Can the UK control foreign companies?

by Miles Dean

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27 Feb 2012

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THE TREASURY has released a further update and amended draft legislation as part of the ongoing overhaul of the tax rules on controlled foreign companies and foreign branch profits. The new rules seek to make the UK's tax system competitive with other EU jurisdictions, whilst also protecting against diversion of profits from the UK to low tax jurisdictions.

In general the new rules are to be applauded in seeking to put the UK on a level playing field with other EU jurisdictions as a place to locate the holding company of an international business.

However, it should also be noted the amended draft legislation now runs to 74 pages and the interaction between the various tests is extremely complex. The issue multinationals will be concerned with is that the UK's legislation is far more complicated than most other jurisdictions.

Furthermore, in countries such as Luxembourg or Switzerland, we can be fairly certain that, regardless of future changes in government, tax regulation and policy is likely to remain relatively stable. However, in the UK, it is never clear whether a future government would reverse those of its predecessors. This can prevent taxpayers from taking positive decisions on whether to locate themselves here.

Turning to the rules themselves, one of the most intriguing features is a proposed exemption that will create an opportunity for any UK based international business to reduce its UK effective tax rate by moving its finance function to a low tax jurisdiction (such as Jersey) within the terms of this exemption. The highest rate payable on profits attributable to the foreign finance activity will be 5.75%, and there is the potential these profits will be fully exempt from UK tax where the loans are funded from "qualifying resources" (such as accumulated profit of the offshore finance business or the proceeds of a fresh share issue) and the group has little or no net financing costs in the UK.

As has been previously commented, this is a curious feature since there is no similar exemption for intragroup financing profits derived by a UK based finance function so this measure potentially encourages finance jobs to leave the UK.

The rules contain provisions to prevent groups "pushing" existing borrowing back into the UK to obtain a UK tax advantage. This of course adds an additional layer of complexity to the already complex UK rules that seek to regulate interest deductibility (including the transfer pricing rules, worldwide debt cap and anti-arbitrage rules).

Ultimately the success of the new rules may be judged by whether it stems the flow of migration of multi-nationals away from the UK. The recent decision of insurance provider Aon to move its holding company from the US to the UK may perhaps be an early indicator of success, although the reasons for the Aon may have as much to do with the City of London's strength in the insurance market as it has to do with the attractiveness of the UK's tax regime.

Miles Dean is the founder of Milestone International Tax Consultants

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