The European Commission has issued a Press Release stating that the UK’s controlled foreign company (“CFC”) finance company exemption gave illegal tax advantages to certain multinational companies. The UK amended certain elements of its CFC rules, including the Chapter 9 finance company exemption, from April 2019 as a result of Finance Act 2019. This was to satisfy the EU’s anti-tax avoidance directive which took effect from 1 January 2019.

The Commission found that the UK scheme unduly exempted certain multinational groups from the UK rules which, according to the Commission, is illegal under EU State aid rules. The UK must now recover the illegal State aid from the multinational companies that benefitted from it.

The Finance Company exemption challenged by the EU is set out in Chapter 9 of the legislation and is a special rule for certain financing income (i.e. interest payments received from loans) of multinational groups active in the UK. Even though this financing income passes through a CFC charge gateway, Chapter 9 provides a derogation from the general CFC rules.

It partially (75 percent) or fully exempts from taxation in the UK financing income received by an offshore subsidiary from another foreign group company, even if this income is derived from “UK activities” or the capital being used is “UK connected”.

Therefore, according to the EU, a multinational active in the UK using this exemption is able to provide financing to a foreign group company via an offshore subsidiary paying little or no tax on the profits from these transactions.