The new rules were originally published in December 2011 however there has recently been additional guidance issued by HM Revenue & Customs (HMRC). As the new rules represent a significant change in approach, HMRC is holding a series of road shows during the autumn on the new CFC regime and the patent box. The road shows will be attended by HMRC's customer relationship managers and tax specialists.
In our earlier article, we introduced some important concepts that will be familiar to transfer pricing practitioners.
For example, some taxpayers may be required to identify whether there are any SPFs carried out in the UK in relation to the business of the CFC. This concept was first introduced in the OECD 2010 Report on the Attribution of Profits to Permanent Establishments.
SPFs are not defined further within the CFC legislation and so reliance will be placed on the definitions in the 2010 report.
Broadly, under the new rules, any non-UK resident company that is controlled by a UK company will be a CFC. Although there are a number of exemptions that may apply, if there are any SPFs that are carried out in the UK, which relate to the business carried out by the CFC, it may be necessary to treat the SPF of the CFC as if it is a UK branch of the CFC and attribute profits of the CFC to the branch.
Hence, the importance of the OECD report: firstly in determining what is an SPF and then how to attribute profits to the hypothesised branch. However, where the activities in the UK are already remunerated on an arm's-length basis, it is possible that no additional charge will arise.
SPFs are people who carry out fundamental business functions that lead to the assumption of risk, the ownership of assets or the on-going management of those assets and risks.
The first step in this process is to determine what are the key functions and risks in the business. What constitutes a key function or risk may be different depending on the business involved. For example, for companies in the pharmaceutical industry, research and development (R&D) may be important, whilst for fast moving consumables, marketing and brand development may be vital.
Once the key assets and risks have been identified, work needs to be performed to identify who performs those key functions, undertakes activities that lead to the assumption of risk, or manages those assets and risks.
Those people may not be the most senior or well paid in the organisation. They should, however, be the people that make active decisions regarding those assets and risks.
For example, in the pharmaceutical company it may be the person who decides whether to abort a project or to extend further funding to it, or interprets the results of the research.
This may not be the same person who is responsible for R&D at board level, nor the person who works in the laboratory performing the R&D.
To identify SPFs, and in particular if there is a UK-based SPF, a functional and factual analysis of the UK company and the CFC should be carried out.
In considering the application of the new CFC rules in a group, an important information source will be the group's transfer pricing documentation, which should already include such functional analysis, although it may require supplementing to analyse the issue in the particular circumstances of the CFC.
Grant Thornton UK held a client webinar on 18 September 2012 at which Liz Hughes, a Director in the Transfer Pricing team, outlined the SPF concept as it applies to CFCs.