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EC State Aid investigation into UK CFC rules

12 December 2017

On 26 October 2017, the European Commission (EC) gave notice to the UK Government of a decision to investigate the UK Controlled Foreign Company (CFC) rules, and particularly the Finance Company Partial Exemption (FCPE) on the basis that certain aspects of the UK rules amount to unlawful State Aid. The notice was officially published in the Official Journal of the European Union on 24 November.

This is relevant to any UK group which has (or has had) an exempt or partially exempt finance company structure (ie under Chapter 9 Part 9A TIOPA 2010).



The UK CFC rules were originally introduced in 1984 to prevent the diversion of profits by UK multinationals to low tax jurisdictions. The original rules were later challenged in the courts as being inconsistent with the principle of EU freedom of establishment. As a consequence, and after a substantial consultation process, the rules were rewritten in 2013 to ensure that only artificially diverted profits (where there is a lack of associated genuine economic activities) are brought within the regime.

The 2013 rewrite introduced revised and new exemptions, including the FCPE, to focus the CFC charge on situations considered high risk. The FCPE allowed companies with an overseas finance company to claim an exemption from a CFC charge for 75% or 100% of certain intra-group finance income.


The investigation

The current EC challenge is focused on whether the FCPE favours certain taxpayers when compared to other taxpayers in a comparable factual or legal position in the Member State concerned, a concept known as ‘selectivity’.

If it were determined that the UK FCPE regime confers an advantage, it would not be treated as selective if it were demonstrated that the regime is consistent with the ‘overall objective’ of the UK tax regime and was not introduced with an ulterior motive.

The UK’s response to date is that the regime must be viewed in connection with its general policy on taxation of the profits of subsidiary companies. The UK does not tax companies on the profits of their domestic or overseas subsidiaries, even when distributed. At the same time, UK companies can take a deduction for interest expenses incurred on borrowing used to fund investment in subsidiaries, domestic or abroad. In order to prevent UK companies from overcapitalising their overseas subsidiaries and thus artificially diverting profits away from the UK, the FCPE regime was introduced as a proportionate and reasonable response to protect the UK tax base.


Next steps

The Government and interested parties have one month from the date of official publication (24 November 2017) to submit comments to the Commission. An adverse conclusion of the investigation by the Commission could then be appealed by the UK to the CJEU. Depending on the outcome, there is the potential for the Commission to require the UK to claw back the State Aid it has given under the FCPE (which might be calculated as the corporation tax exempted, or partially exempted) from the affected UK companies.

Multinational businesses with UK parents which have or have had a FCPE structure should consider whether they wish to make representations or take any other steps in relation to the uncertainty created by this investigation.

For help and advice on international tax issues please get in touch with your usual BDO contact or Nick Udal.

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