Summary extract from the CIOT's detailed representations about the provisions in the 2000 Finance Act. It includes the Inland Revenue’s responses to the points raised by the Institute. References to sections are to the Finance Act. (Article by Adrian Rudd of PricewaterhouseCoopers, Tax Adviser's representative on the Technical Committee; published in the February 2001 issue of Tax Adviser). Section 97 and Schedule 27 – Group relief for non-resident companies
Both new s403D and s403E restrict the amount of losses that may be surrendered to and from a non-resident company, by assuming that any reliefs available in a foreign jurisdiction are automatically taken before determining the amount of group relief that is available. This assumption applies even if deductibility in the other jurisdiction is dependent on whether any amount has been deducted for UK tax purposes. The Institute questioned whether these provisions are within the Treaty of Rome since they were introduced to prevent discrimination, but have the impact of overlooking foreign tax law in determining whether an amount is deductible for UK tax purposes.
The Revenue replied that the rules on the surrender of branch losses in the new s403D and s403E are designed to ensure that losses may be relieved, but not relieved twice – once in the overseas country and again in the UK. The rules are in line with the internationally recognised principle that the country of residence has primary responsibility for relieving losses. The Revenue believe that the rules are fair and do not contravene the EU treaty.
The Revenue thought that it would be helpful to explain in more detail the effect of the ‘tie-breaker’ rules in new sections 403D(6) and 403E(8). The rule in section 403D(6) applies to the losses of UK branches of non-resident companies. If the law of the overseas country makes deductibility dependent on deductibility in the UK, that part of the overseas law is disregarded for the purposes of the new section 403D. The effect is that the loss is treated as relievable in the overseas country and is therefore not available for surrender as group relief in the UK. This is in line with the principle referred to above, that the territory of residence has primary responsibility for relieving losses.
There is a parallel tie-breaker provision in new section 403E(8) for overseas branches of UK-resident companies. In this instance, if the overseas law makes deductibility dependent on deductibility in the UK, group relief will be available in the UK unless the company is dual resident. Once again this is consistent with the principle that the territory of residence has primary responsibility for relieving losses.
The Revenue has published an article in Tax Bulletin (Issue 49, October 2000), giving examples of how the rules in sections 403D and 403E will operate in practice.
Section 98 and Schedule 28 – Recovery of tax payable by non-resident company
The Institute thought that this provision was discriminatory, since there is no equivalent provision for recovery in respect of UK resident group or consortia members. The measure also appears to be draconian since there does not seem to be a link between the receipt of economic benefit by the non-resident company and the liability to pay UK corporation tax.
The Revenue replied that collecting tax from non-resident companies presents special problems which justify the new recovery power, now that UK branches of non-resident companies are treated in a similar way to resident companies for the purposes of group relief and the group rules for company gains. Otherwise groups could misuse the greater flexibility which they will now have, for example by arranging for tax liabilities to accumulate in non-resident members of the group where they are more difficult to collect.
The Revenue believes that a similar power is not required in respect of resident companies because these collection difficulties do not apply. And of course provisions already exist to collect tax from a third party where a UK resident company migrates without paying the tax due.
The new powers broadly match the new rights of non-residents so the Revenue does not believe they are draconian. They will apply only in respect of tax unpaid by a non-resident company which is carrying on a trade here through a branch or agency and which now has the right to claim or surrender group relief in the same way as a UK resident company. And the rules will apply only where the tax has remained unpaid for at least six months.
The rules would not be fully effective if they were limited to companies which had derived a direct economic benefit, such as a surrender of group relief, from the non-resident company. For example, the company which had derived a benefit might no longer exist by the time a tax charge crystallised in the non-resident company.
Section 104 and Schedule 31 – Controlled foreign companies
The effect of Schedule 31, para 2 is to treat a 40% holding in a company as if it were a controlling holding. The Institute suggested that the taxpayer should have the opportunity to show that it has no effective legal, financial or managerial control over the company, in which case the provisions should not apply. It called for guidance to be made available as to how this test would apply in other than the most straightforward circumstances.
The Revenue replied that the purpose of the new provision is to apply the CFC rules in situations where the size of a UK joint venturer’s interest means that it is in a position to exert significant influence. If the provision was limited to situations where a joint venturer has effective control, it would fall short of its purpose. The CFC Guidance Notes will be updated to reflect the CFC changes in the Finance Act.
The Institute pointed out that the new s750A(4) permits limited backdating for the first regulations under this section, but is silent as to the extent of backdating of any subsequent regulations. It asked for confirmation that future regulations will not be backdated, and would prefer that this were made explicit by an extension to sub-section (4).
The Revenue replied that s750A(4) allows the first Designer Rate regulations to be backdated to 6 October 1999 when the Chancellor announced his intention to legislate. The Chancellor said at the time that the first regulations would apply from that date, and details of the regimes to be listed in the first regulations were announced then. The legislation does not provide a power for further regulations to be made retrospectively. There is no need for the legislation to state that explicitly; the absence of a power is enough.
The Institute expressed concern that the extension of the derivation of receipts test, in TA 1988, Sch 25, para 6, to entities and associates of entities where there is no more than 40% UK control could result in significant additional compliance costs, and possibly accidental non-compliance.
The Revenue advised that the derivation of receipts test for joint ventures is in response to evidence of avoidance. The motive test will of course ensure that CFCs not involved in UK tax avoidance will continue to be exempt.
The Institute asked about the interrelationship of the CFC legislation with the Double Tax Relief provisions of Sch 30, and asked for confirmation that it will continue to be possible to specify the source of profits out of which a dividend is paid for the purpose of the CFC legislation. The Institute acknowledged that that specification will be ignored for the purpose of calculating Double Tax Relief, but expressed concern as to whether the interaction of the two provisions will give an equitable result.
The Revenue confirmed that the DTR changes do not prevent companies from specifying profits for CFC purposes. What they do is to remove Section 799(3)(b) from the DTR provisions.
Section 110 – Rent factoring
The Institute questioned why there was an exception from the new provisions for finance arrangements exceeding 15 years.
The Revenue replied that the 15-year exclusion recognises that, whilst longer term arrangements have not proved as attractive as rent factoring schemes, some other longer-term sale and leaseback transactions might otherwise be caught by the legislation. The Revenue highlighted comments made by the Paymaster General about this legislation:
“I want to make it clear, on the record, that the Government intend this clause to stop the abuse. We hope that our action, and the warning that I am about to give is sufficient to achieve that. This is the warning: we will not hesitate to act against any equivalent schemes that are designed to obtain a tax reduction that is not justified by the true substance of the transaction. If we have to legislate to deter new schemes and deal effectively with schemes in existence at the relevant time, we will.”
The Institute pointed out that the drafting is very wide, and that sale and leaseback transactions have already been legislated for. It therefore asked for confirmation that sale and leaseback transactions will not fall within these provisions.
The Revenue replied that the new legislation may apply to sale and leaseback transactions. But it applies only to transactions that in substance replicate loan financing, and it contains exclusions where existing anti-avoidance legislation gives adequate protection.
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February 2001 by