| UK Corporate
Taxation for Multinationals |
Corporate
Taxation for Resident Multinationals
If
a multinational corporation (meaning, a company with subsidiaries
or affiliates in more than just one or two countries) needs
to be based in a high-tax country, for instance because it
must have a listing on a major stock exchange, then the UK
is often a good choice. As a member state of the EU, the UK
is within the EU parent-subsidiary directive, and in addition
the UK has a very broad network of double tax treaties, so
that it is well-placed to receive dividend income with the
lowest possible amount of foreign tax deduction.
However,
this advantage has been somewhat compromised by measures in
successive Finance Acts to limit international tax planning
by multinationals.
Firstly,
the UK's Controlled Foreign Company rules have been tightened
to the point at which only marginal benefits can be obtained
by locating a subsidiary in a low-tax jurisdiction. In addition,
enabling legislation in the 2002 Finance Act allowed the British
government to alter the tax treatment of controlled foreign
companies in jurisdictions which were considered to allow
'harmful tax practices'.
Secondly,
the use of tax 'mixing' intermediate companies in such jurisdictions
as Holland and Denmark was severely pruned back by the Finance
Act 2000. Whereas it used to be possible to use, say, a Dutch
holding company to mix dividends from foreign subsidiaries
taxed at say 10% and 50% to achieve a blended rate of 30%,
thus ensuring that only a very small amount of UK corporation
tax would be payable, the rules were changed.
One
improvement that should be noted, however, was the abolition
of the ACT (Advance Corporation Tax) withholding tax in 1998:
although corporation tax is now payable earlier than before,
the problem of excess ACT has disappeared.
Dividends
to both resident and non-resident shareholders are paid without
deduction of withholding tax.
Another
improvement, contained in the 2001 budget, was the abolition
of withholding tax on interest and royalty payments to companies
subject to UK corporation tax.
Gordon
Brown announced the extension of the abolition of withholding
tax on international bonds and intra-UK payments of interest
and royalties, to include non-bank entities, such as venture
capital companies.
While
this announcement was welcomed by British industry, there
was disappointment that the change was not more far-reaching.
The Chartered Institute of Taxation made the following suggestion
for further reform:
"We are disappointed that this will only apply where
the recipient company is within the charge to UK corporation
tax. Gross rental income may be received by non-resident landlords
who have undertaken to comply with UK tax obligations, and
we would suggest that consideration be given to the introduction
of such a scheme for the receipt of interest and royalty payments
by those outside the charge to UK corporation tax."
Some
further improvements to the withholding tax regime were included
in the 2002 Finance Act
As
a result of the accumulation of negative measures imposed
by the Treasury, it was reported in December, 2004, that leading
tax advisers and accountancy firms such as PricewaterhouseCoopers
and KPMG were advising their international clients to avoid
establishing operations in the United Kingdom.
One
favourable development for existing UK-based multinationals
was (and is) the gung-ho attitude of the European Court of
Justice, which is rapidly tearing down national fiscal barriers
inside the EU. In 2002 it ruled against fiscal exit penalties
on corporate relocation.
In
a preliminary hearing of the Conseil d'Etat v de Lasteyrie
du Saillant case, the ECJ's Advocate General decided that
the French government had violated the freedom of establishment
provisions contained within EU law by levying a punitive residential
exit tax on an individual who wanted to transfer his tax residence
out of France.
Several
of the EU's member countries impose company emigration exit
charges. They include the UK, France, Germany, Italy and Spain.
The huge tax penalties act as a deterrent on companies wanting
to relocate to other member states where running costs are
less.
Tax
charges vary from country to country, but most countries,
including the UK, levy a penalty of about 30% of the value
of a company's capital assets. Individuals must often pay
up to 40%. These have, however, come under attack from the
European Commission, which considers such taxes in breach
of EU freedom of establishment laws.
The
ECJ has ruled against national governments in a number of
cases involving freedom of establishment, and in August 2003
the English High Court followed ECJ precedents in a test case
brought by Deutsche Morgan Grenfell, concerning EU 'freedom
of establishment' and anti-discrimination laws.
