Controlled Foreign Corporation Research Articles

All or Nothing? The Obama Budget Proposals and BEPS

There is a wide bipartisan consensus that the US international tax regime is broken. We have the highest corporate tax in the OECD, which at 35% imposes a real burden on corporations earning mostly US source income. At the same time, US based multinationals pay very low effective tax rates on foreign source income earned through their subsidiaries, leading to a strong incentive to shift profits out of the US. Finally, the US is among the few countries to fully tax dividends paid by foreign subsidiaries to their domestic parents, leading to the “trapped income” phenomenon in which $2 trillion of low-taxed earnings of those subsidiaries cannot be repatriated because of the tax on repatriations, and have to be declared as “permanently reinvested” overseas despite increasing difficulties to find something to do with this pile of money.There is also a broad consensus about what needs to be done: reduce the corporate rate, broaden the base by taxing offshore profits, and eliminate the tax on repatriations, which affects behavior in negative ways without raising revenue. President Obama’s budget for fiscal 2016 does all three, but in a half hearted way that does not fully address the problems and creates new ones.There is, however, a better way. The G20 and OECD Base Erosion and Profit Shifting (BEPS) project has established that our major trading partners all want to eliminate double non-taxation, and that they are willing to revise their Controlled Foreign Corporation (CFC) rules to do so, with specific proposals due in September, 2015. The President should use this opportunity to convince the leaders of the G20 to eliminate deferral or exemption of CFCs at their normal corporate rate, which is always higher than 20%. Such a multilateral solution deals with all the normal objections to abolishing deferral unilaterally in the name of competitiveness, neutrality, or the need to prevent corporate expatriations. It will enable the US to achieve real corporate rate reduction and base broadening without leaving in place the incentives to invert or to shift profits overseas. And it will generate extra revenue that can be used to reduce the top marginal individual tax rate, a move that will please Congressional Republicans and make tax reform easier to swallow for the non-incorporated sector of US business.

U.S. Tax Arbitrage by Foreign Multinational Firms and its Real Effects

Controlled foreign corporation (CFC) laws are designed to restrict the tax arbitrage activities of multinational firms. I estimate a difference-in-differences specification to study profit shifting out of the U.S. following the staggered implementation of CFC laws in 17 foreign countries since 1982. The evidence indicates that when a foreign country implements a CFC law the multinationals based there, and hence subject to the law, shift less of their U.S. profits out of the U.S. A dynamic specification suggests CFC laws have their full effect within two years of implementation. Within-firm interest payments (interest stripping) play a significant role in the aggregate profit shifting patterns. In addition, foreign multinationals appear less likely to establish U.S. subsidiaries, and more likely to dissolve those they have, when a CFC law induces them to realize more of their U.S. profits in the United States.

Is there banks stocks’ manipulation around announcement of national elections and how can we detect and recover ill gotten assets?

Purpose – The purpose of this paper is to examine the influence of major non-economic events, such as the announcement of Greek national parliamentary elections during the period 2000-2009, and search for stock manipulation and methods to detect and recover ill gotten assets. The Financial Sector in Greece is one of the most important and fast growing sectors during recent years and accounts to about 16.17-17.74 per cent of gross domestic product. The ten largest Greek banks listed in the Athens Stock Exchange, accounted to 38.34 per cent of the whole capitalisation of the Athens Stock Exchange during year end 2009. Design/methodology/approach – By using event study methodology and Market Model and analyzing data of all Greek bank stocks prices listed in Athens Stock Exchange, before and after the announcement of four Greek national parliamentary elections during period 2000-2009, we find interesting results about stock market manipulation. Findings – Using daily data from the Athens Stock Exchange, the results of this paper claim that the four Greek national parliamentary elections during the period 2000-2009, had no statistically significant effect on the Greek banks stocks. The results show that Cumulative Average Abnormal Returns (CAARs) were slightly positive or negative for Greek banks’ stocks, but not statistically significant in 5 and 10 per cent confidence levels. Results show no manipulation effect in banks’ stocks even if single-party governments in Greece caused elections early, sudden or even opportunistic timing, having an incentive to attempt to manipulate stocks to increase their chances of re-election. Practical implications – Results show that CAARs were slightly positive or negative for Greek banks stocks, but not statistically significant in 5 and 10 per cent confidence levels, but when illicit funds or assets have been acquired from stock manipulation, as small as can be, then one fact remains constant. Proceeds from illicit activities must be disguised in some way to avoid being discovered and then being recovered. Especially, during current the financial crisis, debt crisis and the extraordinary liquidity support measures taken by the European Central Bank (ECB), International Monetary Fund (IMF) and European Commission to support Greek economy, using methods to detect and recover ill gotten assets are extremely important. Indirect methods such as net worth analysis, bank deposit analysis, expenditure method or sources and application of funds analysis, to detect ill gotten assets, and then when ill gotten income and assets from bank stock manipulation are found, a restraining order or court order will help to recovery assets by freezing and finally confiscating them by two types of forfeiture – criminal and civil forfeitures. Establishing a code of conduct informing employees of the risks and consequences of insider trading, creating a culture of honesty and high ethics and implementing Controlled Foreign Corporation legislation to cope with off-shore companies trading, can help to recover ill gotten assets. Originality/value – The paper examines if there is banks stocks manipulation around announcement of Greek national parliamentary elections during the period 2000-2009; suggesting methods to detect and recover ill gotten assets and improving the current position of the Greek economy. Findings offer important positive implications for investors, political analysts and society as a whole, as Greek banks stocks show that they are not subject to political risk and manipulation and that there are methods to detect and recover ill gotten assets. A stable bank sector is prerequisite for economy growth.

