master’s thesis international business taxation ll.m

Master’s Thesis International Business Taxation LL.M.

The new EU CFC Rules (Council Directive (EU) 2016/1164) and the US

Subpart F Rules; A Comparative Study

by

Mag. Alexander Gregor Albl [ARN. 990734]

Student at Tilburg University

2016/2017

K.R.C.M. Jonas MSc, LL.M – Supervisor

Prof. Dr. P.H.J. Essers – Exam Committee

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Table of Content

1.Introduction ........................................................................................................................... 3

1.1. Purpose ......................................................................................................................................... 6 1.2. Limitation ..................................................................................................................................... 7 1.3. Research Design ........................................................................................................................... 7

2. CFC-Legislation ................................................................................................................... 8

2.1. The Theme Complex of Tax Avoidance and Tax Evasion in the International Environment ..... 8 2.2. What is CFC Legislation? .......................................................................................................... 11 2.3. Short Overview of the Historic Background and the latest Developments of CFC Legislation 13 2.4. Main thumb-prints of CFC Rules (based on the building blocks of the OECD Base Erosion and

Profit Shifting Project - Action Plan 3) ............................................................................................. 14 2.4.1 Definition of a CFC .............................................................................................................. 15

2.4.1.1. Definition of Entities Covered ...................................................................................... 15 2.4.1.2. Level of (sufficient) Control/Influence .......................................................................... 15 2.4.1.3. Exemptions and Threshold Requirements .................................................................... 16

2.4.2. Definition of CFC Income ................................................................................................... 17 2.4.3. Rules for Computing Income .............................................................................................. 19 2.4.4. Rules for Attributing Income ............................................................................................... 20 2.4.5. Rules to Prevent or Eliminate Double Taxation .................................................................. 21

2.5. CFC Rules according to the Council Directive (EU) 2016/1164 of July 12, 2016 .................... 21 2.5.1. Definition of a CFC ............................................................................................................. 22 2.5.2. Exemptions and Threshold Requirements ........................................................................... 22 2.5.3. Definition of CFC Income ................................................................................................... 23 2.5.4. Rules for Computing Income .............................................................................................. 24 2.5.5. Rules for Attributing Income ............................................................................................... 24 2.5.6. Rules to Prevent or Eliminate Double Taxation .................................................................. 25

2.6. CFC Rules according to Subpart F ............................................................................................. 25 2.6.1. Definition of a CFC ............................................................................................................. 26 2.6.2. Exemptions and Threshold Requirements ........................................................................... 27 2.6.3. Definition of CFC Income ................................................................................................... 27 2.6.4. Rules for Computing Income .............................................................................................. 28 2.6.5. Rules for Attributing Income ............................................................................................... 28 2.6.6. Rules to Prevent or Eliminate Double Taxation .................................................................. 29

2.7. Comparative Overview ............................................................................................................... 30

3. Comparison in the Light of the Principles of Efficiency and Effectivity ...................... 32

3.1. Principle of Efficiency ................................................................................................................ 33 3.2. Principle of Effectivity ............................................................................................................... 35

4. Taxation in the International Arena (Overview) ............................................................ 39

4.1. The Legal Concepts of International Tax Law ........................................................................... 39 4.2. The Economic Concepts of International Tax Law / The Aim of Tax Neutrality ...................... 40 4.3. Alternative Approach (2nd best solution) .................................................................................... 41

5. Conclusion ........................................................................................................................... 45

6. Bibliography ....................................................................................................................... 48

7. Appendix ............................................................................................................................. 52

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Preface

This master thesis was written as part of the LL.M. program “International Business Tax” at Tilburg

University, Netherlands, during the academic year 2016/2017 under the supervision of K.R.C.M. Jonas

MSc, LL.M. In this respect, I would like to take the opportunity to explicitly thank my supervisor

K.R.C.M. Jonas MSc, LL.M. for her attentive supervision, helpful advice and for always being very

approachable. She also constantly encouraged me to improve my thesis throughout the whole process.

Further, I want to thank Prof. Dr. P.H.J. Essers for the honour of critically reading my thesis and for

being an inspiration in my first term of university.

Studying both the European approach as well as the US approach with regard to controlled foreign

company (hereinafter referred to as “CFC”) legislation was demanding but at the same time

exceptionally interesting and awarding. In this context, analysing the base erosion and profit shifting

(hereinafter referred to as “BEPS”) proposal was the perfect supplement. My work clearly showed me

that governments, even when adopting rules that aim at similar outcomes (e.g. CFC Rules in allocating

passive income to parent companies and avoiding deferral), might take complete opposite approaches.

During the last months, I became more and more familiar with the – in my opinion – very complex

cross-reference system of the Internal Revenue Code (hereinafter referred to as “IRC”) and the overall

discussions of BEPS.

I furthermore studied the various principles of international taxation and tried to get a deeper

understanding of the policy choices of governments concerning concepts of international taxation. I

discovered that the arena of international tax law (still) relies mainly on principles which – at least in

my opinion – do not reflect economic reality anymore. This is due to the fact that their basic architecture

goes back to the work of the League of Nations formulated in the 1920s1, a set of principles that are

particularly easy to manipulate.

1 See Ault – Some Reflection on the OECD and The Source of International Tax Principles, Working Paper 2013 – 03 Max Planck Institute, reprinted from Tax Notes Int’l, June 17, 2013, p 1195.

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1.Introduction

International tax matters have never been seen as high on the political agenda as they are today.2 In

times of increasing globalisation, tighter networks, facilitated mobility of capital, (local) tax laws

have become an increasingly important factor for decision makers regarding their choice for possible

sites for “doing business”. Due to the principle of national tax sovereignty of countries, countries

are free to compete for (foreign) investments by granting, for example, tax incentives. Among

others, such incentives have a profound impact on the way multinational enterprises (hereinafter

referred to as “MNEs”) are structured and managed.3

International tax planning, “tax efficient” structures as well as the limits of such structures have

constantly been hot topics in both the academia and in tax practice over the last years. Tax planning

generally affects a taxpayer’s overall tax burden as well as the budget of governments of those

countries in which the taxpayer is doing business.4 Various measures and phenomena of tax planning

have developed throughout the last years. The previously mentioned phenomena include in

particular the set-up of partnerships and/or holding companies, contracts between affiliated parties

(in general, transfer pricing issues), tax treaty shopping etc, just to name a few examples.5

This can be exemplified through the Action Plan on Base Erosion and Profit Shifting, which states

that: “When tax rules permit businesses to reduce their tax burden by shifting their income away

from jurisdictions where income producing activities are conducted, other taxpayers in that

jurisdiction bear a greater share of the burden.”6

Consequently, countries might introduce measures that shield their tax revenues from certain

international structures. For instance, one of the most prominent examples for an “aggressive” tax

planning structure is the so-called “Double Irish Dutch Sandwich”7, which has been used by Google

Inc and many others. The “Double Irish Dutch Sandwich” in this constellation requires just 4

companies, 2 established in Ireland, being 1 IP-Holding and 1 Operating Company, as well as 1

Conduit Company established in the Netherlands and the US Parent Company. The IP-Holding

Company has to be a direct subsidiary of the US Parent Company and the sole shareholder of the

2 See e.g. OECD BEPS Action Plan 3, 2015 Final Report, Foreword, p 3. 3 See further Guzzo - Global Actions Against Aggressive Tax Planning: International Business Models According OECD. 4 See Simader/Titz - Limits to Tax Planning, p 7. 5 See Simader/Titz - Limits to Tax Planning, p 7. 6 See OECD (2013), Action Plan on Base Erosion and Profit Shifting, OECD Publishing. 7 See Annex B.

