Whether you approve of him or not, it is difficult to refute President Trump’s assertion that we live in an era where “fake news” abounds. The internet and social media platforms allow dubious information to be distributed at the click of a button to millions of people. Brexit is a case in point.

With no-one really knowing what will happen on March 29, 2019, unsubstantiated claims can be made by bloggers, journalists, MPs and companies that are then taken as the truth, without verification. This has led to a proliferation of sensationalist stories in the media blaming Brexit for various doomsday scenarios, ranging from access to pharmaceuticals to the grounding of airplanes.

Overhaul of Japanese CFC Rules

It has been widely reported in the mainstream media that Panasonic was relocating its European headquarters from the U.K. to the Netherlands.

Laurent Abadie, CEO of Panasonic Europe Ltd, told the Nikkei that Japan could treat Britain as a tax haven if the latter lowered its corporation tax rate to make it more competitive after Brexit.

This, however, is factually incorrect. Brexit or no Brexit, the tax regime in the U.K. is potentially problematic for Japanese companies, after Japan announced an overhaul of its controlled foreign company (“CFC”) rules in 2017.

CFC rules are widely used by jurisdictions around the world to prevent the artificial deferral of corporate tax by using entities established in low tax jurisdictions.

Without CFC rules, Company A, incorporated in a high tax jurisdiction, could establish a subsidiary, Company B, in a low tax jurisdiction and shelter profits from tax. CFC rules dissuade this type of activity by attributing the income of the low tax subsidiary to the parent company on a current basis.

The Japanese government announced in January 2017 that it would be overhauling its CFC regime, taking into account the recommendations of the Organisation for Economic Co-operation and Development base erosion and profit shifting (“BEPS”) Action 3.

The old CFC rules were applied to a foreign company by reference to:

  • the relevant corporate tax rate (the “trigger rate”); and
  • the CFC’s economic substance.

Thus, a foreign company that paid tax at or above the trigger rate of 20 percent was excluded from the CFC rules, irrespective of whether the company had economic substance. By contrast, a foreign company that paid tax at a trigger rate of less than 20 percent was caught by the rules, even if it did have economic substance.

BEPS Action 3, “Designing Effective Controlled Foreign Company Rules,” recommends that CFC rules should focus on the actual economic substance of foreign subsidiaries. As such, the new CFC rules introduced by Japan, effective from April 1, 2018, are aimed at passive income arising to a foreign subsidiary that has insufficient economic substance.

The New Provisions

The new rules can be briefly summarized as follows.

There are three regimes:

  • full inclusion of a CFC’s income;
  • partial inclusion of passive income of the CFC; and
  • full inclusion of a specified CFC.

Where the effective tax rate of the CFC is lower than 20 percent and it fails to satisfy the economic activity test, “eligible CFC income” is attributed to the Japanese parent. Eligible CFC income is the CFC’s income with adjustments for, inter alia, differences between local tax rules and Japanese tax rules, tax losses incurred in the previous seven years and corporate tax paid or payable.

The Economic Activities Test is comprised of four tests that replace the Exemption Tests under the old rules. The four tests are:

1. Principal business test: the CFC’s principal business is not holding shares or bonds, licensing industrial property rights, copyrights, etc., leasing vessels or aircraft.
2. Substance test: the CFC maintains offices, stores, factories or other fixed places of business necessary to conduct business in the jurisdiction where its head office is located.
3. Management and control test: the CFC manages, controls and operates its business on its own in the jurisdiction where its head office is located.
4A. Business location test: the CFC conducts its principal business in the jurisdiction where its head office is located.
4B. Unrelated party test: more than 50 percent of the CFC’s transactions are with unrelated parties.

Income of a CFC that satisfies the Economic Activities Test will not be subject to the CFC rules irrespective of the effective tax rate. However, passive income of a CFC subject to an effective tax rate of 20 percent or less may be caught by the CFC rules.

Income of a CFC that does not satisfy the Economic Activities Test and is subject to an effective tax rate of 20 percent or less will be subject to the CFC rules.

Income of a CFC that is a paper company, a cashbox company or a blacklist company, and which is subject to an effective tax rate of 30 percent or less, will be subject to the CFC rules.

With regard to Panasonic, the relocation of the U.K. headquarters to the Netherlands is being done by means of cross-border legal merger, with the surviving company being Panasonic Europe BV. The current rate of Dutch tax is 25 percent, so assuming the BV meets the Economic Activities Test above, no CFC apportionment will be due.

Is it Brexit?

Finally, it is worth recalling that the U.K. government announced legislation in the Summer Budget 2015, setting the Corporation Tax main rate at 19 percent for the years starting April 1, 2017, 2018 and 2019, and at 18 percent for the year starting April 1, 2020. In the Budget 2016, the government announced a further reduction for the year starting April 1, 2020, setting the rate at 17 percent.

As we all know, the Brexit Referendum vote was held on June 23, 2016, almost a year after the announcement to cut U.K. Corporation Tax rates. Panasonic’s claim that it is relocating to the Netherlands because of Brexit and its repercussions is, as President Trump would say, “Fake News!”


This article was published in Bloomberg BNA

Reproduced with permission from Copyright 2018 The Bureau of National Affairs, Inc. (800-372-1033) www.bna.com

Posted in Uncategorized

September 24, 2018


Posted by Miles

Miles is a founder of Milestone having started his career in international tax in 1994.

Read More All Posts By Miles Dean

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