Controlled Foreign Corporation In International Taxation

Controlled foreign company (CFC) is a foreign company which is established in tax havens and low-tax areas and directly or indirectly controlled by its shareholders who are native residents. Multinational companies have a great diversity of purpose to set up CFC, but the most important objective is to take advantage of its international tax avoidance. So countries around the world enact legislation to regulate this behavior system. This paper is divided into four parts which generally introduce CFC tax system on two levels from home and abroad using the methods of comparative analysis and Summary and compare the differences of CFC tax system between developed and developing countries and propose the ideas to enact our country's CFC tax system on the base of experiences learning from other countries.The first part outlines CFC legislation. The principle that company and its shareholders are separably taxed is the legal background of CFC legislation. It has been recognized by states tax laws of that company and its shareholders are all independent taxable entities. Company and its shareholders respectively commit to the tax obligations of the state in which they reside for their own taxable incomes. Because company is deemed to be an independent tax entity and is not national of country in which its shareholders reside, the country can not exercise jurisdiction over tax. Only when company's shareholders have gotten the taxable incomes, the country in which shareholders reside can exercise jurisdiction over tax on the taxable incomes. That is to say if company does not allocate to its shareholders, the country in which shareholders reside will not be able to tax. This creates opportunities for taxpayers to delay or evade national tax. The existence of tax havens is the economic background of CFC legislation. Tax havens can be traced back to ancient Greek times. It usually has the following characteristics: (1) Zero or low tax rate in the income tax and capital gains tax; (2) Tight banks or commercial confidentiality provisions; (3) Freedom of currency exchange; (4) Refuse to cooperate with foreign tax authorities; (5) Limited tax treaty network or no tax treaty;(6)Good communications facilities and transport facilities.CFC is the clever linking of the two above. Taxpayers in multinational companies set up CFC in tax havens and control the company's allocation with their control status. In this way they delay taxes payment to host country for the purpose of tax avoidance. On the one hand, deferred tax seriously damages the dignity of the country and affects the taxpayers'trust in the tax authorities. On the other hand, deferred tax also destroys the capital neutral and distorts the tax environment of fair competition, because the residents who invest overseas can get more tax benefits than those who invest domestically. For this reason, many countries have this legislation system. Neutral principle of capital output and neutral principle of capital input are expressions of the neutral principle of international tax from different angles. From the point of view of the state of source, it is the capital input neutrality. From the point of view of the State of residence, it is the capital output neutrality. Capital neutral principle is theoretical basis of legislation in many countries. However, these countries also make some provisions exempting CFC from incomes tax in their CFC tax regime. That show these countries have deviated from the principle of capital output neutrality, and then have turned to the principle of capital input neutrality. In brief, the relations between CFC legislation and the two principles above is CFC legislation has upheld both the principle of capital output neutrality and the principle of capital input neutrality. Capital output neutrality is a principle and capital input neutrality is an exception.Corporate personality independent system playing an important role in the course of the operation of company is one of important systems. But Personality independent system is too focused on the protection of the interests of shareholders and is inequitable to the creditors of company. All of these cause that its shareholders, especially those who have controlled the company abuse personality independent system for seeking illegal interests. Corporate personality denied system is a remedial measure taken against the defects of personality independent system in specific circumstances. The essence of jurisprudence of corporate personality denied system is that legal system is the need of social life and is set up for the public interests and convenience. If the legal entity is established for unlawful purposes or has an antisocial tendency or other situations not allowed by the public interests, the nation has the right to deprive the personality of the legal entity and denies the existence of the legal entity.It is recognized by all countries in tax law that company personality is independence. So company as an independent taxpayer takes independently on their tax obligations. Because of its independent personality, foreign companies are treated as an individual tax entity. Therefore, the country in which the shareholders reside can not exercise jurisdiction over tax on residents. The country in which the shareholders reside can not tax on the shareholders'income until the foreign company allocates income to the domestic shareholders. Many multinational corporations make good use of the principle and take on tax avoidance by establishing CFC in tax havens. In view of this, many countries have created CFC tax system. CFC legislation is a reflection of the principle of piercing