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ICC Policy Statement
ICC Statement on
Controlled Foreign Corporations (CFC) Rules
Prepared
by the Task Fo
rce on CFC legislation
Introduction
The objective of this policy statement is to draw the attention of domestic
and international tax policy makers to the problems created for enterprises
engaged in cross-border activities by the application of a variety of
country specific Controlled Foreign Corporations Rules (CFC rules).
Globalisation has
led to a tremendous increase in foreign direct investment worldwide in
the last two decades. Many countries have removed or reduced barriers
to the free flow of capital and investment. The number of companies having
foreign entities has grown considerably and amounts to over 65,000 transnational
corporations which themselves have more than 850,000 affiliates abroad.
These developments have improved the functioning of the economies in all
countries and have enhanced the possibilities for improving welfare and
the economic conditions for the broader public.
However, in parallel
with this development, we have also witnessed the proliferation of rules
directed against tax avoidance and evasion: general anti-abuse clauses
in domestic law, anti-avoidance rules in bilateral tax treaties, or specific
domestic rules designed to counteract transactions considered as abusive,
such as CFC rules. The US introduced CFC as subpart F rules in 1962, and
in particular in the last decade, an important number of other countries
followed and created their own CFC rules.
CFC rules hinder international exchanges
CFC legislation can be broadly defined as a technical provision that allows
the shareholder's country of residence, to tax on a current basis, the
income produced by a foreign company which is controlled by the shareholder.
CFC rules apply to individuals and corporations as shareholders with a
controlling interest. In principle, double taxation is avoided by a tax
credit for taxes paid abroad.
Depending on how the
CFC rules are designed and implemented, these rules will pose a hindrance
to the free movement of capital. Multinational enterprises (MNEs) risk
being confronted with a number of country specific CFC rules and conflicting
requirements. The owners of companies in the same country may face very
different taxation rules depending on where their business is carried
out.
The reasons for the
introduction of CFC rules vary. CFC legislation in some countries is implemented
as a provision to ensure that capital export neutrality (CEN) is achieved
(i.e. income from foreign operation shall be taxed the same way as domestic
income). However, in an increasingly economically integrated world, capital
import neutrality (CIN, i.e. foreign income shall be taxed in the foreign
state according to domestic rules) will become more and more important
to ensure overall economic efficiency and to improve the competitiveness
of enterprises with international activities.
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position: CFC rules may considerably hinder international exchanges,
in particular for MNEs. The price for the protection of the national
tax base is a loss of economic efficiency for that country in the
longer term. ICC therefore believes that governments must carefully
weigh the short-term advantages of CFC rules against competitive disadvantages
in terms of location for business and for its enterprises operating
abroad. It is generally recognized that the arm's length principle
in transfer pricing is an effective measure to protect the national
tax base. |
Entity
versus transactional approach
National CFC rules vary considerably. As far as the common features of
CFC legislation implemented in the OECD countries are concerned, they
can be classified essentially under two different models:
- Transactional approach
- Entity or jurisdictional approach.
Under the transactional
approach, the tax characterization of income attributed to resident shareholders
depends on the type of income. Usually, passive income is considered as
"tainted". The entity approach provides for the imputation of
the total amount of income earned by the CFC in a given jurisdiction.
This "all-or-nothing" effect is seen as one of the weaknesses
of the entity approach.
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position: In order to make sure that double taxation is avoided in
practice (by domestic rules or tax treaties) CFC rules which are based
on an entity approach must always provide for a clause under which
a foreign company can be excluded from the application of the CFC
legislation if it carries out a real business activity. Under such
an approach, the overall business activity must be taken into consideration.
The notion of real business activity should not be limited to industrial
or commercial activities, but also include financial or holding activities
as an integrated part of multinational corporations. Furthermore,
it is very important that the rules for determining whether certain
activities may render an enterprise subject to CFC legislation are
clearly specified, practicable and transparent. The method of doing
business may not have an impact in this respect. Business carried
out through the Internet should not be regarded as generating "tainted"
income. |
Identification
of low tax regimes
CFC rules generally provide that the income produced by controlled foreign
companies which is subject to a lower tax rate in their country compared
to the tax rate applicable to the resident shareholders, or which benefits
from a favorable foreign tax treatment, will be classified as CFC income.
Within a CFC context,
jurisdictions may be classified as follows:
- a designated list of countries that are excluded from ("a white
list") or are included in the CFC legislation ("black list"),
based on criteria which are considered as "acceptable" in the
former, or as "harmful" in the latter case.
- a comparative approach, according to wh
ich the CFC legislation will
apply to certain items of income where the amount of taxes paid by the
CFC is less than a specified rate or amount. For this purpose, withholding
taxes on interests, dividends and royalties must also be taken into account.
