Foreign affairs
29 Jun 09
Taxation of foreign profits to be reformed
Plans to reform the taxation of foreign profits will be finalised this month when the Finance Bill 2009 is heard in parliament.
Together with the ongoing review of the UK’s controlled foreign companies (CFC) regime, reforms aim to ensure that the UK tax system remains internationally competitive and represents a move towards a more territorial approach to the taxation of foreign subsidiaries and wholly UK groups.
The package now comprises four key elements:
• introduction of a dividend exemption for the majority of both UK and foreign dividends which will apply to dividends and other distributions received on or after 1 July 2009
• introduction of a “debt cap” restricting UK tax deductions for finance costs to the level of a group’s external finance expense which will apply to finance expenses payable in accounting periods beginning on or after 1 January 2010
• repeal of the Treasury Consent legislation and replacement with a new quarterly reporting requirement which will apply to transactions undertaken on or after 1 July 2009
• abolition of the CFC acceptable distribution policy exemption and exempt activities non-local holding company exemptions (subject to a two-year transitional period for the latter) effective for accounting periods 1 July 2009 onwards with transitional provisions for accounting periods straddling this date.
The new dividend exemption is a fundamental change to the treatment of all dividends received by UK companies. On the face of it, the exemption is broadly beneficial to business – reducing the compliance burden and facilitating repatriation of profits to the UK.
However, the replacement of the blanket exemption for UK to UK dividends with a system whereby all dividends are prima-facie taxable introduces complexity and uncertainty to the profit repatriation decision.
There is an exemption for small companies (defined as those with turnover or balance sheet below €10m or with less than 50 employees). Otherwise, all distributions, both UK and foreign, will be taxable unless they are deemed to fall within one of the five exempt classes, as follows:
• “Controlled companies” – dividends or other distributions received from controlled companies within the relevant control definition.
• “Non-redeemable ordinary shares” – dividends or other distributions received in respect of non-redeemable ordinary shares will be exempt (a share is only considered redeemable if its terms of issue anticipate redemption).
• Portfolio holdings – dividends or other distributions received in respect of portfolio holdings (shareholdings of less than 10 per cent) will be exempt.
• Transactions not designed to reduce tax – a dividend is exempt if received from transactions not designed to reduce tax. There is a grandfathering rule whereby profits earned before 1 July 2008 are considered “good” profits.
• Shares accounted for as liabilities – a dividend is exempt if received in respect of shares accounted for as liabilities.
To be exempt, the distribution must not be tax deductible in the payer’s territory or be of a capital nature. There are specific anti-avoidance provisions which mirror the above exemptions whereby any scheme designed to ensure that an exemption applies will prevent the relevant exemption applying. Also, there are a number of targeted anti-avoidance provisions in respect of schemes involving payments for distributions, payments not on arm’s-length terms, converting trading income into distributions and schemes where a deduction is obtained outside of the UK.
The rules do not yet address the corresponding treatment of branch profits resulting in an inequitable position, but overall the introduction of a dividend exemption has been broadly welcomed by taxpayers because generally they should find themselves within one of the five exempt classes. Appropriate analysis will need to be undertaken before any dividend is paid and, in particular, consideration is now required in respect of UK to UK dividends which in the past was not an issue, so the dividend recipient should beware!