Budget measures to stop the avoidance of UK tax through controlled foreign companies (CFCs) will be legislated, as announced. This will bring the UK CFC regime more into line with practice elsewhere.
Nor is it acceptable that UK companies can obtain a tax advantage from using offshore mixing companies. It is therefore confirmed that the tax advantages of offshore mixer companies, which were the focus of the Budget measures concerning double taxation relief, will be stopped, as previously proposed.
However, the Government’s discussions with business have led it to conclude that there are circumstances in which a limited form of onshore pooling of foreign tax on dividends will be allowed, where this involves genuine business activity.
Together these measures
* tackle tax avoidance, with a firm clampdown on abuse of offshore holding companies
* protect the tax base, which was at clear risk of significant further avoidance through plans which have come to light during the Government’s recent discussions
* underpin the Government’s broader aims for the UK corporate tax system. It is only if avoidance is tackled and loopholes are closed that further progress can be made in reforming the system in line with the Government’s aim that the UK should be an attractive place to do business and for multinationals to locate.
The Government is also tabling amendments covering a number of technical points, described in detail below.
Given the scale of the avoidance that has come to light since the Budget, the impact of the overall package described above will be broadly similar to the estimates provided in the FSBR.
Double taxation relief
1. The changes that the Government intends to introduce at the Report stage of the Finance Bill will mean that
* dividends paid by CFCs to satisfy an acceptable distribution policy, where none of the other CFC exemptions (including the motive test) are met, will not be able to be mixed with any other dividends
* underlying tax in relation to foreign dividends paid up through overseas subsidiaries will be capped at 30%, as in the Bill currently
* underlying tax above the cap will, within certain limits, be able to be credited against UK tax payable on dividends other than dividends paid by CFCs as mentioned above and dividends where the underlying tax has already been capped
* similar relief will be allowed for some foreign tax above 30% paid on dividends received by UK companies directly from foreign subsidiaries (onshore pooling).
2. The amendments that are being tabled today include the following points.
3. Paragraph 5 of Schedule 30 deals with the interaction of double taxation agreements and relief for foreign tax under UK domestic law. It contains a rule that says that if a double taxation agreement has an express provision to the effect that a taxpayer cannot have relief for foreign tax in a particular situation, he cannot claim the relief under UK domestic law instead.
4. As drafted, that provision would have effect in relation to claims for credit relief made on or after 21 March 2000. That is, it would apply in relation to claims where there is an existing double taxation agreement. However, that would work inappropriately with some existing agreements.
5. The amendment ensures that the new provision will apply only where there is an express provision denying relief for foreign tax in a double taxation agreement that is made in the future.
6. Paragraph 10 of Schedule 30, which introduces new rules concerning relief for underlying tax and mixer companies, contains a start date of 1 July 2000. This is because the Government recognised that the changes should not come into effect immediately. It wanted companies to have a period within which to bring dividends into the UK under the old rules.
7. However, some groups with complex, multi-tiered structures face complications arising, for example, from the position of minority shareholders in foreign subsidiaries and foreign law constraints on when dividends can be paid, placing them at an artificial timing disadvantage vis-a-vis others. The Government has therefore decided that the start date for the restriction on the use of mixer companies should instead be 31 March 2001. That will apply to the whole of paragraph 10.
8. Paragraph 10 of Schedule 30 introduces a restriction on the use of mixer companies to average out rates of foreign tax paid on low taxed and high taxed profits. Dividends paid by companies in the ownership chain below a UK company will not have attributed to them underlying tax at a rate exceeding the UK corporation tax rate (currently 30%).
9. As drafted, that restriction will apply if the company paying the dividend and the company receiving it are both resident in the same country, as well as in cases where they are resident in different countries. It was suggested in representations that the restriction is not necessary in cases where dividends are paid between companies resident in the same country that are subject to the same tax rules and tax rates there.
