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UK corporate tax rules found to partially constitute illegal EU State aid

  • United Kingdom
  • Corporate
  • Procurement strategies
  • State aid
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On 2 April 2019, the European Commission issued a press release regarding its State aid investigation into aspects of the UK controlled foreign company (CFC) rules. This press release explains that certain aspects of the CFC rules under investigation have been found to be illegal under EU State aid rules, but also that other aspects under investigation can be justified.

In relation to the illegal aspects, the Commission states that the UK must now recover this illegal State aid from the relevant multinationals that benefitted from it.

What was the focus of the Commission’s investigation?

The Commission has been investigating whether the Group Financing Exemption (GFE) to the UK CFC rules could give rise to illegal State aid (see our previous briefing on the commencement of this investigation).

The UK CFC rules seek to prevent UK companies from artificially diverting profit generating activities from the UK to subsidiary or controlled entities in low or no tax jurisdictions. The rules are complex and apply in a variety of different circumstances, but the Commission’s investigation focussed on the rules applicable to financing profits (i.e. interest) earned by CFCs from loans made to other non-UK group companies.

In relation to CFC lending activities generally, the UK CFC rules provided that as a general rule such financing profits of a CFC would be brought into the charge to UK tax to the extent that:

• the lending activities to which the financing profits relate (i.e. principally the people managing the lending) are located in the UK (what the Commission call the “UK activities test”)

• the loans made by the CFC are financed with funds or assets which derive from capital contributions from the UK (what the Commission call the “UK connected capital test”)

However, very broadly in relation to loans made by a CFC to other non-UK group companies, the GFE could be applied to partially (75%) or wholly exempt relevant financing profits from UK taxation, even though the UK activities or UK connected capital tests were satisfied.

Since the GFE only applied in specific circumstances such that taxpayers in comparable legal and factual situations could be treated differently under these rules, and the justification for such differential treatment was not clear to the Commission, it was concerned that the GFE was providing a selective advantage and as such constituted illegal State aid. Consequently, it commenced an investigation in October 2017.

The Commission’s findings

The detailed Commission findings are not yet available, but the press release summarises their findings as follows:

• the application of the GFE in circumstances where the UK connected capital test is satisfied can be justified and therefore does not constitute State aid. This is because in these circumstances, in line with the UK’s arguments during the investigation, the exemption avoids complex and disproportionately burdensome intra-group tracing exercises

• however, if the UK activities test is met the GFE is not justified and constitutes illegal State aid. This conclusion was reached because in the Commission’s view it is not burdensome or complex to determine the extent to which income derives from UK activities

What next?

In the absence of any appeal, the UK now has a 4 month period to assess which UK taxpayers have benefitted from the State aid determined above and recover the benefit from such taxpayers. However, this may well be a complicated exercise and could take longer. The impact of Brexit would also need to be considered. Most forms of Brexit other than a no-deal Brexit would require the UK to uphold this finding, but the impact of a no-deal Brexit is more uncertain.

Affected taxpayers, and indeed the UK government, could also consider appealing this finding. It will be necessary to review the Commission’s detailed findings before considering any appeal, but affected taxpayers will be rightly frustrated that a UK statutory exemption can be retrospectively overturned in this manner. Many companies will have structured their affairs in a manner compliant with this exemption and may well have approached their group structure differently (and in a manner compliant with the Commission’s position) but for this statutory exemption.

How can we help you?

If you would like to discuss with us the likely impact of the investigation on your business and what you might do to protect your position please contact our specialists, Totis Kotsonis, competition lawyer and State aid expert, and Ben Jones, tax law expert, via the contact details below.

For more information contact

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