State Aid In Disguise?—EC Investigates UK Tax Regime

In Short

The Background: The European Commission has opened an in-depth investigation into a specific provision of the UK-controlled foreign company rules.

The Issue: The Commission will investigate whether the UK's so-called Group Financing Exemption unfairly allows these multinationals to pay less UK tax, in breach of EU state aid rules.

Looking ahead: The investigation is part of a broader trend of cases in which the Commission has targeted provisions in Member States' tax legislation that it feels are capable of constituting unfair and improperly advantageous fiscal arrangements; but this one raises new political issues given the UK's "Brexit" vote.

The European Commission ("Commission") has launched an in-depth antitrust investigation into a UK tax regime that provides for an exemption to the UK's Controlled Foreign Company ("CFC") legislation, which the Commission believes may allow multinational companies to benefit from an unlawful, selective tax advantage in breach of European Union ("EU") state aid rules.

The UK's Controlled Foreign Company Regime

The general purpose of the UK's CFC rules is to preclude UK companies from using a subsidiary, based in a low- or no-tax jurisdiction, to avoid taxation in the UK on income that would have been taxed or taxable there or in another higher-taxed jurisdiction. Under these rules, the UK tax authorities can effectively reallocate all (or the relevant proportionate share of) profits of such an offshore subsidiary back to the UK parent company, where it can then be subject to normal UK tax.

However, since 2013, the UK's CFC rules have included an exception for certain types of group financing income (i.e., the interest payments received from intragroup loans) of multinational groups active in the UK—the Group Financing Exemption ("GFE"). Generally speaking, financing arrangements are often seen by tax authorities as giving rise to a risk of profit shifting by multinational groups, especially given the mobility of capital. The Commission argues that "by exempting from reallocation to the UK ... the financing income received by an offshore subsidiary from another foreign group company, a UK-based multinational can provide financing to a foreign group company via an offshore subsidiary and thereby pay little or even no tax (depending on where the foreign finance affiliate is located) on the profits derived from these sorts of transactions. This is because:

The offshore subsidiary pays little or no...