The Government has released draft legislation on the taxation of foreign profits. These changes will be of fundamental significance for all worldwide corporate groups and represent a move towards a territorial approach to taxing foreign subsidiaries. 

The draft legislation is the result of consultation that started in June 2007. The intention is to introduce the legislation in the Finance Bill 2009, with the key aspects include the following.

Dividend exemption
The central measure is an exemption from tax for dividends received by large and medium groups regardless of the source.

"Introducing a dividend exemption in place of the complex credit relief system currently in place will be very welcome, " said Nick Farmer, international tax specialist at Menzies. "This change in treatment will put the UK on a par with other more favourable holding company jurisdictions. It is however a shame that this dividend exemption will not be extended to small companies."

Interest
A worldwide debt cap is to be introduced and the existing unallowable purpose rules for interest expense will be extended. The worldwide debt cap will restrict the deductibility of interest by UK members of a worldwide group by reference to the group’s net external interest payments.

Farmer said: "The government has introduced this to balance the potential cost to the exchequer of  the dividend exemption. It will prevent a UK company from deducting more interest expense than the net external interest incurred by the worldwide group. In-bound investors will need to look at how they finance a UK company, and as there is no commercial motive test, this issue will remain even if borrowing is on arm’s length terms’

Anti-avoidance legislation
The existing controlled foreign companies (CFC) legislation is to be reformed. The acceptable distribution policy (ADP) exemption is to be repealed, as is the exemption for certain holding companies within the exempt activities test.

Farmer said: "It is this aspect that has caused much uncertainty and has given rise to the migration of a number of high profile companies this year. Companies have felt that the changes could tax the profits they earn in their overseas subsidiaries, and obviously this has caused considerable concern. The Government is still consulting on exactly how the CFC legislation will be reformed, and whilst this issue remains unresolved the true impact of the foreign profit reforms cannot be determined."

Treasury consent
The existing treasury consent rules will be replaced with a post-transaction reporting requirement targeted at transactions or events with a value above £100.

-- ends --