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Irish Operating Company and the Dutch Conduit Company.8 The IP-Holding Company is managed,

for example, in Bermuda with the result that the Irish tax authorities will consider the company to

be resident in Bermuda. The US will treat the company as an Irish company because tax residency

is based on the jurisdiction of incorporation according to US tax law.9 Nevertheless, also other

(basic) transfer pricing transactions – when used “tax effective” – can lead to similar results. A

variety of different measures to deal with the different (tax efficient) structures such as interest

limitation rules (e.g. thin and fat capitalisation rules), exit tax legislation or specific rules to combat

hybrid mismatches have been introduced. Very effective, but also highly controversial rules are the

so-called Controlled Foreign Company Rules (hereinafter referred to as “CFC Rules”). 2

approaches can be found: The residence country of the shareholder might tax a “deemed dividend”

the moment a profit is realised at the level of the subsidiary. Alternatively, the country of residence

of the shareholder might simply ignore the corporate veil of the subsidiary.10

Whilst CFC Rules are common to most Member States11 of the Organisation for Economic Co-

operation and Development (hereinafter referred to as “OECD”), not all EU-Member States have

established CFC-Rules. Probably influenced by the OECD BEPS Action Plans, by the fact that the

United States of America – one of the biggest and most successful economies in the world – have

been applying CFC Rules (the so-called “Subpart F” within the IRC) from the very beginning as

well as by the latest tax scandals regarding some of the largest MNEs such as Apple Inc., Starbucks

Corporation, FCA Italy S.p.A. (Fiat) etc, the EU recently introduced the Council Directive (EU)

2016/1164 of July 12, 201612 (hereinafter referred to as “ATAD”) laying down rules against tax

avoidance practices that directly affect the functioning of the internal market. ATAD introduces

harmonised interest limitation rules, rules concerning exit taxation as well as CFC Rules13. EU-

Member States are obliged to implement Art 7 and 8 ATAD into domestic law by December 31,

2018.14 The Member States will have to apply the implemented CFC Rules from January 1, 2019

onwards.15

8 See Fuest, Spengel, Finke, Heckemeyer, Nusser – Profit Shifting and “Aggressive” Tax Planning by Multinational Firms: Issues and Options for Reform, Discussion Paper No. 13-078, p 4-8. 9 See Fuest, Spengel, Finke, Heckemeyer, Nusser – Profit Shifting and “Aggressive” Tax Planning by Multinational Firms: Issues and Options for Reform, Discussion Paper No. 13-078, p 4-8. 10 See also Avi-Yonah and Halabi - "US Subpart F Legislative Proposals: A Comparative Perspective" (2012). Law & Economics Working Papers. Paper 69, p 21; See also Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 5. 11 See Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 5. 12 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016L1164&from=en. 13 See Art 7 and 8 ATAD regarding the CFC Rules. 14 See Art 11 (1) ATAD. 15 Not all provisions of ATAD need to be implemented until the end of 2018; see therefore Art 11 (4), (5) and (6) ATAD.

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In contrast to the field of indirect taxation (e.g. EU VAT16), direct taxation17 is scarcely harmonised.

The reason for this might be the fact that in European direct taxation the only legal basis for

harmonisation can be found in Art 115 of the Treaty on the Functioning of the European Union

(hereinafter referred to as “TFEU”), which requires unanimity.18 Due to the obligation of all

Member States to implement Art 7 and 8 ATAD, starting with January 1, 2019 it is safe to say that

this date can be seen as the hour of birth of (at least partially) harmonised EU CFC Rules.19

The effectiveness, the enforceability, and the functionality of the newly harmonized EU CFC Rules

are of special significance for the economic development of the EU due to budgetary bottlenecks

and “social peace”20 system of European society. At the same time, it is also important to show the

MNEs – in particular, companies with US background – that they are welcome within the EU.

While, there is still space to structure their businesses tax efficiently, there are certain rules

preventing the usage of structures established with the sole aim of avoiding taxation.

CFC Rules therefore require a balancing act between the prevention of profit shifting/tax avoidance

and the legitimate use of tax advantages/incentives following cross border transactions.

Additionally, the question of compatibility/conflicts between CFC legislation and tax treaties21 and

EU law which likewise arises when introducing (new) CFC Rules, pops up. This being said, it is

evident that introducing CFC legislation is a delicate matter and therefore requires the consideration

of many aspects, especially as international trade should not be impaired by such legislation.

Hence, a comparison, based on the building block recommendations of the OECD BEPS report,

between the mechanics of the CFC Rules of 2 of the largest national economies in the world (i.e.

the United States of America and the European Union) seems to be a crucial part in the evaluation

of possible strengths and weaknesses of the chosen set of rules. Due to the current system of

international taxation, the profit obsession of MNEs concomitant with the financial non-contribution

to these ecosystems (e.g. infrastructure, education, social and economic stability etc) and the lack

of willingness within countries (at least within the European Union) to close tax loopholes and

harmonise direct taxation, anti-tax avoidance rules such as CFC Rules are important to secure

“social peace” and to prevent the exploitation of countries’ ecosystems.

16 See also Van Doesum, Van Kesteren, Van Norden – Fundementals of EU VAT LAW, p 2 – 32. 17 The most important directives are (i) the Parent-Subsidiary Directive, (ii) the Tax Merger Directive, (iii) the Interest and Royalty Directive and (iv) Savings Interest Directive. 18 See Terra, Wattel – European Tax Law, p 16. 19 For the direct effect and primacy of EU law see inter alia Terra, Wattel – European Tax Law, p 80 – 84. 20 See further Stevens – The Duty of Countries and Enterprises to Pay Their Fair Share, INTERTAX 2014, p 702 – 708. 21 See further Endress, Spengel – International Company Taxation and Tax Planning, Kluwer Law International, §7.03 [A] and following, p 223 and following pages; see also Andersson – CFC Rules and double tax treaties.

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1.1. Purpose

The purpose of this master thesis is to compare the new EU CFC Rules (introduced through the

Council Directive (EU) 2016/1164 of July 12, 2016) and the CFC Rules established by the United

States of America, widely known as Subpart F legislation.

The main aim of comparing the CFC Rules of these 2 important national economies22 is to evaluate

possible strengths and weaknesses of the respective approaches. More specifically, the following

paragraphs will not only point out a critical juxtaposition between the different characteristics of the

chosen set of rules, but will also show common features.

Therefore, the main research question is:

Do the US Subpart F rules or the new EU CFC Rules achieve the goal of preventing base erosion

and/or profit shifting more effectively and at the same time constitute an economically reasonable

(in the sense of monitoring/compliance costs) set of rules.

In order to answer this main research question in an academic way the aforementioned comparison

will be conducted in the light of the principle of effectiveness and efficiency considering the

following sub questions:

(1) what are the differences and similarities between the US Subpart F rules and the new EU CFC

Rules;

(2) are the US Subpart F rules or the new EU CFC Rules more efficient; which set of rules show a

better cost-efficiency-ratio;

(3) are the US Subpart F rules or the new EU CFC Rules more effective.

Throughout this thesis, I also want to briefly illustrate a limited taxonomy of international taxation

as it plays an important part in allowing MNEs to make use of the current (international) tax systems.

Further, I will advocate a probable tax policy approach in order to answer the claim that:

(4) the change from Capital Export Neutrality (“CEN”) to Capital Import Neutrality (“CIN”), from

residence to territoriality respectively, could eliminate the need for CFC Rules, as taxation would

take place where the (real, intellectual) value has been created and not where a company is a

resident.

22 In 2015 the population of the EU was estimated to be 508,2 Million (http://ec.europa.eu/eurostat/documents/2995521/6903514/3-10072015-AP-DE.pdf/1dc02177-b1d7-47ed-8928-66fec35e2e36). According to the United States Census Bureau the population of the United States of America on July 4, 2016 amounted to 323,1 Million (http://www.census.gov/popclock/).

http://ec.europa.eu/eurostat/documents/2995521/6903514/3-10072015-AP-DE.pdf/1dc02177-b1d7-47ed-8928-66fec35e2e36


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1.2. Limitation

Due to the multifaceted nature of possible problem areas regarding CFC Rules (e.g.

compatibility/conflicts23 between CFC legislation and tax treaties24 and EU law25), this master thesis

focuses mainly on the comparison between the new EU CFC Rules and the Subpart F legislation of

the US.

This aspect is chosen due to the fact that the comparison between the new EU CFC Rules and the

CFC Rules of the first country to introduce CFC legislation (namely the United States of America)

is fruitful. Hence, this master thesis does not cover all aspects of the Subpart F rules, the US tax

system in general, or deeper aspects of tax treaty law and EU Law, as well as questions regarding

accounting issues, other approaches in combating tax avoidance (e.g. earning-stripping rules, thin-

capitalization rules, hybrid mismatches), and in-depth discussion about the systematology of

international taxation.

1.3. Research Design

To achieve the purpose of this master thesis 2 different methods are pursued:

1. A substantial part of my research is based upon literature. This holds especially true for the

general description of CFC Rules, their history and the currently used principles in international

taxation.

2. The second method utilized is a legal comparison between Art 7 and 8 ATAD and the Subpart F

legislation of the US, taking the OECD BEPS recommendations as starting point. The rules/laws

(ATAD and IRC) themselves will be used for this purpose.

In order to assess the similarities and differences of both approaches, general features of CFC Rules

will be pointed out and compared. Subsequently, those features of both approaches (Art 7 and 8

ATAD and the Subpart F legislation) will be evaluated in the light of the principles of efficiency and

effectivity.

Concluding, I will briefly demonstrate that overall CFC Rules might not be necessary, if

governments would agree to adapt the principles currently used in international taxation.

23 See inter alia Lang – CFC-Regelungen und Doppelbesteuerungsabkommen, IStR 2002, 717 – 723. 24 See further Endress/Spengel, International Company Taxation and Tax Planning, Kluwer Law International, §7.03 [A] and following, p 223 and following pages; see also Andersson, CFC Rules and double tax treaties. 25 See inter alia Lang – CFC-Gesetzgebung und Gemeinschaftsrecht, IStR 2002, 217 – 222.

