Happy Friday the 13th! Taxpayers who claimed the benefit of the UK’s CFC finance company exemption before 1 January 2019 will have shaken off their post-election hangovers this morning to find a 39 page statement from HMRC in their inboxes snappily entitled "HMRC Statement Regarding EC Decision on State aid SA 44896". The statement provides some welcome clarity on how the UK intends to undertake the recovery of the unlawful (according to the Commission’s decision) State aid.

So is it good news or bad news?  The answer, as ever, is that it depends.

Guidance on specific people functions (SPFs)

Appendix 1 to the statement sets out further guidance on SPFs.  This is, on the whole, to be welcomed.  It helps to reconcile the existing HMRC guidance which was quoted in the Commission’s decision, and which is widely perceived in the market as overstating the likelihood of finding UK SPFs in relation to intra-group lending in order to encourage groups to volunteer some UK tax on their overseas finance profits rather than seeking to demonstrate there is no tax due, and the 2010 OECD Report which is incorporated into UK law and which the statement recognises provides "the definitive guidance".

HMRC run through the various different SPFs in the OECD Report (or key entrepreneurial risk-taking functions (KERTs) as they are identified there) relating to traditional banking business and then look at how to apply them to intra-group lending.

Where is the decision to lend made?

Sensibly, they draw the conclusion that various SPFs identified in relation to traditional banking business - such as inducing clients - have no real relevance to intra-group lending and draw the conclusion that:  "The active decision to lend the money is likely to be the SPF in relation to credit risk, and also the SPF in relation to the creation of the loan asset".

In my view that is the right answer. So, in each case, this should all boil down to a question of whether the decision to lend was properly taken by the CFC in its place of residence.  And, if it was, the loan should not be attributed to a notional UK permanent establishment and should not therefore give rise to profits which would have passed through the CFC gateway as a result of the SPF test (rather than the UK connected capital test in relation to which the Commission has accepted the finance company exemption is not unlawful).

Or, in the words of HMRC: "Most often the question is whether, on the facts, the CFC Board has taken an active decision to make a loan on particular terms, or whether it is instead implementing a decision that has already been made". 

Pausing there, that should be good news for everyone.  It should mean that taxpayers, advisers and HMRC have a common understanding of what the relevant SPFs in relation to intra-group lending are.  Of course given their citing of HMRC’s existing guidance it remains to be seen whether the Commission push back on this but as a matter of principle they should not.  HMRC have done a good job of explaining how to apply the definitive OECD approach to intra-group lending.

Active decision-making by CFC board

Of course, that leads to the next challenge for taxpayers: can they demonstrate that the active decisions to lend were taken by their respective CFC boards?  HMRC list eleven factors which in their view indicate "an active decision was not taken by the CFC Board of Directors".  Most of these will come as no surprise as they go the relevant board not having sufficient information, time or experience to make a proper decision.

Two that may raise more eyebrows are "the loan being commercially irrational from the perspective of the CFC, for example an interest free loan" and the CFC having any directors who have already been involved in a UK approvals process.  

Structures involving Irish CFCs advancing interest free loans, either back to the UK for on-lending or to another CFC, and with the borrower claiming a compensating adjustment for a deemed interest payment, were sufficiently common to merit their own write up in HMRC’s guidance as an example financing structure.  It is not obvious that the mere fact that a loan is interest free should call into question whether the decision to advance it is real (or "active") or not.  Indeed, one might imagine that a diligent director bearing his fiduciary duties in mind might actually put more thought into deciding to advance an interest free loan rather than less.  Similarly, with the UK individual involved in both the approvals process and on the CFC board.  That may well mean that that individual helps the board to make a better and more informed decision than it would without them.  

Recovery methods

The statement also sets out HMRC’s waterfall of how they intend to effect recovery:

1. using closure notices issued within normal time limits; 
2. using discovery assessments for closed periods within the 4 year time limit for discovery assessment;
3. taking High Court action;  and
4. contract payments as an alternative to High Court action.

And with the note that whilst HMRC don’t think specific legislation is required to facilitate recovery, it remains a fallback option.  

I don’t think there is any surprise with the first of these two routes.  The third and fourth will raise some interesting questions, such as: what is the nature of a payment a taxpayer voluntarily contracts with HMRC to pay to it and in what circumstances, if any, would it be sensible to agree to make such a payment?  Or on what basis could HMRC take High Court action?  It is certainly the case that the Commission believe national courts have an obligation under community law to recover unlawful aid, but as far as I am aware the exact scope and nature of that obligation has yet to be fully tested in relation to tax.  It received some consideration from the Outer House, Court of Session in John Gunn and Sons, a 2018 aggregates levy State aid case, but with a lot less at stake.  And that’s before you add in any complexity of Brexit surely now going ahead on 31 January, 2020.

Calculation of recoverable amount, reliefs and penalties

Other things the statement covers include how the recoverable amount is calculated, including impact with the corporate interest restriction, and how and when reliefs can be taken into account which will be of interest to many groups who, had there potentially been a higher CFC charge at the time, would have had losses or other reliefs to offset it.  And penalties, where HMRC state they will not charge a penalty in respect of adjustments to the value of exemption claimed under Chapter 9.  I can only imagine the outcry if they did seek to apply penalties for fully complying with UK legislation which the UK promoted and which the UK continues to maintain is fully compliant with EU law.

So quite a lot in the statement, and still a lot of detailed work for individual taxpayers and HMRC to do to agree recoverable amounts, if any, in each specific case, but overall I think a helpful statement from HMRC which should help to move matters forward. (And I understand water’s edge companies who have previously responded to HMRC’s information requests should expect to hear back shortly.)