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CLAUSE 80: CONTROLLED
FOREIGN COMPANIES (CFCs)
SUMMARY
1.
This clause protects the UK tax base by closing a loophole in the
CFC rules that are designed to prevent UK multinationals from diverting
profits to low tax regimes. It will put a stop to the use of artificial
tax avoidance schemes to exploit one of the exemptions from the CFC
rules. It also corrects a minor defect in the existing rules, which
would otherwise prevent a large number of CFCs from benefiting from
the exemption.
2.
A CFC is exempt from the CFC rules if it pursues an acceptable distribution
policy (ADP) - that is, it pays a dividend to a UK person equal to
at least 90% of the profits on which it would have been chargeable
to tax had it been resident in the UK.
3.
By arranging for their CFCs to enter into circular and wholly artificial
transactions with, for example, UK banks or insurance companies, UK
multinationals can satisfy the exemption whilst avoiding paying UK
tax on such dividends or even in substance bringing back to the UK
any of the CFC’s low-taxed profits. Such schemes exploit an unintended
loophole.
4.
This clause closes the loophole by providing that certain dividends
paid to UK banks, financial concerns and insurance companies no longer
count towards an ADP if they are paid as part of an avoidance scheme.
Genuine commercial transactions are not affected
DETAILS OF THE CLAUSE
5.
Subsection (1) provides for amendments to the relevant legislation
concerning the ADP exemption (Part I of Schedule 25).
6.
Subsection (2) amends sub-paragraph (1A) of Paragraph 2 of
Schedule 25 so that dividends chargeable either under Case I of Schedule
D (i.e. dividends received in the course of a trade) or, in certain
circumstances, under Case VI (i.e. certain dividends received by insurance
companies) do not count towards an ADP if the dividends are involved
in a UK tax avoidance scheme.
7.
Subsection (3) introduces new Paragraph 2B.
8.
Sub-paragraph (1) of Paragraph 2B provides that new Paragraph
2B has effect for the purposes of Paragraph 2 (1A)(b).
9.
Sub-paragraph (2) provides that payment of a dividend paid
solely to satisfy the ADP exemption (i.e. and not also, for example,
to avoid a tax charge on the receipt of the dividend in the UK) does
not of itself constitute an avoidance scheme.
10. Sub-paragraph
(3) defines what is meant by a "UK tax avoidance scheme"
(i.e. any scheme or arrangement, the main purpose or one of the main
purposes of which is to achieve a reduction in UK tax).
11. Sub-paragraph
(4) defines what is meant by a “reduction in tax”.
12. Sub-paragraph
(5) defines what is meant by an "arrangement" and "United
Kingdom tax".
13. Subsection
(4) corrects a minor defect in the current rules in Paragraph
4(1) of Schedule 25 allowing dividends paid indirectly
to UK companies by CFCs through a chain of one or more overseas companies
to count towards an ADP. It ensures that, where all the conditions
relating to indirect dividends are met, the relevant conditions applying
to direct dividends are also deemed to be met.
14. Subsection
(5) provides for parallel amendments to those relating to dividends
paid direct to the UK in subsection (2) above to the rules governing
ADP dividends that are paid to the UK indirectly through a chain of
one or more overseas companies in sub-paragraph (1A) of Paragraph
(4).
15. Subsection
(6) provides for a minor amendment to sub-paragraph (2) of Paragraph
4 to make it clear that the reference therein to related companies
is to companies not resident in the UK.
16. Subsection
(7) introduces new Paragraph 4A which provides for broadly
parallel anti-avoidance provisions to those in subsection (3) above
in respect of ADP dividends that are paid to the UK indirectly through
a chain of one or more overseas companies.
17. Subsection
(8) provides that the amended rules have effect for dividends
paid by CFCs on or after 7 March 2001 (Budget day) for accounting
periods ending on or after that date.
18. Subsection
(9) provides that “accounting period” and “controlled foreign”
company have the same meaning as in the existing CFC rules.
BACKGROUND NOTE
19. A CFC is a
company which is not resident in the UK (but which is controlled 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 UK.
20. The CFC rules
are designed to stop UK companies avoiding tax in this country by
diverting income to subsidiaries situated in low tax regimes. The
rules work by, broadly, charging UK parent companies of CFCs on an
amount equal to the profits that would otherwise avoid tax.
21. There are
a number of exemptions, one of which is where the CFC pays to UK persons
a dividend equal to at least 90% of its profits. This is called pursuing
an acceptable distribution policy (ADP). The rationale for the exemption
is that, since the dividends will be taxable in the UK, there is no
significant avoidance of UK tax and thus no reason to apply the CFC
rules.
22. Some UK multinationals
have arranged for their CFCs to enter into artificial and circular
schemes aimed at enabling their CFCs to satisfy the ADP exemption
whilst ensuring that no UK tax is paid on receipt of the dividend
in the UK.
23. The
schemes involve money going round in a circle from a UK bank to a
CFC owned by the UK multinational and then back to the bank again.
Very broadly:
a) the CFC issues shares
to the UK bank in return for cash;
b)
these shares entitle the bank to receive dividends from the CFC;
but
c)
they have in effect to be sold back to the CFC for a fraction of
their initial cost.
24. The amount
the bank pays under a) above roughly equals the amounts it receives
under b) and c).
25. This is clearly
an artificial scheme because:
- the dividends paid by the CFC are designed to be sufficient
to meet the CFC exemption; but
- the bank
pays no net UK tax on the dividends as it can offset against them
the loss it makes when it, in effect, sells the shares back to
the CFC.
26.
The measure provides that dividends paid by a CFC to UK companies
that can offset losses in this way (e.g. banks, other financial concerns
and insurance companies) do not count towards the ADP exemption if
they are involved in a UK tax avoidance scheme. This ensures that
genuine commercial transactions are unaffected but those carried out
to avoid tax no longer achieve their purpose.
27.
The measure also corrects a minor defect in the rules for the ADP
exemption. Currently, the exemption only applies if certain conditions
are met. Of these two are of particular importance. The first is that
dividends must be paid by the CFC to UK shareholders. The second is
that, where these are companies, the dividends must be taxable in
their hands.
28.
Many CFCs are owned through a chain of one or more foreign holding
companies. Where dividends flow to the UK through such a chain there
are special rules. Where the overseas companies in the chain act purely
as conduits, these rules treat the dividends paid by the CFC as if
they were paid directly to a UK company. This is designed to ensure
the first condition in paragraph 27 above is met.
29.
However, the rules do not at present provide that such dividends are
also to be treated as if they were taxable in the hands of UK recipient
companies. This means that the second condition in paragraph 27 above,
strictly, can never be met where dividends are paid through a chain
of foreign companies.
30.
The defect in the present rules would prevent companies, in some circumstances,
from being able to rely on the ADP exemption in cases where they should
be able to do so. The clause ensures that the rules now work as intended.
No action will be taken in respect of dividends not within the ambit
of the amendment but for which the ADP exemption was intended yet
not strictly due (i.e. dividends otherwise satisfying the conditions
of Paragraphs 2-4 of Schedule 25 but which were paid before 7 March
2001 for accounting periods ending on or after that date or dividends
paid after 7 March 2001 for accounting periods ending before that
date).
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