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2. CFC-Legislation

CFC Rules have now been in use for more than 5 decades.26 Due to the latest tax scandals,

specifically budgetary bottlenecks, the general discussion about base erosion and profit shifting and

“aggressive” tax planning schemes of MNEs, legislation on controlled foreign companies has

obtained increasingly more attention in recent discussions.

In the following paragraphs, I will elaborate on basic challenges of tax avoidance and tax evasion,

followed by a general clarification of CFC Rules. Furthermore, I will discuss the history of such

legislation and its latest developments. Subsequently, I will point out the general characteristics of

CFC Rules based on the building blocks of the proposed recommendations of the OECD for

designing effective controlled foreign company rules, as laid down in BEPS Action Plan 3.27 On

the basis of the general characteristics mentioned above, I will then compare the newly introduced

EU CFC Rules with the Subpart F legislation of the US. The findings will be summarised in a

comparative table.

2.1. The Theme Complex of Tax Avoidance and Tax Evasion in the International Environment

As long as no harmonisation between the various tax jurisdictions is achieved (e.g. the distinction

between residence and source taxation), companies tend to take advantage of the discrepancies

between countries’ tax systems, which – at least in my opinion – does not necessarily mean that they

resort to illicit practices. When following the news, one could obtain the impression that no one is

paying taxes anymore – or at least not the “fair” share – and tax avoidance is ubiquitous. Non-

Governmental Organisations (hereinafter referred to as „NGOs“) contribute their part in this

perception, as it seems that they condemn any kind of company structure and accuse companies of

conducting transactions with the sole purpose of tax avoidance. In recent years, the voice for

punishment of MNEs and the allegations of not paying their “fair share” of taxes has come to the

forefront. One of the major problems in this discussion is the fact that (i) there is no definition of

what a „fair share“28 is and (ii) the disparate definitions and interpretations of the term “tax

avoidance” itself. This lack of clear and common definitions, as well as the contradicting visions of

MNEs and NGOs complicate the discussion surrounding this topic.29 Often, ethical aspects,

26 As the first country in the world, the United States of America introduced CFC legislation in 1962. 27 See therefore OECD Action Plan 3, 2015 Final Report. 28 See for possible approaches for example: Stevens – The Duty of Countries and Enterprises to Pay Their Fair Share, INTERTAX 2014, p 702 – 708; see also De Wilde – Some Thoughts on a Fair Allocation of Corporate Tax in a Globalizing Economy, INTERTAX 2010, p. 281-305. 29 See for further arguments regarding the multifaced situation Altshuler, Grubert – The Three Parties In The Race To The Bottom: Host Governments, Home Governments and Multinational Companies, CESifo Working Paper No. 1613.

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assumptions and perceptions are mixed with (hard) legal, economic and empirically verifiable

facts.30

For me a general definition of tax avoidance could read as follows:

“the process whereby an individual seeks to legally achieve a reduction of tax liabilities.”

Therefore, tax planning could be described as:

“the activity by which a taxpayer seeks to arrange his affairs so that his tax liability is minimized;

avoidance of tax within the limits of tax law is perfectly legitimate. Some forms of avoidance are

merely tax planning by using reliefs or exemptions, for example, by choosing tax-efficient

investments. Others are convoluted and rather artificial.”31

In general, one has to bear in mind that there are many shades of tax avoidance. Whilst some

types/mechanisms of avoidance might even be encouraged by governments (for example savings

into pension) clearly not all methods of tax avoidance are condoned.

In this context, it is therefore highlighted that tax avoidance and tax evasion are not the same

phenomena. Tax avoidance must be distinguished from tax evasion, which is the employment of

unlawful methods to circumvent tax laws and subsequently tax liabilities. While tax evasion is

unlawful and in general constitutes a crime, tax avoidance clearly is not. In my opinion, the general

definition of tax evasion could be the following:

“[the] intentional and fraudulent attempt to escape payment of taxes in whole or in part. If proved

to be intentional and not just an error or difference of opinion, tax evasion can be a chargeable

Federal crime.”32

According to the Explanatory Statement of the final BEPS Report 2015 of the OECD, between 2013

and the publication date of the final report (October, 5 2015), a potential magnitude of BEPS was

detected, with estimates indicating that the global corporate income tax (hereinafter referred to as

30 According to a survey, responses from nearly 600 corporate tax executives to investigate companies’ incentives/disincentives for tax planning have been analysed. The result was that reputational concerns matter to executives – 69% of executives, rate reputation as important and the factor ranks second in order of importance among all factors explaining why firms do not adopt a potential tax planning strategy (Graham, Hanlon, Shevlin, Shroff – Incentives for Tax Planning and Avoidance: Evidence from the Field (November 11, 2013), The Accounting Review, Vol. 89, No. 3, pp. 991-1023, May 2014; MIT Sloan Research Paper No. 4990-12). 31 http://legal-dictionary.thefreedictionary.com/tax+avoidance with further reference to Collins Dictionary of Law © W.J. Stewart, 2006. 32 http://legal-dictionary.thefreedictionary.com/tax+evasion with further reference to Gerald N. Hill and Kathleen T. Hill.

http://legal-dictionary.thefreedictionary.com/tax+avoidance

http://legal-dictionary.thefreedictionary.com/tax+evasion

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“CIT”) revenue losses, was potentially laying between 4% to 10% of global CIT revenues which

corresponds roughly to between USD 100 and 240 billion annually.33

To combat BEPS the OECD published its so-called BEPS Action Plans, comprising 15 concrete

measures/action plans. The action plans have been developed in the context of the OECD/G20 BEPS

Project, with the aim of equipping governments with domestic and international instruments to

combat tax avoidance, ensuring that profits are taxed where economic activities generating these

profits are performed and where value is created.34 These action plans cover inter alia the tax

challenges of the digital economy, recommendations for neutralising the effect of hybrid mismatch

arrangements, CFC Rules, limitation rules for interest deductions, measures to combat treaty abuse,

changes to the definition of permanent establishment to prevent its artificial circumvention, the

alignment of transfer pricing rules with value creation, mandatory disclosure rules and the signing

of a multilateral instrument.35

At EU level, on January 28, 2016 the Commission presented its proposal for an Anti-Tax Avoidance

Directive as part of the Anti-Tax Avoidance Package. The Anti-Tax Avoidance Package consists of

4 key elements, namely the ATAD proposal, the revision of the Administrative Cooperation

Directive, the Recommendation on tax treaties and a communication on an external strategy for

effective taxation. On June 20, 2016, the Council adopted the Directive (EU) 2016/1164 laying

down rules against tax avoidance practices that directly affect the functioning of the internal

market.36

When reading the explanatory memorandum of ATAD it becomes clear that ATAD can be seen as

a direct responds to the finalisation of the BEPS project by the G20 and the OECD, as a step further

to hard law, as well as a means to reach the goal of a stronger and more coherent EU approach

against corporate tax abuse.37 The explanatory memorandum further states that “the schemes

targeted by ATAD involve situations where taxpayers act against the actual purpose of the law,

taking advantage of disparities between national tax systems, to reduce their tax bill.”38

Furthermore, the preamble of ATAD itself demonstrates its intension when discussing the necessity

to lay down rules against the erosion of tax bases in the internal market and the shifting of profits

33 Explanatory Statement OECD BEPS Final Report 2015, p 4. 34 See http://www.oecd.org/tax/beps/beps-actions.htm. 35 For further details of each action plan see http://www.oecd.org/tax/beps/beps-actions.htm. 36 For completeness sake, it has to be noted, that in the meanwhile an “ATAD 2” as well as further developments regarding the CCCTB emerged. 37 See 1. Context of the proposal of the explanatory memorandum of ATAD. 38 See 1. Context of the proposal of the explanatory memorandum of ATAD.

http://www.oecd.org/tax/beps/beps-actions.htm

http://www.oecd.org/tax/beps/beps-actions.htm

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out of the internal market.39 In contrast to the OECD Action Plans the Commission obviously was

of the opinion that in order to contribute to achieving the aforementioned objective only 5 specific

measures were required (e.g. rules concerning limitations to the deductibility of interest, rules

regarding exit taxation, a general anti-abuse rule40, CFC rules and rules to tackle hybrid

mismatches). One major concern of ATAD is that the rules should not only aim at countering tax

avoidance practices, but also prevent the genesis of other obstacles to the market, such as double

taxation.41

It seems fair to say, that in past decades most effort has been focused on double taxation relief rather

than on prevention of non-taxation.42 Recent developments – as described above – suggest that this

effort has and will continue to shift in future.

