Chartered Institute of Taxation “ International Issues ” Liesl Fichardt Partner Berwin Leighton Paisner LLP

Why are companies leaving the UK? Tax rate Complexity of tax system –CFC rules –Taxation of foreign profits –Losses Uncertainty

Complexity and Uncertainty 1.ECJ cases and UK reaction –CFCs Cadbury Schweppes Vodafone 2 UK reaction? –Foreign profits FII GLO –Losses M&S European Commission 2.Issues when leaving UK –Exit Tax –Residency

CFC regime Cadbury Schweppes (C-196/04) - 12 September 2006 ECJ test (paragraph 75): “Articles 43 EC and 48 EC must be interpreted as precluding the inclusion in the tax base of a resident company established in a Member State of profits made by a CFC in another Member State, where those profits are subject in that State to a lower level of taxation than that applicable in the first State, –unless such inclusion relates only to wholly artificial arrangements intended to escape the national tax normally payable. Accordingly, such a tax measure must not be applied where it is proven, on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives that CFC is actually established in the host Member State and carries on genuine economic activities there”

CFC regime ECJ test: CFC rules can apply to “wholly artificial arrangements” but NOT if there are “genuine economic activities” (paragraph 67): “finding must be based on objective factors which are ascertainable by third parties with regard, in particular, to the extent to which the CFC physically exists in terms of premises, staff and equipment”

CFC regime ECJ left issue for domestic court to decide (paragraph 72): “In this case, it is for the national court to determine whether… the motive test, … lends itself to an interpretation which enables the taxation provided for by that legislation to be restricted to wholly artificial arrangements or whether, on the contrary, the criteria on which that test is based means that, where none of the exceptions… applies and an intention to obtain a reduction in the UK is central to the reasons for incorporating the CFC, the resident parent company comes within the scope of application of that legislation, despite the objective evidence such as to indicate the existence of an arrangement of that nature”

CFC regime The reaction of the Government: Finance Act 2007 (section 48 Schedule 15) –can apply to have apportionment reduced –“if satisfied that the specified amount does not exceed the amount equal to so much of those chargeable profits as can reasonably be regarded as representing the net economic value” –the net economic value must arise to the company and be created directly by “qualifying work” –“qualifying work” is work done by CFC in territory and by individuals working for CFC –individuals working for CFC in territory are employed or directed to perform duties on behalf of CFC focus on labour only!

CFC regime Further steps: Discussion Document: June 2007 Treasury Technical Note: July 2008 Treasury Updates

CFC regime – in the interim Vodafone 2 [2008] EWHC 1569 (Ch) Revisit question left open in Cadbury Schweppes “The guidance in Cadbury Schweppes is that we should consider whether ‘the motive test, as defined by the legislation on CFCs, lends itself to an interpretation which enables taxation provided for by that legislation to be restricted to wholly artificial arrangements’ (as that phrase is explained by the European Court) so that the CFC legislation applies, in the case of a CFC established in a member state, only in a case where there are such wholly artificial arrangements intended to escape the United Kingdom tax normally payable”.

Vodafone 2 Section 2 of European Communities Act 1972 “Any enactment passed or to be passed… shall be construed and have effect subject to the foregoing provisions of [that] section’, in particular s 2(1) which relevantly provides that all such rights from time to time created or arising by or under the treaties as in accordance with the treaties are without further enactment to be given legal effect or used in the United Kingdom shall be recognised and available in law, and be enforced, allowed and followed accordingly”. Obliged by section 2 to construe motive test as set out in s 748(3) ICTA 1988 in conformity with guidance of ECJ S 748(3) “(3) Notwithstanding that none of paragraphs (a) to (e) of subsection (1) above [exceptions from the application of the CFC legislation] applies to an accounting period of a controlled foreign company, no apportionment under section 747(3) falls to be made as regards that accounting period if it is the case that (a)insofar as any of the transactions the results of which are reflected in the profits arising in that accounting period, or any two or more transactions taken together, the results of at least one of which are so reflected, achieved a reduction in United Kingdom tax, either the reduction so achieved was minimal or it was not the main purpose or one of the main purposes of that transaction or, as the case may be, of those transactions taken together to achieve that reduction, and (b)it was not the main reason or, as the case may be, one of the main reasons for the company’s existence in that accounting period to achieve a reduction in United Kingdom tax by a diversion of profits from the United Kingdom, and Part IV of Schedule 25 shall have effect with respect to the preceding provisions of this subsection.”

