The EU State aid rules are designed to stop Governments and local authorities giving companies a selective advantage, as doing so would create an unequal playing field. Say for example, a competitor in one country was given a 10% subsidy by the Government whilst the company’s closest competitor in another country was not given the same subsidy. It is likely the latter would not be able to compete effectively and could be driven out of business. These State aid rules also apply to tax breaks, the basic rule being that countries throughout the EU can have different tax levels, but they cannot apply advantages to a company or some companies which other companies do not enjoy. This means that a special tax break or status granted to a company can infringe the EU State aid rules.

On 26 October 2017, the EU Commission accused the UK of granting such a break, and therefore violating the EU State aid rules. According to the Commission, the infringing rule in question is the UK’s so-called ‘group financing exemption’ to its Controlled Foreign Company (CFC) rules. The general purpose of the UK’s CFC rules is to prevent UK companies from using a subsidiary, based in a low or no tax jurisdiction, to avoid taxation in the UK. In particular, they allow the UK tax authorities to reallocate all profits artificially shifted to an offshore subsidiary back to the UK parent company, where it can be taxed accordingly.

The group financing exemption to CFC exempts financing income from UK taxation when that income is received by an offshore subsidiary from a foreign group company. The EU believes this exemption is being used by multinationals in the UK to channel their capital from the UK, to offshore subsidiaries. From there it goes through loan and interest repayments from the offshore subsidiary to a foreign group company and then back to the offshore subsidiary, where it then finally locates that capital back in the UK, where it will be free of tax.

The investigation has just commenced so it may be some time before the Commission either demands remedial action from the UK Government or fines particular companies it believes have enjoyed these select advantages.

The Commission’s press release (and helpful diagram) can be found here.