Five leading tax professionals took part in a Tax Journal roundtable discussion on UK tax competitiveness. The discussion focused on CFC reform and, in particular, its compatibility with EU law, the discussions on a potential gateway test to filter cases out of the CFC regime, the impact of the reform on the insurance sector, clearances and the treatment of intellectual property. Other topics discussed included reductions in the rates of corporation tax and the Patent Box regime. The discussion was chaired by John Overs, Head of Corporate Tax at Berwin Leighton Paisner.
JO: John Overs, Berwin Leighton Paisner
JK: Judith Knott, HMRC
IB: Ian Brimicombe, AstraZencea
TV: Tim Voak, Tesco
ME: Mark Edwards, Association of British Insurers
JO Perhaps the right place to start is to hear from Judith on the recent policy changes.
JK By way of background, the government made it very clear soon after last year’s election that the UK is ‘open for business’ and the intention is for the UK to have the most competitive tax system in the G20.
That’s the overriding theme and there have been a number of actions so far to try to move towards that.
First, we now have a CT rate of 26% down from 28%, and the commitment to reduce this further to 23% by April 2014.
That’s very much aimed at businesses operating in the UK, and at stimulating growth.
We also have the Patent Box, very much with the aim to encourage innovation.
Then we have branch exemption and reform of the controlled foreign companies (CFC) regime.
We’ve had some interim CFC reforms and full reform is intended to go through in FB 2012.
The aim here is to make the system more territorial, to encourage investment in and from the UK, and to boost the attractiveness of the UK as a holding company location.
Alongside the specific actions on various fronts, we’ve had the five-year roadmap.
This is a really important development in terms of setting the direction of travel, giving stability and certainty, which are very important to business.
We also have the new policymaking process, ensuring full consultation for measures introduced.
In some cases that means the measures don’t get introduced at all, depending on the reaction.
We have seen one instance of that already [tax treaties anti-avoidance measures] in the summer.
So there is a real commitment to full consultation.
I’d be very interested in views on how far people feel we are achieving the aims set out by the government last year and, importantly, in terms of priorities for further action to improve competitiveness.
IB If you put together the cuts in the CT rate, the Patent Box, the CFC regime, interest deductions, branch exemption etc, you must be looking at one of the most competitive regimes in the G20, and that’s been very positive.
It’s a shame that the measures proposed in relation to the UK tax regime have largely been overshadowed by the global economic downturn, but I think the UK is making the right steps to attract a greater proportion of global business and should put itself in a very competitive position when the global economy does recover.
TV It’s interesting as well that 23% is almost baked in as of today and we have to remind ourselves that this year’s rate isn’t 23%, it’s 26%.
IB It’s useful in investment appraisal, because clearly we’re investing in intellectual property the whole time.
We’re making estimations based on the Patent Box as well.
So this is really helping today, even though it’s not quite law yet.
Even if it’s just an upside, it helps the UK being promoted as the location of choice.
Compatibility with EU law
JO The topic of the moment is CFC reform.
Judith, you said the main aim is to be the most competitive tax system in the G20, but at the same time, that must be within the constraints of the EU Treaty?
We know that the European Commission has started infringement proceedings, and at the back of the consultation document there is an annex explaining HMRC’s view as to what EU law as interpreted by the ECJ will permit or prohibit.
A number of commentators have suggested that the view expressed may not be correct on the basis that it seems, in part, to conflate some of the transfer pricing principles with the way in which each Member State should allow the four fundamental freedoms to operate.
The annex argues that if the diversion is artificial, the Member State of the parent may nevertheless tax the profits.
A number of additional transfer pricing ‘overrides’ apply in determining whether or not something is artificial.
My question is that, if activities are genuine business activities in another Member State, and the transfer pricing has been correctly applied to whatever goods and services are sold to or sold by that business establishment, why is it that the CFC rules can still apply?
JK Perhaps I can step back a bit from that question.
We set down in the annex what our views were on EU law.
This was something that we’d been asked to do in the past and we wanted to be open about where we saw EU law currently, based on what has been developed in case law.
Some of the transfer pricing principles that you mentioned, which are discussed in the annex, are very much the fruits of some of the developing case law involving other Member States.
But the annex is not a statement of what CFC reform is about and it doesn’t reflect back on the actual proposals in the document.
We’ve been having discussions since the document went out and our thinking has been developing in any event.
The annex was not meant to restrict in any way the proposals in the document.
The other important point to stress is that we are not undertaking CFC reform because of European issues.
We need to make sure we are confident that whatever we introduce is compatible with EU law but that’s not the motivation for the reform.
