LOOPHOLE CLOSED IN CONTROLLED FOREIGN COMPANY RULES

A loophole in the anti-avoidance rules for controlled foreign
companies (CFCs) will be closed with effect from today, protecting
the UK tax base.

The measure will put a stop to an avoidance scheme used to exploit an
anomaly in one of the CFC exemptions. Companies will no longer be
able to avoid CFC tax by routing UK dividends through a CFC.

The Chancellor's announcement reflects the Government's determination
to crack down on tax avoidance, and builds on changes introduced last
year to improve the fairness and effectiveness of the CFC rules.

DETAILS

Background

1. The CFC rules are designed to stop UK companies avoiding tax in
this country by diverting income to subsidiaries (CFCs) in tax havens
and preferential regimes. The rules work by making UK companies pay
an amount of CFC tax equal to any tax that would otherwise be
avoided.

2. There are a number of exemptions. One of these is where a CFC pays
to the UK a dividend equal to at least 90 per cent of its profits.
This is called pursuing an acceptable distribution policy (ADP).

The Avoidance Scheme

3. Some UK companies have entered into arrangements which are
designed to enable their CFCs to satisfy the ADP exemption without
paying any of their low- taxed profits to the UK.

4. The arrangements typically involve a UK multinational transferring
ownership of one of its normally taxed UK subsidiaries to one of its
CFCs (which has undistributed, low-taxed, profits). Dividends from
the UK subsidiary are then routed through the CFC to the UK parent.

5. The way the CFC rules are currently written means that the UK
dividend which is routed through the CFC:

- does not normally count towards working out how large a dividend
the CFC has to pay to the UK to satisfy the ADP exemption; but

- does count towards demonstrating that the required amount has been
paid;

and as a result the CFC is able to satisfy the ADP exemption without
paying any of its low-taxed profits to the UK.

6. The UK parent pays no tax on the dividend which is routed through
the CFC because it is entitled to double taxation relief for the UK
tax paid on the UK profits giving rise to the dividend.

Closing the Loophole

7. Dividends which a CFC pays to the UK will no longer count towards
satisfying the ADP if they are paid out of UK dividends (or other
distributions) which do not count towards computing the chargeable
profits of the CFC. The change will apply to dividends paid by CFCs
on or after today for accounting periods ending on or after today.

8. A copy of the clause that will be included in the Finance Bill is
attached to this press release.

NOTES FOR EDITORS

1. A CFC is a company which is not resident in the UK (but which is
controlled by individuals or companies who are) and which is subject
to a level of taxation less than three quarters of what it would have
paid had it been resident in the UK. Subject to various exemptions,
the difference between the UK tax it would have paid and the overseas
tax it has paid can be charged on UK companies with an interest of at
least 10 per cent (25 per cent under self-assessment) in the CFC.

2. The rules require that a CFC's chargeable profits should be
computed as if it were resident in the UK. Dividends (and other
distributions) which a UK company receives from another UK company do
not normally count towards chargeable profits. This means that UK
dividends (and other distributions) received by a CFC do not normally
count towards working out how large a dividend the CFC must pay to
satisfy the ADP exemption.

3. The yield from the measure is estimated at #20m for 2001-2002 and
#50m for 2002-2003.

INLAND REVENUE PRESS OFFICE
Media enquiries to: 0171 438 6692/6706/7327
(Out of hours: 0860 359544)

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(Office hours only)

Inland Revenue information is on the Internet:
www.inlandrevenue.gov.uk

# = pounds sterling

FINANCE BILL CLAUSE

-(1) In Schedule 25 to the Taxes Act 1988 (cases where section 747(3)
does not apply), after sub-paragraph (1A) of paragraph 2 (acceptable
distribution policy) there shall be inserted the following
sub-paragraph-

"(1B) A dividend paid by a company shall not fall within
sub-paragraph (1)(d) above if, and to the extent that, the profits
which are the relevant profits in relation to the dividend derive
from dividends or other distributions paid to the company at any
time which are dividends or other distributions-

(a) to which section 208 applied; or

(b) to which that section would have applied if the company had
been resident in the United Kingdom at that time.

Subsections (3) and (4) of section 799 (double taxation relief:
computation of underlying tax) apply for the purposes of this
sub-paragraph as they apply for the purposes of subsection (1) of
that section."

(2) Subsection (1) above applies for the purpose of determining
whether dividends paid on or after 9 March 1999 for accounting
periods ending on or after that date fall within sub-paragraph (1)(d)
of paragraph 2 of that Schedule.