Controlled Foreign Company Research Articles

Double tax discrimination to attract FDI and fight profit shifting: The role of CFC rules

Governments worldwide use targeted tax policies to trade off the gains from increased FDI against the cost of excessive profit shifting by multinational firms. We show that nationally optimal tax systems generally incorporate both thin-capitalization rules, which tax discriminate between purely national and multinational firms, and controlled-foreign-company (CFC) rules, which discriminate between home-based and foreign-based multinationals. In the non-cooperative policy equilibrium both thin-capitalization rules and CFC rules are set more lenient than if tax policies were chosen cooperatively, implying an ‘excessive’ tax discrimination in favor of multinationals. We also analyze the effects of reduced transaction costs for FDI and reduced costs for debt shifting on the optimal policy mix. Our results correspond to the observed developments of anti-avoidance rules in OECD countries.

Chinese Controlled Foreign Company Rules in the Post-BEPS Era: New Developments

In this article, the authors argue that key concepts, such as “reasonable business needs”, in China’s controlled foreign company (CFC) rules have not been defined clearly. Consequently, disputes are easily triggered. In response, China promulgated its Implementing Measures for Special Tax Adjustment (Discussion Draft) in 2015, which followed the recommendations of the OECD’s BEPS Action 3 Final Report and provided more specific guidance. However, the Discussion Draft did not clarify how to determine “reasonable business needs”, how to strike a balance between maintaining international competitiveness of Chinese enterprises and protection of China’s tax base, or how to deal with losses suffered by CFCs. The authors suggest that, when China revises its CFC rules, it does not blindly follow the BEPS recommendations nor indiscriminately pursue stricter rules. Rather, it would be preferable to strike a balance between tax base protection and competitiveness in line with China’s economic development strategy and policy objectives.

The Application of Spanish CFC Rules to Investments in EU Alternative Funds: Current Overview and the Impact of the ATAD Directive

This article focuses on the application of the Spanish controlled foreign company (CFC) rules to EU alternative investment funds (AIFs) as defined in article 4(1)(a) of Directive 2011/61/UE of the European Parliament and the Council of 8 June 2011 on Alternative Investment Fund Managers (AIFM Directive). The focus of the article is in particular on AIFs managed by AIF managers that meet all the requirements of the AIFM Directive and, therefore, can be freely distributed throughout the European Union at least among professional investors.

Controlled Foreign Companies: Selected Policy Issues – or the Missing Elements of BEPS Action 3 and the Anti-Tax Avoidance Directive

The discussion of controlled foreign corporations (CFCs) in both the Final Report on Action 3 of the OECD’s Base Erosion and Profit Shifting Project and the Anti-Tax Avoidance Directive (ATAD) has failed to address some high-level policy questions that are worth considering in more detail. Depending on the scope of the tax system (worldwide vs. territorial) and the means by which double taxation is avoided (credit vs. exemption), the crucial policy questions revolve around the issue as to which tax base should be protected and in which capacity (i.e. as the residence state or the source state). Moreover, the question as to whether deferral and income diversion should be curtailed as a matter of principle or only if the deferred/diverted income is low taxed in the state of residence of the CFC must be answered. On an operational level, the means by which income is included require careful assessment. Depending on whether a CFC regime pierces the CFC’s corporate veil or applies a deemed dividend approach, the interaction with both the relevant distributive rules and – in case of EU Member States – the EU Fundamental Freedoms, potentially limit the scope of a CFC regime. By tracing back the underlying structural tensions inherent in domestic corporate tax laws and highlighting the policy choices that legislators face along the way to enact coherent CFC regimes that counter both tax deferral and income diversion while respecting the existing network of rules governing the allocation of taxing rights in cross-border situations, this article facilitates a principled discussion and, thus, helps to overcome the widespread BEPS fallacy of accepting the technical outcomes of the BEPS project without questioning the underlying principles.

Revolutionary Changes to the Arm’s Length Principle under the OECD BEPS Project: Have CFC Rules Become Redundant?