The Devil in the Details: Reflections on the Tax Reform Act of 2014

The Discussion Draft of the “Tax Reform Act of 2014” (TRA14) released by US House Committee on Ways and Means Chairman Dave Camp (R-MI) on February 26, 2014 represents a major effort for fundamental and far reaching reform of US tax law. Unfortunately, while many parts of the proposal seem quite sensible as an effort to bring back the “spirit of 1986”, the international tax reform proposals are deeply flawed and based on obsolete assumptions on the world facing US multinationals in 2014.Overall, TRA14 represents a welcome effort to propose a revenue neutral combination of base broadening and rate cutting. TRA14 envisages three individual rates of 10%, 25% and 35% and a corporate rate of 25%. This rate structure is quite sensible, and if it can be achieved in a revenue neutral fashion that is an added advantage. However, the international tax proposals are based on the assumption that because most other OECD countries have adopted a limited version of territoriality, i.e., a “participation exemption” for dividends out of the active income of Controlled Foreign Corporations (CFCs), the US must follow suit to preserve the competitiveness of US based MNEs. But this assumption is wrong, for three reasons. First, the empirical data indicate that under current law US based MNEs do not face a competitive disadvantage despite the fact that they are nominally taxed on a worldwide basis without a participation exemption. Second, the OECD BEPS project suggests that the effective tax rates of foreign MNEs are headed up, not down. Third and most importantly, reducing the US corporate tax can be done without putting US-based MNEs at a competitive disadvantage even if deferral were completely eliminated, and this has the added advantage of eliminating both lock out (the main problem the participation exemption is designed to solve) and the incentive to shift profits out of the US (which this version of TRA 14 does little to address).This paper will discuss these points and conclude that as far as the international proposals are concerned it would be better to go back to the drawing board and start from scratch with a simple proposal of full inclusion at whatever corporate rate is judged to be similar to the effective rates paid by foreign-based MNEs.

CFTC harmonization rules: CPOs of RICs benefit from “substituted compliance”

Purpose – To explain regulatory developments and changes to compliance obligations for asset managers registered with the Commodity Futures Trading Commission (CFTC) as commodity pool operators of registered investment companies. Design/methodology/approach – Provides a general overview of new CFTC rules (Harmonization Rules) that afford relief to commodity pool operators of commodity pools that are registered as investment companies under the Investment Company Act of 1940; describes the specific CFTC disclosure, reporting and recordkeeping requirements that remain applicable to commodity pool operators that are also subject to Securities and Exchange Commission (SEC) regulation by virtue of operating commodity pools that are registered investment companies; discusses reliance on substituted compliance with applicable SEC requirements; outlines the method for claiming relief under the Harmonization Rules; provides guidance for CPOs of RICs that use controlled foreign corporations (CFCs). Findings – CPOs of RICs benefit from “substituted compliance” under the CFTC Harmonization Rules. Practical implications – Explains to investment advisers that have registered as CPOs of RICs the disclosure, reporting and recordkeeping obligations that apply to them, how to take advantage of compliance with SEC requirements in lieu of CFTC requirements, and how to claim relief with respect to certain CFTC compliance obligations. Originality/value – Practical explanation by experienced derivatives and securities lawyers.