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position: The identification of low tax regimes or low tax income
is a crucial issue for the application of CFC rules. ICC urges governments
to give careful consideration to the selection of criteria on the
basis of which such identification is made. It must also be made sure
that the criteria are applied in a non-discriminatory manner. |
Relationship
with "harmful" tax competition
The OECD Report of 1998 on Harmful Tax Competition recommended the introduction
of CFC rules as means of curbing harmful tax practices. The fact is, however,
that CFC rules go in many cases much further. Since CFC income is attributed
to the shareholder and taxed in its country of residence, CFC rules tend
to totally negate the effects of international tax competition. There
is a widespread consensus that competition among countries in the field
of taxation is necessary and healthy. Based on generally accepted criteria,
a tax regime shall not be considered as harmful if it is transparent and
if sufficient information is available. When the OECD comes to the conclusion
that these conditions are fulfilled, CFC rules are no longer justified
and should not be applied.
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position: The international business community is convinced that international
tax competition contributes to enhancing economic efficiency. ICC
is strictly against any attempts to harmonize tax burdens or tax systems
on a world-wide scale. On the other hand, governments should refrain
from applying domestic CFC rules when a foreign tax regime is considered
transparent and an effective international exchange of information
is possible. This would exclude the application of CFC rules to regimes
that are not considered harmful. |
Conflicts between CFC legislation and international
obligations
There can be a number of conflicts between a CFC legislation and international
obligations of a country. Such conflicts may arise in particular from
international tax treaties or from the obligations as a member in an economic
organization, such as the European Union.
The superiority of
international over domestic law is established as a principle in many
countries. In such case, domestic law may not override engagements resulting
from international conventions. In other countries, domestic law passed
after the entry into force of international agreements takes precedence.
But even if the principle of superiority of international law is not acceptable
for a country, all countries are obliged to respect their international
engagements (pacta sunt servanda - international customary law and Vienna
Convention on the law of treaties).
Compatibility with tax treaties
The question of whether CFC rules must be compatible with international
tax treaties has been a subject of debate for many years. Although the
commentaries to the OECD model tax convention speak in favour of a position
under which CFC rules are regarded as independent from tax treaties, the
arguments brought forward for such a position are rather formalistic and
seem to be contrary to the general principles underlying the OECD model
and the spirit of tax treaties. For these reasons, an increasing number
of OECD Members do not support the views expressed in the OECD commentaries
regarding the relationship between CFC and tax treaties. On the other
hand, there is consensus that countries may agree on tax treaty clauses
allowing them in clearly specified situations to exclude certain kinds
of income or certain entities from the advantages of the tax treaty (e.g.
limitation of benefits clauses).
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position: The international business community is of the view that
if a country has the intention to limit the scope of its conventional
obligations by domestic CFC rules, it can do so only if its tax treaty
partners agree. In no case shall it be done if the CFC rules would
be in conflict with the wording or the intentions of a treaty partner
in the (former) negotiations. Countries that consider the introduction,
extension or application of CFC rules must in all cases inform their
treaty partners and provide for the necessary adjustments in the tax
treaties. |
Compatibility with the treaty of the European
Union
The question of whether CFC rules may be in conflict with the obligations
resulting for members of an economic organization, and in particular the
European Union, is also under debate. A number of EU countries already
take this view and limit their CFC rules to countries outside the Union.
From an economic point of view, it is clear that the use of CFC legislation
is an obstacle to the objective of creating a single market. It is also
evident that CFC rules can impede the free flow of persons, capital and
services, and that they may affect the right of establishment.
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position: ICC is of the view that CFC rules and their application
must be compatible with the rules and objectives governing regional
organizations. Particularly within the European Union, CFC rules are
no longer justified (Code of conduct) and must be abolished in order
to preserve the freedoms guaranteed by the EC Treaty of the European
Union. From an economic point of view, CFC rules are clearly an obstacle
to the objective of creating a single market. |
Conclusions
ICC has come to the conclusion that the advantages of CFC measures must
be carefully weighed against their disadvantages, such as the loss of
international competitivene
ss and negative effects on the overall economic
efficiency of a country.
ICC sees in particular
the following dangers for enterprises with international business activities:
- The proliferation of national CFC rules increases the risk of conflicting
taxation claims;
- Conflicting CFC approaches and local requirements, together with anti-abuse
clauses in tax treaties, lead to uncertainty for international business,
and in particular for multinational enterprises active in a large number
of countries;
- Documentation requirements resulting from national CFC rules constitute
a heavy burden on international business, in particular if enterprises
are obliged to justify their business structures;
- CFC rules tend to reduce sound tax competition and have a negative effect
on the competitive position of a business location as such, or on the
enterprises doing international business from that location.
For these reasons ICC recommends that:
- CFC legislation
should in no case apply to enterprises that carry out real business activities
in a low tax jurisdiction, which is transparent and provides for an effective
exchange of information;
- CFC legislation must be clear, practicable and transparent and should
not be discriminatory;
- CFC legislation has to always be in line with obligations resulting
from tax treaties and from membership in a regional organization, such
as the European Union;
- CFC legislation shall be used as a last resort only by countries to
counteract purely tax driven transactions that are not part of a normal
business;
- where a tax treaty exists, clearly defined anti-abuse provision should
be put in the tax treaty; and
- CFC legislation may in no case be used as means for reintroducing restrictions
to the free flow of capital or investments.
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17 September 2003
Document 180-52/1rev.2Final
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