Controlled foreign corporation rules – Part 1

Overview of Controlled Foreign Corporation (CFC) rule –

  • Controlled foreign company (‘CFC’) rules have become significant policy instrument for governments in their attempt to curb profit shifting by multinational companies and to protect tax bases. CFC rules applies generally to passive income like interest payments and royalties which can easily be placed in affiliates in tax havens without having a substantial physical presence there.
  • CFC rules stipulate a minimum tax rate that must be levied in a host country, in order to avoid additional taxation in the parent country. Thus, CFC rules reduce the tax gain for multinationals from placing valuable assets in a tax haven.
  • Certain points in relation to the taxation of CFC income –
    • First, an ownership threshold is used to determine whether an entity is considered a controlled foreign corporation. Most European countries consider a foreign subsidiary a CFC, if one or more related domestic corporations own at least 50 percent of the subsidiary.
    • Second, once a foreign subsidiary is considered a CFC, there is a test to determine whether the subsidiary’s income should be taxed domestically. Most European countries determine a subsidiary taxable if the foreign tax jurisdiction levies a tax rate below a certain threshold and/or a certain share of the income is passive.
    • Third, once a foreign subsidiary is considered a CFC and its income is taxable domestically, a country defines what income earned by the foreign subsidiary is subject to tax. 

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