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Foreign profits of companies - UK taxation

The following changes in relation to the taxation of foreign profits will be introduced in Finance Bill 2009. The date from which these will take effect is yet to be announced. Detailed draft clauses will be released for consultation in the coming weeks.

For fuller commentary on these measures please click here.

Foreign profits reform - foreign dividends received by UK companies
Foreign profits reform - tax deductions for interest
Foreign profits reform - treasury consents
Foreign profits reform - changes to treatment of controlled foreign companies


Foreign profits reform - foreign dividends received by UK companies


  • Any foreign dividend received on an ordinary share will be exempt from UK corporation tax;
  • Exemption will only be available to large and medium businesses. Small businesses which receive foreign dividends will still be subject to UK tax with credit;
  • The above exemptions will be subject to a Targeted Anti-Avoidance Rule (TAAR) which will apply where there is a scheme which is tax motivated and carries certain characteristics. No detail has yet been provided on this;
  • Any other dividends will still be subject to UK tax, with credit given for overseas tax suffered.

Our view
This brings a welcome resolution to over two years of debate on the introduction of an exemption from UK corporation tax for overseas dividends.

Tax accounting view
Subject to clarification of the detail, the exemption for foreign dividends may result in the partial release of deferred tax liabilities for large and medium groups reporting under International Financial Reporting Standards currently provided on:

  • unremitted earnings of foreign investments where there is no control over the repatriation policy; and
  • unremitted earnings of foreign subsidiaries where there is an intention to remit profits.

Any release would be relevant for balance sheet dates following substantive enactment of the legislation.





Foreign profits reform - tax deductions for interest

  • Extension of the current unallowable purpose test (which applies to deny tax deductions for loan relationships which have an unallowable purpose) to apply to a scheme or arrangement. Currently this test is applied on an entity by entity basis to the party entering into a loan relationship or derivative. As this test applies to each accounting period where an entity is party to such a relationship this change will affect existing arrangements as well as future ones;
  • The introduction of the worldwide debt cap. This will limit the amount of UK deductible interest available by reference to the group's consolidated net external finance costs;
  • The definitions used and the precise mechanics of how this cap would operate have not yet been published, so a number of significant uncertainties remain;
  • The comparison with group consolidated interest is on a net basis and therefore interest income would be expected to be netted against interest expense. It is therefore expected that cash rich groups who currently have debt in the UK will be caught by the cap. However, the open letter published by the Financial Secretary to the Treasury in July of this year did suggest there would be a set-aside provision whereby the cap will not apply in circumstances where the group is in a temporary cash surplus position.

Our view
The interest cap proposals are likely to negatively impact UK outbound groups with upstream loans where external debt is borrowed wholly in the UK. Inbound groups could also be adversely impacted by the interest cap proposals as, even if this does not result in additional tax cost, it is likely to be a compliance cost, depending on the detail of the rules.

Cash rich groups, or groups required to hold liquid assets in their business, are likely to be adversely impacted by the debt cap depending on how the net consolidated interest position of the group is calculated and how much of their external debt is located in the UK (if interest on UK debt remains deductible in spite of the cap).






Foreign profits reform - treasury consents

  • Today's announcement includes the abolition of the treasury consent rules in s765 and 765A ICTA 1988, which require advance consent to be obtained from HM Treasury for particular types of cross-border transactions, and require notification of these transactions where they take place within the EU.
  • In place of these rules, a new post-transaction quarterly reporting requirement is introduced for high risk transactions with a market value of £100m. No report is required for transactions with a value below this threshold.
     

Our view

It is currently not clear what level of information will be required to be reported. If this is a light touch requirement, then this reform is likely to be a positive move for business, especially in relation to removing the requirement to obtain advance consent for some transactions and the custodial penalty. If the information requirement is burdensome this may not be much of an improvement.




Foreign profits reform - changes to treatment of controlled foreign companies

  • The current CFC exemption for companies which pay at least 90% of their chargeable profits back to the UK via a taxable dividend (the Acceptable Distribution Policy Exemption or ADP) is being abolished in the light of the introduction of a dividend exemption;
  • In addition, today's announcement suggests that the current exemption from CFC status provided under the Exempt Activities test for holding companies will also be abolished. This is subject to a 24 month transitional period to allow existing holding company structures to be unwound.

In addition, the Government stated it will continue to examine options for reform of the UK CFC rules, and the letter published today by the Financial Secretary to the Treasury to the CBI and Hundred Group commits to consultation on the modernisation of the CFC regime.

Our view
Whilst the statement of the expected future intention of the CFC rule is reassuring, the continued uncertainty over timetable and the outcome of this reform may be unsettling for some businesses.