We consider further the implications of the EC’s state aid investigation into the UK’s CFC Finco exemption.
Last week, we reported on the European Commission’s announcement to open an investigation into whether the Group Financing Exemption included in the UK’s Controlled Foreign Company (CFC) rules (the Finco regime) breaches state aid rules. This week we will consider the announcement in more detail, including the next steps.
A reminder of the UK’s Finco regime
The application of the CFC rules to offshore financing companies is complex. The relevant gateway provision defines the finance profits that are within the scope by considering the source of the funding of the CFC and where the key entrepreneurial risk taking (KERT) functions take place that relate to the finance profits. Where loans are funded from overseas sources and the key decisions on assumption of risk are undertaken outside of the UK, the finance profits fall outside the regime.
However, to apply this principled approach can be challenging. It requires tracing of funds, functional analysis to identify KERTS (including split KERTS) and subjective analysis.
As such, the Finco regime is an elective regime that is pragmatic and simpler in determining the finance profits that are potentially diverted from the UK. Where conditions are met, the regime provides that 25 percent or less of the offshore finance company’s profits are brought into account to UK tax.
Why is State Aid potentially in point?
The State Aid rules consider whether there have been selective advantages provided to certain taxpayers.
The announcement advocates that the Finco regime could be inconsistent with the UK’s wider CFC regime as a selective advantage is given to those taxpayers who use financing structures that meet the specific requirements of the regime over others who do not.
What are the next steps in the investigation?
As part of the standard procedure in state aid investigations, the EC will publish a non-confidential version of this preliminary decision. Based on prior experience, this could take at least three months for release.
The next step will be an in-depth investigation by the EC which gives interested third parties and the Member States concerned an opportunity to submit comments.
There is no legal deadline for completing an in-depth investigation and its actual length depends on many factors, including the complexity of the case, the information provided and the level of cooperation from the Member State concerned. The EC will reach a final decision at the end of the formal investigation.
What are the implications if the EC’s challenge is successful?
If, at the end of the investigation the Finco regime is considered to be in contravention of the State Aid provisions, the UK Government will be required to seek repayment of the lost tax from the relevant taxpayers. The investigation can look back to a maximum of 10 years and so, given the timing of the introduction of the UK’s current CFC regime, would apply to all Finco structures. The process for computing the lost tax is not necessarily straight-forward as it may be possible to take into account the tax attributes of the taxpayer on a case by case basis and arguments based on the fundamental freedoms where the Finco is established in the EU.
What should businesses do now?
At this stage, we recommend that affected companies keep up to date with developments, in particular as and when further information is provided by the EC.
As we approach the end of the year, groups will no doubt wish to consider the impact on tax provisions in their accounts. The opening of a State Aid investigation is unlikely, in itself, to lead to the requirement to provide, but groups will need to review their individual circumstances and discuss provisioning, any disclosure implications and their analysis of any exposure position with their auditors.
As such, to the extent not already done so, affected companies should collate together their implementation documentation (e.g. professional advice obtained, technical analysis, any correspondence with HMRC etc). This should ease the process of any subsequent transaction review once further details of the investigation are made available by the EC.
Groups undertaking M&A transactions where the target group has availed itself of the Finco exemption may wish to ensure that these are reviewed as part of appropriate due diligence.
Groups may also wish to consider how to engage with HM Treasury and HMRC; if you have any queries on this, please get in touch with your usual KPMG contact or one of the named contacts below.
To view our previous article click here.
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