Budget2011: What is the price of attracting business to the UK?

IN A BUSINESS FRIENDLY Budget, one of the most friendly reforms was a change to the effective UK tax rate for foreign financing companies. The new rate of 5.75% was a decrease from the 10% announced in December.

This will be part of the reforms to the controlled foreign company (CFC) legislation, which will be announced in full in May. But, with the announcement that the whole CFC reform is to cost £2.5bn during this Parliament, is this good value for attracting big business to the UK?

The change announced today will introduce “ultra-competitive” effective rate of 5.75% in relation to financing subsidiaries. This will affect UK companies that own subsidiaries that participate in group financing activities and are based in low tax countries.

Kevin Hindley, managing director of Alvarez & Marsal, said that this is a good move for business. It is “tacit approval” for UK companies to increase the amount of equity that they can use to capitalise financing subsidiaries without paying UK tax. Whereas the 10% rate was effectively a debt to equity ratio of one to two, this has apparently changed to one to three, he said.

Also announced in the Budget Book is the cost of the reforms – around £865m a year by 2015/16 and £2.5bn throughout the whole of the Parliament

The new CFC rules, which will be introduced in the 2012 Finance Bill, are designed to “allow groups based in the UK to compete more effectively with those based overseas, while protecting against the artificial diversion of UK profits”, the government said.

The legislation would bring in retrospective interim improvements, effective from 1 January this year, to remove tax for overseas trading between a UK-based companies’overseas subsidiaries and for intellectual property that has no UK connection, increase the de minimis limits from £50k to £200k and extend a grace period for subsidiaries that have been acquired. The full reform, which is due in 2012, includes other measures designed to bring different exemptions to the CFC charge.

The government’s overall approach to CFCs is encouraging, Hindley said, as reform of the legislation must be the chancellor’s top priority. “When companies come to us, including US multinationals, they say UK is an attractive proposition.” But they are put off by the problems with the current CFC legislation.

In this case, £865m a year is good value. It would only take a few big businesses to set up in the UK for the Exchequer to make this money back, Hindley added.

However, the £865m “is maybe a bit bigger figure than I would have expected”, said Paul Smith, head of international tax at Grant Thornton.

“The interim improvements are not going to achieve that much. They seemed quite narrowly drafted, so there won’t be too many people saving from it.”

But ultimately the reforms must be welcomed, he said. The changes to foreign finance subsidiaries “will remove the incentive for groups to move out of the UK in order to obtain similar finance company benefits in the Benelux countries, Switzerland etc.”

Simon Palmer, international tax partner at KPMG, said that the effectiveness of any legislation will not be known until the full reforms are published.

“If it is properly implemented, it will make a difference to companies migrating out of the UK,” he said. “It is hard to know companies reasons for not coming to the UK.

“But what has been very obvious has been when people have been migrating outside the UK and that does not look good. Most people have pointed the finger at a very complicated tax system and particularly the CFC rules, and within that the finance company regime.” Because of this, today’s announcement is a positive step.

Coupled with the changes in corporation tax, the reforms to foreign financing companies make the UK a more attractive place for businesses. But £2.5bn is a lot of money for an impoverished Exchequer. The politics involved in reducing revenue for businesses means that a failure to attract businesses will hit the government at the ballot box.