UK CFC Financing Exemptions partly illegal and partly justified under State aid rules

On 2 April 2019, the European Commission ("Commission") found that the UK's Controlled Foreign Company ("UK CFC") scheme was in breach of State aid rules in cases where multinationals received an exemption for financing income derived from UK activities. This decision, which follows the recent annulment of the Belgian excess profits decision by the EU General Court, was more limited in scope than the initial investigation and consequently the overall amount subject to claw-back by the UK will be significantly lower than expected.

In October 2017, the Commission opened an in-depth investigation to verify whether the Group Financing Exemption ("GFE") included in the UK CFC rules complied with State aid rules (see our previous Global Tax Insight article). The GFE provided a derogation from the general CFC rules by partially or fully exempting from taxation the UK financing income received by an offshore subsidiary from another foreign group company, even where this income is derived from "UK activities"¹  or if the capital used is "UK connected"².

In April 2019, the Commission's investigation concluded that the GFE and, hence, the different treatment, is partially justified:

• In particular, the Commission found that the GFE is justified when financing income from a foreign group company is financed with UK connected capital. This is because such an exemption avoids complex and disproportionately burdensome intra-group tracing exercises that would be required to assess the exact percentage of profits funded with UK assets. The exemption in this case provides a clear proxy that ensures the effectiveness of the CFC rules.
• Conversely, the Commission considered that it is neither burdensome nor complex to assess to what extent income is derived from UK activities such that a proxy rule in this case is not justified. It therefore found that the GFE was unjustified in this respect.

Since the opening of the formal investigation in October 2017, a number of multinationals have declared that they would earmark millions of pounds in potential tax repayments, preparing for the worst³. In this context, the Commission's final decision will significantly reduce the exposure of companies to UK tax authorities if the income does not derive from UK activities. 

Against this background, it is notable that this decision, involving a tax "scheme",⁴ comes in the aftermath of the annulment by the EU General Court of the Commission's decision concerning the Belgian excess profits scheme.⁵  This decision was annulled on 14 February 2019 on the basis that the Commission had failed to prove that the measure was a general "scheme" and not a series of individual rulings. The Commission is now "carefully reflecting" on how to respond to this Court setback. It may either appeal this judgment to the European Court of Justice or alternatively start 35 individual investigations against the concerned multinationals. An appeal would buy time as the Commission waits for judgments in the current high-profile cases involving individual taxpayers⁶ in Ireland and Luxembourg.⁷ 

It remains to be seen whether the UK or any alleged beneficiaries of the CFC exemption scheme will challenge the Commission's UK CFC decision in the midst of the Brexit conundrum. Such appeals would join an already long list of pending cases against the Commission's recent fiscal State aid decisions revealing how controversial these are for both Member States and taxpayers.

With thanks to Scheherazade Oozeerally of Ashurst for her contribution.

1. When lending activities, which are most relevant to managing the financing activities and thus generating the financing income, are located in the UK.
2. When loans are financed with funds or assets, which derive from capital contributions from the UK.
3. For example, UK spirits producer Diageo declared that it faced a potential maximum liability of £250 million.
4. The UK CFC decision and the Belgian excess profits decision are the only two cases involving tax schemes in the Commission's recent crackdown on alleged fiscal advantages granted to multinationals.
5. Joined cases T-131/16 and T-263/16, Kingdom of Belgium and Magnetrol International v European Commission, EU:T:2019:91. The Belgian excess profits decision was subject to 29 appeals by the Belgian State and by alleged beneficiaries (including companies such as AB InBev, BASF, Atlas Copco etc.). Given the number of appeals, the General Court chose two cases (that of the Belgian State and Magnetrol) to spearhead the challenge and stayed the 27 other appeals.
6. Such as Fiat, Starbucks, Amazon, Apple and Engie.
7. The General Court judgment in the Belgian excess profits case left unanswered a number of substantive questions which would have helped in assessing the merits of other cases.