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-à-

vis 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 Recommendation

Definition of CFC 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 Exemptions

and threshold

requirements

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

Definition of income 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)

Recommendations are not minimum standards, but set out building

blocks for effective CFC rules

Building Blocks Recommendation

Computation of

Income

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 of income 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

Prevention and

elimination of double

taxation

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 Background

USA 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 Definition of CFC

USA 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 non-

resident 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 Applicability and tax impact

USA 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

UK 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 Applicability and tax impact

South

Africa

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 Target income subject to CFC Rules

USA 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

UK Share of the profits (excluding capital gains) of the CFC taxable in UK

COMPARATIVE ANALYSIS

Country Target income subject to CFC Rules

South

Africa

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 Tax Credit

USA Foreign taxes are ‘deemed paid’ on taxable distributions from foreign

corporations

UK NA

South

Africa

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 Exemptions from CFC Rules

USA 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

UK 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 Exemptions from CFC Rules

South

Africa

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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