Corporation tax reform

Mark Joscelyne, Tax Partner, CMS

Whilst it will be the unexpected 2% cut in the main rate of corporation tax which will no doubt feature in the headlines, the radical reform of the tax treatment of foreign profits is perhaps more significant to the international tax competiveness of the UK.  The Chancellor was reportedly hoping to announce that at least one of the companies which had left the UK for a more tax competitive climate would now be returning, but it seems that he still has some persuading to do.

In today’s Budget, it was announced that the Government would be proceeding with the reforms to the CFC regime and new exemption for foreign branch profits announced in December, with some changes mainly in response to points raised during the consultation process. A summary of the draft legislation published in December was set out in our earlier Briefing. The revised draft legislation has not yet been published, but it was announced today that there will be a number of amendments.

Implementation of the CFC interim reform measures has been brought forward and will now apply for accounting periods beginning on or after 1st January 2011, except for the transitional rules for holding companies which will be deemed always to have had effect.

The CFC measures include a three year period of grace for foreign companies which were previously not CFCs but subsequently come within the CFC regime, typically following acquisition by UK shareholders or a group reorganisation. This was intended to apply only to companies coming within the CFC rules for the first time, but will now also apply to companies which were previously CFCs but ceased to be so before becoming UK controlled once again. Presumably the legislation will contain anti-avoidance provisions to prevent groups removing their subsidiaries from the CFC regime temporarily in order to benefit from this three year CFC exemption.

It was previously announced that the threshold for the de minimis exemption would be increased to £200,000 for large groups and that there would be a switch to an accounts-based measure of profits from the current tax-based measure. Today’s Budget notes refer to this as an “alternative” to the current de minimis exemption, suggesting that companies may be able to satisfy either the old or the new minimis test. We may need to wait for the revised legislation to see if this will be the case.

The more radical reforms to the CFC regime are still expected to come into force in 2012. The Budget confirms that the partial exemption for group finance companies will result in an effective CFC tax rate equal to one-quarter of the main rate of corporation tax, 5.75%, by the time corporation tax is reduced to 23% in 2014.

The corporation tax exemption for foreign branch profits will be available for accounting periods commencing on or after Royal Assent to the Finance Act 2011. It will now be extended to some life insurance companies. There will be revisions to the rules preventing diversion of profits from the UK to the exempt branch, the transitional provisions for companies which have previously claimed relief for branch losses and the application of capital allowances.  Details of these changes have not yet been published.

One aspect of the foreign branch legislation that does not appear to have changed is the fact that the election to opt into the regime is irrevocable (subject to a short cooling off period).  The requirement for a company to commit irrevocably to the regime (when there are downsides to doing so such as the fact that foreign branch losses will not be allowable and the election cannot be revisited after a change of control) will undoubtedly make the election less popular than it might otherwise have been.

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