Chancellor Gordon Brown infuriated advisers this week by attempting to restrict the impact of the Cadbury ruling at the European Court of Justice on controlled foreign companies.

The moves, which one adviser described as an ‘insult’, appeared to accept the implications of the Cadbury judgment, but detailed documentation indicated Brown hadn’t relaxed the rules as expected.

The Cadbury judgment had indicated that offshore vehicles could be exempted from UK corporation tax where there was genuine economic activity.

But whilst accepting that ruling, the Treasury also gave its view that economic activity only referred to profits resulting from ‘labour’ offshore, and not from ‘capital’.

‘This is not good news for business; in fact it is an insult. It would have been better for the chancellor to say nothing, rather than push the agenda in this way,’ said Deloitte corporate tax partner Bill Dodwell.

Chris Morgan, head of international tax at KPMG, said the detail of the draft legislation indicated that the government was determined to limit the impact of the Cadbury Schweppes decision.

The full draught legislation says: ‘The distinction is in essence one between the creation of profits in another member state and the diversion of profits to another member state from elsewhere. And the distinction within a CFC is, in essence, between profits, that arise from labour and those that arise from capital.’

Morgan said:‘The draft legislation is over-complicated and will just cause more litigation. What it does is allow profits on labour in a CFC to be tax-exempt, but profits from capital will not be exempt. There is going to be plenty of representation disagreeing with this point.’

PBR documents indicated that the Treasury in any case expected the judgment to cost it £540m by 2010. A consultation on the issue will open in 2007, and it is anticipated the rules in the draft legislation will be hotly contested.