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Comments from ACCA
To HM Treasury
September 2007

Introduction

The Association of Chartered Certified Accountants (ACCA) welcomes the opportunity to comment on the above discussion paper and to contribute to the debate on this area of taxation, which is important to maintaining a competitive taxation system for UK business and to enable it to respond to and benefit from the forces of globalisation.

Overall, we welcome the proposal to move to an exemption approach for foreign dividends. We also applaud the proposal to maintain the existing arrangements for interest relief deductions, subject to the limited and targeted changes proposed, and to remove the existing Treasury consent rules.

We do, however, have serious concerns about the element of the package related to Controlled Foreign Companies. As set out below, we believe that these overreach the proper policy aims and objectives and could impair the competitiveness of British business. We also believe that some relaxation of these proposals would not undermine protection of the Exchequer. The Exchequer will be best protected in a globalised economy by the Government maintaining a competitive rate and system for CT.

We would therefore recommend that the Government re-examine this area and come forward with new proposals. We are confident that a continued dialogue will produce a new regime which meets the needs of Business and addresses the Government's concerns.

In our comments below we have followed the format set out in Chapter 7 - The questions for consideration.

Dividends – Exemption or Credit

We believe that exemption of participation dividend income is now more appropriate than the current approach, on the assumption that, as proposed, a general deduction for interest is maintained. We welcome the Government's willingness to listen to business, which has long maintained that an exemption approach should not be linked to a regime for restricting interest deductions.

Such an approach has the potential to be a competitive tax system for UK business and will encourage companies to develop their businesses on the basis of market fundamentals and opportunities. A general interest restriction would have given rise to the risk that businesses would be deterred for tax reasons from grasping strategic opportunities and would have left them at a competitive disadvantage against their international competitors.

The exemption approach should lead to positive behavioural consequences such as increased repatriation of profit, more direct ownership lines and, in some cases, relocation of the oversight of foreign subsidiaries from overseas coordination centres back to the UK, with attendant benefits for Government receipts from income tax, national insurance and VAT.

The exemption method may also be expected in due course to lead to an improvement in the terms of double taxation agreements such as the reduction in dividend withholding taxes and tax exemptions for capital gains in the other countries. This is based on the number of cases where the UK 's current DTA terms have in the past been bettered by other countries with exemption systems, e.g. The Netherlands.

This change will also have positive effects on the reputation of the UK for having an open, fair and investment-friendly tax regime.

Exclusions from Exemption

For similar reasons, as explained further below, we believe that the exclusions from exemption should be as few as possible and limited to those aimed at preventing artificial tax avoidance.

Smaller Business

For smaller businesses, there is an attraction in having a simplified regime but we question whether it would be right to deny to smaller companies the benefits of exemption which are to be made available to larger ones. In addition, exemption should be the simplest system and perfectly appropriate for smaller companies. We certainly do not think that smaller companies should be denied tax credit relief for lower tier companies as hinted at in para 3.14. A better approach would therefore be to apply exemption to all companies but to have a simplified controlled company regime for smaller companies as already proposed.

Behavioural consequences and anti-abuse measures

As indicated above, we believe that many positive behavioural consequences will follow from the introduction of an exemption method. In relation to possible abuse, the main issue is with interest because it tends to be freely locatable and has little essential associated business activity.

We believe, however, that because most businesses face fierce competitive pressures in the globalised international market place, they need to be able to respond to these pressures without facing onerous anti-avoidance rules which impinge on the optimum way of organising their business operations. In our view, the economic gains from enabling UK businesses to compete effectively will in the long run far exceed the perceived revenue costs of giving up theoretical CT receipts on the income from foreign activities. This is partly because the force of global competition means that these future tax receipts are themselves very contingent on firms' competitiveness. The situation requires a dynamic view rather than seeing it as a zero sum game.

Portfolio Dividends

Exemption for foreign dividends is likely to be the only acceptable solution to the problem posed by the ECJ's judgement. Taxing UK dividends without credit would be very damaging from an economic standpoint and providing credit for underlying tax would be administratively difficult and extremely expensive for companies and HMRC to operate.

Controlled Companies Regime

Overall Approach

We find the proposal to apply these rules within the UK to be unnecessary. We know of no perceived abuse or avoidance associated with artificial location of profit within the UK . Further, the comments in Box 1 in para 4.11 indicate that the real reason for this proposal is to bolster HMRC defences against a challenge in the ECJ for the proposed new controlled company regime. Further, no such extension to UK companies would be necessary if the current CFC regime or the proposed CC regime were fully justified as being for the purposes of anti-avoidance or to counter artificial arrangements. It is likely therefore to be viewed by many as a fairly transparent and deliberate attempt to maintain a CFC regime beyond the scope of the ruling in Cadbury Schweppes.

