CONTROLLED FOREIGN COMPANIES PRESENTATION BY [NAME] [DATE]
OUTLINE 1. Controlled Foreign Company ( CFC ) The Concept 2. CFC International scenario 3. BEPS Action Plan 3
THE CONCEPT
CFC THE CONCEPT CFC rules are prevalent in around 30 countries In general, CFC is a foreign company that: Is directly or indirectly controlled by resident taxpayer; Earns substantial passive income; and Is subject to substantial lower taxation than in resident state Passive income arising in overseas jurisdictions is attributed to resident shareholders Passive income interest, rent, dividends, royalties and capital gains Nature of control Generally > 50% ownership (e.g., US, UK) Voting power (e.g., US)
THE INTERNATIONAL SCENARIO
CFC THE INTERNATIONAL SCENARIO (1/4) Most advanced economies have tax regulations dealing with CFC. Typically, CFC regulations deal with the following: Define control thresholds that need to exist to be classified as a Controlled Corporation Define exemption / activity thresholds that need to be satisfied for exclusion Active business exemption Australia Business criteria, substance criteria, management and control criteria Japan De-minimis test, exempt activity test, acceptable distribution test UK Same country exception for dividend and interest, rents and royalties, De-minimis test, Full inclusion, Earnings and Profits Limitation Test USA
CFC THE INTERNATIONAL SCENARIO (2/4) Define tax rate thresholds that can act as reference point vis-àvis home country tax rates Excluded country test UK Listed country and non-listed country test Australia Provide taxing mechanisms to enable current taxation of undistributed profits of the CFC Provide tax credit mechanisms for taxes paid / underlying tax credits / participation exemptions to mitigate the effects of any potential double current taxation
CFC THE INTERNATIONAL SCENARIO (3/4) Two broad approaches to CFC legislation in OECD countries Transactional approach Location of CFC disregarded but rules will result in taxing specific incomes, which are generally passive ( bad or tainted income) Entity / jurisdictional approach Low tax jurisdictions are identified and all income of CFC in such countries taxed irrespective of their source ( all or nothing effect ) Fairly advanced CFC regulations exist in US, UK, Australia, Japan, France
CFC THE INTERNATIONAL SCENARIO (4/4) Analysis of CFC legislation in a few countries on following key aspects: Background Definition of CFC Applicability and tax impact Type of target income Tax credit Exemptions
BEPS ACTION PLAN 3
BEPS ACTION PLAN 3 (1/3) Recommendations for the design of effective CFC rules to combat BEPS and long-term deferral Final Report recognizes that different policy considerations underpin CFC rules and this determines their scope Shared policy considerations Deterrent Backstop to transfer pricing Balance effectiveness with compliance burden Balance effectiveness with avoidance of double taxation Specific policy objectives may be prioritized differently (i.e. worldwide versus territorial tax system) Balance between taxing foreign income and maintaining competitiveness Extent to which prevent base stripping (i.e., parent or foreign base stripping)
BEPS ACTION PLAN 3 (2/3) Recommendations are not minimum standards, but set out building blocks for effective CFC rules Building Blocks Definition of CFC CFC Exemptions and threshold requirements Definition of income Recommendation how to determine when shareholders have sufficient influence over a foreign company how non-corporate entities and their incomes should be brought under the ambit of CFC rules CFC rules to apply only to those CFCs that are subject to effective tax rates that are meaningfully lower than those applied in parent jurisdiction CFC rules should include a definition of CFC income, and set out a non-exhaustive list of approaches or combination of approaches that CFC rules could use for such a definition
BEPS ACTION PLAN 3 (3/3) Building Blocks Recommendation Recommendations are not minimum standards, but set out building blocks for effective CFC rules Computation of Income Attribution of income Prevention and elimination of double taxation CFC rules should use rules of the parent jurisdiction to compute CFC income to be attributed to shareholders CFC losses should only be offset against profits of the same CFC or other CFCs in the same jurisdiction Attribution threshold should be tied to control threshold and amount of income to be attributed should be calculated by reference to proportionate ownership or influence Emphasizing on the importance of preventing and eliminating double taxation, the report recommends that countries with CFC rules should allow a credit for foreign taxes actually paid (including tax assessed on intermediate parent company) Countries should also consider relief from double taxation on dividends on, and gains arising from disposal of CFC shares where income of the CFC has previously been subject to taxation under a CFC regime