Vive La Petite Difference: Camp, Obama, and Territoriality Reconsidered

The recent tax reform proposals by Chairman Camp (R-MI) of the House Ways and Means Committee and by President Obama seem to offer starkly contrasting visions of how to reform the taxation of foreign source income earned by US-based multinationals (MNEs). Both acknowledge the problem, which is that US-based MNEs currently have over a trillion dollars of “permanently reinvested” income offshore, which they cannot bring back to the US without incurring a 35% tax penalty. However, they seem to offer radically different solutions: Under the Camp Proposal, a participation exemption will enable US-based MNEs to bring back the income without paying significant tax. Under the Obama Proposal, deferral will be abolished and US-based MNEs will have to pay a minimum tax on foreign source income earned by their controlled foreign corporations (CFCs) as it is earned. The result would be that the tax penalty on repatriating such income would be reduced because dividends would only be subject to tax at the difference between the statutory rate (reduced to 28% under the Obama Proposal) and the minimum rate. However, a closer look reveals that these proposals have more in common than meets the eye. Specifically, the Obama Proposal’s minimum tax on foreign source income of CFCs is perfectly compatible with exempting such income from further tax when it is repatriated, as the Camp Proposal envisages. Conversely, the provisions to prevent income shifting in the Camp Proposal can in practice result in precisely the minimum tax on the foreign source income of CFCs that is the centerpiece of the Obama Proposal. This level of agreement suggests that a compromise embodying elements of both proposals should not be impossible to reach when tax legislation is enacted after the fall election.

Politicians, political parties' funding in Greece and anti-money laundering regulatory framework

Purpose – The purpose of this paper is to examine politically exposed persons and major Greek political parties' funding sources as well as the anti-money laundering regulatory framework for political parties' funding sources. Design/methodology/approach – This paper aimed at investigating data about Greek political parties' funding by identifying new problems and developing solutions. Findings – The main findings are that Greek political parties' major sources of revenues are public subsidies and bank loans. Also, data show that two major Greek political parties cannot easily repay their bank loans (especially PASOK) and must renegotiate terms with banks and must agree for a new, long-term and lower payment schedule at a lower interest rate. Extending the period of repayment is necessary for viability of debts, and banks will protect themselves against default and total losses of about 253.1 million euros from the two major political parties. Public subsidies are the only collateral that Greek political parties offer to banks. Practical implications – As a result of research, structural changes are necessary to immediately be made in order to cope with politically exposed persons and political parties' corruption and funding in Greece, especially during the current fiscal crises. Greek political parties need to raise funds from other sources than only public subsidies. Anti-Money Laundering Regulatory Framework have to stop conduit contributions and force banks to apply Know Your Client Principle for donors. Also, to include on Suspicious Activity Report a checkbox of “Political Finance Violations”. Establishing a code of conduct informing employees of the risks and subsequences of political corruption, creating a culture of honesty and high ethics and implementing Controlled Foreign Corporation legislation to cope with corruption in political parties' funding can help to recover ill-gotten assets. Finally, implementing Business Principles for Countering Bribery and UK Bribery Act will increase transparency in funding of Greek political parties. Originality/value – The paper examines corruption and funding sources of Greek political parties, especially during the period 2009-2011, suggesting policy measures to deter and detect money laundering and illegal funding to politically exposed persons and political parties. Findings offer important measures for political analysts, government and society as a whole. A stable political system is prerequisite for a healthy society and for economic growth.