In our view, it would be an inappropriate use of UK legislation for the Government to seek to escape or undermine the purpose and effect of the EU Treaties, as interpreted by the ECJ, through the use of artificial provisions crafted to appear to apply to all companies but in

We believe that both from a general policy standpoint and in order to comply with the ECJ's ruling in Cadbury Schweppes, the new rules should only target avoidance schemes and arrangements and that genuine commercial activity carried out in overseas subsidiaries should not be exposed to UK tax.

Income categories

We agree that the new regime should focus on mobile income but we believe that this should be restricted to passive income so that income from genuine economic activity carried on outside the UK should not be subject to further tax in the UK . As set out above, this principle should enable UK business to compete effectively in the wider world. If, for instance, a group sets up a shared service, trading or distribution centre in a lower cost and lower tax rate country, the profits from that operations (controlled via the OECD transfer pricing rules) should not be regarded as having been diverted from the UK but as being earned outside it and therefore exempt in the UK. The economic gains from the lower costs and taxes will tend over time to be competed away in the market place but they will preserve or advance the group's competitive position in the market. If the UK seeks to tax these profits, the likely result will be to deter the group taking up the optimum route in the first place and the group will not prosper as it might have done.

We would therefore propose that the exclusions set out in para 4.29 should not be continued in the new regime. We believe that they go beyond what is permissible under the ECJ judgement and are against the interests of UK business. Nor will it preserve UK CT receipts as hoped. In a dynamic and competitive world foreign competitors will win more business and income if UK business is discouraged from globalising their business operations. UK CT receipts will be maximised by the UK maintaining a competitive low rate for CT and having a competitive system.

We are also extremely concerned about the proposal in para 4.21 to include active income which may be deemed to derive from intangible assets. It is surely wrong in principle for the UK to tax such profits. The ownership of intangible assets by a foreign subsidiary should not be treated automatically as a tax avoidance arrangement, which should be the only justifiable reason for seeking to tax the income in the UK . Such a rule would for instance make it difficult for a UK company to contemplate buying a foreign group with operations in a lower tax country. For groups operating in the fields of publishing and software, the actual normal trading income sales may well be in the form of licences.

Such a provision would also be very cumbersome and expensive for groups to operate and for HMRC to check. It would require all companies in the group owning intangibles to be identified and for their income to be apportioned between that derived from intangibles and the balance. For ordinary sales income, this would require a valuation of the related intangible in terms of a royalty value, something which would not have been done already for any business reason.

We would suggest that the proposals on capital gains would be likely to give rise to similar issues and difficulties.

Exemptions

We agree with the proposals to exempt active finance and group treasury companies. If, as we have argued, the regime is to be more targeted at tax avoidance then it would be reasonable to test the level of equity capital to see if it is higher than is needed for genuine commercial purposes, as opposed to generating higher interest income in the treasury company.

Underpinning

We believe that the proposals need more demonstrably to be underpinned by the principle that they operate to counter tax avoidance.

Measurement of income

The issues on income measurement arise mainly because the proposed regime is more extensive than needed to counter tax avoidance. The proposals to identify and tax income derived from intangible assets could not be achieved using GAAP rules and would require a separate system of estimation.

Impact and Cost of New Rules

As indicated above, the potential negative impact of the proposed rules could be extensive. There is the negative economic impact through groups being unable freely to organise and run their operations in an optimal manner. It is difficult to estimate or measure this but we believe it is nonetheless very real.

It is also clear that the proposals for identification of deemed passive income from intangibles would be very expensive from an administrative standpoint.

Interest and other elements

The Association welcomes the Government's decision to keep the general deduction for interest costs and to make the minimum changes needed as a result of the introduction of dividend exemption.

The main difficulty with the proposal to restrict deductions by reference to the group's total external finance costs is that it is not clearly in accordance with arm's length principle. Many companies, particularly in a start up phase, may have an arm's length level of debt finance even though the multinational group has little or no net debt and interest costs. It would be unfortunate if this proposal deterred foreign groups from investing in the UK .

If a similar rule were to be introduced by other countries it could be damaging to UK owned multinational groups. This may be more likely if the UK introduces such a rule.

The Association welcomes the proposals to repeal Section 765 and would like to hear what is proposed for information reporting. Our preference would be for the additional information to be provided with the tax return.

Follow Up

We would be happy to meet with representatives of HM Treasury to discuss this response further.

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