Mr
Justice Park's decision in the High Court was the conclusion
of a case first initiated when 50 companies submitted a group
claim in the English courts as the result of an European Court
of Justice precedent which ruled that the British government
had illegally imposed advance corporation tax.
Under
the rules which applied until the 2001 and 2002 reforms of
corporation tax, UK subsidiaries of European firms were wrongly
made to pay tax on dividends repatriated to their continental
parent companies.
Although
tax law in this area has since changed (as mentioned above),
the UK investment banking arm of the German bank was attempting
to establish how far claims of wrongly paid tax can be backdated.
The
Inland Revenue (now HMRC) argued that the claims are restricted
to a six year period by the 1980 Limitation Act. However,
Justice Parks ruled otherwise, announcing that such claims
were not time-barred by the 1980 Act.
However,
he added that: "This is not a result which I reach with much
enthusiasm."
A
further blow for national treasuries came in September 2004
when the ECJ ruled that the Netherlands' domestic tax law
on 'exempt participations' was discriminatory and as a consequence,
unlawful.
The ruling related to a case involving Bosal Holdings, a Dutch
manufacturer of car exhausts which acquired a number of European
firms during the 1990s, and was prevented from claiming tax
relief for interest paid on borrowings financing subsidiaries
which did not generate income taxable in Holland.
The
ECJ found that this breached Bosal's fundamental 'freedom
of establishment' rights, laid down in the founding Treaty
of Rome, and therefore upheld its claim against the Dutch
government.
The
ECJ decision was expected to benefit many firms elsewhere
in the union which had similar claims pending against national
governments.
One
such company was UK retail firm Marks and Spencer. M&S argued
that under Article 43 of the European Union Treaty, it should
be allowed to offset losses of around 160 million euros made
by its French, Belgian, and German subsidiaries between 1997
and 2001 against UK profits, claiming a tax refund of GBP30
million.
In
March 2005 came the initial result of the much-followed Marks
and Spencer case, in which Advocate General Mr Poiares Maduro
agreed with the company. European Union finance ministers
however vowed to find a "defence mechanism" to counter the
likelihood of tax revenue shortfalls should the British retailer
ultimately be successful in its legal bid to offset losses
made by foreign subsidiaries against tax.
The
issue formed one of the main talking points during an Ecofin
meeting of EU finance ministers. "There is great concern about
this," remarked Jeannot Krecke, Economy Minister of Luxembourg,
which was holder of the rotating EU presidency at that time.
The
Advocate General's opinion was supported later that year by
the full ECJ.
With
regard to CFCs, further changes were brought forward in the
2005 budget. The 2005 Controlled Foreign Companies (Excluded
Countries) (Amendment) Regulations aimed to prevent CFCs from
manipulating their profit location in order to evade taxes,
to stop them from secreting income in non-corporate entities,
and to exclude them from receiving the benefits of the CFC
regime if they are not liable for tax in another country.
The measures came into full force on March 31st.
A
spokesman for the Inland Revenue (as HM Revenue & Customs
was known at the time) explained that: "All of the changes
made are a reaction to schemes including some that were identified
via the disclosure rules. The government could not have allowed
significant amounts of tax to remain at risk."
In
February 2006 HM Revenue and Customs won an important legal
battle when the House of Lords ruled that companies which
claimed a tax credit on a dividend paid to a foreign parent
cannot claim a refund of advanced corporation tax.
The
group litigation was brought by more than 60 companies and
led by Pirelli, the Italian tyre manufacturer, which claimed
that the obligation to pay advance corporation tax (ACT) in
the UK on dividends it paid to its Dutch parent was in breach
of European Union law concerning taxes levied on dividends.
Although
the Dutch parent had received a repayment of 50% of the tax
credit attached to the dividend under the tax treaty between
the UK and the Netherlands, it claimed that the parent's right
to receive the credit was legally separate from any obligation
of the subsidiary to pay ACT.
However,
in overturning judgments by the High Court and the Court of
Appeal, Lord Nicholls, one of the five judges on the panel,
said that Pirelli was looking to obtain "the best of both
worlds."
