Analysis Roadmap to the CFC regime SPEED READ This article aims to help the reader navigate the upcoming changes to the controlled foreign company (CFC) rules, applicable to CFCs for accounting periods beginning on or after 1 January 2013. The article compares the new CFC rules (TIOPA 2010 Part 9A) with the old (found in ICTA 1988 Part 17, Chapter 5 and Sch 25) in tabular format through the use of a case study, together with a decision tree and suggested road map through the business profits gateways. Martin Lambert is Head of International and Corporate Tax at Grant Thornton UK. He has extensive experience of advising large multinational companies on all aspects of international tax structuring including tax-efficient financing and profit repatriation. Email:
[email protected]; tel: 020 7728 2363.
Zoe Wyatt is an International Tax Senior Manager at Grant Thornton UK. Specialising in international tax, she typically advises on group structuring for tax efficient profit repatriation and exit strategies, finance company structures and has a special interest in double tax treaty interpretation and application. Email:
[email protected]; tel: 020 7728 2435.
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For related reading, visit www.taxjournal.com: FA 2012 analysis: CFCs: the new regime (Andy Boucher, 6.9.12) A changing European landscape (Drew Bailey, 18.4.12)
he controlled foreign company (CFC) reform is, for now, complete; enacted in FA 2012 and codified in the TIOPA 2010 Part 9A, it is effective for accounting periods beginning on or after 1 January 2013. While the final legislation is an improvement on the earlier consultation drafts, the rules remain fiercely complex and we still await full and final HMRC guidance in respect of a substantial part of the new regime (the draft partial guidance is available at lexisurl.com/9KgI6). The purpose of this article is to create a quick reference guide that will help navigate the provisions that will most commonly be used. It begins with a comparison table of the old (found in ICTA 1988 Part 17, Chapter 5 and Sch 25) and new rules, followed by a very high-level case study to highlight the considerations in assessing whether a CFC charge arises. All legislative references are to TIOPA 2010 Part 9A unless otherwise stated.
Overview of new CFC rules Table 1 sets out, at a high level, familiar concepts and terminology used under the old rules and their equivalent or similar under the new rules.
Diagram 1
Trade subs 75%
Trade Co Malta
New Acquisition Cyprus
Low Profit Co
Assume all entities are controlled 100% and accounting periods start 1 January.
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Case study
Irish Hold Co
Foreign Finance Co
New HK Co
Irish Trade Co
www.taxjournal.com ~ 14 September 2012
Diagram 2 walks through the questions the taxpayer must answer to determine whether any condition is met. The grey italics in Diagram 2 offer some guidance in interpretation of the questions asked.
Detailed gateway test: Ch 4: Profits attributable to UK activities This gateway is significantly more complex than the initial business profits gateway, although it includes four exclusions to reduce or eliminate a CFC. The step plan (Diagram 3) demonstrates the best approach to the detailed business profits gateway to minimise the compliance burden. Step 1: By applying the trading profits exclusion (aka safe harbour) first the complexity of this gateway can be bypassed. If the conditions of this safe harbour (s 371DF) are not met, it will be
necessary to next identify UK ‘significant people functions’ (SPFs). This will require a functional and factual analysis. A group’s existing transfer pricing document may help support this process but will unlikely contain all the required information. Step 2: The gateway seeks to identify and charge to UK tax, profits of the CFC that arise on assets it owns and risks it bears as a result of active day-to-day management of those assets or risks being undertaken in the UK. These UK activities are effectively SPFs. Where UK SPFs exist, the legislation deems them to create a UK PE. Step 3: The legislation requires profits to be attributed to the deemed PE following principles set down in the OECD Report on the Attribution of Profits to a PE. However, before carrying out such a lengthy attribution exercise the
Diagram 2 Condition A Motive/purpose
Condition B No UK managed or controlled assets or risks
Condition C Commercially effective
Does the CFC hold any assets or bear any risks under an arrangement*? *any agreement, scheme or transaction or understanding whether legally enforceable or not.
Are there UK activities that contribute to bearing of risks or the creation, acquisition, development or exploitation of assets held by the CFC? Include activities specifically in relation to the CFC and its assets or risks rather than more generally in relation to the group or activities carried out by the parent in its role as shareholder.
If the CFC has UK managed or controlled assets or risks, Condition C may still allow for no profits to pass through the gateway.
