Some food for though on Concept of Controlled Foreign Corporation

1. Concept of CFC
JULY 11, 2010
BY: CA.GAURAV GARG
JG ARG E CONOMIC A DVISORS

2. Agenda
 What is CFC?
 Different Approaches
 Different Exemptions
 CFC regulations vs. DTAA
 Glimpse of CFC regulation in some countries
 Examples of other anti-avoidance rules in some countries
Disclaimer: In the presentation the speaker has also touched upon the CFC regulation and other anti-
avoidance rules in other countries, the same is based upon the information available in the public
domain and the same are not vetted by the practitioner of those countries. Accordingly, we (Speaker,
JGarg Economic Advisors Pvt. Ltd., any Director, any Employee and any Consultant) takes no
responsibility of any decision taken based on the information available in this presentation.
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3. What is CFC?
 A Controlled Foreign Company („CFC‟) is a company
resident of State other than the home State of the taxpayer
that controls/ owns it
 As per revised discussion paper on DTC
“Foreign company which is directly or indirectly controlled by
resident in India”
 The goal of CFC regulation is to avoid the loss of tax
revenue because of domestic companies allocating their
profits to companies resident in low tax countries or tax
havens
 Eliminate the deferral of taxation of the income of CFCs
 Concept of income arises vs. income distributed
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4. Different Approaches
 Two common approaches for establishing taxing rights:
 Jurisdictional vs. Global Approach
 Entity vs. Transactional Approach
 Two common approached for taxing:
 Treating the income as fictitious dividend
 Taxing at shareholder level
 As per revised discussion paper on DTC
“Passive income earned by a foreign company which is
controlled directly or indirectly by a resident in India and
where such income is not distributed to shareholders
resulting in deferral of taxes, shall be deemed to have been
distributed”
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5. Different Exemptions
 The distribution exemption – the CFC repatriate
substantial percentage of its chargeable income.
 The active income exemption – the CFC engaged in real
commercial transactions with unconnected parties.
 The public traded exemption – the CFC is listed on a stock
exchange.
 The motive exemption – sound business and economic
reasons for using the CFC.
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6. CFC regulations vs. DTAA
 According to CFC regulation the domestic shareholders are
taxed on the income of the CFC
 Question of compatibility between CFC regulations and
DTAA
 As per OECD commentary on MTC, CFC are not contrary to
the articles
 As per revised discussion paper on DTC
DTAA will not have preferential status over the domestic law
when CFC provisions are invoked
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7. CFC Regulations in Australia
 Criteria for CFC
 Five or fewer Australian residents control or own more than
50% of the foreign entity; or
 When one Australian resident owns 40% or more of the
foreign entity
 Shareholder means
 Resident shareholder with stake equal to 10% or more
 Foreign earning subject to current taxation
 Pro-rata share of passive earning
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8. CFC Regulations in Australia
 Additional features of CFC rule
 CFCs resident in “listed” countries (Canada, France, Germany,
Japan, New Zealand, UK and US) have fewer types of income
that may be attributed to domestic corporation
 Credit for foreign taxes
 Foreign income taxes paid by a CFC in relation to attributable
amount
 Australian taxes
 Withholding taxes paid by CFC
 Attributed income not taxed again
 Dividend from previously attributed amounts is treated as
exempt income
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9. CFC Regulations in Australia
 De minimis exemption, no attribution if attributable
income is less than:
 AUD 50,000, or
 5% of the CFC‟s gross turnover, whichever is less
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10. CFC Regulations in Canada
 Criteria for CFC
 Five or fewer Canadian residents control or own more than
50% of the foreign entity
 Shareholder means
 Resident shareholder with stake equal to 10% or more
 Foreign earning subject to current taxation
 Pro-rata share of passive earnings
 Credit for foreign taxes
 Credit mechanism available
 Attributed income not taxed again
 Dividend from previously attributed amounts is allowed as
deduction
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11. CFC Regulations in France
 Criteria for CFC
 Foreign entity is located in a country with an effective tax rate
that is 50% or less than that of France;
 French residents control or own more than 50% of the foreign
entity;
 Shareholder means
 Who directly or indirectly hold 50% or greater
 Foreign earning subject to current taxation
 Pro-rata share of all earnings
 Credit for foreign taxes
 Credit mechanism available
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12. CFC Regulations in France
 Attributed income not taxed again
 Dividend from previously attributed amounts is exempt upto
95%
 Additional features of CFC rules
 CFC rule do not apply if the foreign subsidiary is located in
another EU country and does not exist solely to avoid French
