On 2 April 2019, the European Commission announced its decision that the group financing exemption allowed under the UK's controlled foreign company (CFC) Rules gave an illegal tax advantage to certain multinationals, constituting illegal State aid.
The general purpose of the UK's Controlled Foreign Company (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.
These 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, namely: (i) “UK activities test” where the lending activities, which are generating the financing income, are located in the UK; or (ii) “UK connected capital test” where loans are financed with funds or assets, which derive from capital contributions from the UK.
Between 2013 and 2018, the Group Financing Exemption provided 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".
Consequently, 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 response to the exemption, the Commission opened an in-depth investigation to verify whether the Group Financing Exemption complied with EU State aid rules. The Commission's investigation has concluded that the Group Financing Exemption and, hence, the different treatment, was partially justified.
The Commission found that when a multinational fulfills the “UK connected capital test” the group financing exemption is justified and does not constitute State aid under EU rules.
However, the Commission found that to the extent the financing income from a foreign group company, channeled through an offshore subsidiary, derives from “UK activities”, the group financing exemption is not justified and constitutes state aid under EU rules as it requires to assess to what extent the financing income of a company derives from UK activities is not particularly burdensome or complex.
The Commission 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.
Apart from the decision, as of 1 January 2019, the current CFC rules is no longer raising concerns under State aid rules since UK has adopted the CFC rule aligned with the Anti-Tax Avoidance Directive (ATAD). 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).
Source: European Commission
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