How the CFC rules are to be reformed for BEPS

The discussion draft focuses on 7 building blocks to create effective CFC rules to address BEPSconcerns. These are:

Definition of a CFC

Threshold requirements

Definition of control

Definition of CFC income

Rules for computing income

Rules for attributing income

Rules to prevent or eliminate double taxation

The building block that is most discussed in the OECD paper is the definition of CFC income.

A traditional approach to defining CFC income is a combined form and substance based approach.For example, dividend, interest, royalties would be CFC income but sales, services and other incomefrom carrying on a business would not. A substantial contribution, a viable independent entity, andemployee and establishment analysis tests would be used to identify genuine economic activities in aCFC. However, the paper argues this traditional approach may no longer accurately attributeincome for BEPS concerns in the modern business environment.

In defining 'CFC' or 'attributable income' to address BEPS the paper discusses:

A categorical approach, whereby passive income will be included in CFC income unless the CFC canmeet a substance test. Active income will be excluded from CFC income unless CFC cannot meet asubstance test.

An alternative excess profits approach. This approach requires a calculation of a 'normal return' andthen subtracting this normal return from the income earned by the CFC. The difference is the excessreturn which is treated as CFC income. The logic behind this is that for income such as IP income,taxpayers cannot expect to earn a profit in excess of normal returns from simply purchasing andselling and provided services or manufacturing.

Submissions on the draft discussion paper are due by 1 May 2015. If you have any comments or youwould like to discuss the OECD's proposed recommendations, please give me a call.

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