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UK attack on 12.5p.c. CT rate Back  
The UK has proposed to extend the application of its controlled company legislation to UK controlled subsidiaries operating in Ireland. This move is a threat to economic development in Ireland. It could encourage our fellow Europeans to follow suit.
Controlled foreign company legislation (CFC legislation) is quite a common feature of tax legislation in major economies. Generally it seeks to attach a tax liability to a locally resident company in respect of the profits arising to subsidiaries of that company located in other jurisdictions.
CFC legislation has an obvious motivation. It is a disincentive to companies on locating business overseas. The UK has such legislation. Like many countries, but by no means all, the UK has a list of countries where UK controlled subsidiaries are not liable to have their profits effectively attributed to the UK parent for UK tax purposes. Ireland was on that list although Irish companies benefiting from one or other form of the 10p.c. corporation tax rate (manufacturing relief, Shannon relief etc) did not benefit from this excluded status granted to other Irish companies.

Which companies are affected?
The fact that Irish subsidiaries of UK groups which were taxed at the 10p.c. rate of corporation tax were not on the excluded countries list did not mean that they were necessarily targeted by the UK CFC rules. Apart from the excluded countries list referred to, there are a number of other exceptions to the application of UK CFC legislation. One of these is the ‘exempt activities’ test. Generally speaking UK controlled Irish subsidiaries which manufactured goods and sold them to unconnected parties outside of the UK were exempt from the application of the UK’s CFC legislation. However the Irish subsidiary of a UK group which sold to connected parties, or sold into the UK, or engaged in wholesale, distribution, financial services, or other service type businesses mainly with connected parties (broadly speaking) were not excluded from the ambit of the legislation on the grounds of their activities alone.
Many types of business, including holding intellectual property, dealing in securities, leasing, shipping and air transport, banking, trusts administration, securities brokerage, and many forms of insurance business, were activities which were not per se excluded from the ambit of the legislation. There were always therefore categories of UK subsidiaries in Ireland which were potentially within the legislation ( in the absence of excluded countries status) either by reason of benefiting from the 10p.c. rate of corporation tax, and/or, engaging in some of the activities described above.
Such a company could however benefit from a further exemption known as the ‘motive test’. If the foreign subsidiary could demonstrate that they had been set up for bona fides commercial reasons and not for the purpose of the avoidance of UK tax, then its profits would not be within the scope of the legislation.
The removal of Ireland from the exempt countries list largely has the implication that a company carrying on any of the activities described above, and which would not benefit from the 10p.c. corporation tax rate but would from 1 January 2003 be taxed at 12.5p.c. in Ireland, is now exposed to UK taxation (via its parent) unless it can pass the motive test.

Impact on growth
Ireland’s 12.5p.c. corporation tax rate is expected to be important in driving forward our economic growth in the next decade. It would no doubt have caused many UK companies to examine their activities with a view to seeing whether some of them could be relocated in Ireland to take advantage of the low corporation tax rate. Many of these activities would have consisted of providing services or goods to fellow group members. Such carve-outs of the activities of UK groups on their relocation in Ireland will now be tax effective only if the motive test can be met. Of course not all carve-outs are driven solely by Ireland’s lower tax rate. Availability of skilled labour, operating costs, proximity to customers (eg the many multinationals located in Ireland) may all be factors in influencing a location. But if the UK move is not challenged, the extent to which the 12.5p.c. corporation tax rate will attract UK businesses to locate in Ireland will be severely restricted.
If the impact of the UK move were solely to restrict our ability to attract UK enterprises to Ireland, the matter would be unfortunate but not fatal. The danger is that other EU member states will do something similar, if they see that the UK gets away with it.

Is it going to happen?
Why shouldn’t the UK get away with it? Well there are possibly three reasons why they should not.
Firstly, the UK has a double tax agreement with Ireland which precludes them from taxing the trading profits of Irish resident companies which do not trade in the UK through a permanent establishment there. On the face of it that ought to preclude a CFC levy on the UK parent in respect of the Irish subsidiary’s profits. However the UK courts have held that because what the UK parent is taxed on is not the Irish profits per se but a notional sum equal to those profits, that the charge is not prohibited by a double tax agreement. This is a very dubious interpretation of the double tax agreement.
The French courts have reached an opposite conclusion in the application of French CFC legislation in the context of the France Switzerland double tax agreement. On the other hand, the Finnish courts have concluded that Finland’s CFC legislation is not overridden by double tax agreements. In other words, this is an area of unresolved confusion.
The second reason why the UK should not get away with its move is that it is an apparent breach of EU rules on the freedom of movement of capital, and the freedom of establishment of businesses. It is quite plainly an attempt to penalise companies which make a free choice to locate outside of the UK.
The compatibility of CFC legislation with EU rules has long been a subject matter of debate but it has not so far been ruled on by the European Court of Justice. It seems inevitable that a case will end up there in the next year or two and there must be a very good chance that the European Court of Justice will hold that the application of CFC legislation as between EU member states is illegal.
If the Inland Revenue are being cynical, the possibility of a rap on the knuckles from the ECJ may not worry them too much. It will take some years to filter through and they will have had the advantage of their move for that period of time. The damage to Ireland could well be done by then.
The third reason the UK should not get away with it is that the UK does not have that many ‘friends’ in the EU. The attack on Ireland’s interests represented by the UK CFC move is of so fundamental a character as would justify Irish ministers reconsidering their positions on many issues in an EU context, where the UK may be seeking support. That may not be a technical tax consideration, but it might prove a speedier and more effective remedy than either of the two previously mentioned.
The UK move of course is not the end of the world. Ireland’s industrial development policy has been based primarily on attracting inward investment from the United States of America. That is largely unaffected by the UK move and by any copycat actions by our fellow members of the EU. Similarly, our ability to attract inward investment from other major economies such as Japan, Korea, Taiwan, Singapore, India or the South American countries is not affected. But it is a blow sufficiently serious to warrant attention at every level of government, including the very highest. This is not ‘business as usual’. This is a slap in the face and it requires serious attention.

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