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UK: CFC rules provided tax advantages to certain multinational companies

UK: CFC rules provided tax advantages

The European Commission today announced its findings that the UK controlled foreign company (CFC) rules targeting tax avoidance was partly justified and did not constitute state aid to the extent that the tax regime provides for the proper functioning and effectiveness of the relevant tax rules. The EC, however, found that the tax regime unduly exempted certain multinational groups from the UK regime and that this was illegal under EU state aid rules.


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As noted in today’s EC release, the UK must recover the amount of this illegal state aid from the multinational companies that benefitted from it.


The general purpose of the UK's CFC rules is to prevent UK companies from using a subsidiary, based in a low or no tax jurisdiction, to avoid taxation in the UK. The CFC rules allow the UK tax authorities to reallocate all profits artificially diverted to an offshore subsidiary back to the UK parent company, where it can be taxed accordingly.

UK CFC rules establish 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:

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

Between 2013 and 2018, the UK's CFC rules included a special rule for certain financing income (that is, interest payments received from loans) of multinational groups active in the UK. This is referred to as the “Group Financing Exemption.”

The Group Financing Exemption provided a derogation from the general CFC rules. It partially (75%) or fully exempted from tax in the UK, financing income received by an offshore subsidiary from another foreign group company, even if this income were derived from “UK activities” or the capital being used were “UK connected.” Therefore, a multinational active in the UK using this exemption was able to provide financing to a foreign group company by means of an offshore subsidiary paying little or no tax on the profits from these transactions.

Findings of EC investigation

In October 2017, the EC opened an in-depth investigation to verify whether the Group Financing Exemption complied with EU state aid rules.

Today, the EC announced that its investigation has concluded that the Group Financing Exemption and, hence, the different treatment, was partially justified. At the same time, the EC found that the exemption granted a selective advantage to certain multinational companies.

In particular, the EC 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 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, thus, acknowledged that the Group Financing Exemption in these cases provides for a clear proxy that was justified to provide for 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 was not justified and constituted state aid under EU rules because the exercise required to assess to what extent the financing income of a company derives from UK activities was found not to be particularly burdensome or complex. Thus, the use of a proxy rule in these cases was found not to be justified. Moreover, the Group Financing Exemption did 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 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.

Read an April 2019 report prepared by KPMG’s EU Tax Centre

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