2.2. What is CFC Legislation?

The image below illustrates the basic idea of CFC legislation and the (simplified) underlying

problem43.44

Source: (http://ec.europa.eu/taxation_customs/business/company-tax/anti-tax-avoidance-

package/anti-tax-avoidance-directive_en).

39 See paragraph (5) of the preamble of ATAD. 40 General anti-abuse rules (GAAR) are generally used to tackle abusive tax practices that have not yet been dealt with through specifically targeted provisions. The function of GAARs is quite straightforward and clear namely filling in gaps, which should not affect the applicability of specific anti-abuse rules. 41 See paragraph (5) of the preamble of ATAD. 42 See also Ault – Some Reflection on the OECD and The Source of International Tax Principles, Working Paper 2013 – 03 Max Planck Institute, reprinted from Tax Notes Int’l, June 17, 2013, p 1195 and 1199. 43 One of the preferred schemes of MNEs regarding IP-rights is the so-called “Double Irish Dutch Sandwich”. Without “proper” CFC Rules tax structures such as the aforementioned will continuously erode tax bases; see for further details about the “Double Irish Dutch Sandwich”, Fuest, Spengel, Finke, Heckemeyer, Nusser – Profit Shifting and “Aggressive” Tax Planning by Multinational Firms: Issues and Options for Reform, Discussion Paper No. 13-078, p 4-8. 44 For more detailed examples see also See also Ault – Some Reflection on the OECD and The Source of International Tax Principles, Working Paper 2013 – 03 Max Planck Institute, reprinted from Tax Notes Int’l, June 17, 2013, p 1199.

http://ec.europa.eu/taxation_customs/business/company-tax/anti-tax-avoidance-package/anti-tax-avoidance-directive_en

http://ec.europa.eu/taxation_customs/business/company-tax/anti-tax-avoidance-package/anti-tax-avoidance-directive_en

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In order to benefit from tax advantages by shifting profits into a controlled foreign company which

has been incorporated in a low-tax jurisdiction, it is generally required that the CFC is treated as a

separate legal entity for tax purposes.45 Due to generally accepted principles of international

taxation, profits earned (but not distributed) by a subsidiary not resident in the country of a parent

company, are not subject to instant taxation at the parent company’s level.46 Without specific rules,

taxation of these profits at the parent company’s level is “deferred” or postponed until repatriated.47

CFC Rules have the effect of re-attributing the income of low-taxed controlled subsidiaries to their

parent company. Subsequently, at the parent company level a tax liability for this attributed income

arises (namey: the parent company becomes taxable on this attributed income) in the country where

it is resident for tax purposes.48 In other words, CFC Rules lead to (immediate) taxation of income

of a CFC company in the hands of its shareholder even though no flow of money occurred (i.e. no

dividend distribution takes place).

Due to heterogeneous policy priorities of different countries, CFC rules may target different subject

matters, (i) an entire low-taxed subsidiary, (ii) (only) specific categories of income or (iii) (only)

income which has artificially been diverted to the subsidiary. Following the “mechanical system”

of established CFC Rules, CFC taxation is generally only triggered if certain requirements are met

(e.g. ownership, passive income, low tax rate etc).

This being said, one should always bear in mind that the principle of efficiency, the principle of

certainty and simplicity and the principle of effectiveness and fairness have to be taken into account,

as these principles can be seen as commonly accepted policy considerations. Especially when

dealing with rules that effect international business activities, such as CFC Rules, the principle of

efficiency proves to be crucial, since compliance costs for both, companies and governments, should

be minimised as far as possible, and therefore not hinder companies to conduct cross-border

business, while at the same time discharging governments resources when monitoring the

companies. Additionally, the principles of effectiveness and fairness play a major part when dealing

with CFC Rules, as taxation should generate the “right” amount of tax at the right time, while

avoiding both, double taxation as well as double non-taxation.49 Hence, a balance between the

45 See Heidenreich – CFC Rules as an instrument to Counter Abuse in Simader, Titz – Limits to Tax Planning, p 221. 46 See also Heidenreich – CFC Rules as an instrument to Counter Abuse in Simader, Titz – Limits to Tax Planning, p 221. 47 See also Heidenreich – CFC Rules as an instrument to Counter Abuse in Simader, Titz – Limits to Tax Planning, p 221. 48 See also paragraph (12) of the preamble of ATAD. 49 See OECD BEPS Report, Action Plan 1 - 2015 Final Report, p 20.

13

various policy aims has to be achieved, and can be found most clearly when examining the rules on

defining CFC income.50

2.3. Short Overview of the Historic Background and the latest Developments of CFC Legislation

The United States of America were the first country to put some limits on tax deferral, by enacting

the “Accumulated Earnings Tax” 51 and later the “Foreign personal holding company rule”52.53 This

pioneering role might be based on the strong US economy and the amount of US MNEs. Even

before introducing specific rules to combat deferral, the US authorities were well aware of the

shielding effect of foreign corporations in low tax jurisdictions.54 The latter (“Foreign personal

holding company rule”) was not effective enough to hold back tax deferral as it only applies to

individuals.55 “Given the failure of these two previous rules in limiting tax deferral, the U.S., in

1962, under the Kennedy administration, was the first country to adopt CFC legislation, called

Subpart F, which is still the most important U.S. anti-deferral regime.”56 These rules are to be

found in the Subpart F (as its name already suggests) of part III of subchapter N of chapter 1 of

subtitle A of the IRC.

After their first introduction in 1962, an increasing number of countries started adopting CFC

Rules.57 In 1990 the OECD Council adopted a recommendation in which it advised counties, which

had not incorporated CFC Rules into their domestic tax laws, to implement such legislation.58

In February 2013, the OECD released its (new) report addressing base erosion and profit shifting.

Subsequently, in September of 2013 the OECD and G20 countries developed a 15-point Action

Plan to combat BEPS. During the following 2 years, the involved countries increasingly worked

together, also in conjunction with the European Commission.59 After these 2 years the 15 Action

Plans were completed and consolidated into the final BEPS Action Plans of 2015. According to the

50 See OECD BEPS Report, Action Plan 3 - 2015 Final Report, p 14. 51 Adopted in 1921. 52 Adopted in 1937. 53 Avi-Yonah, Halabi, “US Subpart F Legislative Proposals: A Comperative Perspective” (2012). Law & Economics Working Papers. Paper 69, p 3. 54 See Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, p 15. 55 Avi-Yonah, Halabi, “US Subpart F Legislative Proposals: A Comperative Perspective” (2012). Law & Economics Working Papers. Paper 69, p 3. 56 Avi-Yonah, Halabi, “US Subpart F Legislative Proposals: A Comperative Perspective” (2012). Law & Economics Working Papers. Paper 69, p 3. 57 Starting with Germany in 1972 followed by Canada and Japan; see Avi-Yonah, Halabi, “US Subpart F Legislative Proposals: A Comperative Perspective” (2012). Law & Economics Working Papers. Paper 69, p 4. 58 See OECD, Harmful Tax Competition – An Emerging Global Issue, Paris 1998. 59 See OECD BEPS Action Plan 3, 2015 Final Report, Foreword, p 3.

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executive summary60 of the BEPS Action Plan 3 of 2015, currently 30 of all the countries

participating in the OECD/G20 BEPS Project have CFC Rules, and many others have expressed

interest in introducing them.

Moreover, in July 2016, also the EU introduced an “Anti-Tax Avoidance Directive” (the Council

Directive (EU) 2016/1164) including inter alia CFC Rules (Art 7 and 8 ATAD) with the aim of

harmonising anti-tax avoidance measures within the internal market. Member States are obliged to

implement Art 7 and 8 ATAD into their domestic law before December 31, 2018.61

2.4. Main thumb-prints of CFC Rules (based on the building blocks of the OECD Base Erosion

and Profit Shifting Project - Action Plan 3)

As already mentioned, the political background as well as technical details of CFC Rules vary

between different countries. The structure of the CFC legislation itself, however, is quite similar in

many countries.62 Therefore, it is important for governments, as well as tax advisors/tax lawyers to

understand and identify these similarities (basic elements) if they want to adopt their own CFC

legislation.63

In general, 4 essential elements can be found in CFC Rules:

a) a definition of control;

b) the criterion of the effective level of taxation;

c) the criterion of activity;

d) a definition of the type of income.

The OECD Action Plan 3, offers 6 building blocks that are, according to the OECD, necessary for

effective CFC Rules. As these building blocks include all 4 key elements described above and also

exemplify additional aspects to be considered when implementing (new) CFC Rules, I will

illustrate the main characteristics of CFC Rules based on the 6 building blocks recommended by

the OECD. Subsequently, I will analyse Art 7 and 8 ATAD and the Subpart F legislation according

to these building blocks.

60 See OECD BEPS Action Plan 3, 2015 Final Report, p 9. 61 See Art 11 (1) ATAD. 62 Heidenreich – CFC Rules as an instrument to Counter Abuse in Simader,Titz – Limits to Tax Planning, p 223. 63 See also Aigner / Scheuerle / Stefaner in Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 16.

