Memorandum submitted by the Institute
of Chartered Accountants in England and Wales
1. Measures to Improve UK Productivity (Leitch,
Barker and Eddington)
The ICAEW welcomes the Leitch, Barker
and Eddington Reports.
2. Improving the UK Tax System
The need to keep UK corporation tax
rates globally competitive.
Ensuring UK taxation on foreign profits
does not disadvantage UK companies compared to those in the EU.
The need for real progress on simplifying
the UK tax system.
3. Delivering Efficient and High Quality
Transition without investment in
HMRC is resulting in poorer tax services.
4. Regulation & the Administrative Burden
Government must act to address the
cost of new regulation on the smallest businesses.
5. Missing Trader Intra-Community Fraud (MTIC)
The fundamental incentive for fraud
has still to be addressed.
6. Controlled Foreign Companies (CFC)
CFC changes should be EC Treaty compliant.
7. Six year limitation period for all Direct
The retrospective nature of the legislation
and the way it pre-empts a legal ruling is of concern.
8. Managed Service Companies
We welcome the consultation on these
changes, as safeguards are needed for workers.
9. Construction Industry Scheme (CIS)
Lack of evidence for revenue raising
from small construction operators.
1. MEASURES TO
IMPROVE UK PRODUCTIVITY
The ICAEW warmly welcomes the publication of
the Leitch, Barker and Eddington Reports. As out own Enterprise
Survey Report 2006 demonstrated, UK business is experiencing a
unique challenge from increasingly global competition as well
as unique opportunities. Tackling core barriers to UK productivity
growth, particularly skills, is essential to equipping business
to compete on a global scale. Improving the UK tax system and
dealing with regulation are however areas where we would have
liked to see a similar level of progress in this PBR.
THE UK TAX
The ICAEW welcomes the Government's determination
(paragraph 5.102 of the PBR Book) to maintain the overall competitiveness
of the UK tax system. We also welcome the Government's announcement
that next year it will consult with business on a wider package
of reform. However, we believe there were a number of lost opportunities
for improvement in this PBR.
We have welcomed the recent proposal in the
Varney review "Links with large business" which do make
a significant contribution on the issue of uncertainty. The recommendations
are ambitious but will require investment in appropriate resources.
However, the Varney proposals still do not address the fundamental
complexity of the UK tax system. Complexity is a significant factor
in the investment decisions of multinational businesses. For small
business it impacts upon such decisions as expansion and taking
on their first employees.
The Global Competitiveness of the UK Corporate
We believe that PBR could have gone significantly
further to maintain and improve the UK's competitive position.
The ICAEW believes there are two particular initiatives that the
PBR should have included:
Reducing the headline rate of corporation
tax. The UK's level of 30% is now looking expensive relative to
European Union neighbours over whom we would wish to maintain
our competitive edge.
Improving way in which the UK taxes
foreign profits so that UK companies operating abroad are not
at a relative disadvantage to EU companies operating here. The
UK's credit method system results in a far higher ratio of business
compliance costs to the revenue raised by government, than the
exemption system of most other EU countries. The UK Government
has been considering the issue but it is now time for open consideration
of the advantages to UK business from moving to an exemption system.
Addressing, as well as consulting on the above
two concerns in 2007 would help address the increasing belief
of business that the UK tax system is becoming less competitive.
Potential Measures to Address the Complexity of
the UK Tax System
The ICAEW has consistently drawn attention to
the increase in volume of tax legislation, doubling in the past
10 years. Finance Acts are now three times longer than they were
in the 1980s. Complexity, like regulation (see further section)
has a much greater impact proportionately on the smallest businesses
and tackling this is of key importance for the UK's enterprise
The Government has sought to examine the particular
burdens faced by business in complying with the tax system, for
example in the Admin burdens project published earlier this year.
But initiatives to reduce the burdens on smaller businesses appear
to be stalled, for example the work of the Small Business Review,
launched in 2001, has yet to be taken forward.
