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European Commission rules UK's CFC regime granted state aid to multinationals

Thursday, 4 April, 2019

Dozens of multinationals will have to repay the tax benefits they obtained from the UK’s controlled foreign companies (CFC) tax regime, modified in 2012 with the addition of an exemption for group finance companies.

This week, the European Commission decided that the group finance company exemption (GFE), applying to interest income earned by offshore subsidiaries, amounted to unlawful state aid, at least in part.

The Commission's analysis is highly technical, as is the CFC legislation itself. The GFE rules only applied in specific circumstances, and taxpayers in comparable legal and factual situations could be treated differently under these rules, depending on whether the people managing the company's profit-generating lending activities were located in the UK. The justification for this different treatment was not clear to the Commission, and it decided that the GFE was providing a selective advantage to some companies, amounting to state aid.

Companies that benefited from the GFE will now have to demonstrate 'adequate substance' in their CFCs' foreign lending operations, in order to escape, or at least reduce, the retrospective bills. The substance criterion is now a part of EU legislation for tax years from 2019 onwards, but was not previously a requirement in the domestic rules. The Commission's view is that the rules should always have been as they now stand.

The Commission has thus ordered the UK to recover the unlawful state aid, but it is unlikely to be able to do so within the usual four-month deadline, because each case will have to be examined to quantify the extent of the exempt income. Taxpayers must now prepare for that case-by-case testing, on the assumption that the UK government does not seek to annul the decision through litigation. Companies themselves can also appeal, and those with finance subsidiaries in EU/EEA states will have a stronger basis to resist enforcement against them, says law firm Clifford Chance.