businesses.)
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Business has changed since then. Globalisation,
along with transportation and communications advances, allow many
more types of business easily to locate in tax havens in order
to avoid United Kingdom tax.
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Paragraphs 5 and 8 of Schedule 31 extends
the types of business that are excluded from the EAT, so that
the EAT no longer applies to any CFCs receiving 50% or more of
their income from the provision of services to affiliates.
Holding Companies
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Holding companies are outside the CFC rules
if at least 90% of their income comes from non-resident subsidiaries
that meet one or more of the CFC exemptions. There is a logic
in saying that from a United Kingdom point of view it is largely
immaterial whether the post-tax profits of a non-resident subsidiary
are retained in the subsidiary or are held in a non-resident holding
company.
International holding companies
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The logic breaks down, though, where the payment
from the subsidiary to the holding company crosses national borders
and comes out of pre-tax profits - eg where the payment is in
the form of interest or royalties. For, in those circumstances,
pre-tax profits are shifted from the subsidiary to the holding
company and from one country to another.
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There is a tax deduction in the subsidiary
and a new source of income in the holding company. However, the
existing exemption for holding companies does not distinguish
between holding companies that receive their income in the form
of dividends and holding companies that receive their income in
other forms. As a result, the exemption is distorting the way
some overseas investments are structured, and is leading to a
loss of UK tax.
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For instance, a UK company wanting to put
additional funds into a subsidiary in the United States
will commonly borrow in the UK, put the borrowed money into a
low tax subsidiary (e.g. in the International Financial Services
Centre in Dublin Docks) in the form of share capital, and the
low tax subsidiary will then lend the money to the United States.
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In this way, the group gets two lots of tax
deductions at normal tax rates (in the UK and the United States)
and a single tax charge at a low rate (in Dublin Docks).
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This kind of structure has become increasingly
common since the abolition of Advance Corporation Tax (ACT). This
is because groups are no longer under the same pressure as they
were to bring profits back to the United Kingdom in order to absorb
ACT set-offs.
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Paragraph 7 of Schedule 31 stops this
loss of tax by restricting the holding company exemption so that
the 90% income test can only be met where the income is in the
form of (non tax deductible) dividends.
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This particular form of avoidance generally
only works where the holding company is resident in a different
territory than its subsidiary. Paragraph 7 of Schedule 31
therefore allows the holding company to continue to receive income
in forms other than dividends where it is received in the
territory in which the company is resident and is from subsidiaries
resident in that territory.
Local holding companies
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The CFC rules distinguish between holding
companies that receive at least 90% of their gross income from
exempt subsidiaries that are resident in the same territory as
the holding company (called "local holding companies")
and other types of holding company.
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For similar reasons to those described in paragraph
37 above, local holding companies will continue to be able
to receive income in forms other than dividends.
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Paragraph 6 of Schedule 31 stipulates,
however, that the income must be received in the territory
in which the local holding company is resident. This
will prevent local holding companies carrying out the above avoidance
scheme by receiving the income in a branch located outside the
territory in which it is resident.