We believe that action is required in a number
The Government needs to move forward
with the Small Business Review and bring forward proposals to
reduce some of the key burdens that small businesses face, for
example taking on your first employee.
The Government needs to make a formal
policy commitment to tax simplification and set a timescale for
implementation. We appreciate that the Tax Law Rewrite Project
has produced benefits and made the UK's tax rules clearer, but
it does not address tax simplification, which was the original
intention of the legislation which gave rise to this project.
The use of an independent committee, including representatives
from business and the tax profession, should be considered to
help achieve consensus on a long-term programme.
We welcome the Government's aim to create world-class
tax services through sustained investment and far-reaching reform.
In principle, we support the Government's drive to make public
services more efficient and therefore freeing up resources for
frontline services. We will work with HMRC to help build a tax
system that is fit for the 21 century.
Nevertheless, we are concerned that the ambitious
cost-cutting proposals, and consequent reductions in staff numbers,
are resulting in far-reaching reform now without the level of
investment necessarily needed to improve services. In any event,
technological improvements take time to feed through to real improvements
in the tax system, as they need to be designed, built and tested
thoroughly to ensure that they work properly and are implemented
The result is that, on the ground, services
have deteriorated with the closure of local offices and the increased
reliance on call centres. HMRC's local support structure has been
dismantled but no mechanisms have been put in place to replace
it, let alone lead to improvements. These developments have led
to considerable frustrations for taxpayers and their agents and
advisers, and are probably the largest single cause for complaints
that we receive. Given the year-on-year budget reductions faced
by HMRC, it looks inevitable that services will get worse in the
short-term, calling into question the benefit of any longer-term
Our recommendations for improvement are as follows:
If customer services are to be improved,
there needs to be greater transparency about HMRC's reorganisation
and restructuring and how existing services will be maintained
and improved. This process needs input from tax professionals
and its customers. Whilst returning to the former "District"
structure may no longer be possible, practical steps can be taken
to improve local dialogue and accountability. HMRC is working
on a number of initiatives, for example by nominated staff "owning"
particular issues and by the nomination of named staff as a contact
point for tax agents, but this needs to be translated into sustained
action on the ground and a willingness to work more closely with
There also needs to be recognition
that year-on-year reductions in department budgets may not be
realistic if services are to be improved. A year on year budget
reduction of 5% may not reflect the longer lead-time needed for
investment in new technology to lead to cost savings. A commitment
to a savings in the medium term would focus attention on the necessary
investment required to feed through to improvements rather than
The ICAEW understands the Administrative Burdens
Project Reports quantifying the administrative impact of current
Government regulation will soon be released, together with details
of a 25% across the board reduction target. Though they were not
made available with the Pre-Budget Report, this project has been
cited regularly in Budgets and PBR statements. Together with the
implementation of the Hampton Review, these will make a substantial
contribution to improving current regulation and its enforcement
as well as to wider culture change.
The ICAEW still finds, however, that the cost
of new regulation remains unabated and has actually risen to £7.7
billion this year, with 74% of that impact falling upon businesses
with less than 10 employees (ICAEW Enterprise Survey Report 2006).
The regressive nature of regulation is perhaps the most troubling
aspect of the regulation agenda due to its impact on UK entrepreneurs.
The ICAEW also believes this is the issue least dealt with in
the regulatory agenda and again has not been addressed in the
To help ensure the forthcoming publications
of the Administration Burdens Reports have the greatest impact
on the UK regulatory culture, Treasury Committee may wish to consider
the following timely recommendations:
The figure for the total sum of annual
administrative burden should be published together with the individual
The proportion of the administrative
burden falling upon different sizes of business should be made
That the 25% reduction in administrative
burden should focus most on the smallest business currently realising
the bulk of the burden.
That new administrative burden should
not be "grandfathered" into the targets ie burden should
be 25% less than now even if new regulations have come forward.
That Government widen its Better
Regulation Agenda to include the tackling of the regressive nature
of the cost of new regulation on the smallest businesses.
