Controlled foreign companies

Mark Joscelyne, Tax Partner, CMS

As expected, the government has announced that a full reform of the controlled foreign companies (“CFC”) regime will be legislated for in Finance Bill 2012, with the new rules to take effect for accounting periods beginning on or after 1 January 2013.

 The current CFC regime has been heavily criticised by business in recent years for its broad scope and the uncertainty of its application. In response, the government passed some intermediate reforms in Finance Act 2011 and has been conducting extensive consultation about a complete reform of the rules.  The aim of the reforms is to make the CFC regime more targeted and, in turn, to make the UK’s tax regime more internationally competitive.

 The draft legislation published during the consultation period introduces a much more territorial-based regime, the intention being that companies should only come within the regime to the extent that they are involved in the artificial diversion of profits from the UK.  The draft legislation is centred around a number of “gateway” tests for (broadly) business profits derived from UK activities.  The legislation contains various safe harbour provisions and broader, entity-level exemptions. It also introduces a partial exemption for most intra-group financing profits (taxing only 25% of such profits, an effective tax rate of only 5.50% once the main rate of corporation tax comes down to 22% in 2014) and a complete exemption for certain narrowly defined finance profits.  The proposed new rules have been generally welcomed although concerns have been expressed over the complexity of the proposed gateway tests. Last month the government published revised draft legislation to address these concerns, and this revised draft legislation is expected to form the basis for the provisions which will appear in the Finance Bill.

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