YES
NO
Condition A met
Is the main purpose or one of main purposes of the arrangement to reduce UK tax? Assess by considering alternatives and comparing the non-tax benefits of the alternatives and the arrangement – tax benefits of arrangement must be > negligible. YES
NO
Condition A met
Does the CFC expect its business to be more profitable as a result of the arrangement? YES
NO
Condition A met
Is there an expectation that one or more persons will have liabilities, to tax or duty under law of any territory, reduced? YES
NO
Condition A met
Is it reasonable to assume that, without the expectation, the arrangement would not be made? YES Condition A not met
YES
NO
Condition B met
Are these UK activities carried on by the CFC, or by companies connected with the CFC under arrangements that would mean they could not be replaced by unconnected companies? Evidence the latter with benchmarking of similar companies. This question is seeking to catch arrangements that would require control or restrictions being imposed on an unconnected party. YES
NO
Condition B met
Is this to a 'significant' extent? This requires a greater degree of involvement in active decision making in relation to assets and risks than the setting of general parameters, strategy or guidelines. Active day-to-day decision making should not take place in the UK – where guidance given from the UK on specific matters one must consider the skills and capacity of the CFC's staff to understand and evaluate the guidance to make appropriate decisions that take account of it.
NO Condition A met
14 September 2012 ~ www.taxjournal.com
YES Condition B not met
NO Condition B met
Does the CFC have the capability to ensure that its business is commercially effective, were the assets or risks to stop being managed? Ie, the CFC is fully competitive, capable of exploiting all its assets efficiently and delivering an appropriate return on the resources invested in it. YES
NO
Condition C NOT met
Can the CFC be commercially effective without altering its business in anyway? YES
NO
Condition C NOT met
If, in order to be commercially effective, the CFC needs to outsource the UK activities to a third party, can this third party be unconnected? (Note, if the CFC already has support from non-UK connected parties this does not have to be disregarded) YES Condition C met
NO Condition C not met
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Table 1 Old CFC rules
New CFC rules
Control test for definition of CFC
50% ownership, entitlement to assets on winding up and voting power by a UK company represent the requisite control to render the subsidiary a CFC. (Note: where a joint venture exists between a UK company and an overseas company the ownership test is reduced to 40% for the UK, provided the overseas company owns between 40% and 55%) (ICTA 88 s 747(1A)).
New definition of control essentially remains the same, considering control of company’s affairs and economic control over the CFC’s income and assets (Ch 18). There is a new measure whereby control will exist where a person is a parent of the CFC for the purposes of accounting consolidation under FRS 2 (s 371RE).
Foreign – requirement for the foreign company to be non-UK resident for definition of CFC
Non-UK resident company (ICTA 1988 s 747(1) (b) s 749B).
Non-UK resident company (s 371AA(3)) or exempt foreign branch (s 371AA(3)).
Dual resident (UK incorporated, treaty non UK resident)
Deemed UK resident for the purpose of CFC legislation (ICTA 1988 s 747(1B)).
Not considered UK resident for the purpose of the new CFC legislation (Ch 20).
Lower level of tax
Forms part of the CFC definition – broadly less than 75% of the tax that would be due if the CFC were a UK resident company (ICTA 1988 s 747(1)(c) and s 750).
No longer forms part of the definition of a CFC – instead it will form the basis of the tax exemption (Ch 14) and is broadly still at least 75% of the UK tax that would be due if the CFC were UK resident.
De minimis exemption
De minimis exemption for CFC profits less than £50,000, subject to certain conditions (ICTA 1988 s 748(1)(da)).
Two new similar exemptions: 1. The low profits exemption which exempts CFCs with: accounting profits of ≤ £500,000 and non-trading income ≤ £50,000. 2. Low profit margin exemption available if: accounting profits (before interest deductions) ≤ 10% operating spend (with certain expenditure excluded).
Exempt period
The CFC could be exempt from charge in certain scenarios for 24 months after its accounting period end (ICTA 1988 Sch 25 Part 3A).
Exempt period exemption where CFC may benefit from a 12-month grace period provided no CFC charge arises after the end of that 12-month period (s 371JB) eg, by virtue of restructure or availability of exemptions/failure of gateway tests. The 12-month period can be extended by notice by the taxpayer, subject to agreement by HMRC (s 371JD).
Exempt activities test
CFC exempt from charge where gross receipts 20% of aggregate value
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Table 2 Entity
Facts
Old CFC rules
New CFC rules
Trade subs >75% UK rate
UK group has wholly owned foreign trading subsidiaries that are taxable at more than 75% of the UK tax that would be due.
These entities are not CFCs as they are not subject to a ‘lower level of tax’ (ICTA 1988 s 747).
These entities are CFCs as 'lower level of tax test' removed (s 371AA(3)). Consider if 'the tax exemption' applies (Ch 14).
Trade subs