Why Y? Reflections on the Baucus Proposal

The international tax reform proposal introduced by Sen. Max Baucus (D-MT) on November 19, 2013 contains several significant innovations that promise to define the terms of the debate for the foreseeable political future. It is therefore worth examining in detail even if it seems unlikely that progress toward meaningful reform can be achieved very soon.The major component of the proposal is a move toward territoriality coupled with two alternative anti-profit shifting options, option Y and option Z. This article will argue that option Y represents a significant step forward and can be the basis of adopting a territorial regime, while option Z is deeply flawed and risks further profit shifting unconstrained by the current limits on repatriating profits. Other important innovations in the Baucus proposal include a new destination based tax on Controlled Foreign Corporations (CFCs) on their sale of goods and services into the US; a major modification of the PFIC rules and other simplification measures; and a significant rollback of the portfolio interest exemption.This article will analyze each of these elements of the proposal and then offer some suggestions for further improvement. The two major missing elements from the proposal are additional broad limitations on inbound base erosion and preventative measures against corporate expatriations.

INTERNAL DEBT AND MULTINATIONAL PROFIT SHIFTING: EMPIRICAL EVIDENCE FROM FIRM-LEVEL PANEL DATA

This paper explores the role of internal debt as a vehicle for shifting profits to low-tax countries. Using data on German multinationals, it exploits differences in taxes in more than 100 countries over 10 years. The results confirm that internal debt is used more by multinationals with affiliates in low-tax countries and increases with the spread between the host-country tax rate and the lowest tax rate among all affiliates. However, tax effects are small, suggesting that profit shifting by means of internal debt is rather unimportant for German firms. Further testing indicates that this is partly due to the German controlled foreign corporation (CFC) rule.

Like-kind Exchanges Pursuant to Section 1031 Internal Revenue Code and their Consequences under German CFC-rules

On the basis of sound economic reasoning, numerous tax systems have provisions that allow for tax-free exchanges of like-kind property. When the property is sold after the exchange the gain will usually be taxed so that it is in fact not a tax-free exchange but rather a deferral of taxation until the sale of the property. After a brief overview of the basic like-kind exchange rules under the US Internal Revenue Code (IRC) and the basic concepts of the German Controlled Foreign Corporations (CFC-) rules, this article discusses the possible consequences of a like-kind exchange of US property by a US corporation, owned and controlled by shareholders resident in Germany under German CFC-rules. As a few examples will demonstrate, a like-kind exchange under US law could - if certain conditions are met - lead to the application of German CFC-rules thereby reversing the non-recognition event. In these instances, German CFC legislation overreaches the basic purpose of CFC-rules - to prevent or reduce abuse and designs for tax evasions.

US Subpart F Legislative Proposals: A Comparative Perspective

This article reviews recent US proposals to amend the US Controlled Foreign Corporation (CFC) rules, also known as Subpart F. It places the US debate in a comparative perspective by describing how the US proposals fit in with developments in other countries that have CFC rules.

Brazil: CFC Rules Update

In August 2011, the Supreme Court of Brazil continued the judgment on the constitutionality of the Brazilian Controlled Foreign Corporation (CFC) legislation. The final decision is dependent on a sole justice's opinion, but some conclusions can be drawn from the case so far. In April 2011, the Superior Court of Justice of Brazil also decided one leading case on the CFC rules, which restricted its scope. The case law under review is a signpost that the Brazilian CFC legislation needs to be reformed in order to match reasonable and internationally accepted parameters. In this article, the author provides an overview of the Brazilian CFC regime. It was originally written as a paper presented at the 2nd London Alumni International Tax Conference, Institute of Advanced Legal Studies, University of London.

Fifty Years of Subpart F Revisited In the Light of Modified Economic Conditions

With the enactment of the subpart F rules in 1962, it was the major concern of the US legislator to construct a precisely fitting concept against tax haven deferral consistent with economic conditions of that time. However, the world economy went through enormous changes since the enactment of subpart F in 1962. Local incorporation matters little today and products and services may be divorced from a specific location. In addition, the check-the-box regulations revolutionized entity qualification. All these changes are not considered within the subpart F regulations. These may be the main reasons why the following analysis shows a striking inefficiency of subpart F provisions based on data regarding the example of Bermuda, Switzerland and Germany. Thereby, Bermuda and Switzerland as well-governed low-tax countries were chosen as representatives of typical tax havens, whereas Germany was chosen because it is one of the biggest industrialized countries and among the United States' major trading partners. Examined data substantiate alleged inefficiency of subpart F within surrounding economic conditions of the now globalized world. A major conclusion, therefore, is that the controlled foreign corporation (CFC) regime today has lost its original rationale and, thereby, most of its justification. Significant modifications and modernizations appear to be indispensable in order to adjust the CFC set of rules to the modern economic framework and to align it with the goal to curb tax haven deferral effectively.

