Changes to the UK Rules on Controlled Foreign Companies (CFCs)

Our view
The new rules proposed by the Pre Budget Report to restrict the application of the CFC rules in relation to CFCs established in EEA territories only restrict the application of those rules to profits arising from the activities of employees and not of capital. Therefore, it would appear that they will only have a major impact if trading operations are transferred to an EU or EEA territory and the examples given by HMRC in their guidance confirm this. These changes do not seem to be entirely compatible with the Cadbury decision. It also does not provide for any advance clearance mechanism so companies face further uncertainty over their tax affairs.

The changes to the effective management test actually make it much more onerous for EEA based companies to now satisfy the Exempt Activities exemption. For example, European based holding companies which would have previously qualified for the exemption prior to 6 December 2006 may now no longer satisfy this test.

The Government has announced that it will publish a paper in relation to CFCs in late Spring. In addition, we would expect to see in future additional changes made to the taxation of foreign dividends and potentially even the deductibility of interest as part of the package of further international tax reforms being considered by the Government.