Tag Archives: full inclusion

Controlled Foreign Corporations

The BMG has now submitted its comments on the proposals under Action 3 of the OECD-G20 BEPS Project, Strengthening CFC Rules.


Rules on controlled foreign corporations (CFCs) override the ‘separate entity’ principle by providing that, in defined circumstances, profits channelled to an affiliate of a Multinational Enterprise (MNE) in a low-tax country can be attributed to its parent and taxed by the home country of the MNE. In effect CFC rules give the primary right to tax business profits to the source country (where the activities take place), thus ensuring neutrality between domestic and foreign-owned firms, but a secondary right to the country of residence of the foreign owner, to ensure neutrality between home and overseas investments. CFC rules should act as a deterrent removing the incentive for MNEs to shift profits out of source countries. To achieve this however, they must be set at a high standard and coordinated. A weak standard which is left to states to implement would be counter-productive, as it would encourage source states to reduce their tax rates, and hence worsen the race to the bottom in corporate tax.

We therefore support adoption of full inclusion approach, under which the home country would tax all CFC income, with a credit for foreign taxes paid. An acceptable alternative would be a substance test based on the proportion of profit to employees, determined by payroll costs. It should apply if the effective tax rate in the CFC’s country of residence is below 95% of that of the home country, since a high threshold is essential both to remove pressures on source countries to reduce their tax rate, and to ensure competitive equality between MNEs from different home countries. We urge rejection of a ‘top-up tax’ as an inadequate alternative which would give unfair advantages to MNEs which continue to engage in BEPS behaviour.

Such strong CFC rules could give the BEPS project some chance of success, but weak rules would mean its failure. The inability to coordinate CFC rules until now has led to their weakening, due to economic globalization allowing MNEs to play states off against each other. Strong and coordinated international action is now needed in order to ensure that MNEs are taxed ‘where economic activities take place and value is created’. In our view the most effective response to BEPS would be to adopt a more explicitly unitary approach to MNEs, for example by systematizing and regularizing the profit split method with defined concrete allocation factors and weightings for all commonly used business models. Apportioning profits according to appropriate measures of real economic activity would leave states free to set their corporate tax rates, balancing encouragement of investment in real activities with optimizing tax revenues. The BEPS Project has preferred a different approach, including CFC rules, but it remains to be seen whether it can achieve agreement on the high standards necessary to make them effective.