Tax ruling is good news for captives  (Published courtesy of CAPTIVEandART.com)

UK CFC legislation states that unless a CFC distributes 90% of its profits to its resident parent company or passes a ‘motive test’ to prove it was not set up for tax avoidance reasons, any profits made will be taxed at the UK rate regardless of low tax rates in its foreign location.

The ECJ’s finding clarifies that only companies set up as “wholly artificial tax arrangements” would fall under UK CFC legislation. The ruling comes as reassuring news for the captive industry.

Stephen Cross, chief executive of Aon Captive Services Group, believes captives should be formed to benefit the overall risk management perspective of their parent companies and never solely for tax reasons, and as such should not fall under CFC rules.

“As long as the captive has genuine economic activities, and the EU parent is able to demonstrate that the EU captive adds real economic value to the group activities, it should be able to benefit from the tax regime in place in any EU member state, regardless of the corporation tax rate there,” said Cross.

  The legislation was put to the test in the case of Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd versus Commissioners of Inland Revenue, in which Cadbury Schweppes was accused of setting up two subsidiaries in Ireland to take advantage of the country’s 10% tax rate.

Sarah Goddard, chief executive of the Dublin International Insurance Management Association, commented: “We welcome the clarification of the position regarding the UK’s legislation on CFCs. The decision by the ECJ recognises that the UK’s previous position on European-based foreign companies was a restriction on freedom of establishment, and potentially removes a barrier previously imposed on UK companies when looking to set up captive subsidiaries in other EU member states.”

However, Cross warned that although the ECJ decision has given some guidance on what arrangements could be regarded as artificial, it will be difficult to advise on the precise structure required of local subsidiaries in other member states by the UK tax authorities until the final decision of the UK courts is received.

“Depending on the nature of any particular client, we may suggest that they talk to their tax advisers with a view to considering the possibility of reclaiming any UK taxes paid in prior years,” Cross added.