the corporate veil in tax area. Its purpose is opening the corporate veil only for the purpose of tax avoidance and ordering the taxpayers to pay taxes. It is an exception to the universal principle of individual tax entity.The second part introduced the content of CFC tax regime including the definition of CFC, the taxpayer of CFC tax system, the geographical scopes of application, the object of CFC tax system, the income exemption of CFC and the new development of CFC tax system-- inversion transaction. The CFC tax system is applied with the premise of the definition of CFC. In defining CFC, the provisions of countries are very different, but commonly using the control standards, the real interest standards and the presumption standards.In defining the taxpayer of CFC, the two methods of part application and full application are mainly used. Both methods above have their advantages and disadvantages. The methods of part application are more equitable. It allows the small shareholders who have no impact on CFC exempted from the application of the CFC tax system. However, it adds up to the tax cost of the tax authorities that identifying the shares held by shareholders is difficulty. Full application rules can avoid these shortcomings to a certain extent, but may be contrary to the principle of equity of tax law.The geographical scopes of application of CFC tax system include three ones. They are the specific region (mainly tax havens or countries and regions adopting a certain low-tax policy), the global and the two above mixed. The first two approaches have their advantages and disadvantages. So some countries have taken the third method that may learn from strong points to offset weakness.In identifying the object of CFC tax system, there are three methods such as entity income, transaction approach and the mixed method. The three methods have their advantages and disadvantages. Compared with Transaction Approach, entity income is simple, but it does not have differences between pollution income and non-pollution income. So it has across-the-board deficiencies. Transaction approach is more accurate than Entity Income avoiding the shortcomings of the across-the-board. However, the tax authorities need to individually review each transaction of CFC so as to increase the cost of collection and management. The mixed method can reduce the negative impact of the first two methods in some extent, but it is impossible to fundamentally eliminate all of the impact.The income exemption of CFC includes following types: real business activities exemption, non-tax motivated exemption, the minimum exemption and other exemptions. Inversion transaction that sets up a new parent company in the low-tax countries or tax havens and then makes the parent company originally based in high-tax countries under the new foreign parent company is the new development of CFC. Inversion transaction has two hazards. On the one hand, it may reduce the native tax from the native income. In the inversion transaction, the parent company in the tax havens may transfer native income to overseas through transferring pricing. On the other hand, it may reduce the native income tax on domestic companies from foreign sources. For this new trend of development, only the United States carried out its regulatory system at present. I believe other countries will enact laws to regulate the means of avoiding the tax.The third part mainly introduces some countries'CFC tax systems including both developed and developing countries and then makes a simple comparison of their CFC tax systems. We can find that there are similarities in their CFC tax systems by comparison. For example, the structure of the CFC tax systems includes the definition of CFC, taxable Income, the definition of tax havens, the taxpayer, the exemption provisions. Of course, there are also differences between them.The fourth part proposes the ideas to enact our country's CFC tax system on the base of analyzing status quo of our country's CFC tax system. Firstly it introduces overseas investment of our domestic enterprises. At the beginning of the reform and opening up, China focused mainly on attracting foreign investment. So the development in overseas investment has been relatively slow. It have made significant headway in our country's overseas investment that 1999's "going out" strategy and China's accession to the WTO. At the same time there are some enterprises making use of CFC for tax evasion. Therefore it is necessary to carry out our regulatory system in China.Secondly China's regulations on CFC have some inadequacies. China's first regulation of CFC was reflect in"The Interim Procedures of Taxable Income from Outside"(1997) which had obvious flaws. For example, the provisions about taxpayers are too simple lacking for operable. In addition, a strict foreign exchange control system in the early stage of reform played an objective role in regulating tax avoidance activities of taxpayers using tax havens. But there are negative effects in foreign exchange control, for example, it has restrictions on the free market playing a role and impeding the development of international trade. Although the new "People's Republic of China Enterprise Income Tax Law" firstly conducted a regulatory system to control CFC tax avoidance, it is only a framework and lacks of operable and is obviously not able to meet the need of the reality.Finally, it proposes the ideas to enact our country's CFC tax system on the base of experiences learning from other countries. These specific contents include the CFC policies and objectives, the definition of CFC, the taxpayers, the object of CFC tax system, the exemption and the geographical application.