Vodafone 2 What is scheme of ECJ test? –Rule applies exclusively to abusive situations What is scheme of CFC legislation? –Attributes profits of CFC to UK co –Exceptions (including motive test) exclude from attribution –Inclusive rule subject to exceptions What is scheme of motive test? –Prevents apportionment where tax conditions requiring absence of tax avoidance purpose are present

Vodafone 2 Q: Can s 748(3) be read to conform with the freedom of establishment (Article 43 EC)? –No –Provisions of s 748(3) are clear –Purpose to defeat tax avoidance by parent company where one of main reasons is to achieve tax advantage –But, Cadbury Schweppes test that establishment with such objective is protected by Article 43 EC – only not protected where there is wholly artificial arrangement –No words in s 748(3) which are capable of being construed so as to limit it to comply with ECJ test –Also, legislation enacted without Article 43 EC in mind – not a case where there was a lacuna which has to be filled

CFC regime Vodafone 2 finding: –Where statutory provision found to be non compliant with Community law, disapplication? –Not in every case –But, where the defect is such “that a single solution is required that can reasonably be applied to all taxpayers” (per Lord Hope, Fleming) –Therefore, CFC rules to be disapplied pending amending legislation or executive action

CFC regime Where are we now? –Cadbury Schweppes heard by Special Commissioners in March 2008 –Vodafone 2? Appeal? Practical implications? Evidence not yet considered What is “genuine economic activity” / what is not “wholly artificial”? current UK legislation – compatible?

Foreign Profits FII GLO (C-446/04) 12 December 2006 Heard by High Court in June 2008 Issues: 1.Historical:UK ACT/ FII regime 2.Current:Taxation of foreign dividends / UK credit system

Foreign Profits Taxation of foreign dividends: ECJ finding (paragraph 57) “the fact that notionally sourced dividends are subject to an exemption system and foreign sourced dividends are subject to an imputation system does not contravene the principle of freedom of establishment… provided… the tax rate applied to foreign sourced dividends is not higher than the rate applied to nationally sourced dividends… and the tax credit is at least equal to the amount paid in the Member State of the company making the distribution, up to the limit of the tax charged in the Member State of the company receiving the dividends” But: “it is for the national court to determine whether the tax rates are indeed the same and whether different levels of taxation occur only in certain cases by reason for a change to the tax base as a result of certain exceptional reliefs”

Foreign profits FII GLO High Court What is the question? –HMRC: only issue is small companies’ relief, exceptional –Claimants: must look at effective rate of tax on domestic dividends In essence issue of discrimination

Losses Marks & Spencer (C-443/03) 13 December ECJ test (paragraph 55): The UK group relief rules go beyond what was necessary to attain the objective pursued where: –“the non-resident subsidiary has exhausted the possibilities available in its state of residence of having the losses taken into account for the accounting period concerned by the claim for relief and also for previous accounting periods, if necessary by transferring losses to a third party or by offsetting the losses against the profits made by the subsidiary in previous periods. –there is no possibility for the foreign subsidiary’s losses to be taken into account in its state of residence for future periods either by the subsidiary itself or by a third party, in particular where the subsidiary has been sold to a third party”

Losses The reaction of Government: Finance Act 2006 Deny relief where there are arrangements which –result in losses becoming unrelievable outside UK that may otherwise be relievable –give rise to unrelievable losses which would not have arisen but for availability of relief in UK If the main or one of the main purposes of those arrangements is to obtain UK relief. –current rules unaffected –new rules where UK Co has Sub Co in EEA or trades as PE is EEA –narrow application

Losses 1 April 2006 (section 403 E,F,G ICTA 88) UK Co able to claim foreign loss of 75% subsidiary in EEA Tax loss accepted under rules of EEA territory – then recomputed under UK rules. 4 conditions to be met: (1)Equivalence condition: loss of same nature as losses already allowable under existing rules. (2)EEA tax loss condition: loss under rules of EEA territory (excluding losses of UK PE) (3)Qualifying loss condition: loss cannot be relieved in EEA territory and has not been relieved in any other territory (4)Precedence condition: loss cannot be relieved in any territory of residence of an intermediate foreign company in chain

Losses Marks & Spencer –High Court –Court of Appeal –Special Commissioners

Losses European Commission September 2008: Formal request to implement M&S –“Reasoned opinion” – Commission may refer matter to ECJ –The issues: restrictive interpretation that there be no possibility of use of loss in state of subsidiary date for determination: end of accounting period in which loss arises time limit for claim: 12 months after filing date of tax return only applies to losses after 1 April 2006

Issues when exiting UK Exit Tax –UK provisions Section 185 TCGA 1995 –Tax on unrealised capital gains and losses Section 337(1() ICTA 1988 –Trade ceases, balancing charges/allowances on plant/machinery unless left in trading UK branch Section FA 1988 –Notification to HMRC Board –Make arrangement to settle liabilities –Guarantor for outstanding liabilities Deferral of tax in limited circumstances

Issues when leaving the UK: Exit Tax ECJ Experience: Cases relating to individuals –Are there restrictions which are prohibited? Tax levied on unrealised gains only when person leaves, and not on those who did not leave Provision of guarantees to secure payment of tax was restriction which deprived taxpayer of enjoyment of assets which were given as guarantee Failure to take account of decrease in value after transfer –Are they justified? Yes, power of allocation – states can negotiate by treaty –Do they go beyond what is necessary? Declaration was not unreasonable Provision of guarantee was unreasonable Need to take account of any adjustments in value

Issues when leaving the UK European Commission December 2006 Communication –Call on member states to coordinate exit tax rules Sweden –Call on Sweden to change restrictive exit tax provisions for companies

Issues exiting the UK Residency: –“Central management and control” test –Treaties: “tie-breaker” clauses

International issues Where does this leave us?