CFC Reform

1. CFC Reform HMT/HMRC open event 8 July 2011

2. Agenda 2:30 � 2:45 Introduction Mike Williams, Director of Business and International Tax, HMT 2:45 � 3:00 Overview of the new regime Jennifer Payne, Corporate Tax Team, HMT 3:00 � 3:30 Low risk exemptions and the finance company rules Robert Edwards, �Corporate Tax Team, HMT 3:30 � 4:00 The territorial business exemptions; general purpose exemption and intellectual property proposals Alison Hughes, Business International, HMRC 4:00 � 4.10 Other issues and next steps Jennifer Payne, Corporate Tax Team, HMT 4:10 � 4:15 Closing remarks Judith Knott (Director CT, International & Anti-Avoidance, HMRC) Jon Sherman (Deputy Director Corporate Tax Team, HMT)

4. CFC reform: aims and objectives Better reflect the way businesses operate in a more globalised economy moving towards a more territorial corporate tax system Strike the right balance between delivering a more competitive tax system and protecting the UK tax base recognising that most CFCs held for genuine commercial reasons targeting the highest risks of artificial diversion of UK profits Build on interim CFC improvements Maintain compliance with EU law

5. CFC reform: principles A sustainable tax base a more territorial approach targeted at artificial diversion of profits from the UK Exempt profits arising from genuine overseas economic activities Adopt a proportionate response Aligned with modern business practice fit with current business models, flexible, some sector specific rules minimises impact on commercial decisions reflects increase in centralisation and intra-group transactions A stable regime � Use of TAARs being considered Maintains level playing field Minimises complexity

6. Overview of proposed CFC regime Overall structure will have some similarity to existing regime but exemptions modernised Applied to entities, but CFC charge limited to artificially diverted profits CFC = controlled by UK, resident outside UK, lower effective tax rate Exempt low risk entities Low profit exemption ? Territorial Business Exemptions Excluded Countries Exemption ? Sector specific rules Temporary Period New finance company rules New General Purpose Exemption

8. Defining a CFC Aim is to identify overseas companies that are subject to a lower level of tax whereby there is a potential risk of artificial diversion of profit from the UK Control Principles based approach Accounting standards approach Mechanical approach Foreign Resident outside of the UK Lower level of tax test Based on actual tax paid in territory of residence Retain threshold at 75% of UK corporate tax that would have been suffered if overseas company was resident in the UK UK chargeable profits v accounts based measure

9. Low profits exemption The Government proposes different options for how low profits exemption could operate to increase the number of CFCs that can qualify Option A - �500k with investment income cap For example, cap at �50k or 10% of total income Option B - Low profit threshold relative to the size of group Allow larger groups a more proportional threshold to their circumstances and potential risks Upper limit of �1m, minimum of �200k Option C - �200k with no investment cap Measure of profits will be based on accounting profits, subject to adjustments

10. Excluded countries exemption Aims to exempt CFCs that are located in jurisdictions with tax regimes that have broadly similar rates and bases to the UK Consideration of a �white list� of jurisdictions and whether the non local source rules could be made simpler to operate Various options under consideration involving different lists of jurisdictions and different level of conditions attached General conditions Income arising from transactions the UK Investment income Branch income where branch in another territory subject to a lower tax charge Territory specific conditions

11. Temporary period exemption following reorganisation Aim to assist UK multinationals with M&A activity and help make it easier for groups to relocate or to establish regional holding companies in the UK Exemption for up to 3 years for potential CFCs which come under the control of the UK as a result of a third party acquisition or group reorganisation Anti-avoidance rules to protect against abuse Transitional rules

12. Finance company rules - overview Introduction of FCPE is a pragmatic and competitive approach to allow groups to manage overseas finance operations while protecting UK tax base Recognises that multinationals prefer to manage overseas financing centrally, but also removes to ability to �swamp� finance income Deliver an effective UK tax rate on overseas intra-group finance profits of 5.75% in the majority of circumstances Applied to intra-group finance income that represents structural surplus cash not working capital Does not apply to monies held on deposit with third parties, or finance income on most upstream loans to the UK Sector specific rules TAAR

13. Finance company rules � mechanics of rules Imputation v apportiontment Design options Simplest option to apply to wholly equity funded CFC that only lends to overseas group companies More flexible options to cater for more complex overseas finance arrangement, should remove need for groups to restructure Move flexible options include Option A � a mechanical set of rules that focuses on chargeable finance income Option B � allows an election to disregard three quarters of intra-group finance income and three quarters of corresponding finance expense Option C � seeks to apportion one quarter of chargeable finance profits. A proportional credit for overseas tax paid in respect to apportioned profits

14. Finance company rules � other issues The Government is considering a full exemption in limited circumstances For example, where group makes the vast majority of profits overseas, which are reinvested overseas, no net borrowing in UK Where a CFC is funded through funds raised from shareholders Treasury companies and interaction with finance company rules Treatment of upstream loans Application to exempt foreign branches Interaction with arbitrage provisions Application of principles from the General Purpose Exemption Profits commensurate with activity of the CFC would be exempt

16. Territorial business exemptions Three TBEs to exempt a CFC that carries on commercial activities that do not pose a significant risk of artificial diversion of UK profits Mechanical v principles-based approach � early indication required CFC needs to satisfy a local management condition Safe harbour Cost base Mark up Exclusions Minimal conditions