Title question of the article is deliberately provocative. The subject of interactions between Controlled Foreign Company (CFC) regulations and transfer pricing (TP) regulations is a complex topic that has been bringing divergent opinions over many decades (In United States, from where both CFC regime and TP regime originated, the literature on this subject has been present at least since 1969, being no more than one year after the introduction of detailed US TP regulations (1968). CFC regulations – Subpart F – was introduced therein in 1962. See for instance: L. Kauder, Taxation of Domestically Controlled Foreign Corporations: A Comparative Study of Subpart F and Section 482, 14(2) Villanova L. Rev. (1969)). The polemic in this regard has, however, acquired a new dimension together with the OECD’s adoption of modifications to the arm’s length principle as referred to in Article 9 of the OECD Model Convention under the Base Erosion and Profit Shifting (BEPS) project, which led to publishing the 2017 TP Guidelines for Multinational Enterprises and Tax Administration (OECD, 2017 TP Guidelines for Multinational Enterprises and Tax Administration, available at http://www.oecd.org/tax/transfer-pricing/oecdtransfer- pricing-guidelines-for-multinational-enterprises-and-tax-administrations-20769717.htm). These amendments, which involve the expansion of the guidelines on the relationship between (1) the legal title to the asset, and (2) the eligibility of a cross-border group of related entities to recognize the corresponding income generated by that asset, has led to an unobservable earlier approximation of the scope of CFC and TP regimes. It is therefore the study question of this article to verify whether the enhanced TP regulations are capable of replacing CFC regulations.

The Implementation of the Controlled Foreign Company Rules in the EU Anti-Tax Avoidance Directive in Finland, Luxembourg and the Netherlands – The Effects on the Holding Company Structures of Finnish Groups

In this article, the author considers the implications of the implementation of the controlled foreign company rules in the EU Anti-Tax Avoidance Directive (2016/1164) in Finland, Luxembourg and the Netherlands, with special emphasis on the effects regarding the holding company structures of Finnish groups.

The Cadbury Schweppes Judgment and Its Implications on Profit Shifting Activities within Europe

In 2006, the European Court of Justice (ECJ) decided with the Cadbury Schweppes judgment that European Controlled-Foreign-Company (CFC) rules infringe the principle of freedom of establishment and restricted the applicability thereof. This paper analyzes the impact of mandatory amendments to European CFC rules on tax planning activities within Europe. Using a difference-in-differences approach, my results provide robust evidence that pre-tax earnings of subsidiaries located in European low-tax jurisdictions have increased by around 10 % after the Cadbury Schweppes judgment. My analysis shows further that the increase of pre-tax earnings is related to facilitated profit shifting activities. Multinational corporations with high incentives or enhanced profit shifting opportunities react more pronounced to the Cadbury Schweppes judgment. The findings point out that CFC rules became less effective and thus, profit shifting activities within Europe are less restricted after the ECJ judgment. Additional tests suggest further that on average 90 % of the increase in pre-tax earnings is attributable to strategic transfer pricing determination, while less than 10 % is attributable to debt shifting activities.

Controlled Foreign Companies and Tax Avoidance: International and Comparative Perspectives with Specific Reference to Polish Tax and Constitutional Law, EU Law and Tax Treaties

A lion’s share of global investments is likely being conducted for tax avoidance purposes via controlled foreign companies (CFC) which are established in tax havens or low tax jurisdictions. Avoiding tax via CFCs causes several problems, in particular it: (i) leads to unfair and unbalance taxation of income; (ii) may widen the gap between the poorest and the richest that may further adversely affect sustainable development; (iii) erodes the tax base of the States that undermines the integrity of the tax system; and (v) it can harm fair competition among enterprises. Considering the negative consequences of tax avoidance via CFCs, I have worked hard to improve provisions specifically designed to prevent tax avoidance via CFCs – CFC rules. As a result of in depth international and comparative research and analysis, I submitted a set of proposals for designing CFC rules in order to increase the ability of States to effectively prevent tax avoidance schemes while shielding at the same time genuine cross-border economic activities. Even though the analysis and conclusions (proposals) concern the Polish CFC rules in principle, they are, mutatis mutandis, relevant to the CFC rules of other countries as well, and may be used as a yardstick by countries without CFC rules at present to draft rules of their own. The proposals ensure the appropriate balance between preservation of the domestic tax base while fostering competitiveness, are compatible with EU/EEA law and tax treaties, and reflect the most recent thinking of the OECD on the issue under BEPS. Thus, the proposals may contribute to fair and balance taxation of income, narrow gap between the poorest and the richest that may positively affect sustainable development. Once the proposals are implemented by concerned States, there may be no reason to insert the conjunction “and” between controlled foreign companies and tax avoidance.

New Controlled Foreign Company Legislation in Taiwan

In this article, the author discusses the controlled foreign company legislation recently introduced in Taiwan. The article gives an overview of the main features of the legislation and the Ministry of Finance’s implementation rules. It also addresses double tax relief issues in the context of tiered foreign companies, and the different tax treatment of interests in companies in Mainland China and those in other foreign jurisdictions. The author canvasses the impact on the new rules of the simultaneously introduced place of effective management law, and exchange of information agreements.

