Further to our December 2010 Newsletter, draft clauses setting out the detailed proposals for a branch profits exemption regime, which has been under discussion for some time, have now been published. These proposed changes are part of the Government’s “road map” to make the UK an attractive place to do business and are designed to help eliminate most of the differences between carrying on non UK activities through a branch or a subsidiary.
The exemption, which will apply to all large and medium sized companies and to small companies with branches in jurisdictions with a “full” UK treaty, will apply on an elective company by company basis. The operative date has not been announced yet but for December year end companies the earliest period to which the rules will apply will probably be the year ended 31 December 2012.
If an election is made the aggregate profits and losses attributable to all the company’s non UK branches will be left out of account for the purposes of calculating the company’s UK tax liability. The attributable profits or losses, including capital gains and losses and investment income, of each branch have to be computed on treaty principles. An election is irrevocable following the filing date for the first returns applying the election, and applies to all future accounting periods of the company. If no election is made the company will continue to be taxed under the existing credit relief system.
It will be possible for groups to make the election in respect of some companies but not others such that the group’s non UK branches can be organised into appropriate companies, with some remaining within the UK tax net, and the others electing to be treated as exempt. There also doesn’t appear to be anything to stop a group moving non UK branch assets out of a company which has made an election into one that hasn’t, and vice versa, with the result that the branch profits and losses could come in and out of the scope of UK tax. If not amended through the consultation phase this may present planning opportunities, although there will, of course, be local jurisdiction consequences to take into account before moving assets between corporate entities.
There are however transitional rules dealing with losses. If, in aggregate, a company electing into the new regime has non UK branch accumulated losses (ignoring any capital gains and losses, and, if relevant, that any of those losses have been utilised for UK tax purposes, for example by offset against other income or by way of group relief), from the six years prior to the first year in which the election is made, or since 2005 if the losses are more than £50 million, any net profits from non UK branches will not be excluded until such time as the post election aggregate profits (ignoring any post election net losses, or post election capital gains or losses) exceed these accumulated losses. During this time credit will be available for any non UK tax paid on these profits.
This deferral of the effective date could mean that it may not be possible to protect capital gains on non UK branch assets if the company is trading but there is no income in the non UK branches. As with the comment above it would however appear to be possible to move assets from one UK company to another, subject to there not being any non UK tax cost, before making the election in the transferee, such that the transferee would have no past losses to absorb before the exemption applies.
There are a number of exclusions from the election. As noted above the exemption does not apply to any profits or losses of “small” companies (i.e. those with fewer than 50 employees, and with both turnover and a balance sheet total of less than €10 million) attributable to jurisdictions which do not have a “full” double tax treaty with the UK containing a non discrimination clause. The exemption is not available to investment companies, in respect of capital gains of close companies, nor in respect of profits which would be subject to a CFC apportionment if held in a non UK subsidiary. Further, the exclusion is not available if profits which have been diverted to a “low tax” jurisdiction exceed certain de-minimus levels, and the diversion had as one of its main purposes the reduction in UK tax.
We would expect that most oil and gas companies, even in the exploration phase, are unlikely to be “small”, but if they are, this exclusion could mean that, for example, capital gains made on licences in oil provinces where the UK does not have a treaty may still not be exempt, even if an election has been made.
As the reason for oil and gas companies conducting upstream operations outside the UK will be because that is where the licences are located, it is not thought that the diverted profits exclusion could apply. However groups with other activities outside the UK will need to review these rules to determine whether an election will be effective.
As noted above the potentially exempt profits attributable to a non UK branch are computed in accordance with treaty principles. The initial requirement is that the branch profits must be those which would have arisen if the branch had been an independent entity. This is then caveated that it should be assumed that the branch has the same credit rating as the company and that equity and loan capital is allocated on a just and reasonable basis.
It is not clear how this rule should work if, for example, a company had a producing interest in the UK which gave it capacity to take on third party bank debt, but had only exploration interests in the non UK branch, or vice versa.
The introduction of these rules should make tax compliance easier for UK resident companies with non UK activities. The flexibility of an elective regime ensures that all upstream oil and gas players should be pleased with the new regime which also, as drafted, appears to offer a significant amount of planning opportunities. Any clients wanting CWE to carry out a review of their position, and the potential opportunities open to them, should speak to their usual CWE contact.