THE TREASURY HAS MADE PUBLIC AN EXCHANGE of letters between Richard Lambert, directorgeneral of the CBI, Julian Heslop, chairman of the Hundred Group fiscal committee, and Jane Kennedy, the Financial Secretary, in which HM Treasury has indicated that it will back down on some aspects of the proposed changes to the UK tax system in relation to foreign profits earned by UK multinational enterprises.
In 2007 the government announced that it was proposing to reform the UK tax rules relating to foreign profits. Under the current rules, companies receiving foreign dividends pay UK tax on them. In order to alleviate economic double taxation of profits, the UK will give a credit for any taxes withheld at source from the dividend payment and, provided the UK recipient holds a significant stake (10%) in the foreign payer of the dividend, a credit for foreign taxes on the profits distributed in the UK. The rules regarding credits for underlying taxes are complicated by the fact that the UK will not grant a credit for taxes paid in excess of the UK tax liability on the same profits. In addition, the UK introduced rules to prevent companies from mixing low-tax and high-tax dividends with a view to setting off excess foreign tax paid on profits against lowly taxed dividends.
This system, which requires considerable efforts on the compliance side, has been seen as adversely affecting the UK's competitiveness as a holdingcompany jurisdiction. For some time, interested parties have been lobbying the government to introduce an exemption system, under which dividends paid out of taxed overseas income would not be taxed when received by corporate shareholders in the UK.
While the 2007 announcement that the UK would be moving to an exemption system was welcomed by business, other elements of the package designed to ensure that the measures were broadly fiscally neutral were not. Two elements, in particular, caused considerable concern.
First, the government announced that it would be reforming the UK's controlled foreign company (CFC) rules. These rules are designed to ensure that multinationals cannot artificially locate their operations in low-tax jurisdictions to minimise tax on their profits pending their eventual repatriation to the UK. The rules are complex, and over the years companies and their advisers have been able to design strategies to avoid them. Some reform of those rules was therefore expected, if not welcome.
However, the proposed reforms went much further than anticipated. Broadly, the government's proposal was to distinguish between active income and passive income. Active income would not be subject to the new rules. Passive income, on the other hand, would be taxed at UK rates even if not remitted to the UK. The new system would have resembled the US's subpart F income rules. This aspect of the proposals caused considerable concern to multinationals whose businesses depended on IP. The reforms meant that these companies would have had to pay much more UK tax on the IP-related receipts of their business. This proposal would have particularly affected pharmaceutical groups; therefore, it was no surprise earlier this year to see Shire plc take steps to 'migrate' to Ireland. No doubt, the Shire move had been under consideration for some time, but one can only assume the move was given further impetus by the announcement of the proposed changes to the CFC rules.
Secondly, the government wanted to introduce restrictions on the ability of UK multinationals to offset interest against profits where the loans were used to finance overseas operations. This was not an unexpected part of the package, and a number of jurisdictions that operate exemption systems for foreign dividends have introduced such limitations. However, the government also proposed extending current anti-avoidance provisions in this area in a way that would have caused uncertainty for those subject to the rules.
In her letters to the CBI and the Hundred Group, Jane Kennedy admitted that the negative response from business to the package suggested means that the original timetable for introduction of an exemption system cannot be met. The earliest the measures could now be introduced is in the Finance Act 2010. The Treasury is also backing down on the most controversial aspect of the changes to the CFC rules, and will now explore with business possibilities for an improved set of rules based on the current rules, which focus on the type of entity receiving the income, rather than the characteristics of the income itself (passive vs active). In addition, the Treasury is shelving, for the moment, the proposals to extend the current anti-avoidance rules for interest deductions, although it is clear that it views some of the tax planning in this area to be unacceptable and will seek to stop it in the future.
By Blaise Martin-Curtoud, partner, Jones Day. E-mail: bmarin-curtoud@jonesday.com.