5. MISSING TRADER
We welcome the Government's announcement of
the measures it is introducing to tackle the fraud and that more
staff are being deployed to help tackle this pernicious attack
upon the tax system. We remain committed to assisting the Government
in its fight against MTIC.
Nevertheless, we remain concerned that the proposed
measures do not address the root cause of the problem and that
unless co-ordinated action is taken at the EU level to address
this issue, MTIC will remain a serious threat to the UK's tax
system. As we said in our PBR submission, the UK Government needs
to work with other Member States and combat MTIC fraud by addressing
the incentive for fraud. The proposed derogation to impose a reverse
charge mechanism is in our view only a short-term fix and in any
event there remains the possibility that the derogation will not
be obtained, which would take the UK back to square one. The UK
needs to consider other possible solutions to reduce MTIC. Our
The imposition of a limit on the
amount of input tax that each VAT-registered business could reclaim
in an accounting period. It would be set at an amount that in
the normal course of events the business would not reach, with
a fast-track clearance procedure for abnormal transactions such
as a property purchase.
In the longer term, national VAT
systems need to be changed so that VAT is charged on cross-border
transactions between registered traders. We recognise that this
may inhibit cross border trade and will require fundamental changes
to the current VAT systems, but operationally we see such a system
as most likely to end the fraud.
The UK has been required to amend its existing
CFC rules to make them EC Treaty compliant.
On 12 September 2006, in the Cadbury Schweppes
case, the European Court of Justice held that the UK CFC regime
is prima facie contrary to the freedom of establishment provisions
of the EC Treaty. However, the breach may be justified provided
the regime applies only to "wholly artificial arrangements"
which do not reflect economic reality. In other words companies
which carry on genuine economic activities in the EEA (the European
Union plus Iceland, Norway and Switzerland) should not be caught
by the UK CFC rules once they have been made compliant with the
EC Treaty. It is this case that has resulted in the requirement
to change the rules.
A company is a CFC if it is resident outside
the UK and is controlled by UK residents and is subject to less
than 75% of the tax that it would pay if it were UK resident.
Any UK resident company that has an interest in the CFC and to
which, with connected persons, at least 25% of the chargeable
profits would be apportioned, must pay tax on the apportioned
profit of the CFC. There is no such apportionment if one of several
The first of the PBR proposals is that companies
which have an EEA business establishment, which comes within the
CFC rules, may apply to HMRC to exclude from an apportionment
that part of the chargeable profits of the CFC which represents
the net economic value created by work carried out by individuals
working for the CFC in business establishments within the EEA.
The second main proposal in the PBR is a change
to the exempt activities test. Currently a CFC satisfies the exempt
activities test if it has a business establishment in its territory
of (overseas) residence, its business affairs in that territory
are effectively managed there, and it does not undertake certain
types of (non-exempt) business. This rule is to be amended so
that a CFC resident in an EEA territory will only be treated as
effectively managed in that territory if there are sufficient
individuals working in that territory who have the competence
and authority to undertake the company's business.
The two proposals are likely to give rise to
the apportionment of profits of CFCs which go beyond profits attributed
to "wholly artificial arrangements which do not reflect economic
We submitted a paper to HM Treasury and HM Revenue
and Customs in November 2006 setting out amendments to the existing
CFC rules which we believe are proportionate and would make the
UK regime EC Treaty compliant.
We recommend the UK Government amend the CFC
rules along the lines proposed in our paper (Appendix 1).
7. SIX YEAR
New provisions will be introduced in FA 2007
which will amend section 32 in respect of any direct tax action
involving mistake of law brought before 8 September 2003 except
where a claimant is subject to a final judgment given by the Courts
before 6 December 2006.
