01 Dec 2010

Corporate Tax Reform: Delivering a More Competitive Tax System

Introduction

The Government has this week published a document entitled “Corporate Tax Reform: Delivering a More Competitive System”.

The thrust of the document is to make the UK corporate tax system more competitive in a global context so that companies will be attracted to locate in the UK, and to prevent any further exodus from the UK of groups which are currently UK based.

Most of the content has been discussed already, at least in general terms.  Details of a number of the proposals will become available when the draft Finance Bill 2011 is published on 9th December.  A number of areas still need to be developed further and continue to be the subject of consultation.

The document includes what the Government calls a “Road Map for reform” under which it sets out its intention to reform the UK corporate tax regime using the following principles

a)    Lowering the rate while maintaining the tax base

b)    Maintaining stability

c)    Alignment with business practice

d)    Simplicity, and

e)    Maintaining a level playing field

They acknowledge there might be some tension between these principles.

A key objective is to have one of the lowest EU CT rates, the process for which has already been set in motion with the proposal put forward earlier this year to reduce the rate to 24% by the end of this Parliament. The intention is also to make the UK tax base more territorial by aiming to only tax those profits that have been earned from activity in the UK.

Consistent with this approach is the amendment of the CFC rules and an exemption for overseas branch profits, both of which have been under discussion with industry for some time.  There are, however, a number of other areas dealt with in the document, which are discussed further below.

CFC Changes

The new CFC regime will be a mainly entity-based system with a CFC charge arising only on the proportion of the entity’s profits that are viewed as having been artificially diverted from the UK. Little detail is given at this stage however on how the scheme will operate.

The proposals outlined in the current document concentrate on two main areas for reform, monetary assets and IP.

The approach with respect to finance companies (monetary assets) is that partial exemption from a direction is to apply where the company is funded with an appropriate level of debt to equity (to be agreed). The rules for financing companies are also to be extended to cover trading companies. Where these companies hold cash which is not incidental or ancillary the financing company exemption will apply such that only a proportion of that excess cash will generate a CFC direction.

In terms of the oil industry, the CFC changes under discussion, both the interim improvements to be introduced in the Finance Bill 2011, and the more comprehensive changes scheduled for Finance Bill 2012, are unlikely to have a significant impact.

The one area where the industry typically has a problem with the CFC rules is where operations are run through the branch of a non UK resident and incorporated entity, typically a Dutch company. This does not appear to be being addressed.

A number of further helpful changes are, however, proposed such as

      I.    An increase in the deminimis test from £50,000 to £200,000

    II.    In assessing whether a lower level of taxation applies profits are to based on accounting figures rather than those produced under UK tax principles

   III.    A three year grace period when companies are taken over

Comment

With the other recent changes to the UK regime, both those already enacted and currently proposed, it is likely that many UK based groups will be happy to run such operations from a UK company in future.

Branch Exemption

The other significant change referred to in the paper which will have an impact on the oil and gas industry is the proposed branch exemption.  This again has been under discussion for some time and it appears that most of the concerns raised by the industry are to be accommodated in the new regime.

There is to be an exemption by way of opt in, i.e. either the company continues under the current system of worldwide taxation, relief for losses, and credit relief for foreign tax, or one makes an irrevocable election for exemption, which will be a complete exemption.  Capital gains and finance income attributable to the branch will also be exempt, although there are to be some anti-avoidance rules.

The rules will be applicable for all branches of medium or large companies.  For small companies only those branches based in an appropriate treaty country will fall within the opt-in regime.  

The measure of profits to be exempt will be based on the relevant treaty or, if no treaty applies, based on the OECD Model Treaty.

Where tax losses have previously been relieved, transitional provisions will apply to prevent exemption until an amount of branch profits equal to those losses have been earned.  In most cases only losses utilised in the last 6 years will need to be taken into account but where the losses are “large” (yet to be defined) the full amount will be required to be clawed back.

Comment

The optionality deals with the divergent views in the industry between those with non ring fence UK profits who wanted to retain relief for losses, against the majority of E & P companies who have only ring fence income in the UK and would prefer the simplicity of exemption. Government has also listened to the lobby for capital gains to be included which was thought to be essential by many of the UK players with non UK interests.  It appears that groups will be able to choose to exempt certain branches from the charge to UK tax whilst having other remain within the UK tax net (in order to access reliefs) by ensuring that branches are held by different legal entities within the group.

Interest Expense

As part of this review Government has stated that there is no intention to change the UK’s regime for granting financing cost deductions.  Such a change would arguably be seen as consistent with a more territorial based approach, but the existing regime is seen as attractive compared to other jurisdictions, and the Government seem keen to maintain this “advantage”.

Patent Box

The other major change proposed in the document, for a “Patent Box” under which profits from patents would, again by election, be taxed separately at a 10% rate, is thought unlikely to be of relevance to the oil and gas industry.

R&D

Following the Dyson report which considered the impact of the current R&D regime on the decision making process of companies investing in R&D, and HMRC’s own assessment, the Government proposes further consultation on changes to the regime.

Capital Gains Tax

We understand that the provisions dealing with the reform of corporate capital gains, that have been the subject of prior consultation, and which might be thought to be part of this road map process but are not mentioned in the document, are nevertheless to be included in the draft Finance Bill 2011 that is due to be published next week.


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