The new UK-controlled foreign companies tax regime represents an improvement says KPMG’s Michael Kearney
For accounting periods beginning on or after 1 January 2013 the new controlled foreign companies (CFCs) tax regime will apply.
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The CFC tax regime seeks to stop artificial diversion of profits from the UK and works by attributing and taxing any such profits to the
UK tax resident companies which control the overseas company. The new regime forms part of UK government policy to create the most competitive G20 tax system.
Under the previous regime, where an overseas company was subject to tax at a rate of 75% or less of the UK equivalent, it generally was classified as a CFC. If the company met the definition of a CFC all the overseas profits were taxed in the UK controlling company unless one of various exemptions applied.
For most companies the objective ‘exempt activities test’ was relied upon. However leasing income was treated as ‘investment income’ and, as such, the ‘exempt activities test’ could not apply. This left lessor companies relying on the far more subjective ‘motive test’, routinely rejected by HMRC.
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By GlobalDataUnder the new regime almost all overseas companies controlled from the UK will be classified as CFCs. However a number of exemptions can exempt all the profits of a CFC from taxation in the UK .
The key exemptions are where the company is resident in an excluded territory (generally one where the tax rate is at least 75% of the UK rate) or where the local tax paid is at least 75% of the amount that would be payable in the UK.
Where a full exemption does not apply it then needs to be determined whether any of the CFCs profits are taxable in the UK. Unlike the previous regime it is not all or nothing.
The profits potentially taxable in the UK for a CFC with a leasing business are:
- Profits attributable to UK significant people functions;
- Profits are taxable in the UK to the extent that they arise in a CFC due to arrangements that separate ownership of an asset, or bearing of a risk, outside the UK from the relevant significant people functions (i.e. management) carried on in the UK. This potentially applies to all profits of a lessor;
- Trading profits of a lessor from a finance lease or hire purchase contract are taxable to the extent they arise from the CFC having excess capital (the amount above that which an independent company would require);
- Non-trading profits from a finance lease or hire purchase contract can also be taxable in the UK. Such profits should only arise where a lessor company is not considered to be trading and therefore should not normally be a concern.
The new regime is generally positive for lessors and should only catch artificially diverted profits of leasing. This is better than the previous regime which often taxed commercial leasing profits derived from non-UK activities. Whether this encourages the establishment of international leasing operations in the UK is, however, yet to be seen.
Michael Kearney is a senior tax manager at KPMG