Do US Firms Pay Less Tax than Their European Peers? On Firm Characteristics, Profit Shifting Opportunities, and Tax Legislation as Determinants of Tax Differentials

Using pairs of similar US and European firms listed on the S&P500 or StoxxEurope600, we examine effective tax differentials between US multinational corporations (MNCs) and their European peers. We show that statutory tax rates and profit shifting opportunities are important determinants of effective tax rates. Our findings suggest substantially lower total tax payments of US MNCs after the 2017 US tax reform. Based on past reforms of Controlled Foreign Company (CFC) rules and of the principle of worldwide taxation, we confirm that international tax legislation affects effective tax expenses. We also provide evidence for heterogeneity in firm responses: MNCs with profit shifting opportunities benefit most from more-lenient CFC rules.

Group Provisions in the Common (Consolidated) Corporate Tax Base

In this article the author discusses the participation exemption, the switch-over provision and the controlled foreign company (CFC) rules in the proposals for directives on a Common Corporate Tax Base (CCTB) and a Common Consolidated Corporate Tax Base (CCCTB) published on 25 October 2016.

Current Challenges for EU Controlled Foreign Company Rules

This article focuses on the challenges presented by the controlled foreign company rules in articles 7 and 8 of the EU Anti-Tax Avoidance Directive, not purely from a technical standpoint, but also from the perspective of tax policy.

The Provisions of the EU Anti-Tax Avoidance Directive Regarding Controlled Foreign Company Rules: A Critical Review Based on the Experience with the German CFC Legislation

The EU Anti-Tax Avoidance (ATA) Directive of 12 July 2016 introduced common minimum standards for fighting tax avoidance practices by the Member States of the EU. Besides interest limitation rules, rules on exit taxation, general anti-abuse rules as well as measures against hybrid mismatches, the ATA Directive provides minimum standards for the treatment of Controlled foreign corporations (CFCs). It is evident that the respective provisions follow, at least partly, the handwriting of the German CFC Rules, which are the oldest within the European Union (EU) and rank among the oldest in the world. In this context, the following article critically reviews the provisions of the ATA Directive regarding CFC Rules, taking into account the experience with the German CFC legislation.

Decline of Controlled Foreign Company Rules and Rise of Intellectual Property Boxes: How the European Court of Justice Affects Tax Competition and Economic Distortions in Europe

AbstractThe European Court of Justice (ECJ) has become an influential player in the field of direct taxation in the European Union (EU) in the past 20 years. However, it is unclear whether or not the ECJ's decisions and the corresponding reactions by the member states actually contribute to tax neutrality in economic terms and, therefore, to the achievement of the internal market. In 2006, the ECJ limited the applicability of specific tax rules in the EU that are intended to prohibit the excessive use of low‐tax countries by multinationals. Our counterfactual analysis shows that the court's restriction of so‐called controlled foreign company rules and the related second‐round reactions by some member states – i.e. the introduction of low‐tax regimes for income from acquired intellectual properties (IP boxes for acquired IP) – cast doubt on the seemingly positive effects the ECJ has on reducing tax distortions. In addition, we demonstrate that the restricted applicability of IP boxes as endorsed by the OECD and the European Commission would strengthen tax neutrality in Europe.

New Zealand Taxpayer Entitled to Foreign Tax Credit for Tax Sparing Granted to Controlled Foreign Company

This note summarizes the New Zealand High Court decision in Lin v. Commissioner of Inland Revenue, which entitled a New Zealand-resident taxpayer with relevant interests in certain controlled foreign companies in China to a foreign tax credit for both tax paid in China by the controlled foreign companies and to tax spared in China arising from tax concessions granted to those companies.

