Brussels attacks barriers to capital flows

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Multinationals based in the UK are illegally prevented from exploiting low tax rates in other European Union countries, the EU Commission has ruled – the latest twist in a row over how to prevent profits that should be taxed in Britain from being diverted ­overseas.

The Commission rapped the UK on Thursday for breaching EU anti-discrimination provisions when it reformed its tax rules after a 2006 court case involving Cadbury Schweppes, the confectionery company. The EU’s executive arm said Britain had failed to exclude all bloc subsidiaries “which are not purely artificial and are not involved in profit-shifting transactions” from its anti-avoidance rules.

“Despite the 2006 court’s ruling in the Cadbury Schweppes case, the UK is still not complying with EU law on freedom of establishment and free movement of capital,” it said.

Unless the UK replies satisfactorily in two months, it may be referred to the EU’s Court of Justice.

Experts said the Commission’s request that the UK change its legislation challenged planned reforms of the “controlled foreign companies” regime – anti-avoidance measures affecting foreign profits. These reforms were put forward by George Osborne, the chancellor, to try to defuse a row over previous proposals that led to the departure of a number of big companies to countries such as Ireland, which lacked such rules.

Mr Osborne’s proposals were sufficiently business-friendly to persuade WPP, the advertising group, to announce its return after this year’s Budget. But Chris Morgan, a tax partner of KPMG, the professional services group, said the Commission’s ruling highlighted a weakness in proposals on taxation of intellectual property that had been shifted overseas. He said the Commission’s ruling strengthened the arguments of businesses that intellectual property that had been taxed on its transfer abroad should not be taxed under the CFC regime. He said: “The Treasury needs to rethink this.”

Gary Richards of Berwin Leighton Paisner, a law firm, said: “HMRC is already in the process of reforming CFC legislation. But this new challenge, implicitly criticising UK law for focusing too narrowly on the value of work done overseas, suggests its new proposals may need to be revised before they have even become law.”

The ruling would influence imminent reform of taxation of foreign profits and strengthen the hand of companies about to settle long-standing disputes with the Treasury, tax advisers said.

The Commission’s intervention might mean companies paying tens of millions of pounds less to settle old disputes over CFC regimes, they said. They suggested it would cast a favourable light on the settlement of a high-profile dispute with Vodafone that critics said was too generous to the telecoms company.

The Treasury is expected to issue a consultation on the planned reforms of the rules before mid-June.

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