In
February, 2006, the ECJ seemed set to confirm the House of
Lords ruling, when Advocate General Leendert Geelhoed stated
that whilst the UK tax authorities were required to treat
non-UK firms fairly, there was no pre-requisite for equal
treatment.
Consequently
the UK was entitled to enter into different tax treaties with
different countries and did not need to offer the same benefits
to everyone. In his opinion, Mr Geelhoed noted that this was
an area where "predictability and legal certainty are crucially
important, so that Member States can plan their budgets and
design their corporate tax systems on the basis of relatively
reliable revenue predictions.”
Following
up on the M & S case, the United Kingdom government announced
in February, 2006, that it would introduce legislation in
the Finance Bill 2006 to amend the UK loss relief rules.
According
to the UK government, the ECJ considered that the country's
group loss relief rules are in principle compatible with European
law, meaning that the system of group relief can be kept broadly
as it is now, although the Court also held that, in some very
limited circumstances, relief should be available in the UK
for the otherwise unrelievable losses of some group companies
resident in other States.
However,
the government fears that groups with loss-making companies
resident in another state could "engineer" their circumstances
so as to preclude the possibility of a loss making company
obtaining relief in its state of residence by, for example,
liquidating that company whilst transferring its business
to another company.
In
response, the government introduced legislation to deny loss
relief where there are arrangements which either: result in
losses becoming unrelievable outside the UK that were otherwise
relievable, or; give rise to unrelievable losses which would
not have arisen but for the availability of relief in the
UK, if the main purpose or one of the main purposes of those
arrangements is to obtain UK relief.
The
legislation was to be effective from Monday, February 20 of
that year.
Then
in April, 2006, the European Court of Justice Advocate General,
Leendert Adrie Geelhoed, gave an opinion in favour of four
UK companies who had claimed that corporation tax charged
on dividends received from EU subsidiaries was illegal under
EU free movement of capital rules.Between 1973 and 1999, when
the UK scrapped its Advanced Corporation Tax system, which
allowed UK companies to pay up dividends domestically at a
favourable rate, dividends from non-UK EU subsidiaries of
UK companies were charged at higher rates.
Although
the four companies in the case, British American Tobacco,
British Petroleum, Aegis Group and Imperial Chemical Industries,
were claiming refunds of 'only' some hundreds of millions
of pounds, the UK government warned during court proceedings
that the total cost of an adverse ruling might be as high
GBP7 billion if many companies applied for refunds, and that
the ECJ should therefore reject the companies' case on the
grounds that the UK's financial stability could be affected.
Mr.
Geelhoed denied this reasoning.
In
December 2006, the European Court of Justice followed his
opinion, and ruled that ACT operated illegally between 1973,
when the UK acceded to the EU, and 1999, giving rise to the
prospect of substantial rebates to companies which have paid
this tax in the past.
The
Treasury warned that such a ruling could leave it open to
repay claims totalling GBP9 billion, although draft blocking
legislation which would limit a company's claims to six years
would reduce this to about GBP2 billion, the government has
estimated.
“In
principle, today’s decision is good news for companies
hoping for an ACT rebate. However, they are unlikely to receive
anything until the UK and European courts reach a decision
as to the legal status of the blocking legislation –
a process that is likely to take some time," observed
Jonathan Bridges of KPMG’s EU law group at the time.
The
Court referred the matter back to the UK courts to determine
whether the UK rules operate to achieve this parity.
“It
is disappointing that the ECJ has stopped short of ruling
that the UK should apply the same rules to both UK and foreign
sourced dividends," Bridges noted.
He
continued: “Achieving equality of treatment via a credit
system may, on the face of it, sound reasonable but it is
not straightforward."
"The
ECJ’s ruling today fails to fully appreciate the fact
that not all profits in the UK are taxed at the corporate
tax rate of 30%. For example those deriving from share sales
are completely exempt."
Bridges
concluded:
"What
today’s ruling does is potentially introduce yet another
layer of complexity into the UK’s already overly cumbersome
corporate tax system.”