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2.4.1 Definition of a CFC

According to the OECD, when adopting a “sufficient” definition of the term controlled foreign

company a distinction between 2 questions must be made, i.e., (i) whether a foreign entity is of the

type that would be considered a CFC and (ii) whether the parent company has enough control over

the foreign entity.64

2.4.1.1. Definition of Entities Covered

The recommendation of the BEPS report shows a very broad definition of what should be considered

a CFC. Although some scholars argue, that CFC legislation should only apply to those foreign

entities that are treated as separate taxable persons with regard to domestic tax purposes65, the OECD

advocates for a very broad definition whereby the CFC rules could also apply to transparent entities

and even to permanent establishments (hereinafter referred to as “PE”).

Even though the OECD stipulates that transparent entities, in case their profits are (already) taxed

in the parent jurisdiction, should by no means be treated as a CFC, it still recommends to draft the

definition as inclusive as possible in order to include transparent entities as well as PEs.66

This approach, combined with the proposed hybrid mismatch rule (with the aim of solving non-

taxation of income/transactions due to different classifications in different jurisdictions) should be

adopted to ensure that the legal form or rather the change of legal forms of subsidiaries per se does

not allow companies in the parent jurisdiction to circumvent CFC Rules.67

2.4.1.2. Level of (sufficient) Control/Influence

When defining control/sufficient influence 2 different determinations are required: the type and the

level of control.

Type of Control: while under most CFC legislations substantial influence is established (“only”)

through a certain percentage of shares,68 Action Plan 3 mentions a variety of possibilities on how to

64 See OECD BEPS Action Plan 3, 2015 Final Report, p 21. 65 See also Aigner / Scheuerle / Stefaner in Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 18. 66 For examples, why such a broad definition might be necessary see OECD BEPS Action Plan 3, 2015 Final Report, p 22 – 23. 67 For examples, why such a hybrid mismatch rule might be necessary see OECD BEPS Action Plan 3, 2015 Final Report, p 22 – 23. 68 See Aigner / Scheuerle / Stefaner in Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 18.

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establish control (e.g. legal control, economic control, de facto control or control based on

consolidation)69:

• legal control: refers to the holding of share capital to identify the percentage of voting rights

(mechanical test);

• economic control: focuses on the rights to receive profit distributions in certain

circumstances, such as disposal, dissolution or liquidation (mechanical test);

• de facto control: takes factors such as top-level decisions and the ability to influence the

daily business / activities (generally used as an anti-avoidance rule);

• control based on consolidation: looks at whether a non-resident company is consolidated in

the accounts of a resident company (based on accounting principles).

The BEPS report recommends to apply (at least) both, legal and economic control criteria.

Additionally, the OECD suggests to include a de facto test to prevent circumvention.

Level of Control: the OECD proposes a threshold of (minimum) 50% control.70 It suggests 3 different

ways for establishing the level of control, the acting-in-concert test71, the related party test72 and the

concentrated ownership requirement73. In conclusion, the BEPS report clearly recommends that the

definition of the level of control should include direct and indirect control, irrespective of which one

of the 3 approaches was chosen.

2.4.1.3. Exemptions and Threshold Requirements

Exemptions and/or threshold requirements are used to (i) limit the scope of CFC Rules and make

them more targeted and effective and (ii) to reduce the overall level of administrative burden.74 The

BEPS report discusses 3 different options of exemptions and threshold requirements:

• De minimis threshold: income that normally would be treated as CFC income is not included

in the taxable income of parent companies as long as it does not surpass a(n) specified

limit/amount;

• Anti-avoidance requirement: only structures and/or transactions that are

established/conducted with the sole purpose of avoiding tax shall be subjected;

69 See further OECD BEPS Action Plan 3, 2015 Final Report, p 24. 70 The BEPS report stipulates that even a lower threshold might be required. 71 Focuses if minority shareholders are acting together. 72 Looking to the relationship of the parties involved. 73 Could for example, entail that the interest of all residents in the CFC is aggregated as long as each single interest is higher than 10%. 74 See further OECD BEPS Action Plan 3, 2015 Final Report, p 33.

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• Tax rate exemption75: CFC Rules shall only apply if the CFC is subject to a tax rate below

a specified level; therefore, generally a comparison between the taxes levied in the foreign

country and the domestic taxes takes place.76

Overall, the OECD recommends the adoption of a tax rate exemption. The exemption shall eliminate

the applicability of CFC Rules for subsidiaries subject to an effective tax rate that is sufficiently

similar to the effective (domestic) tax rate of the parent company. In addition, the tax rate exemption

could be linked to a specific list77 such as a white list.78 For some experts, one of the major

advantages of tax rate exemption is the fact that it ensures legal certainty for companies involved in

international/cross-border business activities.

2.4.2. Definition of CFC Income

In case a company falls within the definition of a CFC, the ensuing step is the question of whether

the income of the CFC is of a type that could be associated with profit shifting activities and should

therefore be attributed to shareholders/controlling parties. An income, which might raise such BEPS

concerns, is, amongst others, income earned by the CFC that provides banking and financial services

or engages sales invoicing as well as income from IP assets.79

The BEPS report points out, that due to the various domestic policy frameworks, one basic (global)

definition might not be applicable for all the Member States. Therefore, the report provides a non-

exhaustive list of possible approaches, which can be applied on a stand-alone-basis or combined

with each other. The OECD recommends that, at a minimum, the funding return allocated under

transfer pricing rules to a low-function cash box (if this cash box meets the other requirements of

the building blocks) should be captured, regardless of which approach might have been adopted.80

The report presents the following possibilities for countries to choose from:

• Categorical Analysis Approach: following this approach, income is divided into categories

and attributed differently following the directed categorisation. Usually a distinction

between 3 subcategories can be made (i.e. legal classification, relatedness of parties and

75 For practical examples on how the exemption functions see OECD BEPS Action Plan 3, 2015 Final Report, p 38. 76 See Aigner / Scheuerle / Stefaner in Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 19. 77 For the possible problem areas of such white lists see further Aigner / Scheuerle / Stefaner in Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 19. 78 See further OECD BEPS Action Plan 3, 2015 Final Report, p 33. 79 See further OECD BEPS Action Plan 3, 2015 Final Report, p 43. 80 See OECD BEPS Action Plan 3, 2015 Final Report, p 43.

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source income). While the legal classification typically focuses on so-called “passive

income”, such as dividends, interest, insurance income, royalties and IP income, the

relatedness of parties’ categorisation refers to the party from whom income was earned

rather than the legal classification.81 The categorisation based on the source of the income,

generally classifies the income resting upon the jurisdiction in which it was earned. This

approach usually takes the form of either an anti-base-stripping rule or a source country

rule;82

• Substance Analysis Approach: this approach basically refers to the activity of a CFC; the

focus lies on whether the income has been separated from the underlying substance via

proxies for measuring the “substance”, such as employees (and people in general), premises,

assets and risks. Hence, the substantial question to be answered is whether the CFC was

capable of generating the income itself.83 The report states that the substance analysis

approach usually applies alongside more mechanical rules and might be combined with

other approaches;84

• Excess Profit Approach: when establishing this approach, the main characteristic is the

expectancy of investors that profits, which are in excess of a normal return and earned in

low-tax-jurisdictions, are to be considered as CFC income. The notion “normal return”

should be understood as the return a regular investor would expect to make with respect to

an equity investment.85 The report also shows a formula for calculating the normal return.86

Finally, the OECD notes that despite of the approach adopted, for an encompassing definition of

CFC income, a decision between the “Transactional Approach” and the “Entity Approach” has to

be taken.87 While the Transactional Approach evaluates the character of each stream of income to

determine whether that stream of income is attributable, under the Entity Approach, an entity that

does not earn a specified percentage/amount of the CFC income will be recognized not to having

any attributable income (even if some of the income would generally be of an attributable character).

Hence, the opposite occurs when applying the Transactional Approach, as some income can be

included even when a major part of the income does not fall within the definition of CFC income.

Therefore, the main difference between these 2 approaches is, that under the Entity Approach either

all (in case the majority of income falls under the definition of CFC Income) or none of the income

81 See OECD BEPS Action Plan 3, 2015 Final Report, p 46. 82 See OECD BEPS Action Plan 3, 2015 Final Report, p 46. 83 See OECD BEPS Action Plan 3, 2015 Final Report, p 47. 84 See for more details about the substance approach OECD BEPS Action Plan 3, 2015 Final Report, p 47. 85 See OECD BEPS Action Plan 3, 2015 Final Report, p 49. 86 The normal return might be calculated by multiplying the rate of return with the eligible equity; see further OECD BEPS Action Plan 3, 2015 Final Report, p 49. 87 See also Aigner / Scheuerle / Stefaner in Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 22 - 23.

