Controlled foreign company (CFC) rules in 2023
- Several jurisdictions have tax rules to combat the use of low-tax overseas vehicles owned by resident individuals and businesses for the purpose of tax avoidance;
- These rules are separate from those around tax residence, which typically impose tax liability on a company in the country in which the majority of its directors live;
- Instead, CFC rules focus on ownership rather than day-to-day control, removing opportunities for tax avoidance from a second angle;
- The three most prominent CFC regimes are imposed by the United States, the United Kingdom, and Australia. Other countries, such as France, impose similar rules based on blacklists;
- As many of Healy Consultants’ Clients have businesses in these countries, this page will summarise the criteria that trigger each of the three main jurisdictions’ CFC rules, and will refer to relevant pieces of legislation to provide a basis for further research.
Summary of how CFC rules work
- CFC rules are one way that some countries have tried to tackle the problems of tax deferral, base erosion and profit shifting;
- The main systems focus on either specific types of income, or companies in specific jurisdictions;
- They work by attributing the income of the foreign company on the resident shareholder, thus increasing the taxable income of the shareholder in their home country;
- Where attributed income is not received by the controlling party in that tax year, double taxation is avoided by exempting already-attributed income from taxation on receipt;
- By having this mechanism in place, it makes it more difficult for companies and individuals to divert taxable income artificially, without unnecessarily increasing the tax burden on international businesses.
US CFC rules
- The United States’ CFC regime affects US taxpayers who hold at least 10% of the shares or voting power in a foreign company, and who together with other US taxpayers own at least 50% of those rights;
- The United States does not maintain a whitelist or blacklist of countries, so their CFC rules apply worldwide. Instead, the focus of US CFC rules is on certain kinds of transactions;
- In particular, the US CFC rules include the certain categories of the following in their calculation of taxable “foreign base company income”:
- Capital gains;
- Services performed for outside of the CFC’s home jurisdiction (or on behalf of) related parties; and
- Sales to related parties.
- American CFC rules are contained in, and governed by, Subpart F of the Internal Revenue Code. For this reason, income attributable under CFC rules is often called “Subpart F income”.
UK CFC rules
- The UK CFC system requires 25% UK ownership (alone or with related parties) of a foreign-resident entity to invoke the CFC rules;
- Unlike the US rules (above) and the Australian rules (below), the UK’s CFC rules do not have a collective hurdle rate above the main threshold;
- Generally speaking, trading income from foreign companies is exempt from CFC rules if:
- The arrangement makes sense for non-tax commercial reasons (even if the arrangement does, in fact, reduce tax);
- The CFC has no assets, risks or other activities carried on in, or managed from, the UK; or
- The foreign company could continue operations if any assets managed form the UK were managed from elsewhere.
- The CFC rules apply if the company does not meet the above tests, which are known as the “pre-gateway”. However, there are a number of wide-reaching exemptions that remove most legitimate businesses from the scope of the regulations;
- There are three main categories of CFC exemptions in the UK:
- “Gateway” exemptions, which exclude from CFC tax liability i) trading profit subject to five conditions ii) there are significant non-tax benefits to the arrangement iii) arrangements made with related parties at arm’s length and iv) CFCs with minimal UK activities. These are similar to the “pre-gateway” tests, but require further investigation;
- Our Clients can also avoid CFC liability by electing to use an entity-level exemption. These are available for CFCs with i) profits of less than £50,000 ii) operating margins below 10% iii) an effective tax rate of at least 75% of the level that would be owed on that income in the UK iv) tax residency in a specified jurisdiction (known as an “excluded territory”);
- Finance company exemptions, which are applied on loan-by-loan basis for qualifying intra-group lending arrangements. These are not relevant for most of Healy Consultants’ Clients.
- The UK controlled foreign company regime combines a number of different laws. The most comprehensive government resource on this topic is therefore HMRC’s manual on CFCs.
Australian CFC rules
- Australia’s CFC regime takes effect when either i) an Australian tax resident owns at least 10% of a foreign company, with a hurdle requirement for five or fewer Australian tax residents to control 50% or more of the company or ii) a single Australian tax resident holds at least 40% of a foreign company;
- These rules focus on passive income, largely exempting trading income from the scope of the regulations. However, at least 95% of the CFC’s income must be considered as “active” for this exemption to apply;
- In addition to passive income, the law attributes “tainted” sales and services income. These are broadly defined as transactions made for non-commercial reasons or the purpose of tax avoidance;
- Attribution under Australia’s CFC rules is relaxed for seven “listed” countries. These are the United Kingdom, the United States, Japan, Germany, Canada, France and New Zealand;
- For CFCs that are tax resident in listed countries but fail the active income test, passive income and tainted sales & services income are taxable in Australia only if subject to a concessionary rate of tax in that listed country;
- CFCs in listed countries also benefit from an exemption if they have after-tax profits of less than AU$50,000 AND profit margins of less than 5%;
- Dividend income received by CFCs is exempt from attribution if received if the companies paying and receiving the dividends are i) resident in a listed country or ii) resident in a section 404 country. Most unlisted “onshore” countries including Singapore are included on this list. There are no further benefits available for countries on the section 404 list.