CFC

Controlled Foreign Corporation/Company

Table of Contents

Introduction1

Controlled Foreign Corporation3

Resident and Non-Resident Companies in the UK5

CFC Rules6

Exemptions8

Low Profits Exemption8

Excluded territories exemption8

The Tax Exemption9

Low Profit Margin Exemption9

Temporary Period Exemption10

Finance Company Partial Exemption10

European Union and CFC10

The Tax System12

Complexities in the CFC Regulations13

CFC and the Collection of Information and Authority to Forcibly Collect Taxes14

One-Sided Approach14

Bilateral and Multilateral Approaches20

Conclusion22

References23

Controlled Foreign Corporation/Company

Introduction

It has been seen that foreign source income is taxed when it is accrued or received as income in the country of residence of the recipient. Therefore, it is possible to avoid the tax on certain income earned in a foreign country including dividend income by not declaring dividends or receiving them in an intermediary entity located in a tax-free or low tax country. Many countries have enacted CFC rules to ensure that there is no deferral or avoidance of taxes on foreign income. CFC rules enable domestic law to extend the residency tax rules to foreign income and tax such income when it arises and not when it is declared, distributed, received or accrued (Palan et al. 2010: Pp. 18 - 30).

The CFC rules normally apply only to foreign companies (certain countries may extend it to foreign permanent establishments or any other entity) located in a tax-free or low tax jurisdiction. The CFC rules are applied in cases where the resident shareholders have substantial influence or control over a foreign entity. The level and form of control varies widely in countries operating CFC rules. The control could be based on equity ownership, voting control, or the ability to share profits or assets on liquidation, and it may include direct and indirect control. The CFC rules apply only to the attributable income of the controlled foreign company or entity. Therefore, not all transactions may be subject to the CFC legislation. The resident country normally requires the attributable income (or profit) to be calculated under its own domestic tax rules for attribution to its resident tax payers (Taylor et al. 2007: pp. 609-642).

A resident shareholder must own a minimum percentage of shares of the CFC before the attributable income rules are applied. This is referred to as the “ownership test” in the CFC context, and it includes direct and indirect shareholdings. The minimum shareholding is usually 10%, but it could vary from less than 10% to 50%.

Several countries grant exemptions from the CFC rules. These exemptions usually follow one or more of these criteria (Arnold et al. 2002: pp. 56-73):

Active income exemption: the CFC generates income from genuine business activities and has a business presence in the country

Motive exemption: the CFC is not established with the motive to avoid or defer tax

De minimis rule: the total or attributable income of the CFC is below a minimum amount, or the pro rata share of such income does not exceed a certain percentage of the total income of the CFC.

The countries that have enacted CFC legislation include Australia, Argentina, Brazil, Canada, Denmark Estonia, Israel, Finland, France, Germany, Hungary, Italy, Japan, Korea, Kazakhstan, Mexico, New Zealand, ...