The House of Lords recently determined in the
case of Deutsche Morgan Grenfell that the company had paid
CT earlier than it need to have done [because it should not have
been subject to ACT accounting] under a mistake of law (paragraph
143 of the decision) and that the mistake could be held to have
been discovered only when the ECJ gave its Judgement in the Hoechst
case in March 2001. The fact that the early payment represented
a mistake of law meant that section 32 of the Limitation Act 1980
was in point and section 32 provides that the period of limitation,
for making a claim, only starts when the mistake is discovered.
The effect of the proposal will be to deprive
claimants which have commenced litigation to benefit, in restitution
(or damages), from the rectification of their earlier mistake
of law. In these cases the litigation is a civil law procedure
under common law, and not a Taxes Act claim.
In the context of EU law, the ECJ has held that
limitation periods cannot be reduced without allowing an adequate
period after the enactment of the legislation for lodging the
claims for repayments which persons were entitled to submit under
the original legislation. The current proposal does not give effect
to this and in our view is itself therefore a new and inexcusable
breach of the EU law principle of effective remedy.
The Treasury Committee may wish to ask HM Treasury
what other alternatives to this drastic action were considered
and the reasons for their rejection.
8. MANAGED SERVICE
Managed Service Companies (MSCs) are corporate
structures through which workers provide labour services. The
current proposals seek to differentiate MSCs from Personal Service
Companies (PSC), which will continue to be dealt with by the IR35
MSC structures are most commonly used by persons
working in construction, information technology, teaching and
health workers, but could be used by any sector. The workers are
not usually managing their own businesses, but are performing
in the same capacity as an employee doing the same work, with
the management of the umbrella company being undertaken by a corporate
provider. It is this lack of control which distinguishes workers
in MSCs from those in PSCs and which be most difficult to define
MSCs are used to reduce income tax and national
insurance liabilities by paying each of the workers within it
using dividends rather than using a salary. However, it is important
to stress that another key reason for using these structures is
to cut costs by trying to deny the worker employment rights. In
most cases this succeeds because of the practical difficulties
of having to go through the employment tribunal process to gain
We understand the difficulties associated with
trying to use the IR35 legislation against MSCs and support the
Government's attempts to tackle this problem without disturbing
the vast number of PSCs. However, we are concerned that the workers
employed by MSCs do not usually have a choice when they accept
work, about how the engagement is structured. Indeed many will
not even realise that they are involved in MSCs.
We are pleased that these proposals are going
to be the subject of wide consultation and believe there should
be adequate safeguards to protect vulnerable low paid workers
who could otherwise be those hurt most by this legislation.
The standard deduction rate for the new CIS
is set at 20%. The equivalent rate for deduction under the current
scheme is 18%.
The new CIS comes into operation on 6 April
2007 and will operate very differently from the current one. The
existing system of exemption certificates, registration cards
and annual returns, will be replaced by a system which will be
heavily reliant on online facilities and a monthly return. For
contractors, the entire key to the new scheme is to classify workers
quickly and accurately and then take appropriate steps to deal
with the consequences. This classification of workers falls into
two stages, with the second leading on from the first under certain
A contractor has first and foremost an obligation
to determine whether the person he wishes to engage is in fact
an employee. In such cases, all payments are subject to PAYE and
the CIS is not relevant. If the subcontractor is correctly classified
as self employed, then under the new scheme, on engagement the
contractor will check with HMRC to enable him to decide whether
the subcontractor is to be paid gross or is subject to tax deduction
at one of two rates (please see appendix two). Such self employed
subcontractors will settle their eventual exact tax liability
under the self assessment system in the usual way, having deducted
any CIS deduction already suffered.
The ICAEW does not see the evidence for justifying
such an increase in accelerated tax collection. This standard
deduction rate of tax is meant to be an estimate of the tax that
a subcontractor will eventually be paying for a tax year. This
seems to suggest that the current 18% rate has resulted in serious
underpayment of CIS tax in recent years, but no evidence has been
produced to support this.
We also note that this increase, and presumably
the current under collection of tax which has given rise to it,
has not been discussed at any of the current consultation meetings
with representative bodies and other interested parties.
