UK and International Tax news
EC Concludes On State Aid Investigation Into UK CFC Group Finance Exemption
Friday 12th April 2019
The European Commission has concluded that part of the UK’s CFC Group Finance Exemption 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. However, since 2013, the CFC rules include an exception for certain financing income of multinational groups active in the UK [the Group Financing Exemption].
The UK’s Group Financing Exemption was introduced with the reform of the UK CFC regime under the Finance Act 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.
Following the adoption of the Anti Tax Avoidance Directive (ATAD), all EU Member States had to introduce CFC rules in their legislation as of 1 January 2019. In line with ATAD, as of 1 January 2019, the Group Financing Exemption applies only where a CFC charge on financing income from foreign group companies would otherwise apply exclusively under the UK connected capital test (i.e. not also or exclusively under the UK activities test). The CFC rules as currently applied therefore no longer raise concerns under State aid rules.
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 (“CFC charge”), 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 Group Financing Exemption provided a derogation from the general CFC rules. It partially (75%) or fully exempted from taxation in the UK 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.
In October 2017, the EC opened an in depth investigation to verify whether the Group Financing Exemption complied with EU State aid rules.
The investigation does not call into question the UK’s right to introduce CFC rules or to determine the appropriate level of taxation. The role of EU State aid control is to ensure Member States do not give some companies a better tax treatment than others. The case law of the EU Courts makes clear that an exemption from an anti-avoidance provision can amount to such a selective advantage.
The EC’s investigation has now concluded and has found that when financing income from a foreign group company, channelled through an offshore subsidiary, is financed with UK connected capital and there are no UK activities involved in generating the finance profits, the Group Financing Exemption is justified and does not constitute State aid under EU rules.
This is because such an exemption avoids complex and disproportionately burdensome intra-group tracing exercises that would be required to assess the exact percentage of profits funded with UK assets. The EC therefore acknowledges that, in line with UK arguments, the Group Financing Exemption in these cases provides for a clear proxy that is justified to ensure the proper functioning and effectiveness of the CFC rules.
However, the EC found that when financing income from a foreign group company, channelled through an offshore subsidiary, derives from UK activities, the Group Financing Exemption is not justified and constitutes State aid under EU rules.
This is because the exercise required to assess to what extent the financing income of a company derives from UK activities is not particularly burdensome or complex. Thus, the use of a proxy rule in these cases is not justified. Moreover, the Group Financing Exemption does not seek to address any possible complexity related to the allocation of financing income to UK activities nor has the UK claimed it does.
The EC therefore concluded that multinationals claiming the Group Financing Exemption while meeting the “UK activities test” received an unjustified preferential tax treatment that is illegal under EU State aid rules (under Art 107 TFEU).
As long as the UK is an EU Member State, it has all the rights and obligations of the membership and EU competition law, including EU State aid rules, continue to apply in full to the UK and in the UK, until it is no longer a member of the EU.
As a matter of principle, EU State aid rules require that illegal State aid is recovered in order to remove the distortion of competition created by the aid. There are no fines under EU State aid rules and recovery does not penalise the companies in question. It simply restores equal treatment with other companies.
When State aid takes the form of tax measures or other levies, the amount to be recovered should be calculated based on a comparison between the amount of tax actually paid and the amount which should have been paid if the generally applicable rule had been applied.
In this case, the UK should reassess the tax liability of the UK companies that have illegally benefitted from the Group Financing Exemption as it was applied to profits derived from UK activities. The precise number of beneficiaries affected and the exact recovery amount can only be determined by the national authorities based on a case-by-case examination.Contact Us