How Effective Are CFC Rules in Containing Tax Haven Activities? Evidence from a Sample of European Firms

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CFC rules differ widely across countries. This study examines whether the effectiveness of a CFC rule in containing tax haven activities depends upon these differences. It is based upon a sample of 93,377 parent firms from 32 European countries. The results show that a CFC rule is most effective in limiting tax haven activities if it either includes certain passive income or total income of low-taxed foreign subsidiaries in the tax base of the parent firm. Moreover, the effectiveness of a CFC rule increases if countries use a blacklist to identify low-taxed foreign subsidiaries. Exemptions, i.e. a safe-haven rule or an economic substance exemption, might reduce the effectiveness of a CFC rule. At the same time, however, they ensure that a CFC rule is not only an effective but also an adequate measure against tax haven activities. The results obtained in this study provide valuable insights for lawmakers as to how to design CFC rules so that they are most effective in protecting a country’s corporate tax base.