In
2007, the UK
Finance Bill implemented changes to the Controlled Foreign
Company regime made in response to the previous year's high-profile
Cadbury-Schweppes decision by the European Court of Justice.
Although
CFCs were not mentioned in the Chancellor's March Budget speech,
the Treasury released a detailed response to the ECJ's decision,
which commentators said represented the minimum that the Government
could have done to comply with Cadbury.
The
new provisions restricted the application of CFC rules to
profits arising from the activities of employees but not of
capital, meaning that they will only become significant in
respect of trading operations in a 'low-tax' EU or EEA territory.
The ECJ did not make such a distinction. To the disappointment
of many tax advisers, the Treasury did not provide for an
advance clearance mechanism for the CFC regime. In addition,
the Treasury stiffened the effective management test, making
it more difficult for EEA-based companies to satisfy the Exempt
Activities exemption.
Then
in July 2008, it emerged that Vodafone had won a key legal
battle against the UK tax authority in a judgment that cast
major doubt on the compatibility of the UK's controlled foreign
companies (CFC) regime with European Union law.
Mr
Justice Edward Evans-Lombe ruled in the High Court on 4th
July that Vodafone does not have to pay UK corporation tax
on income attributed to its Luxembourg holding company Vodafone
Investments Luxembourg Sarl (VIL). Consequently, he ordered
HMRC to shut an ongoing tax inquiry into Vodafone's tax for
the year to March 2001.
Vodafone
estimated that the court victory has saved it more than GBP2bn
(USD4bn) in tax and interest that it might have been ordered
to pay had the judgment gone against the company.
However,
the ruling also had ramifications that go much wider than
Vodafone's corporate arrangements, and several UK-based multinationals
with subsidiaries in favourable EU tax jurisdictions such
as Ireland, Luxembourg and the Netherlands, who are said to
be under a similar type of scrutiny from HMRC, are likely
to be breathing a sigh of relief as a result.
The
case dates back to 2002 after Vodafone set up VIL to dispose
of its shares in the German telecommunications group Mannesman,
which it acquired in 2000. VIL is also used to circulate cash
and profits around the group and as a vehicle to fund other
acquisitions.
HMRC
argued that under the UK CFC rules, it had the right to tax
the difference between rate a subsidiary pays in a low tax
jurisdiction overseas and the rate it would have paid on that
income in the UK - a principle that it attempted to apply
in the Vodafone case.
However,
Justice Evans-Lombe referred back to a precedent set in 2006
by the European Court of Justice (ECJ) in the case involving
Cadbury-Scweppes, which said that the UK CFC rules were incompatible
with EU law because they were too restrictive and should only
be applied in cases where companies set up artificial arrangements
aimed solely at avoiding tax.
While
the UK Treasury moved to amend CFC regulations in the wake
of the Cadbury-Schweppes ruling, Justice Evans-Lombe argued
that these amendments had not gone far enough to address their
incompatibility with EU law, and he urged the government to
revisit the legislation.
"In
my judgement, the CFC legislation must be disapplied so that,
pending amending legislation or executive action, no charge
can be imposed on a company such as Vodafone under the CFC
legislation," he said, going on to add that:
"It
seems to me that all UK taxpayers, including Vodafone, were
and are entitled to be told by legislation, of which the meaning
is plain, what the tax consequences for them will be if they
decide to incorporate a controlled foreign company in a (EU)
member state."
The
UK government was in the process of reviewing its stance on
the taxation of multinationals' international income at the
time of the July ruling, but tax experts said that the latest
judgment had thrown the situation into chaos, and may have
left the UK with a completely unenforceable set of CFC legislation.
“The
High Court has expressed ‘some doubt’ as to the
efficacy of sticking plaster amendments introduced in 2006,”
Mark Persoff of Clifford Chance, the legal firm was quoted
as saying by the Financial Times. “This means, as matters
now stand, the UK probably has no enforceable CFC legislation
so far as EU/EEA subsidiaries are concerned.”
Peter
Cussons, a tax partner at PriceWaterhouseCoopers, described
the ruling as a "blockbuster judgement."