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will be included, while under the Transactional Approach all income falling under the definition of

CFC Income will be included even if the majority of income does not.88 The biggest disadvantage

of the Entity Approach is, that it is both, over-inclusive, since it includes all the income if the

majority of income falls under the definition of CFC Income, and under-inclusive, since it subjects

none of the income in case only a small part of the income falls under the definition of CFC

Income.89 The downside of the Transactional Approach is, that it likely increases compliance costs

and administrative burdens, in comparison to the Entity Approach, as a larger number of companies

receive consideration under this approach combined with need to consider each stream of

income.90,91

2.4.3. Rules for Computing Income

According to the OECD BEPS report the next building block covers the computation of CFC income

after the CFC Rules in place determined that the income is attributable. The resulting questions are

(i) which jurisdiction’s rule should apply and (ii) whether any specific rules, for computing CFC

income, are required.

With regard to the first question, the report clearly advises to apply the rules of the parent companies’

jurisdiction when calculating the CFCs income, as it is logically consistent with the nature of CFC

Rules.92 The OECD presents also additional options, such as the application of the CFCs

jurisdiction, the opportunity to choose for the taxpayer which jurisdiction to apply, and finally, the

use of common standards such as IFRS to compute income.93

The recommendation for the second question is to implement a specific rule that limits the offsetting

of losses incurred by the CFC94, so that such losses can only be netted against profits acquired of

the same CFC or against profits of other CFCs located in the same (CFC) jurisdiction.95

88 See OECD BEPS Action Plan 3, 2015 Final Report, p 51. 89 See OECD BEPS Action Plan 3, 2015 Final Report, p 51. 90 See OECD BEPS Action Plan 3, 2015 Final Report, p 51. 91 For an in-depth comparison between the 2 approaches and a juxtaposition of pros and cons of each approach see OECD BEPS Action Plan 3, 2015 Final Report, p 50 – 52. 92 See OECD BEPS Action Plan 3, 2015 Final Report, p 57. 93 Due to various reasons, all of these options show detriments; see further OECD BEPS Action Plan 3, 2015 Final Report, p 57. 94 For a more detailed discussion about offsetting of losses see also Aigner / Scheuerle / Stefaner in Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 24 - 25. 95 See OECD BEPS Action Plan 3, 2015 Final Report, p 58.

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2.4.4. Rules for Attributing Income

The next question to tackle is how the income shall be attributed to the appropriate shareholder of

the CFC.96 The BEPS report subdivides this (main) question into 5 parts and issues

recommendations. The 5 (sub-)parts consists of the following questions:

(i) Which taxpayer shall be subject of the income attribution?

(ii) How much income should be attributed?

(iii) When should the income be included into the taxpayer’s returns?

(iv) How is the income treated?

(v) What is the applicable tax rate?97

The OECD report suggests the following approaches:

• Which taxpayer shall be subject of the income attribution: the subject to whom the income shall

be attributed should be identified according to a minimum control threshold (this means the

attribution threshold should be tied to the earlier determination of control). The second option

provided, is to use a different attribution threshold that attributes the income at least to those

taxpayers who might influence the activities of the CFC;98

• How much income should be attributed: the amount of income to be attributed should be

calculated by reference to the proportion of ownership (e.g. percentage of shares held) and the

effective period of ownership (e.g. in case shares are bought and sold within the same (tax)year,

only the holding period of the shares, until the date of sale shall be relevant);99

• When should the income be included into the taxpayer’s returns: the BEPS report makes no

recommendation with regard to the point in time for inclusion of the income in tax returns, but

stipulates that many existing CFC Rules specify that the attributed income must be included in

the taxpayer’s taxable income for the taxable year during which the CFCs accounting period

ends;100

• How is the income treated: the BEPS report makes no recommendation (with regard to the

treatment of the income). However, the report discusses 2 different approaches, (i) the deemed-

or fictions-divided approach and (ii) the look- or flow-through approach. While the deemed-

dividend approach anticipates, the taxable event relating to the dividend distribution (regardless

of the point of time of distribution, if such distribution actually occurs), the latter approach

96 See also Aigner / Scheuerle / Stefaner in Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 21 - 22. 97 See OECD BEPS Action Plan 3, 2015 Final Report, p 61. 98 See OECD BEPS Action Plan 3, 2015 Final Report, p 62. 99 See OECD BEPS Action Plan 3, 2015 Final Report, p 62. 100 See OECD BEPS Action Plan 3, 2015 Final Report, p 63.

21

deems the controlled foreign company as transparent and, therefore, disregards a CFCs legal

personality for tax purposes;101

• What is the applicable tax rate: the OECD recommends to subject CFC income to taxation at

the rate that would apply to the parent company in the parent jurisdiction.102 The report also

discusses a second approach called “top-up-tax”. This approach works similar to a minimum

tax, since only the difference between the tax paid and a specified threshold would be subject

CFC income.103

2.4.5. Rules to Prevent or Eliminate Double Taxation

In the 6th and last building block the OECD report recommends rules to prevent or eliminate double

taxation which could arise due to the implementation of CFC Rules.104 The OECD explicitly states

that one of the fundamental policy considerations raised by CFC legislation is how to ensure that

CFC Rules do not lead to double taxation, subsequently posing obstacles to international

competitiveness, growth and economic developments.105

To avoid such obstacles and double taxation per se, the BEPS report recommends the

implementation of credit relief for foreign (corporation) taxes actually paid, including CFC tax

assessment of intermediate companies.106 Moreover, the OECD advises to exempt dividends from

the CFC and gains on disposition of CFC shares from taxation in case the income of the CFC has

previously already been subject to CFC taxation.107

2.5. CFC Rules according to the Council Directive (EU) 2016/1164 of July 12, 2016

To fight base erosion and profit shifting activities on a (more or less)108 harmonised foundation, the

European Commission introduced the so-called Anti-Tax-Avoidance Directive in July 2016,

comprising a set of anti-avoidance measures. Art 7 and 8 ATAD lay down the CFC Rules which the

EU Member States are obliged to implement into domestic law until December 31, 2018. As already

101 See Heidenreich – CFC Rules as an instrument to Counter Abuse in Simader,Titz – Limits to Tax Planning, p 224; see also OECD BEPS Action Plan 3, 2015 Final Report, p 63. 102 See OECD BEPS Action Plan 3, 2015 Final Report, p 63. 103 See OECD BEPS Action Plan 3, 2015 Final Report, p 63. 104 See also Aigner / Scheuerle / Stefaner in Lang, Aigner, Scheuerle, Stefaner, CFC Legislation, Domestic Provisions, Tax Treaties and EC Law, p 24. 105 OECD BEPS Action Plan 3, 2015 Final Report, p 65. 106 See further OECD BEPS Action Plan 3, 2015 Final Report, p 66 – 67. 107 See further OECD BEPS Action Plan 3, 2015 Final Report, p 68. 108 Like all directives, the ATAD is only binding as to the result it aims to achieve, Member States are free to choose the method and form.

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explained earlier, Art 7 and 8 ATAD will be evaluated based on the 6 building blocks of the OECD

BEPS report.

2.5.1. Definition of a CFC

Art 7 of the ATAD does not specifically define the types of foreign entities it handles, or fails to

handle. Therefore, the broadest possible approach seems to be chosen by the Commission.

Furthermore, no CFC-targeted hybrid mismatch rule – as recommended by the OECD BEPS report

– is laid out. However, Art 8 ATAD stipulates that the income to be included in the taxable base of

the taxpayer (i.e. the parent company) shall be calculated in accordance with the rules of the

corporate tax law of the Member State where the taxpayer (parent company) is situated or resident

for tax purposes.109 This reference to the parent’s jurisdiction’s corporate tax law may encompass

that domestic hybrid mismatch rules should therefore also apply when dealing with controlled

foreign companies.

With regard to the question of (sufficient) control/influence the ATAD states in Art 7 (1) (a), that in

case the taxpayer (i.e. parent company) by her/himself, or together with its associated enterprises

holds a direct or indirect participation of more than 50 percent of the voting rights, or owns directly

or indirectly more than 50 percent of the capital or is entitled to receive more than 50 percent of the

profits of that entity, she/he shall be seen as controlling/influential.110

2.5.2. Exemptions and Threshold Requirements

Art 7 (1) (b) provides a low-tax requirement provision, stating that the actual corporate tax paid by

the entity or permanent establishment on its profits is lower than the difference between the

corporate tax that would have been charged on the entity or permanent establishment under the

applicable corporate tax system in the Member State of the taxpayer and the actual corporate tax

paid on its profits by the entity or permanent establishment. This means that CFCs which are subject

to an effective tax rate not lower than the difference between the effective tax rate of the parents and

the subsidiaries jurisdiction, are excluded from the scope of the CFC Rules.111

109 See Art 8 (1) ATAD. 110 See Art 7 (1) (a) ATAD. 111 Example: Country A has a tax rate of 30% CIT; Country B has a tax rate of 10% CIT; the difference between the two tax rates is 20%; since the tax rate of Country B (= 10%) is lower than the difference (= 20%), the criterion would be fulfilled; see also Art 7 (1) (b) ATAD.

