Implementation of State Aid decision on CFC Group Finance Company Exemption
Implementation of State Aid decision on CFC Group
HMRC have issued a statement providing guidance on how the UK will be implementing the European Commission’s decision on State Aid.
On 13 December 2019 HMRC issued a 39 page statement to taxpayers containing guidance on how the UK will undertake recovery of the unlawful State Aid and the action required by beneficiaries. The HMRC statement provides guidance only for the purposes of implementing the European Commission (EC) state aid decision and has no wider implications. The main points addressed by the guidance are (i) recovery methods to be employed by HMRC, (ii) calculation of the recoverable amount including a nine page appendix providing guidance on HMRC’s current views on identification of Significant People Functions (SPFs) and attribution of profit to UK SPFs, (iii) availability of reliefs and (iv) interest, penalties, appeals and other administrative matters.
Initial letters were sent out in April 2019 by HMRC to groups identified as having made full or partial exemption Finance Company Exemption (FCE) claims and this was followed by initial information requests issued to beneficiaries in July 2019. HMRC have indicated that they will write to beneficiaries outlining their view of the recoverable state aid amounts for all years. The statement confirms that taxpayers will have the opportunity to make representations following receipt of HMRC’s initial view although no timetable has been specified for this.
The statement also indicates that HMRC will raise estimated assessments for open periods of account. We expect that HMRC might seek to issue discovery assessments for accounting periods ended 31 December 2015 in the next few days to protect their assessment position where they have not already done so.
Four recovery methods are envisaged: (i) full or partial closure notices where corporation tax self-assessment (CTSA) enquiries have been opened within normal time limits; (ii) discovery assessments for periods within the four-year window for such assessments; (iii) High Court action for periods outside the discovery assessment window; and (iv) taxpayers will be invited to enter into contractual payment agreements with HMRC as an alternative to High Court action. HMRC’s statement indicates they do not foresee a need for enabling legislation to facilitate recovery of state aid but they will keep the position under review.
Calculation of the recoverable amount
The methodology for calculating the recoverable amount involves a relatively complex series of steps which will necessitate a number of potentially subjective judgements being made by HMRC. The approach set out by HMRC largely replicates what is set out in the legislation and involves first identifying the ‘relevant assets and risks’ to which the controlled foreign company’s (CFC) Non Trading Finance Profits are attributable (negligible assets and risks can be excluded) and once these have been identified, identifying SPFs carried out by the CFC Group (i.e. looking at the wider group of which the CFC is a member not just the CFC itself) which are relevant to the economic ownership of the relevant assets and the assumption and management of the relevant risks. Once the relevant SPFs have been identified the location of those SPFs is determined. If there are no UK SPFs the analysis would end here but where there are UK SPFs it is then necessary to hypothesise that the UK SPFs are carried out by a UK permanent establishment (PE) and attribute the assets and risks connected with the UK SPFs to the PE. The CFC’s assumed total profits are then recalculated on the assumption it does not hold those assets and risks and the resulting reduction in the CFC’s redetermined profits forms the basis for the CFC charge.
The guidance provided on SPFs is generally helpful. HMRC acknowledge that whilst the OECD Report of PE Profit Attribution is the definitive source of guidance on SPFs it only includes detailed guidance for traditional banking activities and says relatively little on intra-group lending. The statement makes clear that in cases involving significant structural loans HMRC will focus on the active decision making with regard to the initial creation of the loan asset and assumption of credit risk under the agreement as being the activity relevant for identifying SPFs. HMRC have indicated there will be a strong emphasis on the role of group finance (tax and treasury) leading up to the lending decision and that local execution by a CFC of lending decisions made by group finance is unlikely to be considered as SPF activity by itself. Other notable points are that HMRC have indicated that policy/parameter setting of itself is unlikely to be considered an SPF activity in the context of intra-group financing as it does not involve actual assumption of risk. Monitoring of lending risks after the decision to lend have been made is also unlikely to be considered by HMRC as an SPF unless risk has been transferred by the original lender.
Complexities are likely to arise where intra-group loans have been refinanced and where SPFs are found to be located in more than one territory (requiring a profit split analysis with proper weighting of the SPFs in each territory).