We’re undertaking CFC reform because we think we need to have a more competitive system, and because the CFC regime has become outdated and is causing a number of problems for businesses.
We do feel there are certain circumstances where transfer pricing just doesn’t bite, particularly in terms of, for example, equity injections into companies where you just don’t get into transfer pricing.
So we feel very strongly that there are circumstances where we need the extra protection of CFC legislation, obviously within what is provided for under European law.
I think the instances where that protection will come into play will be significantly reduced compared to where we are currently.
‘Drawing the line’
IB I think business recognises that there is a need for a CFC type safeguard under a territorial regime.
Business generally accepts that the transfer pricing regime won’t be able to resolve everything, and you need a safeguard to stop the more egregious schemes and plans that transfer profits overseas without substance and genuine economic activity.
That said, the question then becomes where to draw the line between what is egregious and what is acceptable – and that problem crops up again and again in the tax system, as we know – and it takes some experience and informed judgement to work out where that line should be drawn in order to develop a competitive regime but safeguard the tax base.
I think this is where the debate on CFC is today – how do we draw that line. To date, there has been a pragmatic approach.
The 5.75% rate is a pragmatic cut-off. It doesn’t play too well to the territoriality principle but I think business accepts there has to be some limit, to live within the budget that HMRC and HM Treasury are dealing with.
The ‘gateway’
TV The way things are moving suggests that it will be a question of defining the cases where the CFC rules should bite, as opposed to assuming that they’ll bite everywhere unless you can find a way out.
That would be the best way forward.
You do have to protect against future behaviour but if we can define the gateway, as it’s become known, carefully enough it should only catch the things where there would actually be a consensus that the CFC rule should apply and the genuine commercial activities, wherever they are, would get through.
JK One of the issues that emerged over the summer was a concern about complexity.
There was also a concern about how businesses would operate the system and how much work would have to be done, particularly in looking at profits ‘commensurate’ with activities.
In particular, there was a call for some kind of gateway that could filter out cases.
This would mean that the cases which would get through a gateway, probably 90% of potential CFCs, could do so, easily and quickly.
So we have been listening to that.
I should caveat all of this by emphasising that no decisions have been taken yet by ministers.
We’ve had a number of working groups and recently set up another, of which Tim is a member, to challenge us as we develop the high-level policy into legislation.
We have been developing our thinking as to how that kind of gateway would work.
I think the key point is that the gateway would filter cases out upfront.
Rather than everything potentially being in and then having to show how it met an exemption to get out, you would have this upfront filter.
Only in cases where there was a stark difference between the profits in a CFC and the activities of the key people functions would you actually start to get into the detail of the CFC rules.
Even then, further exemptions would come into play.
The ‘gateway’ idea has proved to be something that businesses and consultees are quite keen on.
The impact on the insurance sector
ME One of the key issues with the gateway for insurers is the reliance on people functions.
Capital is fundamental to insurance business.
That’s not driven by tax, it’s driven by regulation.
Regulators around the world spend a lot of time and effort making sure we have a lot of capital.
Anything that’s focused entirely on people functions is unlikely to work for us as a sector.
JK We’ve looked specifically at how this would work with insurance and we’ve talked to the ABI, the ‘big four’ and insurance companies themselves.
Where we think we may get to on insurance – again, subject to all the caveats I mentioned – is to look at activities of key people functions.
That would mean looking at where the underwriting is done and we think that, in terms of active business, that would cater for the vast majority of situations.
Then, looking at the investment income, we’d be potentially looking at an overcapitalisation test.
Given the regulation that Mark’s mentioned, we think the vast majority of cases should not pose a problem to insurance businesses.
So we feel we’ve moved quite a way forward on insurance.
We may still go further but one of the indicators in terms of where we’ve moved to on insurance is that we have had some indications of insurance companies which had previously inverted wanting to come back to the UK.
ME For the insurance sector CFC reform isn’t a theoretical issue or a ‘nice to have’.
We have had more actual inversions than any other sector.
And – let’s be clear – CFC is not the sole driver of those decisions but it is a major factor.
Fixing the CFC regime could be part of encouraging businesses to locate here, but what I’m hearing currently from my members and more broadly around the sector is that the current gateway ideas are not going to attract insurers back.
What is needed is a regime that gives certainty and is simpler, not one that is more complex and burdensome.
Developing a workable regime
JK The idea is to devise something that the vast majority would pass, so I think we’ve still got a bit more talking to do.
We have had some positive interaction and some indications but I think there’s still further work to do.
TV It has to be a fairly objective test, doesn’t it, something you can measure and which will fall one side or the other of a binary outcome.
If it introduces too much judgement and subjectivity then the position can become difficult and you would probably have to look for some other exemptions or even the general purpose exemption.
