Summary of Measures
Changes to the controlled foreign company rules to ensure that the UK receives a fairer share of tax on the profits of multinationals were announced today.
The measures build on the steps taken in the last 2 Budgets to reinforce the fairness and effectiveness of the CFC rules, and form part of a continuing resolve to ensure that the rules keep pace with developments in the global economy.
UK companies will continue to be exempt in respect of CFCs which are not involved in UK tax avoidance.
1. The CFC rules are designed to stop UK companies avoiding tax in this country by diverting income to subsidiaries (CFCs) in tax havens and preferential regimes. The rules work by requiring UK companies to pay an amount of CFC tax equal to any tax that would otherwise be avoided.
2. The Budget changes will strengthen the legislation and update the rules to take account of developments in the ways multinationals are structured and do business. The motive test in the CFC rules will ensure that UK companies will continue to be exempt in respect of CFCs which are not involved in UK tax avoidance.
a) Holding Companies
3. Overseas holding companies will have to meet tighter conditions in order to qualify for exemption under the exempt activities test (‘EAT’). The new rules, which will apply to CFC accounting periods beginning on or after today, will stop the use of holding companies to avoid tax on income received to any significant extent out of the pre-tax profits of subsidiaries.
4. Under the new rules, a holding company with subsidiaries outside the territory in which it is itself resident will be exempt under the EAT only if 90% or more of its income is in the form of non-tax deductible dividends from subsidiaries that are themselves exempt from the CFC rules. Previously, there was no restriction on the form of the income – simply a requirement that at least 90% must come from exempt subsidiaries.
5. The old rules meant that multinationals were able to divert pre-tax profits in the form of interest and royalties to tax havens and preferential regimes and shelter the income there without incurring CFC tax. This was distorting the way in which overseas investments were being funded, and was leading to a loss of UK tax.
6. As part of the change, the Inland Revenue will also update its guidance on the application of the motive test to holding companies.
b) Intra-group Service Companies
7. The EAT is also being changed to counter the use of intra-group service companies to shelter income in tax havens and preferential regimes.
8. The general aim of the EAT is automatically to exempt businesses which, because of the nature of their business, can reasonably be assumed not to be involved in UK tax avoidance. It does this by listing (and excluding from the exemption) the types of business which experience suggests lend themselves to being carried on outside the UK for other than purely commercial reasons.
9. The current list of such businesses was drawn up in the early 1980s, based on experience at that time. Advances in technology and communications mean that a far wider range of businesses can now just as easily be located in tax havens and preferential regimes in order to avoid UK tax. In the case of intra-group service activities, the list is particularly out of date in only covering some types of activity. The list of excluded businesses is therefore being extended to add all types of intra-group service business.
10. The change, which will apply to CFC accounting periods beginning on or after today, will mean that the EAT no longer applies to any companies which are mainly engaged in the provision of services and which receive 50% or more of their income from related parties.
11. The definition of whether there is sufficient control of a company from the UK for it to be regarded as a CFC is being changed to keep pace with developments in the ways in which multinationals are structured and organised.
12. The changes, which will apply from today, will bring the CFC rules more into line with the new modernised transfer pricing rules introduced two years ago. In particular, a company in a tax haven/preferential regime will now be a CFC if it is at least 40% controlled by a UK company and at least 40% controlled by a foreign company. Previously, a company was only a CFC if it was more than 50% controlled from the UK.
d) Designer Rates
13. Companies will no longer be able to side-step the CFC rules by the use of so-called designer rate tax regimes.
14. The CFC rules normally apply only to companies paying less than 75% of the tax they would have paid if they were resident in the UK. To enable companies to get round CFC rules, a number of countries have introduced regimes that allow companies to pay just the right amount of tax needed in any given situation. Most commonly, the regimes work by allowing companies in effect to choose their rate of tax.
15. Under the new rules, companies paying tax under designer rate tax regimes will fall within the definition of a CFC regardless of the level of tax paid. The regimes to which the legislation applies will be named in regulations.
16. The new rules will apply to CFC accounting periods beginning on or after 6 October 1999, which was the date when the Chancellor first announced his intention to legislate. The regimes that will be named in the first regulations were set out in an Inland Revenue press release of that date (‘Controlled Foreign Companies – Designer Rate and Similar Regimes’.)
e) Further Information
17. Further information, and a copy of the clauses to be included in the Finance Bill, is available on the Inland Revenue’s website –
18. Also on the website is a copy of the revised guidance on the application of the motive test to holding companies. Clearances given under aspects of the guidance that have changed will cease to apply for CFC accounting periods beginning on or after today. The guidance on the website explains that companies in any doubt as to whether a clearance remains applicable should contact the Inland Revenue for advice. The contact point is:
Telephone 020 7438 7576
1. 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.
2. The rules contain a number of exemptions. One of these is the EAT. The other exemptions are a motive 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.
3. The total yield from the measures is estimated at #200m for a full year. The measures also provide protection against revenue loss.
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