ANALISIS PENERAPAN CONTROLLED FOREIGN COMPANY RULES DALAM MENGATASI BASE EROSION AND PROFIT SHIFTING DI INDONESIA

One cause for the inability to achieve the expected tax revenue target for some last years was the practice of tax avoidance. One form of tax avoidance is the utilization of Controlled Foreign Company (CFC) to defer the recognition of income from overseas over WPDN capital to be taxed in the country. This practice is also faced by many other countries in the world. The issue of the Base Erosion and Profit Shifting (BEPS) has been of concern to developed and developing countries. G20 countries cooperate with OECD to form a BEPS Project to formulate measures to address these BEPS. Indonesia as one of the Associate Members of the Project BEPS has a position that is parallel to the other OECD countries and participates in implementing the BEPS results. BEPS Project has resulted in BEPS Action Plans which one of them is Action 3: Strengthening CFC Rules. Action 3 will provide recommendations to the domestic law related to the design of CFC Rules. Until now, related to Action 3, BEPS Project has issued a Public Discussion Draft Action 3: Strengthening CFC Rules. This draft is divided into seven "building blocks" required for CFC Rules to be effective. The aim of this study is to analyze the effectiveness of CFC Rules in Indonesia, whether it is sufficient to prevent BEPS. After that, we can determine what steps should be taken by Indonesian tax authorities to strengthen the CFC Rules in Indonesia based on seven dimensions of building blocks. The conclusions of this study are (1) CFC Rules in Indonesia as a whole have not been able to overcome BEPS; and (2) When compared with the recommendations of the Discussion Draft Action Plan 3, CFC Rules Indonesia needs to be improved. However, the necessary improvements should be adjusted to match the needs and characteristics of Indonesia.

CFC Rules and Anti-Tax Avoidance Directive

The effects of the Anti-Tax Avoidance Directive (ATAD) on Controlled Foreign Company (CFC) rules have been instructively discussed in depth, especially in the German scholarly literature.1 The following contribution re-examines a few aspects against the background of a hypothetical case and addresses various issues, including the question as to whether the Directive does not also give taxpayers a certain minimum level of protection and at the same time impose general limits on national legislatures.

Tax Avoidance through Controlled Foreign Companies under European Union Law with Specific Reference to Poland

AbstractThis article demonstrates that tax avoidance via controlled foreign companies (CFCs) established in the most favourable tax environments among EU Member States such as Ireland, Luxembourg, the Netherlands, and Cyprus, remains a considerable problem. Not only does it affect taxpaying residents in the Member States but, indirectly, all taxpayers regardless of their EU affiliation, US multinational enterprises (MNEs), for example. Focusing on the use Polish taxpayers make of CFCs, this study undertakes a detailed legal analysis of the problem of tax avoidance under EU law by examining empirical data and EU law on tax avoidance. The choice of this topic is largely justified by the exponential rise in tax avoidance schemes through CFCs involving Polish taxpayers since the country’s accession to the EU. The legal analysis brings to light a series of weaknesses in the current EU law that make it possible for both EU and non-EU taxpayers to avoid taxation. As a solution to this problem, the author suggests that CFC rules should be designed so as to tax only “tax avoidance income” from CFCs. This would ensure their compliance with EU law as well as an effective prevention of tax avoidance via CFCs within the framework of EU law. Interestingly, the solution follows from the author’s interpretation of the concept of “wholly artificial arrangements” in favour of the internal market rather than from Action 3 of Base Erosion and Profit Shifting (BEPS) project or Anti-Tax Avoidance Directive as adopted by the Council on 12 July 2016.

The EU Anti-Tax Avoidance Directive and the Base Erosion and Profit Shifting (BEPS) Action Plan: Necessity and Adequacy of the Measures at EU level

The article scrutinizes the recently adopted Directive 2016/1164/EU (also known as the Anti-Tax Avoidance Directive) in the light of BEPS Actions 2, 3 and 4. For this particular purpose, after a brief overview of the general policy objectives of the Directive, the analysis is focused on the measures of the Directive that refers explicitly to the content of these actions, namely the interest limitation rule in Article 4, the Controlled Foreign Company (CFC) rules in Articles 7 and 8 and the anti-hybrid mismatch rule in Article 9. In respect to each of these provisions, the article illustrates to which extent they are consistent with the corresponding provisions in the BEPS Action Plan and whether they comply with the initial objects and scope of the Directive. Finally, it is assessed their compatibility with the EU primary law and the jurisprudence of the European Court of Justice.

Taxation of Controlled Foreign Companies in Context of the OECD/G20 Project on Base Erosion and Profit Shifting as well as the EU Proposal for the Anti-Tax Avoidance Directive – An Interim Nordic Assessment

Abstract Recently, the controlled foreign company (CFC) rules have gained increased attention; as such, rules play an important role in the ongoing efforts of the OECD/G20 and the European Commission with respect to addressing base erosion and profit shifting (BEPS). In this context, the article revisits the CFC regimes of the Nordic countries in order to assess whether these regimes are in line with the recommendations from the OECD/G20 and to determine whether Sweden, Finland, and Denmark, as EU member states, will have to make amendments if the commission’s proposal for an Anti-Tax Avoidance Directive is adopted in its current form. It is concluded that the Nordic CFC regimes in many ways already are in line with the recommendations as well as the directive, but also that certain amendments have to be made.