ME Yes, but if you’re looking to get people back from outside the UK – where they have certainty, where they have ten-year agreements, where they have simpler or even no CFC rules – you’re never going to make an attractive regime with something that’s full of subjective tests.
JK I understand this point but it seems to me that businesses tend to divide into two camps.
There are those who really want black and white tests that give them certainty so that they know which side of the line they’re going to be on.
There are other businesses which seem to be more at home with a more flexible test.
We’re intending to develop the proposals set out in the ConDoc so that businesses have, in a sense, both options.
So for businesses that want the black and white test, there will be the clear black and white test for them and that’s really where the territorial business exemption comes in, with specific exemptions – safe harbours as it were – for them to go through.
JO The ConDoc itself lists a number of different exemptions.
It seems clear that a particular entity might have to rely on two or even three different exemptions in relation to different strands of business and sources of income, which is quite complex.
Certainly, if you’re using mechanical tests, I could imagine that the compliance burden must be quite extensive in relation to large multinational groups where nothing remains the same year on year.
TV That’s why it is important to develop a workable gateway.
I thought the compliance burden of seeing which of the proposed exemptions you actually meet for all the CFCs, and having to recompute your profits on a UK basis, would be horrendous.
But my current feeling is that if we can really get a gateway to work, what’s left isn’t going to be very much.
Then you have to do the work.
I think we accept that because, if you’re into the finance company regime – and even for a mixed company you’re into that regime – you’ll do the work.
Then if there are other exemptions for those who wish to do the calculations to show that they meet them, then they can achieve 100% certainty.
So we do need both approaches because there will be people who will want that level of certainty and it should be available in non-abusive situations.
Whether they get there through a gateway that they can self-assess, or get more comfort because we’ve done all the arithmetic to get within one of the safe harbours, I don’t think that matters.
It’s a choice, isn’t it? On competitiveness, you’ve got to have an easy way through for the vast majority of companies.
Otherwise people will be put off just by the sheer compliance burden, even if you get to the right answer at the end.
JK That’s what we’re very much looking to develop.
There have been some concerns about how we are going to operate this in practice.
We will be starting a small number of pilot cases where businesses with customer relationship managers will work closely with us to look at that.
We also very much intend to make sure that our CRM population have a good understanding and exposure to the regime before it takes effect.
ME That’s going to be very important because the sorts of tests that have been discussed with us have been ‘does this transaction have economic substance’.
How are tax inspectors going to be judging whether something has economic substance when it’s being done in a commercial context?
JK Hopefully, the number of times those conversations will be necessary will be reduced if we have a good gateway.
But there will be residual cases and we need to make sure that CRMs are ready.
ME How much clarity can you give as to how this gateway is going to interact with other tests? Is it going to be a mandatory gateway through which everyone must pass? If you have an excluded countries list, would you not pick that first?
IB It’s not sequential and companies should be free to select the most efficient way to exclude a company from the CFC regime.
ME But will the gateway include, for example, the excluded countries list and a de minimis?
JK It’s not clear yet.
We want to try to get a gateway that would give clear ‘in or outs’ so that businesses wouldn’t necessarily need to operate some of the other exemptions.
ME ‘Gateway’ implies that you go through it in order to get to somewhere – or can you just say ‘look, we’re on the excluded countries list, we don’t need to pass through the gateway’?
JK The gateway is intended to help, not hinder.
If the CFC qualifies for the excluded countries exemption, then there would be no need to consider the gateway separately.
TV If you would rather use the other exemptions, I don’t see any reason why you couldn’t.
They’ll all be there because one thing we asked for consistently was that there isn’t a flowchart going through each particular exemption but that you can look at the regime it in its entirety and say ‘which exemption fits my facts and circumstances better?’ and then go for whatever that is.
JO When you look at the detail of the exemptions in the ConDoc, in quite a few of them it is a condition that there is local management.
Some people have said that doesn’t reflect the reality of the way multinationals might manage their affairs which could be more on a regional basis.
Is there a particular view on this as to whether the local management condition is an easy condition to satisfy, or would it require too much reorganisation or too much fact finding?
ME It doesn’t make sense if you’re going to have a territorial-based regime to then insist on local management.
You’re trying to draw a ring-fence around the UK.
Whether your overseas businesses are managed on a regional basis or managed in each individual territory shouldn’t really matter.
It particularly doesn’t work with permanent establishments.
What is ‘local management’ of a permanent establishment? It can be so variable because, of course, it’s not a management test as to whether you have a permanent establishment.
JK As our thinking has developed on a gateway, we will also be looking at the specific exemptions, which are essentially intended to be proxies for the more general approach.