We suggest that Treasury Committee might ask
for further evidence as to why increasing the deduction is necessary
in order to deal with the justification given in the PBR.
The Institute of Chartered Accountants in England
and Wales (ICAEW) works in the public interest to promote enterprise,
innovation and sustainable growth in a socially-responsible business
Our strength and knowledge are drawn from that
of our members who hold the world's most highly-respected finance
qualification. They work in every sector of the economy, size
of business and public body, from FTSE 100 boardrooms and Government
departments, to high street practitioners, small businesses and
11 December 2006
CONTROLLED FOREIGN COMPANIES
Review of the current UK regime with recommendations
for change to make a future regime
FC Treaty compliant
Paper submitted to HM Treasury and HM
Revenue and CustomsNovember 2006
|OBJECTIVES FOR AN EC TREATY COMPLIANT CFC REGIME
|ANALYSIS OF EXISTING CFC REGIME||9-27
|RECOMMENDED CHANGES TO THE EXEMPT ACTIVITIES
||Appendix 1 |
|WHO WE ARE||Appendix 2
CONTROLLED FOREIGN COMPANIES
1. The present paper has been prepared by a working party
established under the auspices of the Large Business and International
Tax Committee of the ICAEW Tax Faculty working under the chairmanship
of Peter Cussons.
2. The intention of the working party, and of this paper,
is to assist HM Government in its review of the existing controlled
foreign companies (CFC) regime so as to develop a system that
will meet the needs of business which is compliant with the EC
Treaty and addresses the concerns of HM Government particularly
in ensuring that the UK tax system remains, internationally, competitive.
3. The paper considers the background to the current
CFC regime and reviews it in the light of the Judgment of the
European Court of Justice (ECJ) in the Cadbury Schweppes case
4. Information about the Institute of Chartered Accountants
in England and Wales and the Tax Faculty is set out in Appendix
AN EC TREATY
COMPLIANT CFC REGIME
5. We believe that a future UK CFC regime should be:
objective and as certain as is possible;
not open to further EU challenges;
a single system applying to CFCs established within
the EU and CFCs established outside the EU (this would follow
the precedent set following the ECJ judgment in ICI v Colmer
when the relevant UK legislation was amended for all non resident
designed with a view to keeping compliance costs
to a minimum.
Changes may need to be introduced over a period of time to
accommodate the arrival of relevant ECJ Judgments and to allow
business to adapt from the existing regime.
6. On 12 September 2006, the ECJ gave its judgment in
the Cadbury Schweppes case concluding that:
"Articles 43 EC and 48 EC must be interpreted as precluding
the inclusion in the tax base of a resident company established
in a Member State of profits made by a controlled foreign company
in another Member State, where those profits are subject in that
State to a lower level of taxation than that applicable in the
first State, unless such inclusion relates only to wholly artificial
arrangements intended to escape the national tax normally payable.
Accordingly, such a tax measure must not be applied where it is
proven, on the basis of objective factors which are ascertainable
by third parties, that despite the existence of tax motives that
controlled company is actually established in the host Member
State and carries on genuine economic activities there."
7. The case will now be referred back to the Special
Commissioners, from whom the case was originally referred, to
determine the implications of the Judgment in respect of Cadbury
8. The UK Government will also need to consider what
changes are required to existing UK legislation to reflect the
EXISTING CFC SYSTEM
9. We consider in this section the extent to which the
existing exemptions can and should be retained under a reformed,
EC Treaty compliant, CFC regime.
Exempt Activities Test
10. The exempt activities test allows companies engaged
in certain trading activities and particular types of holding
company to fall outside the CFC rules on the basis that, as such,
they can reasonably be assumed not to be used for reducing UK
tax. To satisfy the exemption, a company must have proper "substance"
evidenced by adequate premises and sufficient employees in its
territory of residence to carry on its business there.
