UK and International Tax news

BP Issues Annulment Action Against EC in Relation To UK CFC Group Finance Exemption

Tuesday 31st December 2019

BP has recently commenced annulment action against the EC’s state aid decision relating to the UK’s CFC Group Finance Company Exemption.

Details of the action have now been published by the EC and these include nine separate pleas in law similar to those in the UK Government’s own annulment action against the earlier decision of the EC that part of the UK’s CFC GFE constitutes state aid.

The general purpose of the UK’s CFC rules is to prevent UK companies from using subsidiaries, based in low or nil tax jurisdictions, to avoid tax in the UK. Since 2013, the CFC rules have included an exception for certain financing income of multinational groups active in the UK [the Group Financing Exemption].

The UK’s GFE was introduced with the reform of the UK CFC regime under FA 2012. In order to benefit from the tax exemption, companies do not need a tax ruling. The scheme was in force from 1 January 2013 until the end of 2018.

The original UK CFC rules established two tests to determine how much of the financing profits from loans granted by an offshore subsidiary are to be reallocated to the UK parent company and, hence, taxed in the UK, namely:

  • The extent to which lending activities, which are most relevant to managing the financing activities and thus generating the financing income, are located in the UK (“UK activities test”); or
  • The extent to which loans are financed with funds or assets, which derive from capital contributions from the UK (“UK connected capital test”).

The GFE provided a derogation from the general CFC rules. It partially or fully exempted from tax financing income received by an offshore subsidiary from another foreign group company, even if this income is derived from “UK activities” or the capital being used is “UK connected”.  Therefore, a multinational active in the UK using this exemption was able to provide financing to a foreign group company via an offshore subsidiary paying little or no tax on the profits from these transactions.

The EC’s 2017 investigation found in particular that, whilst the UK had a right to introduce CFC rules or to determine the appropriate level of taxation, when financing income from a foreign group company channelled through an offshore subsidiary derived from UK activities, the GFE was not justified and constituted State aid under EU rules.

The EC concluded that multinationals claiming the GFE while meeting the “UK activities test” received an unjustified preferential tax treatment that was illegal under EU State aid rules, under Art 107 TFEU.

BP referred in its nine pleas that the EC had defined the reference system too narrowly and looked only at the CFC rules rather than the UK corporate tax system as a whole. In particlar, the EC had failed to show that the finance company exemption conferred an advantage in each case where it had been claimed and that it had not proven the exemption led to a reduction in UK corporation tax.

BP has further argued that the EC has failed to properly understand how the CFC rules work and specifically the finance company exemption, the non-trading finance profits CFC charge gateway or that there were three separate and distinct exemptions applicable to non-trading finance profits.

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