New CFC needed: single, simple, stable

Given current economic pressures, it is more important than ever that the UK’s tax system is competitive. A substantial cut to corporation tax would do the trick, but as the current state of public finances will not bear a significant cut in the short term, this must remain a longer-term objective. Fortunately, rate cuts are not the only way of improving the competitiveness of the UK’s tax system. The ABI’s paper ‘UK Competitiveness: The Way Forward for Insurance’ identified a number of areas of the tax system in need of reform.

UK insurers are international in their outlook and business, and in recent years many have had to redomicile in order to remain competitive with their international peers. Not surprisingly, one of the key areas of concern is the UK tax levied on profits earned in international markets.

To tackle this, the government did introduce a tax exemption for foreign dividends at the last budget. But there is still more that needs to be done, in particular the introduction of a tax exemption for the profits of overseas branches, and reform of the controlled foreign companies (CFC) rules. This is a very high priority for the ABI as it will make a big difference to UK insurers.

With the omission of the group support regime from the proposed Solvency II directive, many insurers are already planning the reorganisation of their European operations into branch structures. But there is a tension between the UK’s tax and regulation systems, which is creating a competitive disadvantage compared to other EU locations.

The UK still taxes the profits of overseas branches, whereas other EU countries, such as the Netherlands and Ireland, offer tax exemption, or the equivalent, for overseas branches. Although the government has said it will review the case for a tax exemption for branches after looking at the CFC rules, the ABI feels this should be done sooner. This is all the more urgent in light of recent speculation about firms basing their European branch operations outside the UK.

The UK’s 25-year-old CFC regime is complex and works against, rather than with, 21st century business structures. Its application is often uncertain and unstable, requiring amends in nearly every Finance Bill in recent years. The cost of complying with the regime is rising as its complexity increases, as is the extent to which it interferes with investment and activities around the world even when there is no UK connection. In contrast, the UK’s key international competitors for insurance business do not have CFC regimes at all.

There are several considerations that must underpin any reform of the CFC rules. It should be consistent with a territorial tax regime and limit itself to tackling the artificial diversion of UK profits from the UK. It should be stable and fully recognise freedom of establishment, so removing the uncertainty of the current regime with regard to its compliance with European law. It must be a single system and avoid the inequities and complexities of separate regimes for EU and non-EU transactions. It must also be simpler and have lower compliance costs than the current regime.

Reform must recognise that businesses established offshore, capitalised and staffed to the level of the business’s needs, do not create an artificial diversion of profit from the UK. It must also leave untouched investments that support life, pensions and general insurance businesses.

Just as important as the detail is the ambition of the reform. It should not be limited to the minimum necessary to retain existing UK insurers. The UK does not currently make the list of possible locations for insurers looking to redomicile from elsewhere. A positive reform of the CFC regime could change that and make the UK an attractive alternative for those with a large proportion of international earnings. We should aim to attract wholesale general insurance businesses, especially from locations such as Bermuda, which are facing considerable uncertainty these days.

There are very real benefits for consumers, government and, of course, insurers in maximising the contribution that the insurance industry can make to the UK. A thriving, competitive and well-regulated insurance sector in the UK will deliver greater growth in the economy, higher tax revenue and less strain on government spending to help repair the public finances.

In 2008, even with the UK entering recession, the industry directly contributed nearly £8bn in total tax revenues, including nearly a quarter of the corporation tax paid by the financial sector. As a nation, we cannot afford to allow more insurers to leave these shores. We must compete to bring business into the UK.

Peter Vipond is the ABI’s director of financial regulation and taxation.