23

The Directive also states, that the CFC Rules should not apply if the CFC carries on a substantive

economic activity (so-called carve-out) supported by staff, equipment, assets and premises, as

evidenced by relevant facts and circumstances.112 However, in the light of non-genuine

arrangements which have been put in place for the essential purpose of obtaining a tax advantage,

the carve-out rule (substantive economic activity) cannot hinder the attribution of the CFC income

to the parent company.113


When analysing the ATAD, it appears that the Commission defined CFC income based on more

than just one approach. Hence, both, elements of the substance approach (exemption for substantive

economic activity supported by staff, equipment, assets and premises) as well as elements of the

categorical approach can be found. The ATAD provides a choice for Member States to either use

(i) an entity based approach or (ii) a transactional approach.

In more detail, Art 7 (2) (a) ATAD covers the following categories of income:

• interest or any other income generated by financial assets;

• royalties or any other income generated from intellectual property;

• dividends and income from the disposal of shares;

• income from financial leasing;

• income from insurance, banking and other financial activities;

• income from invoicing companies that earn sales and services income from goods and services

purchased from and sold to associated enterprises, and add no or little economic value.

Instead of using the categories listed in Art 7 (2) (a) ATAD, Art 7 (2) (b) ATAD allows the Member

States to implement an attribution rule for CFC income in case the income arises from non-genuine

arrangements. Further, Art 7 (2) (b) ATAD also provides for a definition of the notion “non-genuine

arrangements”.

However, Art 7 (3) ATAD stipulates, that Member States may opt not to treat an entity or permanent

establishment as a CFC if one third or less of the income adding to the entity or PE falls within the

categories mentioned in Art 7 (2) (a) ATAD.114 The same holds true for financial undertakings. In

this case Member States are also given the option of (Art 7 (2) (b) ATAD) excluding from the scope

112 See Art 7 (2) (a) ATAD. 113 See Art 7 (2) (b) ATAD. 114 See Art 7 (3) ATAD.

24

(i) profits of no more than EUR 750.000, and non-trading income of no more than EUR 75.000 or

(ii) profits amount to no more than 10% of operating costs for the tax period.

Finally, the Directive actually allows for 3 different systematic approaches, i.e., target an entire low-

taxed subsidiary (Entity Approach) when attributing CFC income to the parent company, target

(only) specific types of income (Transactional Approach) or be limited to income which has been

artificially diverted to the subsidiary. 115


The chosen path in the ATAD for computing CFC income is completely in line with the OECD

recommendations in the BEPS report.

According to Art 8 (1) ATAD the income to be included in the tax base of the taxpayer shall be

calculated in accordance with the rules of the corporate tax law of the Member State where the

taxpayer is situated or resident for tax purposes. Art 8 (1) ATAD further states that losses of the

entity or permanent establishment shall not be included in the tax base but may be carried forward,

according to national law, and taken into account in subsequent tax periods.116


Art 8 (3) ATAD states that the income to be included in the tax base has to be calculated in

proportion to the taxpayer's participation in the entity as defined in Art 7 (1) (a) ATAD.117 This

attribution rule seems, therefore, to be tied directly to the control threshold stipulated in Art 7

ATAD, and thus, results to also be in line with the BEPS report.

Finally, paragraph (4) of Art 8 ATAD states that the income shall be included in the tax period of

the taxpayer in which the tax year of the controlled foreign company ends.118

115 See also the preamble (12) of ATAD. 116 See Art 8 (1) ATAD. 117 See Art 8 (3) ATAD. 118 See Art 8 (4) ATAD.

25


Concluding, the paragraphs (5), (6) and (7) of Art 8 ATAD provide rules for preventing double

taxation to occur.119

With regard to the distribution to a parent company, Paragraph (5) of Art 8 ATAD stipulates that

such distributed profits are included in the taxable income of the parent. The amounts of income

previously included in the tax base shall be deducted from the tax base when calculating the amount

of tax due on the distributed profits, in order to ensure there is no double taxation.120

Furthermore, paragraph (6) of Art 8 ATAD explains that, in case the parent company disposes of its

participation in the CFC or of the business carried out by the CFC (in the form of a permanent

establishment), and any part of the proceeds from the disposal previously has already been included

in the taxable base, that amount shall be deducted from the tax base when calculating the amount of

tax due on those proceeds.121

Finally, Art 8 (7) ATAD stipulates that the Member State of the parent company shall allow a

deduction122 of the tax already paid by the CFC123 from the tax liability of the parent company in its

state of tax residence or location.124

2.6. CFC Rules according to Subpart F

The Subpart F rules in the IRC spread over §§ 951 – 965. A first brief synopsis of the factual

preconditions and legal consequences of the Subpart F rules can be found in the first paragraph of §

951 IRC125. The subsequent §§ 952 – 965 IRC serve for determining and defining the terminologies

119 See Art 8 (5), (6) and (7) ATAD. 120 See Art 8 (5) ATAD. 121 See Art 8 (6) ATAD. 122 The deduction shall be calculated in accordance with national law. 123 It has to be stated, that it does not matter whether the CFC is established in the form of an entity or a PE. 124 See Art 8 (7) ATAD. 125 “If a foreign corporation is a controlled foreign corporation for an uninterrupted period of 30 days or more during any taxable year, every person who is a United States shareholder (as defined in subsection (b)) of such corporation and who owns (within the meaning of section 958(a)) stock in such corporation on the last day, in such year, on which such corporation is a controlled foreign corporation shall include in his gross income, for his taxable year in which or with which such taxable year of the corporation ends— (A) the sum of— (i) his pro rata share (determined under paragraph (2)) of the corporation’s subpart F income for such year, (ii) his pro rata share (determined under section 955(a)(3) as in effect before the enactment of the Tax Reduction Act of 1975) of the corporation’s previously excluded subpart F income withdrawn from investment in less developed countries for such year, and (iii) his pro rata share (determined under section 955(a)(3)) of the corporation’s previously excluded subpart F income withdrawn from foreign base company shipping operations for such year; and

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used in § 951 IRC. The interaction between the Subpart F rules and the check-the-box rules will be

dealt with in the following chapters.

2.6.1. Definition of a CFC

§ 957 (a) IRC defines the term CFC. The definition captures any foreign corporation if more than

50% of (i) the total combined voting power of all classes of stock of such corporation entitled to

vote, or (ii) the total value of the stock of such corporation, is owned126 or is considered as owned

by applying the rules of ownership of section 958 (b) IRC, by United States shareholders for any

day during the taxable year of such foreign corporation. The term “owned” within the meaning of

§ 958 (a) IRC leads to a direct attribution of stock (i) if directly owned by United States

shareholders or (ii) if owned directly or indirectly, by or for a foreign corporation, foreign

partnership, or foreign trust or foreign estate.127 In addition to the direct and indirect attribution of

stock or voting power, § 958 (b) IRC serves as a broader allocation rule, as the allocation is based

on the economic ownership (so-called “constructive ownership”). This allocation rule can be seen

as an anti-avoidance rule as it takes away incentives to shift stocks and/or voting powers to

affiliated parties. Specific (even broader) rules apply for foreign corporations generating insurance

income.128

Additionally, to the requirement of 50% of the total voting power or value of the corporate stock,

a United States shareholder has to own at least 10% of voting power (§ 951 (b) IRC). With regard

to this 10% threshold, § 958 (a) and (b) IRC (direct/indirect ownership and “constructive

ownership”) are applicable. A United States shareholder129, as defined in § 957 (c) IRC in

conjunction with §7701 (a) (30) IRC, is a person (so-called “United States person”), that is (i) a

citizen or resident of the United States, (ii) a domestic partnership, (iii) a domestic corporation,

(iv) any estate130 and (v) any trust (if certain requirements are fulfilled).

The last requirement is a temporal component. Cumulative to the requirement of 50% of the total

voting power or value of the corporate stock and the existence of a United States shareholder

owning a stock of at least 10% of voting power, the foreign corporation has to fulfil both the

(B) the amount determined under section 956 with respect to such shareholder for such year (but only to the extent not excluded from gross income under section 959(a)(2)).” 126 Within the meaning of section 958(a) IRC. 127 Participation shall be calculated proportionate by its shareholders, partners, or beneficiaries (§ 958 (a) (2) IRC). 128 See § 957 (b) IRC. 129 Special rules apply to corporation organized under the laws of the Commonwealth of Puerto Rico, Guam, American Samoa, or the Northern Mariana Islands. 130 Other than a foreign estate, within the meaning of § 7701 (a) (31) IRC.