taxation
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13. CFC Regulations in Germany
 Criteria for CFC
 German residents own 50% or more;
 The foreign entity earns passive income; or
 Passive income is taxed at an effective rate less than 25%
 Shareholder means
 Any level of ownership
 Foreign earning subject to current taxation
 Pro-rata share of passive earnings taxed at the level of
shareholder
 Credit for foreign taxes
 Credit mechanism available
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14. CFC Regulations in Germany
 Attributed income not taxed again
 For corporate - dividend from previously attributed amounts is
exempt upto 95%
 For individual - dividend from previously attributed amounts
is exempt upto 100%
 Additional features of CFC rules
 CFC rule do not apply if the foreign subsidiary exist in another
EU or European Economic Area country and conducts genuine
economic activities
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15. CFC Regulations in US
 Criteria for CFC
 US shareholder own more than 50% of the voting power or
value in the foreign corporation
 Shareholder means
 Resident shareholder with stake equal to 10% or more of
voting stoke
 Foreign earning subject to current taxation
 Pro-rata share of passive income, income from certain sales
between related parties, certain services performed by CFC
outside it country of incorporation for/ on behalf of related
parties, certain oil related income
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16. CFC Regulations in US
 Credit for foreign taxes
Credit mechanism available
 Attributed income not taxed again
 Dividend from previously attributed amounts is treated as
exempt income
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17. Other Anti Avoidance Rules
 Australia – Foreign Investment Fund Rule
 Certain Australian shareholders are subject to annual taxation
on a deemed return on their pro rata shares of foreign
investment funds if:
 The foreign company or trust is not controlled by Australian
residents; and
 The taxpayer‟s shareholding is more than 10% of the total value of
the taxpayer‟s interest in foreign companies and trusts; and
 The foreign company or trust engages in “blacklisted” activities
such as certain financial intermediary, insurance and banking
transactions; and
 The taxpayer holds the interest at the end of the taxable year
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18. Other Anti Avoidance Rules
 Canada – Offshore Investment Fund (OIF)
 Canadian shareholders of an OIF are taxed currently on an
imputed return basis where the investment in the OIF is
established to be motivated by tax avoidance
 France – Abuse of Law doctrine
 General anti-avoidance law that permits the tax authorities to
take action against legal arrangements or particular
transaction when those arrangements and transactions were
fictitious or undertaken for solely tax reasons
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19. Other Anti Avoidance Rules
 Germany – General Anti-Avoidance Rule
 General anti-avoidance rule rewritten in 2007, that prevents
taxpayers from establishing legal forms or structures for the
sole purpose of obtaining a tax advantage.
 Tax authorities may disregard structures for tax purpose in
these situations.
 Netherlands – Low-Taxed Passive (LTP) Shareholding
 The Dutch shareholder that holds 25% or more, alone or
together with an affiliate, of the shares in a foreign entity has
to value its shareholding at market value in case the following
conditions are met:
 At least 90% of the assets of the subsidiary are, directly or
indirectly of the portfolio nature;
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20. Other Anti Avoidance Rules
 Netherlands – Low Taxed Passive (LTP) Shareholding
 The foreign tax paid on profits is less than 10% of tax on profits
if calculated under Dutch tax law; and
 More than 50% of the carrying value of its property is not
investment properly
 United States – Passive Foreign Income Companies (PCIF)
 A foreign corporation is a PCIF if:
 75% of the corporations income is passive income; or
 50% of the corporations assets (by value) are held for production
of passive income
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21. Clarification required?
 What is the meaning of “Passive Income”?
 Applicability of CFC rules – grey list/ white list or all countries?
 Any safe harbor or exemptions from attribution for e.g. if active income of the
CFC is more than 80% no attribution required or if the CFC distributes 75% of
its passive income then no need of further attribution under CFC rule?
 What is the meaning of control (direct/ indirect)?
 What is the meaning of shareholder?
 How to compute the income of CFC – Accounting and Tax principles?
 CFC‟s rule would be applicable on all the passive income earned by the CFC or
only on the passive income available for distribution to shareholders?
 Computation of attributable income?
 FTC mechanism on tax paid by CFC?
 What would happen when CFC will actually distribute the income?
 Treatment of sale of share of CFC?
 Information/ documents required to be kept and maintained?
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22. Thank You
CA. Gaurav Garg
JGarg Economic Advisors Pvt. Ltd.
Email: gaurav@jgarg.com
Mobile: +91 9899994934
JGarg Economic Advisors