Reforms To The UK Controlled Foreign Companies Regime

Government proposals to simplify tax rules while promoting the interests of business are always welcome, and this is especially true of the proposed reforms to the United Kingdom's Controlled Foreign Company ("CFC") legislation. The Government has released the final legislation as part of the Finance Bill 2012 after much discussion and consultation. The new regime will apply to accounting periods of CFCs beginning on or after 1 January 2013. In this Commentary, we provide a summary of the history of the CFC rules and discuss the proposed changes. We also consider the opportunities that the new legislation presents for multinational businesses. The new regime will allow some UK multinational companies that are currently taxed under the CFC regime to fall outside the scope of the new rules. For companies looking to expand into the UK or considering an expansion into Europe through the UK, the new CFC regime should make the UK a more attractive place for such businesses.

History of the CFC Rules

The UK introduced CFC rules in 1984 in response to a perceived increase in tax deferral and artificial diversion of profits to lower-tax jurisdictions following the relaxation of UK exchange controls. Such rules are a common feature of many tax systems that seek to bring profits accumulated outside the jurisdiction within the charge to tax. For example, the rules contained in Chapter 1, Subchapter N, Part III, Subpart F of the US Internal Revenue Code seek to bring the income of US CFCs within the scope of US tax.

Current CFC Rules (for accounting periods beginning before 1 January 2013)

Under the current UK rules, where a company is a CFC and does not fall within one of the specified exemptions, all the profits of that CFC may be apportioned among its participators (broadly, its shareholders). A company is a CFC where the following three criteria are met: (i) the company is not resident in the UK; (ii) the company is controlled by UK residents; and (iii) the company pays a lower level of taxation (i.e., less than 75 percent of the tax that would have been paid had the company been resident in the UK). A CFC can fall outside the scope of the rules and therefore avoid an apportionment of its profits if it satisfies any one of the following five statutory exemptions. These exemptions are parallel tests, in that they may be applied in any order. The exemptions exclude CFCs that: (i) have profits below the de minimis limit1; (ii) operate an acceptable distribution policy2; (iii) carry on certain exempt activities3; (iv) are resident in certain excluded countries4; or (v) do not have a tax avoidance motive5. Where the exemptions do not apply, any UK corporate...