The United Kingdom may be about to leave the European Union but that hasn’t stopped the EU from policing its tax rules.On October 26, the European Commission opened an in-depth investigation into aspects of the UK’s controlled foreign companies (CFC) rules, this tax probe is causing something of a stir in the business world.
The CFC Rules
The CFC regime is intended to prevent UK companies from using a subsidiary based in a low- or no-tax jurisdiction to avoid taxation in the UK. In particular, the rules allow the tax agency to reallocate all profits artificially shifted to an offshore subsidiary back to the UK parent company, where it can be taxed accordingly.
The Group Financing Exemption
The Commission is examining a rule exempting certain transactions by multinational groups from the CFC regime, known as the Group Financing Exemption (GFE). In summary, this allows a company meeting certain criteria to establish a foreign finance subsidiary and pay tax on 25 percent of its intra-group financing profits at the UK corporation tax rate. By using this rule, designed to remove tax barriers to intra-group treasury operations, effective UK tax on the CFC’s profits is reduced to 4.75 percent.
The Commission’s Case
According to the Commission, this exception allows a multinational company active in the UK to provide financing to a foreign group company via an offshore subsidiary and pay little or no tax on profits from these transactions. It is concerned that companies covered by the regime may enjoy a “selective advantage” over other similarly situated taxpayers rendering the exemption a form of unlawful state aid.
If the investigation concludes the GFE does constitute illegal state aid, the UK Government may be obliged to repeal or modify the exemption and to recover any tax benefit improperly derived by the companies in question.
It seems that the Commission’s investigation is linked to its wider examination into tax privileges granted to multinational companies in the wake of the LuxLeaks affair. However, tax experts have questioned its relevance.
The exemption bears little resemblance to the so-called “sweetheart” tax deals alleged to have been agreed between multinationals and member states, including Ireland, Luxembourg and the Netherlands.
What’s more, the timing of the probe is curious, given that the UK will be leaving the EU in less than two years as things stand. State aid cases often drag on for years if appealed through the EU courts, yet the UK may soon no longer fall under EU courts’ jurisdiction.
It has also been suggested that the investigation’s cost could vastly outweigh any tax to be recovered.
For companies that are benefiting from the exemption, the immediate consequence is tax uncertainty. They will now have to decide whether to restructure their tax affairs, or hope that any unfavorable decision by the Commission can be successfully seen off.
However, there are also wider ramifications for the EU tax environment. This case demonstrates that the Commission is willing to challenge any law or ruling that may have allowed multinationals to unfairly avoid tax, and this could fuel more uncertainty as taxpayers ponder where the state aid probes will be focused next.