Changes in the Application of Tax Treaties in Sweden

In 2008, the Swedish Supreme Administrative Court gave precedence to controlled foreign corporation (CFC) legislation over a tax treaty without consulting the tax treaty. Since then, the relationship between domestic law and tax treaties has been a highly debated issue in Sweden. The Court's reasoning was based on an identified conflict between domestic law and a tax treaty, which was solved through reference to general principles on derogation. In a recent judgment in a similar situation, the same Court deviated in principle from the 2008 judgment by giving priority to the tax treaty over domestic law, thereby creating a welcome return to established principles of tax treaty application. Because the Court introduced a rule of exception from the rule that Swedish tax treaties prevail over domestic law, however, this recent decision introduces changes for the application of tax treaties in Sweden. In such situations, the main rule of tax treaty precedence over domestic law is set aside, and the principles of derogation will be applied. This article is divided into four sections, in which I examine and analyse the recent case and its implications for tax treaty application in Sweden. As the 2008 decision is of central importance, I briefly present this case in section 1. In section 2, I turn to the 2010 decision. Conclusions on the effects of the Court's adjudication on tax treaty application in Sweden are presented in section 3, in which I analyse the situations to which the rule of exception is applicable. A significant legal issue following the aftermath of the 2010 decision is presented in section 4.

Foreign Base Company Sales Income under the New U.S. Regulations

U.S. shareholders of a controlled foreign corporation (CFC) are currently taxed by the United States on their ratable shares of the CFC's subpart F income, even if the CFC distributes none of its earnings to shareholders as dividends. The Treasury, in late 2008, revised its regulations on one category of subpart F income, foreign base company (FBC) sales income. The revisions address contract manufacturing arrangements, which U.S. multinationals often use in overseas production, at least sometimes with a purpose of avoiding the impact of the U.S. CFC rules. The revisions also restate some of the rules on branches of CFCs, which often operate in conjunction with the rules on contract manufacturing. This paper describes U.S. law on FBC sales income, after the regulation revisions. It is a draft of material that will be published in Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates & Gifts (Warren, Gorham & Lamont).

Taxation of the Controlled Foreign Corporation on the Deferred Income：Korea

Taxation of the Controlled Foreign Corporation on the Deferred Income：Korea

Offshoring and Transfer of Intellectual Property

Offshore outsourcing of work to support software development and services is seen primarily as a transfer of labor to another shore. But with every outsourced job, intellectual property is transferred as well. Such transfers have significant long term effects on the balance of intellectual property (IP) generation and consumption. The value of intangibles is based on the income that these intangibles are expected to generate in the future. This paper relates the key issues of IP found in software, an important intangible, to business models used for offshoring. The use of a quantitative model for software valuation allows formal exploration of business alternatives. The motivation for this paper is to increase the awareness of the need for software valuation when developers of software and the users of that software reside in different countries. A scenario that involves Controlled Foreign Corporations as the mechanism for IP transfer is analyzed in detail.

The Deemed Dividend Problem

Subpart F currently taxes US shareholders on deemed dividends of Subpart F income from controlled foreign corporations (CFCs), rather than taxing the CFCs directly. This approach is based on a similar approach taken in the 1930s to taxing US shareholders in foreign personal holding companies (FPHCs). The reason for this approach was that in 1937, when the FPHC regime was first enacted, the Treasury took the view that it would be a breach of international law to tax a foreign person (the FPHC) directly on foreign source income. However, today it is clear that the US can in fact tax US-controlled foreign persons on foreign source income, as evidenced by the application of the personal holding corporation (PHC) regime to foreign corporations. Moreover, the deemed dividend approach leads to considerable complexity and planning opportunities, as evidenced in the Brown Group case and in Enron's Apache transaction. Instead of trying to close these loopholes one by one, Congress should substitute direct taxation of CFCs (and repeal the FPHC regime, which is obsolete). This can be done without resolving the continuing debate on what should be the scope of Subpart F income.

Controlled Foreign Corporation Rules – A Proposal for the Caribbean

Controlled Foreign Corporation Rules – A Proposal for the Caribbean

Controlled Foreign Corporations – Critical Aspects

Controlled Foreign Corporations – Critical Aspects