ME We viewed the local management test as an example of where there was too much of a ‘belt and braces’ approach in the proposals.
The discussions over the summer have indicated that you are considering drawing back from that approach and that’s quite important because it goes to that heart of the complexity seen in the proposals.
CFC can legitimately look to fill in any voids but it shouldn’t look to have a big overlap with the transfer pricing and other rules.
JK That's absolutely at the heart of the idea of a gateway, to look at only those cases where there's really an egregious mismatch.
IB Regarding any local management test, for many global companies like AstraZeneca, which has an integrated strategy and objectives developed by global management teams, it’s very hard to distinguish what’s designed and driven by people in a single territory versus a region, versus the global level.
When you look into the individual markets there’s not necessarily strategic decision-making going on at all.
The broader allocation of resources may well take place at a regional level, driven by a strategy that’s developed at the global level.
Global management for a UK Plc doesn’t necessarily mean a management team all of whom are resident and working in the UK.
Global management often refers to teams made up of people from multiple countries, who determine global strategy.
From there, regional and local teams determine their respective responses to the global strategy using the resources allocated.
So you get blurred lines between activities and decisions made in a country, in regions and at the global level.
Decision-making by territory is therefore a difficult test to impose for the purpose of an effective CFC regime.
That’s something which I have to reconcile all the time for transfer pricing purposes and I would recommend that we do not have a local, autonomous decision-making test for the purposes of the gateway.
Upstream loans
JO On the finance company exemption it seems to me it is a condition that there are no upstream loans, other than possibly on a short-term basis back to the UK.
Does that seem workable in practice or is that going to actually distort decisions? I think it’s a complete exclusion.
You can’t take the benefit of the exemption at all.
JK Yes, there have been discussions around cash management and making sure that we don’t have something that just doesn’t fit with the way people do business.
But we’re trying to address risk, and there is a risk from upstream loans.
IB I think that’s right because we’ve been encouraged to keep our Treasury function onshore, and where we’ve got cash generated offshore we pool it, and consolidate it for the purpose of hedging and control at the centre.
Many companies will have upstream loans as well as outbound loans all on commercial terms, with subsidiaries in places like the US, Japan or Germany so there shouldn’t be a problem for CFC purposes.
It would be a shame if those sorts of upstream balances created a CFC administration burden or an adverse tax outcome.
HMRC is right to tread carefully in terms of what’s in and what’s out regarding upstream loans.
The impact on inversions
JK As I mentioned before, it feels as though the tide has turned on inversions.
A couple of years ago we were seeing businesses wanting to invert.
There are now indications that some businesses want to come back.
There are also indications of multinationals seeking to locate their HQ and other functions in the UK.
ME I don’t think you should be too comfortable that the tide has irrevocably turned on inversions.
A lot of people are waiting to see what happens ...
JK I’m not at all complacent on this but a couple of years ago I was having lots of meetings with ‘big four’ firms, bringing in companies which were wanting to invert.
It seems now to be the reverse – we have those firms bringing in businesses which are looking to relocate.
They may not have taken the decision yet but they are considering it.
We are having discussions with businesses looking to put the top company in the UK.
ME I think the roadmap has had a positive impact because it has set out a very positive intent, but the outcome must match.
There have been a number of insurers that have moved out of proximity to the US, given the pressure the US is putting on places like Bermuda, and they haven’t come here.
When you talk to them, the UK still isn’t making the shortlist.
Positive intent is not enough.
JK We’d be very keen to have the opportunity to be part of the discussions, in terms of knowing why the UK is not making the shortlist and what is getting in the way.
Either it’s something that we need to be aware of and develop in our current proposals, or there may be other things that we need to be turning to next.
TV I suspect the CFC uncertainty is probably the biggest issue.
We have the substantial shareholdings exemption and the dividends exemption, although even there you have to stop and think and make sure it’s okay but they’re good exemptions.
Sometimes they can be very complicated, and so that is a plea for CFC reform to avoid too much complexity.
That can put a lot of people off but I do feel that if you can get the CFC reform right it will move the needle quite a lot really, for somebody who’s thinking of coming to the UK.
Clearances
JO The CFC document refers to clearances in a number of places, non-statutory clearances.
Is it envisaged that will be handled by the local inspector or is that going to be centralised?
JK The CRMs will need to be involved but at least in the first instance, we’ll need to have some reference to a central team to make sure that we’re being consistent.
Intellectual property
JO In relation to IP, do you think the conditions in the current ConDoc have gone over the top in terms of the extent to which any UK connection, current or historical, prevents the exemption in the CFC?
