The in-depth probe, announced by the EC on October 26, will look at UK’s group financing exemption, in place since 2013, which exempts some transactions from UK anti-avoidance rules.
Tax justice campaigners have said that the investigation shows that the UK, and other governments in the EU, are allowing multinational companies to legally avoid tax.
“The European Commission has shown yet again how EU governments grant unfair tax schemes to powerful multinationals,” said Aurore Chardonnet, Oxfam’s EU policy adviser on inequality and taxation. “Tax avoidance is one of the most persistent barriers to eradicating poverty. EU member states must not grant automatic tax exemptions to companies shifting profits to tax havens or to countries with harmfully low tax rates.”
The EC believes that the group financing exemption, introduced by former Global Tax 50 entrant and then-UK Chancellor George Osborne, gives international companies an advantage over domestic companies, classifying it as state aid.
A UK Treasury spokesman said: “We do not believe these rules are incompatible with EU law.”
The EC has been especially keen to clamp down on national tax rules that distort competition in recent years, and has also been working to change its own rules which do the same thing.
“All companies must pay their fair share of tax,” said Margrethe Vestager, the influential EC competition commissioner. “Anti-tax avoidance rules play an important role to achieve this goal. But rules targeting tax avoidance cannot go against their purpose and treat some companies better than others. This is why we will carefully look at an exemption to the UK's anti–tax avoidance rules for certain transactions by multinationals, to make sure it does not breach EU state aid rules."
While the EC is in the midst of high-profile cases against Ireland and Luxembourg for alleged ‘sweetheart’ deals to companies such as Apple, Amazon and McDonald’s, this investigation into the UK bears more similarity to its case against the Belgian excess profits tax.
In that case, the EC ultimately ordered Belgium to recover around €700 million ($800 million) from 35 multinational companies, many of which have now appealed against the decision to the European Court of Justice (ECJ).
Osborne’s introduction of the exemption cost the UK £800 million ($1.1 billion) between 2013 and 2016, according to the Financial Times, so the figures are comparable. Those savings by multinationals could be at stake if the EC eventually decides that the regulations constitute illegal state aid and orders the UK to claw back the money.
However, Zoe Wyatt, partner at Milestone International Tax Partners, believes that the sums that companies may have to pay back could be far lower.
“The CFC finance company exemption is hardly akin to the European Commission’s recent ruling against Amazon’s sweetheart deal with the Luxembourg tax office. The finance company exemption is a statutory exemption available to every company in the UK.”
“It is quite possible that the cost of the EC investigation will far outweigh any additional tax that may have to be paid to HMRC,” she added.
Group financing exemption
The group financing exemption essentially enables a mechanism by which multinational groups can shift profits through tax havens to avoid UK tax legally. They can do this because the UK’s 2012 Finance Act, effective from January 1 2013, introduced an exception in the country’s CFC rules for certain types of financing income, such as interest on loans.
The rule exempts financing income received by offshore subsidiaries from being reallocated to the UK, meaning multinationals can pay little or no tax on it. By creating loans from offshore subsidiaries in tax havens to a group company in another country, the interest on the loan paid can move back to the UK with little or no tax paid on it.
The UK first introduced CFC rules in 1984, but it has been making small changes to its CFC regime since 2009 to make it more attractive for companies to base their headquarters within its borders.
This aim is not uncommon in Europe, says Chardonnet, and is a less widely understood aspect of the ‘race to the bottom’ of corporate tax rates.
“Strong controlled foreign company rules against profit shifting are needed so multinationals pay their fair share of tax,” said Chardonnet. “Last year, several EU member states lobbied to weaken EU minimum standards for this anti-tax avoidance measure.”
Will the EC’s decision come before Brexit?
Of course, with the UK set to leave the EU it may be outside of the EC’s jurisdiction by the time a verdict is reached. However, companies should still keep an eye on this case.
“The EC will publish a more detailed opening decision in the coming weeks which will pro-vide further detail on their concerns and the reason for identifying this regime,” said a press release from PwC’s pan-European direct tax group. “This will therefore enable a better understanding of the potential implications of this investigation for businesses availing themselves of this regime.”
The time between the opening of the in-depth investigation into the Belgian excess profit ruling system and the EC’s decision was a little under a year, and under a similar timeframe the UK would still be part of the EU.
This does not take into account for a potential transitional arrangement keeping the UK in the European single market, and therefore bound by its competition rules and under the jurisdiction of the ECJ.
Even if the UK does leave the EU and the single market before the investigation is concluded, a change of government – which is looking more and more likely – could put the left-wing Labour party in charge. Labour has been highly critical of rules that allow multinationals to avoid tax, and could remove the group financing exemption regardless of the results of the EC’s investigation.
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