10. The amendment will mean that the restriction will not apply where the company paying the dividend and the company receiving it are resident in the same country. The Inland Revenue will consult people who have asked for this relaxation about the situations in which they think it should apply and how to prevent it being abused. More details will be included in Regulations later this year, well in advance of the start date for the legislation.
11. Paragraph 14 of Schedule 30, which allows unrelieved foreign tax to be carried backwards or forwards to be credited against UK tax in another period, is – like the restrictions on mixer companies – drafted to apply from 1 July 2000 in the case of foreign tax on dividends. This date will be also amended to 31 March 2001. This will preserve the common start date for the two sets of provisions for which the Bill provides.
12. Paragraph 12 of Schedule 30 provides that, where a group of overseas companies is taxed as a single entity in its home State, those companies are to be regarded as a single taxpayer for the purpose of calculating underlying tax credit relief in the UK. Under the present legislation, relief is strictly speaking denied if it is not possible to identify the company paying a dividend as the company which has itself paid the foreign tax on the profits out of which the dividend is paid.
13. As currently drafted, the new provision applies only where the overseas group is situated in the ownership chain immediately below a UK company. That is, the provision will not apply if there is an intermediate company, or more than one such company, between the overseas group and the UK company. It was suggested in representations that the presence of one or more companies between the foreign group and the UK company ought not to affect the availability of the relief.
14. The effect of the amendment is to ensure that the new provision will apply in cases where there is an intermediate company, or more than one such company, between the overseas group and the UK company.
15. Paragraph 14 of Schedule 30 introduces a provision to allow unrelieved foreign tax to be carried backwards or forwards. This addresses the case where, over a period, broadly the same amount of profits might be taxed in both the UK and another country, but the profits are recognised for tax purposes at different times in the two countries. The Government has received a number of representations that the period of carry back ought to be extended beyond one year if the relief is to fulfil its purpose effectively. The Government has decided to table an amendment to make the carry back period three years. The legislation also contains the necessary ordering rules.
16. Paragraph 14 requires a claim to carry unrelieved foreign tax backwards or forwards to be made within two years following the end of the accounting period to which the foreign tax originally relates. The Government has decided to extend the time limit to make it consistent with the longer time limit for claiming relief for foreign tax generally, which is usually six years.
17. In addition, there are two purely drafting amendments to paragraphs 4 and 5 of Schedule 30.
18. Special provisions for insurance companies were left out of Schedule 30 when the Finance Bill was published to allow time for consultation. Consultation has taken place and the amendments tabled today insert five new paragraphs into Schedule 30 to the Bill.
19. The new paragraphs put into effect the measures which were outlined in paragraph 1.44 of the document “Double Taxation Relief for Companies: Outcome of the review” published on Budget Day. They deal particularly with the special rules needed to ensure that the new double taxation relief regime works properly for insurance companies, particularly life insurance companies.
Controlled foreign companies
20. The CFC legislation is anti-avoidance legislation to prevent multinationals from avoiding UK tax by diverting profits to tax havens and preferential regimes. The Finance Bill closes a number of loopholes and anomalies in the legislation, in order to ensure that the UK is fairly and effectively protected against deliberate UK tax avoidance.
21. Additional tax will only be payable where UK tax avoidance is a main motive for the existence of a CFC or for the transactions of a CFC. Multinationals that are not involved in UK tax avoidance will have no additional tax to pay.
22. The amendments tabled today concern the changes in the Finance Bill to prevent companies avoiding the CFC rules through the use of international joint ventures. In some limited circumstances the changes go further than was intended, and the amendments correct that. The substance of the changes is not affected.
23. Under existing law, a company is only regarded as being a CFC if it is controlled from the UK. Most commonly, this means that more than 50% of the shares must be held in the UK.
24. 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. UK companies are increasingly exploiting this in order to get round the CFC rules.