"This
is big news because there are thousands of UK companies with
foreign subsidiaries in the European Union," he told
the Telegraph. "There will have been CFC tax paid over
the years, hundreds of millions of pounds per annum, and potentially,
upon claims being made, all that tax is up for grabs,"
he added.
Vodafone
suffered a court setback in May 2009 in its bid to avoid the
UK back tax bill in relation to VIL when the Court of Appeal
ruling overturned the 2008 decision by the High Court that
Vodafone does not have to pay UK corporation tax on income
attributed to its Luxembourg holding company.
The
Court of Appeal decided that the UK’s CFC law should
be interpreted as if it had a new exception for companies
established in the European Economic Area (EEA) which carry
on ‘genuine economic activities’ there. This means
that the CFC rules will still apply to companies operating
outside the EEA and also to EEA companies without genuine
economic activities.
The
decision meant that HM Revenue and Customs could reopen its
inquiry into Vodafone’s tax arrangements for the year
to March 2001.
The
UK Supreme Court, which replaced the House of Lords as the
country's highest court in 2009, refused to hear the company's
appeal fo the Court of Appeal ruling.
According
to law firm McGrigors, the Supreme Court's decision to throw
out the case was unexpected, as most tax specialists had anticipated
that, given the potential ramifications of the case, the Supreme
Court would review the matter.
“This
shows that the Supreme Court will not hear cases simply because
of the amounts at stake," observed Rupert Shiers, a partner
at McGrigors.
Shiers
added that Vodafone had won a "convincing" victory
in the High Court in 2008 and can be "entitled to be
surprised and very disappointed not to be allowed their day
in court”.
“HMRC
will see this as a major victory," he noted. "They
were shocked to hear people arguing that once the ECJ intervenes
to say that a piece of legislation is not quite right, the
whole legislation is poisoned and it simply falls away. The
courts have now said very clearly that you should just cut
out the infection and leave the healthy parts intact.”
BACK
TO TOP
Foreign Profits And CFC Reforms
The
Finance Act 2009 foreign profits package was expected to be
implemented during 2009 and includes:
- A
dividend exemption for most foreign dividends irrespective
of the level of shareholding
-
Interest cap, a comparison of a UK tax group’s gross
intra-group finance expense with the global group’s
net finance expense after excluding gross external finance
expense of the UK tax group, with some corresponding UK
taxable income exclusions.
-
Super para 13 looks to whether any group company, and not
just the borrower, is part of arrangements whereby there
are increased debits or reduced credits, and is currently
very wide reaching.
-
Controlled company regime to be modified to remove the ADP
exemption and holding company tests, with a further review
after Budget 2009.
-
Treasury consent to be repealed and replaced by a retrospective
quarterly reporting requirement.
In May 2009, Stephen Timms, Financial Secretary to the Treasury,
announced that the government has amended its proposed changes
to the taxation of foreign profits in an effort to simplify
the legislation.
A
letter circulated by Timms on April 30 explained that changes
to the debt cap element of the reforms will be inserted into
the 2009 Finance Bill, which was published on the same day,
following discussions with business.
“The
legislation in the bill has been subject to extensive consultation
over the past year, and we have worked to ensure the responses
are accommodated, where possible, and the bill is as complete
as it can be,” Timms wrote.
In
its original form, Clause 34 and Schedule 14 of the 2009 Finance
Bill determine the scope of the corporation tax charge on
both UK and foreign company distributions. According to the
relevant Budget Note, the result of the reforms, due for introduction
on July 1, 2009, will be that the great majority of distributions
will be exempt from corporation tax. The Schedule also contains
anti-avoidance rules to prevent abuse of distribution exemption.
Clause
35 and Schedule 15 of the Finance Bill make provision for
the restriction of the tax deduction available for finance
expenses of groups of companies (the 'debt cap'). The effect
of the new measure is to limit the aggregate UK tax deduction
for the UK members of a group of companies that have net finance
expenses to the consolidated gross finance expense of that
group.
Timms
stated, however, that “a couple of areas” of the
proposed reforms “have given rise to significant comment.”