IB IP has proved to be one of the most difficult areas, and connection with the UK is a difficult thing to define.
Again, I refer back to the highly integrated multinational.
Every piece of our intangible property is, in some way, shape or form, connected with somebody operating in the UK and it’s a question of how deep that connection has to be to drag you into the CFC net or without.
The exit of IP from the UK, within a six-year timeframe, is probably okay because intra-group transfers of IP can be successfully achieved with full economic substance.
But I think, as a safeguard, and given what HMRC has witnessed before, that probably is a reasonable safeguard to have in place.
If it’s IP that’s been developed offshore, or even by a third party offshore and bought by an offshore subsidiary that has genuine economic substance, you probably should be leaving that alone.
Now, those deals may be referred up to UK people who sit on a UK oversight board, and that shouldn’t create a UK connection sufficient to attract that profit back to the UK.
JO IP is constantly developing, evolving and IP that might have originated at some point – perhaps in the very recent past – in the UK may, as part of a commercial arrangement, go offshore to be combined with other IP developed outside the UK.
It might go into a joint venture, for example, and be mixed up with other IP.
The best place to develop it and bring it to market could be in some other jurisdiction.
IB Yes, that should be safe if it’s developed overseas by people operating overseas ...
JO ... with elements of it having been transferred.
TV What you wouldn’t want to do is exclude the UK from providing any R&D or contract R&D service to that IP.
JO Yes, which is where the paradox is between on the one hand trying to minimise the UK connection, and on the other hand trying to generate business in the UK.
IB I think that’s been the genuine difficulty in discussions as to not preclude the UK from accessing valuable R&D contracts and work, and service provision, as opposed to calling to account the CFC and taxing those profits unfairly.
JK This is an area where the gateway idea really comes into play.
We wouldn’t be looking at every marginal situation but we’d be looking at those where there was really a stark egregious mismatch between where the people functions are and where the profit is generated.
The point that Ian made about board-level involvement is not what we’re talking about here.
We’re talking about the people actually doing the work and taking decisions at the operational level.
JO The Patent Box. Is it more complicated than it needs to be?
IB One approach would be to have a very loose arrangement like some other regimes where a company may have some patented intellectual property generally and enters into an agreement with the local tax inspector as to what proportion they think should be attributable to the low rate.
But if you want something a bit more certain than that, the regime will become more complicated on a couple of fronts.
First, the scope of intellectual property that would qualify to be included in the Patent Box.
In our business, there are all sorts of nuances within patented IP and we need to understand whether they’re in or out for the purpose of the Patent Box.
The second point is calculating the tax base that will attract a 10% rate.
The idea from HM Treasury is to exclude non-IP related income, such as returns on manufacturing, distribution, and selling and marketing, as well as non-patent related IP such as trademarks, copyrights etc.
Excluding all of those items to arrive at the residual profit pot that attracts the 10% rate takes quite a bit of maths and management, and what we’re working through now is just how you go through those steps in order to get something that is worth having at the end of the day and makes a difference for the UK and its ability to attract jobs and investment.
I think that’s the stage we’ve got to.
Progress has been good and it’s been steady, and steady for good reason because it is quite complicated and we need to keep working to get to a certain and competitive outcome.
Certainty is really important as when any company is conducting an investment appraisal over 20 years, as is the case in pharmaceuticals, we need to have the most accurate view of what the post-tax cash profile looks like over that period.
The more competitive and the greater the certainty of outcome the more confident UK business can be in competing with non-UK based business.
The competition from overseas may be able to access IP regimes in other countries – similar sorts of rates or even lower, so we want to make sure that we’ve got certainty in the UK and a regime that competes with those other regimes.
This should make the UK a preferred location for patent-based IP investment and enhance prospects for job creation.
TV One other point I wanted to mention about competitiveness is an area where perhaps the UK is not as competitive as it could be – tax relief for large investment.
I think the capital allowances regime, generally, has got less attractive as the rates have come down.
We understand that’s the trade-off with the lower rate but there are still quite a few areas where there’s no relief.
I know, in particular, the large infrastructure companies don’t feel that the UK is competitive in that regard on big capital budgets.
IB From my perspective, the tax policy process developed by this government is very positive.
In addition, the UK tax regime is getting more competitive and, hopefully, the patent box and CFC regimes will cap it off as the most competitive in the G20.
Furthermore, other important attributes of the UK tax system including the treaty network, the administration of taxes by HMRC, and the manner in which HMRC conducts business through competent authority processes, APAs, transfer pricing disputes, clearances, the CRM risk-based approach toward large business, alternative dispute resolution, etc, adds up to a first class service.
JO That’s a positive note on which to end. Thank you all very much.