There are a number of potential reliefs which could apply to reduce or eliminate any additional corporation tax liability arising from a reduction of the amount exempted under the FCE. Additional credit for foreign tax paid may be available as this is restricted in partial exemption claim cases and prohibited where full exemption applied. For periods ending prior to 1 April 2017 where the old Worldwide Debt Cap rules applied there might also be the opportunity to exempt additional amounts of finance income or reduce amounts of finance expense which are disallowed. For periods ending before 8 July 2015 there are also a wide range of loss relief and expense set-offs that could potentially apply to limit the incremental CT liability (e.g. using brought forward non-trade losses or claiming additional group relief). The HMRC statement also mentions it is open to Groups to revisit their use of the CFC entity exemptions in light of the state aid decision on the FCE.
There are some important clarifications relating to reliefs contained in the HMRC statement including:
- Claims or adjustments to claims must be validly made but where HMRC Officers have the discretion to accept late claims they will generally do so but only insofar as the claims relate specifically to the state aid recovery process and this discretion would not be used where HMRC have to take High Court action to recover state aid amounts from taxpayers (i.e. where for periods outside the four-year discovery window a taxpayer declines to enter into a contractual payment agreement with HMRC);
- An application must be made for late claims that meets all the other requirements for that claim except the time limit;
- Reliefs can only be claimed to the extent they are putting a beneficiary back in the position it would have been if no aid had been given (i.e. claims cannot be increased beyond the amount of the additional CFC charge calculated in accordance with the state aid decision). HMRC will not accept claims based on hypothetical counterfactual positions (e.g. a company arguing it would have brought forward a pensions top up payment if it had known it would have additional tax capacity in the earlier period); and
- Reliefs cannot generate tax repayments where no repayment was previously due prior to addressing the unlawful state aid.
HMRC’s statement also indicates that there is a de minimis test for state aid recovery whereby no recovery would be required if the aggregate amount of all UK state aid (i.e. not just the CFC related state aid) granted to a group did not exceed €200,000 over any period of three fiscal years.
The recoverable state aid amount is to be calculated using a reference system of the wider UK corporate tax system applicable during each relevant period and taking into account the factual and legal position of the beneficiary.
The HMRC statement was not published on HMRC’s website and is being sent to companies identified as potential beneficiaries of state aid on the basis of previous exemption claims made under section 371IJ TIOPA 2010. Any group which is potentially affected by the Commission decision but is yet to receive a copy of HMRC's statement or would like to discuss the recovery process, please get in touch with your usual KPMG contact or one the international tax specialists listed.
Interest, penalties, appeals and other administrative matters
Interest will be calculated by HMRC after the state aid has been quantified and will be calculated on a compound basis running from the date the unlawful state aid was at the disposal of the beneficiary. For large companies this will run from the relevant quarterly instalment due dates. HMRC have confirmed they will not impose penalties on the reduction on the amount for which the FCE is claimed. However, penalties could be charged where incorrect or incomplete information is provided to HMRC which HMRC relies on for the purpose of calculating the recoverable amount.
Payment of the amount must be made regardless of any challenge the beneficiary intends to make. There is no right of offset against other balances with HMRC and Payments on Account cannot be reallocated in settlement of the state aid. The compound interest will continue to accrue until full payment is made.
HMRC have confirmed that appeals are permitted within 30 days of an assessment being issued if a taxpayer considers the amounts they are being asked to pay have been wrongly calculated. An appeal would not constitute a challenge to the EC state aid decision itself. However, HMRC will not agree to postponement applications but taxpayers could request a hearing at the First-tier Tribunal on postponement.
- Unfiled periods ending prior to 1 January 2019
HMRC intend to open CT Return enquiries into all FCE claims made after 3 April 2019 for accounting periods ending prior to 1 January 2019 and will also start compliance checks on FCE claims in filed returns where they are in time to do so.
- Periods ending on or after 1 January 2019
The EC’s decision confirms that the UK CFC rules, as amended with effect from 1 January 2019, no longer raise concerns under state aid rules. Accordingly, from 1 January 2019 the state aid decision should not have an impact on FCE claims.
It should be noted that for accounting periods beginning before 1 January 2019 and ending after that date (straddling periods) it will be necessary to apportion between the two periods where the state aid decision is relevant for the period to 31 December 2018.
It will be important for Groups to consider the disclosures they make on any FCE claims made for unfiled returns for accounting periods ending prior to 1 January 2019 and accounting periods which commence prior to 1 January 2019 and end after this date.
For further information please contact:
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