What are CFC Rules (Controlled Foreign Company rules)?
There are lots of misunderstandings when it comes to CFC rules (controlled foreign companies rules) and CMC rules (management control rules, part of Corporate Residency Rules). Lots of people get confused about which is which.
You have to pay attention to both.
However, not every country has them, some countries will have CFC but not CMC and vice versa.
So, which are the principles of CFC rules?
Think of it like this…
All the countries want their local companies to reach further than just within the country of origin. They want their businesses to succeed globally. This is very good for the country because it brings more money back to local shareholders, creates jobs, etc.
However, let’s imagine this situation:
An American company sells in Germany. In this case, if they will have to pay taxes in both countries: in the USA and in Germany. This will put them at a disadvantage compared to a German (local) company, which only has to pay taxes in one country.
This would be bad for the US, which wants their companies to be competitive when doing business abroad to gain market share.
Because of this, they created rules that let the company form a foreign subsidiary company to do business there and only pay taxes on the income earned in the other country where they’re doing business.
Of course, this naturally leads to lots of exploitation where companies could either never bring the money back and hence never pay the tax (sort of like creating an unlimited deferred retirement plan (which is why CFC rules are called “anti-deferral rules”). Or, they form foreign companies in countries where corporate taxes are much lower even though it isn’t simply because they are doing business there in order to gain tax savings.
(Sometimes they can bring the profits back tax-free see “participation exemption” or “holding company regime”).
This is where CFC rules come in.
The tax departments are smart, they know businesses will form these foreign companies artificially just to pay less tax or move and keep income abroad to pay less tax.
CFC rules at least, in theory, are designed to prevent this abuse while still allowing for the legitimate uses described above.
The way these rules work is if a company meets certain criteria (usually owned and controlled more than a certain percentage by shareholders of a particular country) and the income of that company meet certain criteria, even though the company is foreign they force the shareholders to pay taxes on the money as though they brought it back even if they didn’t.
It’s very important to be aware of these rules in each country you live and operate.
However, if you are structured properly you can often work around these rules.
You can give us a call and we will discuss how you could avoid paying all the taxes while still following all the rules.
We help clients legally reduce their tax through international tax planning, as well as help with company formations, bank account openings, residency, citizenship, and payment processing. Have a question you want answered? Book a consultation now!