On the whole Draft Finance Bill 2018/19 did not contain any big surprises for multinational businesses, with the majority of the measures either implementing previously announced policy changes, or making smaller scale changes.
If anything, the main surprise from last Friday was the absence of any update on the taxation of the digital economy or royalty withholding tax proposals.
However, changes were announced to both the CFC and the Hybrid mismatch rules (albeit with delayed effect) to bring domestic legislation in line with the Anti-Tax Avoidance Directive (ATAD).
A guidance note has been published setting out two specific changes intended to take effect from 1 January 2019.The first of these is an amendment to the definition of control so that any interests held by associated enterprises, wherever they are resident, are taken into account when assessing control.
This will be of particular relevance to foreign parented groups that have split shareholding structures especially where they fall below the current ‘control’ threshold.
The second amendment concerns the treatment of non-trade finance profits arising to CFCs and will be most relevant to groups with a UK based treasury function.
Under the current rules, Chapter 5 brings non-trade finance profits into the scope of the CFC rules to the extent they are attributed to significant people functions (SPFs) carried out in the UK. However, such profits are often then exempted by Chapter 9, the finance company (FinCo) exemption, meaning such profits fall wholly or partly outside a CFC charge. This amendment effectively removes the ability to rely on the FinCo exemption in these situations.
Groups will now have to undertake a UK SPF analysis for the purposes of Chapter 5. Previously the analysis could effectively be ignored if reliance could be placed on the Chapter 9 FinCo exemption.
This change will particularly affect groups that manage some or all of their treasury activity in the UK and will now require companies to have a thorough understanding of how the group’s financial assets and risks are managed and how profits are consequently apportioned between UK and non-UK. The recently published OECD discussion paper on financial transactions also highlights the importance of the location of decision-making and management of risk.
Many companies are already reviewing their financing structures in the context of the ongoing EU State Aid investigation. These latest changes underline the need for a holistic approach to intra-group financing, one which understands where the real value is added and anticipates the evolving tax and transfer pricing landscape.
The draft Finance Bill also included proposed amendments to the Hybrid and Other Mismatches rules to ensure the UK rules comply with certain aspects of the ATAD.
The change targets certain non-inclusion (D/NI) mismatches arising from receipts from an overseas permanent establishment (PE).
The current rules only apply a counteraction where the person making the payment (and therefore able to claim a deduction) was within the charge to UK corporation tax. This proposal introduces a secondary counteraction where there is a conflict in the PE recognition.
This could arise where the UK resident company attributes the receipt to a PE, but that other territory does not recognise a PE.
This change requires the UK company to override any foreign branch exemption election and bring that receipt into charge. It is unclear how this would operate with treaty overrides.
Conflicts of attribution where a PE is recognised in both territories but, say, each territory regards the receipt as being attributable to the other territory would therefore remain outside the scope of the rules (unless the payer was also within the charge to UK corporation tax).
The provisions as currently drafted suggest that the gross income would be brought into account such that, where expenditure is incurred to earn that income has also been attributed by the UK to the PE, these deductions would be lost. We have brought this issue to the attention of HMRC and are awaiting their comments.
The second amendment relates to regulatory capital and therefore affects financial institutions and insurance groups.
The regulatory requirements for capital held by financial institutions mean that certain regulatory capital instruments issued by banks and insurers, although legally debt, may have equity-like characteristics. UK policy has generally been to allow tax relief for the coupon payable on these instruments. In order to preserve this treatment on the introduction of the UK anti-hybrid legislation, regulatory capital was excluded from the scope of the provisions.
The ability to provide this kind of exclusion is curtailed by the ATAD, which only allows an exemption for banks’ regulatory capital until 31 December 2022 and no exemption at all for insurers’ regulatory capital.
The draft Finance Bill replaces the existing broad exclusion for regulatory capital with a new exclusion for instruments to be specified by the Treasury in new regulations. The content and timing of any new regulations has yet to be confirmed but the ATAD anticipates these will come into force by 1 January 2020 and will limit any exclusion to regulatory capital issued by banks.
This represents a potentially significant change for insurance groups which will now need to urgently assess whether any tax relief currently available may be restricted from 1 January 2020.
Although there is no indication that it is intended to withdraw relief for regulatory capital issued by banking groups, these groups will likely be looking for the Government to confirm the policy on the regulatory capital remains unchanged. The ATAD strictly requires any ongoing exclusion for banks’ regulatory capital to expire on 31 December 2022. The impact of Brexit on this is currently unknown.