The EC has released its conclusion that part of the UK’s CFC rules relating to an exemption for finance income constitute State Aid in contravention of EU rules.
On 2 April 2019, the European Commission (“EC”) confirmed its view that the UK finance company exemption is partly contrary to EU State Aid rules.
The EC focused on the charging provisions in the UK CFC rules in respect of non-trading finance profits that could then be exempted by the UK’s finance company exemption. Specifically it looked at exempt financing income relating to:
The decision concludes that where there are UK activities (i.e., broadly UK significant people functions (“SPFs”) giving rise to the income), this should constitute State Aid (whether or not this also arose from capital investment from the UK). The EC did not consider the connected capital test to be against State Aid rules.
The UK Government is now required to take steps to recover the state aid from recipients.
Since 1 January 2013, the UK controlled foreign company (“CFC”) rules have provided for an elective 75 or full exemption under Chapter 9, Part 9A TIOPA 2010 (“the FinCo exemption”) for certain financing income received by overseas subsidiaries of UK companies. A challenge under EU State Aid rules was announced in 2017, with a preliminary view from the EC being released that the exemption constituted State Aid.
The conclusion of the EC investigation confirms their view that part of the UK finance company exemption constitutes state aid. As noted above, their analysis focusses on financing income that related to UK activities and that related to UK capital investment.
The EC has found that, where financing income of a non-UK subsidiary derives from UK activities, an exemption under Chapter 9 is not justified and constitutes State Aid.
This is because, in the EC’s view, it grants a “selective advantage to certain multinational companies” which is not available to other companies which administer their financing arrangements outside the UK.
The EC further considers that the test essentially provides a proxy for avoiding the need to determine the extent to which the financing is attributable to UK activities.
Therefore, where an overseas financing arrangement is linked to UK activities, and an exemption from a CFC charge has been claimed, this would constitute State Aid in the EC’s view.
It should also be noted that as of 1 January 2019, the UK CFC rules have been aligned with the EU Anti-Tax Avoidance Directive (“ATAD”) such that where non-trading finance profits arise from UK activities, the exemption does not apply. Therefore the EC decision appears to be giving retro-active effect to the 2019 changes brought about by ATAD.
Allowing exemption for amounts relating to UK connected capital that would otherwise be subject to a CFC charge has been determined to be justifiable and not State Aid.
The EC noted this effectively avoids the need for complex and burdensome intra-group tracing exercises that would be needed to determine the extent to which financing might be derived from UK capital contributions. Therefore, the EC considers it justifiable for the proper functioning and effectiveness of the CFC rules.
While the UK remains a member of the EU, the view of the EC is that it has an obligation to recover the State Aid previously granted to companies under the Chapter 9 exemption.
The negative decision means that the UK Government will be required to take steps to recover the state aid. In principle this means affected taxpayers will be required to repay the previously granted benefit associated with the Finco structure, plus compound interest. These amounts could be substantial.
The effect of the UK’s intended withdrawal from the EU makes it unclear whether and how such an obligation might be enforced or complied with by the UK government.
The EC has issued a press release only – a full release of the decision is expected in the coming weeks.
Companies that have claimed the UK FinCo exemption between 2013 and 2018 should consider the extent to which such profits are attributable to UK activities.
Broadly this requires an analysis of where SPFs and Key Entrepreneurial Risk Taking functions in relation to the financing have been located from the time it was put in place to the present day (if such an analysis has not already been undertaken as a result of the changes to align the UK CFC rules with the EU ATAD).
The impact also need to be considered from provisioning disclosure perspective for financial statements, as well as cash flow.
Ongoing monitoring should also be established to consider and manage the SPFs risk associated with overseas financing arrangements.
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