These include the exclusion for financial services and the
targeted anti-avoidance rule. “We plan further discussions
(on these two aspects of the reforms) before the final legislation
is published,” Timms explained.
“There
are also points of detail relating mainly to further exclusions
and interaction with other parts of the tax code that have
not yet been reflected in the Bill because of time constraints,”
Timms continued. “Proposed amendments to be made during
the passage of the bill for these straightforward areas will
also be published on HMRC’s website.”
The
areas concerned include:
- Rules
allowing groups to state they are satisfied that their tested
expense amount, if calculated, would be less than their
available amount for any particular period of account of
the worldwide group.
-
The definition of the available amount will be amended to
include capitalized interest.
-
The calculation of the UK measure and worldwide measure
– providing a method whereby the comparison is made
using the functional currency rather than sterling.
-
Provision will be made to cater for exempt financing income
received by charities, non-departmental public bodies, educational
establishments, local authorities and health service bodies.
-
Where a company brings into account a loan relationship
debit on a paid basis, rules to disregard any amounts accrued
but unpaid for periods of accounts of the worldwide group
before the debt cap applies.
-
A consequential amendment to Schedule 28AA to make clear
that this Schedule applies before the debt cap to any amount
of financing expense of financing income.
-
A consequential amendment to ensure that profits of a controlled
foreign corporation apportioned to a UK group company are
not doubly taxed in respect of any finance expense amount
payable to that CFC.
In
Janaury 2010, The UK government published a discussion document
on proposals for reforming the UK tax treatment of CFCs.
The
proposals set out in the discussion document are intended
to enhance the competitiveness of the UK, while providing
adequate protection of the UK tax base. The discussion document
sets out the overarching framework of the new rules and proposals
for how monetary assets and intellectual property could be
treated.
The
reforms aim to address growing concern from business that
the UK's CFC rules are too complex and reverse a steady flow
of companies shifting their tax bases to jurisdictions considered
to have more business-friendly tax regimes such as Ireland,
Luxembourg and Switzerland.
In
an attempt to achieve this, the discussion document sets out
proposals for a more targeted CFC regime to catch profits
being artificially diverted to low-tax jurisdictions, rather
than a "one size fits all" approach.
The
discussion document also outlines possible approaches to reform
the treatment of intellectual property with the aim of more
effectively targeting situations "where there is a risk
of erosion of the UK tax base."
The
current CFC rules generally target income from IP on the grounds
that it is passive income from a mobile asset. The government
is therefore concerned that there is a risk that UK tax can
be avoided through the artificial movement of intellectual
property (IP) into a low tax jurisdiction. Business, however,
has emphasized that many offshore IP companies undertake genuine
and effective management activity with the aim of maintaining
or increasing the value of their IP, and that a new CFC regime
should reflect the extent to which active management of IP
takes place offshore.
One
proposal for a new regime would be to identify companies that
carry on sufficient IP management activity offshore and to
exempt these companies from the CFC rules. However, the paper
also suggests that an additional tax charge be applied in
certain circumstances, for example where IP is transferred
out of the UK before its value can be accurately determined.
The
discussion document also highlights the need for the new CFC
rules to interact efficiently with current UK transfer pricing
rules, and points out that the proposed "patent box"
regime announced in last month's pre-budget report, which
will offer a reduced rate of corporate tax on patent income,
will have a bearing on the reforms.
Financial
Secretary to the Treasury Stephen Timms said: “Modernizing
these rules is crucially important to maintaining and enhancing
the UK’s attractiveness as a base for global business.
This report, drawing on our discussions with businesses, is
a key step in designing a system that better recognizes the
way multinationals operate today, while protecting our tax
base.”
This
reform is the second part of the foreign profits package.
The first part was introduced in Finance Act 2009 and included
an exemption for foreign dividends and an interest restriction
measure.
The
consultation period for this discussion document began on
January 26 and runs to April 20, 2010. The government aims
to release a further document on the proposals along with
draft legislation later in 2010, with a view to legislating
in the 2011 Finance Bill.
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