17. Territorial business exemptions (continued) Manufacturing exemption Definition Exemption will apply to manufacturing regardless of extent of transactions with the UK Permit incidental amounts of investment/finance income Where activity involves IP, activity using local IP Developed by CFC�s own staff Developed by third parties Acquired by or licensed to for purposes of the manufacturing activity

18. Territorial business exemptions (continued) General exemption for commercial activities Foreign to foreign Foreign to UK where no artificial diversion Low risk IP Other issues Interaction with investment activities Holding and managing non group shares and securities Leasing other than property and tangible asset leasing Incidental investment/finance income Holding companies Local holding companies and mixed activity holding companies Sector specific rules Insurance and banking

19. General purpose exemption (GPE) � how it will operate?

20. General purpose exemption � basis of calculation Determine assets and risks attaching to CFC under �uncontrolled conditions� Could use Article 7 principles Location of active day to day decision making Location of other core functions Profits accruing under �uncontrolled conditions� CFCs with intra group finance income

21. Treatment of Intellectual Property: Principles More territorial approach ? focus on artificially diverted UK profit Protect the UK tax base without distorting or inhibiting the way in which groups manage their commercial operations overseas Rules to be as easy as possible to apply but should not facilitate or encourage the movement of IP out of the UK Encourage innovative activities to take place in the UK patent box some sub-contracting to UK permitted under CFC exemptions Target IP which is transferred from UK where transfer unlikely at arm�s length IP developed or actively managed in UK to such an extent it is likely to be owned in UK at arm�s length IP held as investment

22. Intellectual Property: Trading Business Exemptions A CFC with lower value IP may qualify for the TBE profits rate Safe Harbour A CFC performing �only� manufacturing activities may qualify for the Manufacturing TBE, providing it owns only �Local IP�, i.e. IP developed mainly by own staff and unrelated parties for its trade Acquired/inlicensed IP necessary for the manufacturing activities The TBE also exempts CFCs with most other commercial activities involving the exploitation of IP where the IP has not �recently� been transferred from the UK provided not more than 50% of spend on IP with UK related parties provided not more that 20% of CFC�s gross income from UK TBE also available if, in total, non-qualifying activities are not substantial Also consulting on a principles-based TBE instead of/as well as mechanical rules

23. Intellectual Property: General Purpose Exemption Profits attributable to IP are considered artificially diverted from UK if the UK more likely than not to own the IP under arm�s length conditions Relevant factors include location of day-to-day active decision-making and other �core functions�. Other hallmarks suggested in ConDoc.

25. Foreign branches Aim is for CFC rules, as far as possible, to apply equally to branches of UK companies that have opted into exemption and foreign subsidiaries Where necessary, differences between these operating models will arise (e.g. potentially the application of the finance company rules) The anti diversion rules in the current branch legislation (Finance Bill 2011) will be repealed

26. Insurance exemption The exemption will cover genuine overseas insurance and reinsurance operations Exempt foreign to foreign intra-group insurance activity in line with a more territorial approach Intended to exclude captives within non insurance groups Key issues are Design of UK connection test Capitalisation test driven by extension of the exemption to foreign to foreign intra-group transactions and potential Exchequer risk Other issues: definition of large risks; treatment of global business Significant number of insurance companies should also be able to qualify for the excluded countries exemption

27. Banking exemption The exemption will cover genuine overseas banking operations and improve the way artificial diversion of profits from the UK is targeted Based on consultation, it is proposed to adopt a test that operates in similar way to current rules but which operates in a proportionate manner Factors under consideration in design of capitalisation test: 15% threshold in current capital structure test Whether capital interest should include debt funding from UK Treatment of intra-group guarantees When and how regularly the test has to be satisfied Consideration of approach to be taken on gross trading receipts test and UK business income tests

28. Property investment and operating leasing It is recognised that investment in property in the form of overseas land and buildings does not give rise to a significant risk of diversion of UK profits Property investment activities will be exempt where: Long term leasing of property located outside the UK to third parties CFC has appropriate level of local management Consideration is being given to local management condition and whether the property being leased should be in the same territory as the CFC Similarly, it is recognised that the leasing of large value capital assets (such as ships, aircraft, oil rigs) where there is limited connection with the UK should be exempt where: Fixed term hiring where lessor retains ownership/control, including risks/rewards Value of asset leased is more than �10m Asset has not been subject to a capital allowance claim in the UK UK income/expenditure condition

29. Commencement and miscellaneous Consulting on the commencement date for the new CFC regime earliest possibility is accounting periods beginning after Royal Assent for FB12 Non-statutory clearance mechanism unchanged Will publish guidance to enable self-assessment under all exemptions including GPE

30. Summary Overall structure will have some similarity to existing regime Substantial improvements made Give partial exemption on finance company profits Exempt profits arising on foreign IP and foreign activity Modernise exemptions Partial CFC charge � only on profits artificially diverted from UK But need to maintain effective CFC regime in order to protect against artificial diversion of profits from the UK to low tax jurisdictions No overall relaxation of regime in respect of IP artificially diverted from UK whether by transfer, acquisition or on creation

31. Next steps Businesses can and should play a key role in developing and testing tax policy. The Government encourages all interested parties to engage to ensure a full range of views is heard. Deadline for representations is 22 September 2011 informal, high-level responses welcome an earlier date no need to respond to all the questions Working groups to continue CFC team contacts jennifer.payne@hmtreasury.gsi.gov.uk 020 7270 5072 robert.edwards@hmtreasury.gsi.gov.uk 020 7270 5276 alison.hughes@hmrc.gsi.gov.uk 020 3300 9170 andy.mill@hmrc.gsi.gov.uk 020 7147 2668