COMPARATIVE ANALYSIS Country USA Background Introduced in 1962 - First country to adopt CFC rules UK Introduced in 1984 to prevent UK residents from reducing their UK tax liabilities by diverting profits to foreign companies which they control and situated in low tax jurisdictions South Africa Introduced in 1997 under Section 9D of the Income Tax Act to protect the South African taxation base. Section 9D initially only taxed passive income but later the scope was extended to include active income also
COMPARATIVE ANALYSIS Country USA Definition of CFC A CFC is one in which the US shareholders own more than 50%, by vote or value. UK A CFC is a non-uk company which is controlled by UK residents and which operates in a low tax jurisdiction A non-resident company is regarded as to be controlled by UK residents if UK residents hold more than 50% interest in the company or if UK residents hold 40% or more interest and a nonresident holds at least 40% but not greater than 55% interest. South Africa A foreign company, interalia, becomes a CFC when more than 50% of the participation rights or voting rights are held directly or indirectly by South African residents
COMPARATIVE ANALYSIS Country USA UK Applicability and tax impact Only those shareholders that own (directly or indirectly) 10% or more of the foreign corporation stock are included in the more than 50% ownership test Equal partnership between foreign persons and US shareholders not hit by CFC Regulations A CFC is subject to a lower level of taxation if the tax paid in its country of residence is less than 75% of the corresponding UK tax that would have been payable had it been resident in the UK Currently, UK companies are required to include amounts chargeable under the CFC Regulation in their tax returns
COMPARATIVE ANALYSIS Country South Africa Applicability and tax impact A South African resident is taxable on his share of income in a CFC only if it holds 10% or more in a CFC (whether alone or together with connected persons). Thus, less than 10% holding does not trigger any profit imputation in the hands South African resident shareholder.
COMPARATIVE ANALYSIS Country USA UK Target income subject to CFC Rules Passive undistributed income of CFC taxable in the hands of US shareholder sum of: US shareholders pro-rata share of CFC s income for the year Pro-rata share of certain amount withdrawn from investment in less developed countries Pro-rata share of certain amount withdrawn from investment in shipping operations for the year Pro-rata share of the corporation s earnings invested in US property for the year Share of the profits (excluding capital gains) of the CFC taxable in UK
COMPARATIVE ANALYSIS Country South Africa Target income subject to CFC Rules The net income of a CFC is an amount equal to the taxable income of the CFC for the foreign tax year which ends during the year of assessment of the resident Country USA Tax Credit Foreign taxes are deemed paid on taxable distributions from foreign corporations UK South Africa NA A South African resident is entitled to a credit (or rebate) of South African tax for foreign taxes paid by the CFC on income attributed to the resident
COMPARATIVE ANALYSIS Country USA UK Exemptions from CFC Rules CFC is not established for avoidance of domestic tax De-minimus test where the total income of the CFC does not exceed a certain amount CFC distributes dividend to persons resident in UK which is equal to at least 90% of its chargeable profits within 18 months of the end of its accounting period De-minimus rule - chargeable profits of the CFC is less than 50,000 Pounds Low profit margin CFC s account profits < 10% of its relevant operating expenditure Low level of tax exemption CFC has paid local tax of atleast 75% of the corresponding UK tax
COMPARATIVE ANALYSIS Country Exemptions from CFC Rules CFC has a business establishment in the territory where it is resident and effectively manage its business affairs in that territory from that establishment OR qualifies under one of the specific tests (i.e. > 50% non related business) It is proved that reduction in UK tax by a diversion of profits from the UK is not the main reason behind the CFC s existence Public holds shares carrying at least 35% of the voting rights of the CFC, the shares not being preference and quoted on the stock exchange official list The CFC is resident in a territory listed in the Excluded Countries Regulations and satisfies certain income and gains requirements Exemptions in case of group finance companies
COMPARATIVE ANALYSIS Country South Africa Exemptions from CFC Rules Net income of the CFC which: Is attributable to suitable equipped business establishment outside South Africa used for bona fide business purposes; Relates to passive income, foreign exchange differences and certain capital gains which arise from transactions between the CFC and another foreign entity which forms part of the same group of CFC; Is attributable to any foreign dividend declared to the CFC by another CFC in relation to the South African resident to the extent that the foreign dividend has been or will be included in the income of the resident in terms of the imputation rules
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