In general, the CFC rules 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.

However, in 2013 the rules changed to introduce an exception for certain financing income (i.e. interest payments received from loans) of multinational groups active in the UK. The UK's group financing exemption exempts from reallocation to the UK, and hence UK taxation, financing income received by the offshore subsidiary from another foreign group company.

The Commission pointed out that this means a multinational active in the UK can provide financing to a foreign group company via an offshore subsidiary.

Due to the exemption, it pays little or even no tax on the profits from these transactions, because the offshore subsidiary pays little or no tax on the financing income in the country where it is based; and the offshore subsidiary's financing income is also not (or only partially) reallocated to the UK for taxation due to the exemption.

On the other hand, the CFC rules reallocate other income artificially shifted to offshore subsidiaries of UK parent companies to the UK for taxation.

The Commission said its state aid investigation does not call into question the UK's right to introduce CFC rules or to determine the appropriate level of taxation, but will focus on whether or not some companies are given a better tax treatment than others. The case law of the EU courts makes clear that an exemption from an anti-avoidance provision can amount to such a selective advantage.

Commissioner Margrethe Vestager, who is in charge of competition policy, said: ‘All companies must pay their fair share of tax. Anti-tax avoidance rules play an important role to achieve this goal. But rules targeting tax avoidance cannot go against their purpose and treat some companies better than others. This is why we will carefully look at an exemption to the UK's anti–tax avoidance rules for certain transactions by multinationals, to make sure it does not breach EU State aid rules.’

A Treasury spokesperson said: ‘We do not believe these rules are incompatible with EU law but will cooperate with the European commission’s investigation.

‘We are clear that all multinationals must pay tax ‎on any profits they make in the UK, and our rules prevent these profits from being artificially diverted overseas.’

This is the latest in a series of Commission challenges over breaches of state aid rules. In October 2015, the Commission concluded that Luxembourg and the Netherlands had granted selective tax advantages to Fiat and Starbucks, respectively, while in January 2016, it concluded that selective tax advantages granted by Belgium to at least 35 multinationals, mainly from the EU, under its ‘excess profit’ tax scheme are illegal under EU State aid rules.

In August 2016, the Commission concluded that Ireland granted undue tax benefits of up to €13bn (£11.6bn) to Apple, and the following year it concluded that Luxembourg granted undue tax benefits of up to €250m (£223m) to Amazon. The Commission also has two ongoing in-depth investigations into concerns that tax rulings may give rise to state aid issues in Luxembourg, concerning McDonald’s and GDF Suez (now Engie).

Report by Pat Sweet