BEPS – Strengthening Controlled Foreign Company regimes

By Andy Boucher

The OECD have recently released a discussion draft summarising their latest thinking on Action 3 of their BEPS plan, strengthening Controlled Foreign Company (CFC) rules. The key aims are to encourage more territories to adopt CFC rules and, for those who already have such rules, to amend these to fit with the OECD recommendations.

The overall framework proposed, with its seven ‘building blocks’, is logical and many of the draft recommendations are perfectly sensible. In particular, it is pleasing to see that the OECD accept that you should not apportion profits when you have genuine economic activities in a CFC.

I am, however, concerned by some of the more basic issues which do not seem to have been resolved. Given that the final recommendations will need to be released by September 2015, there is clearly a lot of hard negotiating still to be done.

Imminent outstanding issues

1) The decision as to whether CFC rules should be targeted at preventing the artificial diversion of profits from a parent territory, or whether they should play a more invasive role in BEPS by seeking to challenge foreign-to-foreign transactions between subsidiaries. Making the remit of recommended CFC rules too wide could lead to inconsistent adoption and much greater risks of double taxation.

2) The ‘excess profits’ approach to identifying CFC income, where you would exempt CFC profits up to a normal rate of return based on a measure of eligible equity in a CFC. I feel this would be arbitrary in nature and would lead to apportionments even when you have genuine substance in a territory. Aligning this with the treaty obligations of those OECD territories who are also EU or EEA Member States would be very difficult.

What does this mean for UK businesses?

For UK outbound MNCs, the good news is that the post 2013 CFC regime is broadly consistent with most of the recommendations made in this discussion draft. Indeed, on the question of how a CFC regime should identify bona fide substance, I would argue that the UK’s significant people function gateway approach could be an ideal method. 

What should groups be doing now?

In its current form, the discussion draft will make it difficult for many groups to accurately assess the impact of any prospective changes to domestic rules. Groups who have separated ownership of highly mobile assets and functions such as intellectual property (IP), risk insurance and financing from the economic functions which generated them will, however, clearly be at increased risk of challenge. Such groups should be reviewing their business and corporate structures with a view to establishing more sustainable models.

Andy Boucher

[email protected] /004 4207 213 1165