HMRC issues supplementary guidance on CFC finance company exemption
Tue 02 Dec 2014
The controlled foreign companies (CFC) rules include a special break enabling UK multinational groups to put in place tax efficient financing structures, known as the finance company exemption. Under the ‘partial’ finance company regime, only 25% of the profits of the overseas finance company are charged to tax in the UK, instead of the full amount. A ‘full’ finance company exemption is also available in more limited situations.
In order to benefit from the finance company regime, one of the key conditions is that the profits of the finance company itself must arise from ‘qualifying loan relationships’ (QLRs). Broadly speaking, these are monetary loans made by the finance company to non-UK group members. However, there are a series of exclusions which can prevent a given loan from being a QLR. These include certain restructuring where a main purpose is to achieve a reduction in taxable UK loan relationships (s371H(9A)-(9E) TIOPA 2010).
HMRC issued supplementary guidance on 19 November 2014 expanding on guidance it had issued earlier in the year (17 April 2014) covering further exclusions added by Finance Act 2014. The supplementary guidance makes clear that no changes are necessary to that April guidance which should now be regarded as final and all “draft” references disregarded. However a further illustration has now been added in response to clearance applications from groups which are now considering the need to restructure existing intra-group financing arrangements as a result of changes arising out of the OECD’s Base Erosion and Profits Shifting (BEPS) project, or US reforms targeting hybrid financing structures. In the example given, the ‘tower’ structure is replaced by one involving a Luxembourg finance company that is not vertically integrated. The overall effect is a reduction in taxable loan relationship credits in the UK group company, and as this is a main purpose of the restructuring (s371H (9A)(c)(i), HMRC’s view is that the replacement loans made by the Luxembourg company will not be qualifying loans, so the finance company exemption will be denied accordingly under s371H(9B).
The CFC rules are highly complex, and it is easy to fall foul of them, and the detailed requirements of the finance company exemptions are no exception. Before undertaking any refinancing of overseas group members, it is important to bear in mind the potential impact on the finance company exemption, due to the wide ranging anti-avoidance rules. As a rule of thumb, if the result will be a reduction in taxable loan relationship income, or an increase in loan relationship deductions in the UK, anti-avoidance rules will be in point.