11. However, a company which is engaged in one of the
"precluded" activities listed in the legislation is
prevented from satisfying the exempt activities test even if it
meets the substance requirements. Finance Acts 2000 and 2003 both
expanded the precluded activities so that they now consist of
investment business and dealing in goods for delivery to or from
the UK or to or from connected or associated persons, as well
as wholesale, distributive financial or service business where
50% or more of gross trading receipts are derived directly or
indirectly from, broadly, related persons or unrelated UK persons.
This means, for example, that intra-group service companies, service
and certain insurance companies deriving the majority of their
income from UK customers and banks which receive non-interest
income from UK customers amounting to more than 10% of their total
income are no longer able to satisfy the exempt activities test.
Unfortunately, our experience has been that HMRC are normally
unwilling to accept that these types of company can satisfy the
motive test (see below).
12. We consider that on its own an exemption which does
not apply to companies carrying on particular activities cannot
be EC Treaty compliant hence it cannot be retained following Cadbury
Schweppes since the sole test laid down in the ECJ's judgment
is the requirement that the CFC is actually established in the
host country and carries on genuine economic activities there.
In addition, there is no permissible active versus passive test.
The ECJ's judgment on the recently heard Columbus Container case
will cover this issue (see paragraph 26 below).
13. We consider that the easiest way
to create an EC Treaty compliant CFC regime following Cadbury
Schweppes would be to amend the exempt activities test so that
a company is no longer prevented from satisfying the test where
it is carrying on one of the precluded activities. This would
leave the existing substance requirements in the exempt activities
test, which appear similar to those set out in the Cadbury Schweppes
decision (given the ECJ's reference to a CFC needing to have "staff,
premises and equipment"), to be satisfied. The advantage
of this approach is that substance would then be based on long
established and well understood tests. In this case, the motive
test could be left in place for companies that fail the exempt
activities test but nevertheless are not in existence to avoid
UK tax by a diversion of profits.
14. In addition to the above, there are a number of areas
where we believe changes should be made to the existing legislation.
These are covered in Appendix 1 to this paper.
Excluded Countries Regulations
15. This exemption was originally introduced to reduce
the compliance burden for UK companies by giving them a relatively
easy way of confirming that overseas subsidiaries are not subject
to the CFC rules. Companies resident in a territory on an approved
list of countries and deriving the majority of their income from
local sources are able to fall outside the CFC rules on the basis
that, as such, they are unlikely to be involved in UK tax avoidance.
The exemption, originally set out in an HMRC press release of
5 October 1993, was given statutory basis in regulations following
the introduction of corporation tax self assessment to give UK
companies certainty when relying on it.
16. Following the 2004 Pre-Budget Report, a number of
anti-avoidance provisions were included in the regulations as
a result of perceived abuse of the exemption. The new "motive"
condition (set out in Regulation 4(A1) and (A2)), in particular,
which is widely drafted has made it much more difficult for UK
companies to be certain that the exemption applies in any given
situation, which clearly goes against the original intention for
having this exemption.
17. Given its importance in reducing the compliance burden
for UK companies, we believe that the excluded countries regulations
should be retained. However, we consider that the motive condition
should be removed as it creates too much uncertainty for companies
looking to rely on it. Where HMRC become aware of tax avoidance
schemes which rely on the excluded countries regulations, we do
not see a particular problem with the introduction of anti-avoidance
provisions provided that they are properly targeted at the perceived
abuse. If the motive condition is not removed, it is important
that HMRC issue proper guidance, particularly on the difference
in approach as compared to the motive test itself. In order
to be EC Treaty compliant we also believe that all EU Member States
should be included on the list of excluded countries, otherwise
the exemption breaches Article 12 EC Treaty (prohibition of discrimination
on grounds of nationality).
