The European Commission has ruled that part of a UK tax scheme is illegal under EU State Aid rules, as it exempted certain multinationals, and has ordered the UK to recover the revenue
The EU investigation focused on the UK’s Controlled Foreign Company (CFC) rules, which are aimed at preventing subsidiaries and multinationals avoiding capital gains tax (CGT) in the UK.
This scheme was introduced in 2012 by the then Chancellor George Osborne, in Budget 2011. The June 2011 consultation document set out that the CFC rules were expected to cost the Exchequer £1.9bn from 2012-16. The Commission has not confirmed the level of clawback.
The Commission concluded that the group financing exemption, which formed part of the CFC rules, was partially justified but the exemption also grants a selective advantage to certain multinational companies, which is illegal under State Aid rules.
The exemption is justified if interest payments on inter-company loans were issued by subsidiaries in offshore jurisdictions but not from activities generated in the UK.
Commissioner Margrethe Vestager, head of competition policy, said: ‘Anti–tax avoidance rules are important to ensure that all companies pay their fair share of tax. But they must apply equally to all taxpayers.
‘The UK gave certain multinationals a selective advantage by granting them an unjustified exemption from UK anti–tax avoidance rules. This is illegal under EU State aid rules. The UK must now recover the undue tax benefits.’
Controlled Foreign Company rules
The UK's CFC rules were introduced to prevent UK companies from using a subsidiary, based in a low or no tax jurisdiction, to avoid taxation in the UK. The rules allow HMRC to reallocate all profits artificially diverted to an offshore subsidiary back to the UK parent company, where it can be taxed accordingly.
CFC rules establish two tests to determine how much of the financing profits from loans can be taxed in the UK. These are:
The extent to which lending activities, which are most relevant to managing the financing activities and thus generating the financing income, are located in the UK (UK activities test); or
The extent to which loans are financed with funds or assets, which derive from capital contributions from the UK (UK connected capital test).
Between 2013 and 2018, the UK's CFC rules included a special rule for certain financing income (ie, interest payments received from loans) of multinational groups active in the UK, this is known as the group financing exemption.
Since June 2013, the European Commission has been cracking down on these arrangements. The Commission is currently investigating tax rulings issued by the Netherlands in favour of Inter IKEA and Nike and tax rulings issued by Luxembourg in favour of Huhtamäki, a Finland-based food packaging company.
Report by Amy Austin