25. To counter this, Schedule 31 modernises the CFC control test, broadly in line with a similar up-dating made in 1998 to the control test for transfer pricing. The new rules contain a so-called “40%”, under which a company is treated as being a CFC if it is at least 40% controlled by a UK person and at least 40% controlled by a foreign person.
26. The amendments tabled today restrict the “40% test” so that it will not apply where a foreign person in a joint venture holds more than 55% of the interests, rights and powers. The amendments recognise that in these situations a UK company’s 40% stake may not enable sufficient influence to be exercised over the joint venture from the UK for it to be appropriate to apply the CFC rules.
27. Similarly, the amendments ensure that the rules attributing to a person the interests, rights and powers of another person do not go further than intended. The amendments ensure that the interests, rights and powers of a UK person cannot be attributed to a non-resident person and cannot be attributed from one joint venture partner to another simply because they are partners.
28. The amendments also include consequential changes to bring the exemption for holding companies into line with the new rules for joint ventures.
NOTES FOR EDITORS
Double taxation relief
1. Draft legislation on double taxation relief was published by the Inland Revenue on Budget day, 21 March 2000, in the paper “Double Taxation Relief for Companies: Outcome of the Review”. The Government invited comments on the drafting of the legislation by 19 April.
2. An Inland Revenue press release issued on 3 May “Taxation of Multinational Companies” gave details of some of the changes mentioned above.
3. Double taxation occurs when income is taxed both by the taxpayer’s country of residence and in another country where the income arises. The purpose of double taxation relief is to remove or reduce the disincentive that double taxation represents to outward investment. It is estimated that in the tax year 1999/2000 #5.5 billion of relief will be allowed against income tax and corporation tax. A key part in that is played by double taxation agreements that the UK has entered into with other countries. More than 100 of these are now in force.
4. Most of the double taxation relief that is allowed relates to underlying tax. This is the tax paid by subsidiary companies on the profits out of which they pay dividends. When the subsidiaries pay a dividend to the UK, the UK company is entitled to credit for the underlying tax, as well as for the foreign tax (if any) withheld from the dividend itself.
5. A mixer company is an offshore subsidiary of a UK company which itself has one or more subsidiary companies. Dividends from different subsidiaries are routed into the UK through the mixer company. This allows mixing of the different dividend streams and of the underlying taxes attributable to each. Under the current rules it is possible to mix, and thereby average out, foreign taxes paid in different countries of, say, 60 per cent and 5 per cent, to set against the UK tax charged at 30 per cent on the single dividend that emerges from the mixer. Under the Finance Bill currently, the foreign tax charged at 60 per cent will be limited to 30 per cent for the purpose of calculating the relief that is available in the UK.
6. Special rules are required for life assurance business to reflect the fact that much of the income and gains received by a life company are destined for the payment of benefits to policyholders. To the extent that the income and gains relate to categories of business, such as pension business, where the profit on which the company pays tax is reduced by the increased obligations to policyholders that reflect those benefits, there is no corporation tax liability and so no double taxation of the income and gains in the hands of the company. The special rules are required to identify by apportionment the increased obligations to be deducted from each item of foreign income or gains in order to arrive at the amount that does bear corporation tax and is therefore doubly taxed. Similar rules are required for general insurance business to identify the share of certain expenses attributable to each item of foreign income. The rules also ensure that the total relief for foreign tax cannot exceed the corporation tax charged on the profits of the business in question.
Controlled foreign companies
7. Details of the CFC provisions in the Finance Bill were set out in Budget Note REVBN2K.
8. A CFC is a company which is not resident in the UK (but which is controlled to a significant extent by individuals or companies who are) and which is subject to a level of taxation less than 75% of the level that it would have paid had it been resident in the UK. Subject to various exemptions, the difference between the UK tax it would have paid and the overseas tax it has paid is chargeable on UK companies with an interest of at least 25% in the CFC.
9. The rules contain a number of exemptions. These include a motive test, an exempt activities 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.