Acceptable Distribution Policy
18. A company falls outside the CFC rules provided it
distributes not less than 90% of its "net chargeable profits"
during or within 18 months of the end of the particular accounting
period. Although in form the acceptable distribution policy (ADP)
test resembles the other exemptions, in substance it represents
an alternative form of tax charge as it is only satisfied if the
CFC pays dividends which are chargeable to tax in the hands of
19. This forced distribution is in our view a breach
of either the freedom of establishment or the free movement of
capital, where the CFC is actually established in the member state
concerned and carrying on genuine economic activity there. We
believe that this exemption should however be retained in relation
to CFCs not genuinely locally established as it does still
provide some advantage as compared to suffering a CFC apportionment
(even though this is limited following the "ring-fencing"
of ADP dividends for double tax relief purposes).
Public Quotation Condition
20. A company falls outside the CFC rules, broadly, if
shares representing not less than 35% of the voting power are
held by the public, those shares have been listed on the official
list of a recognised stock exchange during the 12 months before
the end of the relevant accounting period and there have been
dealings in the shares on a recognised stock exchange during that
21. We believe that this exemption should be retained,
but would advocate that consideration be given to extending
it to cover the subsidiaries of a qualifying quoted parent company.
De Minimis Exclusion
22. Companies with chargeable profits of less than £50,000
per annum fall outside the CFC rules.
23. We consider that this exemption should be retained
but that the "de minimis" amount which has only been
raised once since the CFC legislation was introduced in Finance
Act 1984 should be raised to at least £100,000 per annum.
24. In addition to all the above exemptions which can
potentially take a company outside the scope of the CFC rules,
there is also the motive test, although this is often seen as
a last resort. Both legs of the motive test have to be satisfied.
The first leg is that transactions which are reflected in the
profits of the subsidiary company must not have achieved more
than a minimal reduction in UK tax or the reduction must not be
a main purpose of the transactions. The second leg is that it
must not be a main reason for the company's existence to achieve
a reduction in UK tax by a diversion of profits from the UK. Our
previous experience of HMRC's approach to the motive test is that
even if there are strong commercial reasons for establishing a
company offshore to carry on one of the precluded activities set
out in the exempt activities test, HMRC will normally argue that
the reduction in UK tax, if it is significant, must have been
one of the main reasons for the company's existence and that,
therefore, the second leg of the test is not satisfied. In our
view, the motive test and the way in which HMRC apply it is contrary
to the ECJ's decision in Cadbury Schweppes as the focus is very
much on tax motives.
25. If the exempt activities test is changed, as we have
recommended above, then it might be possible to leave the motive
test unchanged to allow companies which do not have the necessary
substance but nevertheless are not in existence to avoid UK tax
to fall outside the CFC rules. If the Treasury/HMRC decide not
to change the exempt activities test to make the CFC rules EC
Treaty compliant, we consider that the next best option would
be to amend the motive test so that it is additionally satisfied
where a company has sufficient substance to carry on its activities.
If this were done, it would be important for there to be objective
criteria for establishing whether there was adequate substance
in any particular situation, otherwise taxpayers would be faced
with significant uncertainty. Our strong preference would be for
these criteria to be set out in the legislation itself, rather
than being dealt with in guidance issued by HMRC.
Distinction between Passive and Active Income
26. One possibility, which we have heard suggested, would
be for a completely new CFC regime to be introduced which focuses
on types of income rather than entities (similar to the US subpart
F rules) so that only passive income would be potentially caught.
However, we can see nothing in the Cadbury Schweppes judgment
to suggest that such a regime would be EC Treaty compliant unless
it targeted only "wholly artificial arrangements". This
would mean that passive income could still not be taxed under
the CFC rules if it was supported by the necessary substance.
The German case of Columbus Container Services BVBA & Co v
Finanzamt Bielefeld-Innenstadt (C-298/05), which was heard before
the ECJ on 28 September 2006, should confirm this point (the Advocate-General's
Opinion and ECJ Judgment will presumably be available some time
in 2007). We believe that it is likely that the ECJ will conclude
that Germany is not allowed, under EC law, to move from tax exemption
to an ordinary tax credit due to a domestic anti-avoidance measure
that applies to the low-tax passive foreign income of foreign
27. We believe that an ongoing clearance procedure for
all material aspects of any revised CFC regime is highly desirable.
