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European Commission investigation into UK tax arrangements – time to consider your options

  • United Kingdom
  • Competition, EU and Trade
  • State aid
  • Tax planning and consultancy
  • Diversified industrials

07-11-2018

In October 2017, the European Commission launched an in-depth investigation into the EU State aid law compliance of what has been described as the Group Financing Exemption (GFE) available under the UK’s Controlled Foreign Company (CFC) tax rules.

The Commission’s decision on the EU law compliance of the GFE is expected in the coming weeks. If the Commission’s initial concerns about the compliance of that exemption with EU State aid rules are confirmed, this can have a detrimental effect on the financial position of businesses that have relied on that exemption in the management of their tax affairs.

We consider below the likely repercussions of a “negative” State aid decision, that is a decision which concludes that the GFE is incompatible with EU State aid rules, and the options available to potentially affected parties.

The issues

The CFC rules seek to prevent UK companies from using a subsidiary in a low or no tax jurisdiction so as to avoid taxation in the UK. More specifically, these rules allow HMRC (the UK’s tax authority) to apportion profits, which were deemed to have been artificially shifted to an offshore subsidiary, to the UK so that they may be taxed accordingly.

As of 1 January 2013, the CFC rules provide for the Group Financing Exemption. This essentially exempts from UK taxation financing income (interest payments received from loans) received by an offshore subsidiary from another foreign group company.

In launching an in-depth investigation into the EU State aid law compliance of the GFE, in 2017, the Commission expressed concerns that the exemption’s effect was to allow multinational groups active in the UK to provide financing to another group company based outside the UK via an offshore subsidiary with the result that:• the offshore subsidiary’s financing income is not (or is not fully) reallocated to the UK for taxation purposes (as it may have been, had the GFE not applied)

• the offshore subsidiary pays little or no tax on the financing income in the jurisdiction in which it is based

On that basis, the Commission’s preliminary view has been that the GFE amounts to granting multinational groups with offshore subsidiaries a “selective advantage” vis-à-vis businesses in legally and factually comparable positions (which do not have an offshore subsidiary) without an objective justification.

If these concerns are confirmed in the Commission’s final decision, the UK entities belonging to multinational groups that have claimed full or partial exemption from the CFC charge to be levied on certain (deemed) non-trading finance profits earned by a CFC would be deemed to have been the beneficiaries of unlawful State aid. This is on the basis that in allowing these entities to benefit from the Group Financing Exemption, the State would have foregone tax income which it otherwise would have had.

Repercussions of a negative State aid decision and options

In such an event, businesses that have relied on the Group Finance Exemption would be required to pay to the State (with interest) the tax which would have been due absent the availability of this exemption.

Unfortunately, the idea that a requirement to make retrospective tax payments would be inconsistent with the principle of legal certainty in that the affected companies would have simply relied on the law of the country as it stood at the time, will not constitute an effective defence in seeking to challenge such a requirement under EU law.

At the same time, there are a number of options which affected businesses could consider in seeking to protect their commercial position in the event of a negative State aid decision.

The most obvious step would be to seek to challenge the Commission’s decision in the General Court of the EU, claiming, for example, that the Commission erred in law when concluding (as it would conclude in the event of a negative decision) that the GFE constitutes a “selective advantage”. Businesses which have relied on the GFE should ordinarily have standing to bring such action, irrespective of the fact that the Commission’s decision would be addressed to the UK.

However, an action against the Commission’s decision in the EU courts would not in itself affect a requirement that would normally be included in a negative State aid decision to (re)pay the “unlawful aid” with interest, although of course such payment would be recoverable in the event of a successful legal challenge against the Commission’s decision.

Indeed, in seeking to challenge a requirement to pay the tax deemed due on the basis of a negative State aid decision, there are a number of other steps that affected parties should do well to consider in addition to a possible action against the Commission’s decision in the EU courts.

Some of these options may relate to the possibility of appropriate action (or actions) in the UK courts. These should be considered carefully whilst recognising that the Commission itself is not challenging the legality of the CFC rules as a whole.

Other issues which affected businesses should also consider is how Brexit might affect a negative State aid decision, including a tax recovery requirement.

Our team of State aid and tax experts have been involved in advising clients on State aid and tax issues across Europe, including in the context of State aid investigations and litigation in the EU and UK courts. If your business might have relied on the Group Financing Exemption and you wish to discuss how best to protect your business’s position in the event of a negative State aid decision, please contact our specialist team via the links below.

For more information contact

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