We do not believe that the COP 10 regime in its current form,
particularly with its limitation on advice on the effect of legislation
passed in the previous four Finance Acts, is adequate. Accordingly,
the existing CFC clearance procedure either needs to be given
a statutory basis or there needs to be an undertaking from HMRC
that it will be available for the long-term. We, therefore, welcome
the proposals contained in the Varney Review Report published
on 17 November 2006.
28. We have summarised below our recommendations for
changes to be made to the CFC regime in the light of the Cadbury
Exempt activities test
29. In order to ensure that the CFC regime is EC Treaty
the exempt activities test should be amended so
that it can be satisfied regardless of the activities carried
on, provided that the company in question satisfies the existing
substance requirements set out in the legislation.
This would have the advantage of "substance" being
based on long established and well understood tests and could
leave the existing motive test in place to be satisfied by companies
which despite not having the necessary substance are not in existence
to avoid UK tax.
30. The other exemptions should be retained allowing
taxpayers to rely on the exemption which is the easiest to satisfy
in any particular situation. However, the following changes should
be made to those exemptions:
Excluded countries regulationsthe
new "motive" condition should be removed and the list
of excluded countries amended so that it includes all of the EU
Public quotation conditionthis exemption
should be extended to cover the subsidiaries of a qualifying quoted
De minimis exclusionthe "de
minimis" amount should be raised to at least £100,000
Changes to apply not just to the EU Member States
31. The changes which are made should apply to both EU
and non-EU subsidiaries. Otherwise, taxpayers will be faced with
the added difficulty of having to apply two sets of CFC rules.
The need for an ongoing clearance procedure
32. Given the importance of having an ongoing clearance
procedure for all material aspects of any revised CFC regime,
the existing CFC clearance procedure either needs to be given
a statutory basis or there needs to be an undertaking from HMRC
that it will be available for the long-term. We, therefore, welcome
the proposals contained in the Varney Review Report published
on 17 November 2006.
We believe that the provisions introduced in FA 2003 (Section
200 and Schedule 42) and in particularly the "habitually
resident" point which, for example, catches Irish subsidiaries
of UK banks which are prevented from doing business with the UK,
constitute a constraint on the freedom to provide services within
the EU. Accordingly, these provisions need to be removed from
While it is helpful that holding companies are able to meet
the exempt activities test, the relevant conditions can be difficult
to satisfy in practice. In particular:
A relatively small amount of "bad" income
can cause the 90% income tests in Paragraphs 6(3), 6(4) and 6(4A)
Schedule 25 to be failed. It would be more reasonable if the threshold
was reduced to, say, 80%.
Paragraph 12(5) Schedule 25 means that the 90%
income test can be failed in purely commercial structures (particularly
where there are a number of tiers of trading company, which is
not uncommon). Paragraph 12(5) should be removed or at least amended
to exclude dividends from non-trading income.
The ability to treat a 40/40 joint venture company
as controlled for the purposes of the holding and income tests
is only allowed under Paragraph 6(ZA) Schedule 25 where the company
in question is a CFC (ie subject to a lower level of taxation)
and a trading company. This is unnecessarily restrictive. Paragraph
6(ZA) should treat any 40/40 joint venture company (whether or
not it is subject to a lower level of taxation or trading) as
controlled for the purposes of the holding and income tests.
Construction Industry Scheme
|Contractor Registered Status||Payment Arrangements
|Registered for gross payment||Pay without deduction of CISTax.
|Registered for net payment||Deduct CIS tax at the first rate from payments for labour. This rate is currently 18%, but following the PBR announcement will be 20% for the new scheme. Do not deduct tax from payments for the cost of materials, but record the amount allowed for materials.
|Not registered||Deduct CIS tax at the second (higher) rate from payments for labour. This rate has been announced to be 30% in the PBR 2006. Do not deduct tax from payments for the cost of materials, but record the amount allowed for materials.
|7 December 2006||