27

aforementioned requirements for an uninterrupted period of 30 days or more during any taxable

year (§ 951 (a) IRC).

2.6.2. Exemptions and Threshold Requirements

According to § 952 (b) IRC, in the case of a controlled foreign corporation, “Subpart F Income”

does not include any item of income from sources within the United States which is effectively

connected to the conduct of such trade or business corporation within the United States.131

§ 954 (b) (A) IRC (de minimis rule) stipulates an exemption limit in case the sum of foreign base

company income and the gross insurance income for the taxable year is less than the lesser of (i)

5 % of gross income, or (ii) USD 1.000.000. In contrast, § 954 (b) (B) provides for a full inclusion

of the foreign base company income and the gross insurance income for the taxable year if the

(total) sum exceeds 70 % of gross income.

Another exemption implicates that foreign base company income and insurance income shall not

include any item of income received by a CFC if the taxpayer is able to demonstrate to the

satisfaction of the Secretary that such income was subject to an effective rate of income tax

imposed by a foreign country greater than 90% of the maximum rate of tax according to § 11 IRC

(which is 35 %, leading to a foreign effective minimum tax rate of 31.5 %).


When examining the Subpart F rules, the notion of “CFC income” can be found in § 952 IRC. The

US legislator clearly chose a categorical approach as § 952 (a) IRC provides an exhaustive list of

so-called “tainted income”. This categorical approach provides 5 categories of income to be

defined as tainted.

In more detail § 952 (a) IRC lists the following categories132:

• insurance income;

• foreign base company income (includes foreign personal holding company income which

in turn covers “passive income”133);

131 Unless such item is exempt from taxation (or is subject to a reduced rate of tax) pursuant to a treaty obligation of the United States. 132 To clear up matters, it is emphasized that there are some exceptions regarding the attribution, even if the income falls within one of the listed categories of income (e.g. income derived from trade or business). 133 § 954 IRC captures: (i) dividends, interest, royalties, rents, and annuities, (ii) excess gains over losses from property sales or exchanges, (iii) net foreign currency gains, unless it was specifically related to CFC business needs, (iv) income earned from notional principal contracts and (v) certain payments in lieu of dividends.

28

• income generated in connection with international boycott actions;

• money from illegal bribes, kickbacks, or other payments of similar nature;

• income derived from counties the government of which the United States do not

recognize.

Special rules apply to investments from CFCs in US assets (see § 951 (a) (1) (B)). The Subpart F

legislation (only) follows the Transactional Approach according to which the rules apply to foreign

companies wherever they are located (even if foreign companies are not situated in low tax

jurisdictions / tax havens).134


The amount of the Subpart F income to be computed to the United States shareholder(s) shall be

determined according to US tax law, i.e. it is subject to the parent jurisdiction (in specific § 964 (a)

IRC). Costs incurred shall be deductible within the same category of CFC income.135 In determining

the Subpart F income (or the deficit in such earnings and profits) the amount of any illegal bribe,

kickback, or other payment shall not be taken into account to decrease the income (or to increase

such deficit).136 The income to be computed to the United States shareholder(s) shall be calculated

in proportion to the shareholder's (direct or indirect) participation in the entity.

Regarding the offsetting of losses incurred by the CFC, such losses can only be netted against profits

of the same CFC or against profits of other CFCs located in the same (CFC) jurisdiction.137 The

offsetting is further limited to losses within the same category of CFC income (e.g. rental losses of

one CFC can only be offset against rental profits of another CFC in the same jurisdiction).

Additionally, a loss carry-forward into the next taxable year is also possible (again only within the

same category of CFC income).138


As soon as the CFC income has been calculated, the United States shareholder shall be taxed in the

taxable year in which the taxable year of the corporation ends (§ 951 (a) (1) IRC). United States

shareholders are taxed on their pro rata share.

134 Avi-Yonah, Halabi - "US Subpart F Legislative Proposals: A Comparative Perspective" (2012). Law & Economics Working Papers. Paper 69, p 4. 135 See § 954 (b) (5) IRC. 136 See § 964 (a) IRC. 137 See § 952 (c) (1) (C) IRC. 138 See § 952 (c) (1) (B) IRC.

29

The regular tax rates according to § 1 IRC and § 11 IRC for natural persons and corporations apply.

The IRC follows the deemed dividend approach.139


To eliminate double taxation, income, which has already been taxed on the basis of the Subpart F

rules, shall be excluded from taxation in case of later distribution or investment in US assets.140

Subpart F income increases the shareholders' basis in the stock and any distributions decreases the

basis (which shall avoid double taxation of the same amounts in case of subsequent distribution or

sale of stake).141

This also holds true for CFC chains (§ 959 (b) IRC). It has to be noted, that only the economic

double taxation (and not the juridical double taxation) shall be decisive, meaning the identity of the

same taxable object.142

Additionally, a deemed foreign paid tax credit (also called indirect foreign tax credit) can be claimed

in case the US shareholder is a corporation and foreign tax has been paid for the dividend income.143

139 See Avi-Yonah, Halabi - "US Subpart F Legislative Proposals: A Comparative Perspective" (2012). Law & Economics Working Papers. Paper 69, p 4. 140 See Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, p 40. 141 See § 961 (a) and (b) IRC; see also Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, p 37. 142 See § 961 (a) IRC; see also Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, p 40. 143 See Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, p 42.

30

2.7. Comparative Overview

The idea for this overview has been derived from Schmidt144:

OECD BEPS Report ATA Directive Subpart F

Definition of a

CFC

• Foreign Entity

• Inclusion of

Partnerships and PEs

• Broad Definition

• Legal and Economic

Ownership Test + 50

% Control

• Foreign Entity

• Possibly also

inclusion of

Partnerships and PEs

• > 50 % of the Voting

Rights, Capital or

Proftis (direct and

indirect)

• Foreign

Corporation

• Only Corporations,

therefore, exclusion

of Partnerships and

PEs

• Owner = United

States Shareholder

• > 50 % of the

Voting Rights or

Stock (direct and

indirect +

constructive

ownership)

• United States

shareholder (> 10%

ownership)

• At least 30 days

within any tax year

Exemptions and

Threshold

Requirements

• Tax Rate Threshold

(+ possible additional

requirements, such as

white list)

• Low-Tax

Requirement (< 50%)

• Substantive

Economic Activity

Exemption

• Buisness/Trade

(sourced in USA)

• > 31.5 % effective

foreign tax

• foreign base

company income

and the gross

insurance income

less than the lesser

of (i) 5 % of gross

income, or (ii) USD

1.000.000

144 Schmidt – Taxation of Controlled Foreign Companies in Context of the OECD/G20 Project on Base Erosion and Profit Shifting as well as the EU Proposal for the Anti-Tax Avoidance Directive – An Interim Nordic Assessment, DOI 10.1515/ntaxj-2016-0005, Nordic Tax Journal 2016, p 20 - 22.

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Definition of

CFC Income

• Flexibility for

countries to decide

on how to define

CFC income

• Entity or

Transactional

Approach

• Opt-out possibility if

CFC income ≤ 1/3

• Exhaustive list of

income categories

• Entity Approach or

Transactional

Approach

• Exhaustive list of

income categories

• Transactional

Approach

Computation of

Income

• Rules of parents

jurisdiction

• Deductability of

losses only against

profits of the same

CFC or other CFS

but in the same

jurisdiction

• Corporate tax law of

parents jurisdiction

• CFC’s losses shall

not be included in the

parent’s tax base, but

can be offset against

income of the CFC in

subsequent tax years

• Tax Law (IRC) of

parents jurisdiction

• Deductability of

losses only against

profits of the same

CFC or other CFS

but in the same

jurisdiction + loss-

carry forward

Attribution of

Income

• Tied to Control

Threshold

• Attribution based on

the proportion of

ownership

• Application of parent

jurisdiction’s tax rate

• Tied to Control

Threshold (> 50 %)

• Attribution based on

the proportion of

participation

according to the

control threshold

• Inclusion of the CFC

income at the end of

the CFCs tax year

• United States

shareholder (> 10%

ownership)

• Attribution based

on the proportion

of participation

• Inclusion of the

CFC income at the

end of the CFCs tax

year

Rules to Prevent

or Eliminate

Double Taxation

• Credit relief

(including relief for

CFC tax in

intermediate

companies)

• Exemption for

dividends/gains on

the shareholding

• Deduction of

actually paid foreign

taxes

• Exemption for

dividends / gains on

the shareholding

• Deemed foreign

paid tax credit

• Exemption for

dividends/gains on

the shareholding if

already been

subject to Subpart

F taxation

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3. Comparison in the Light of the Principles of Efficiency and Effectivity

In the 18th century Adam Smith was the first to outline principles, amongst others the principle of

efficiency, of an ideal tax system in his well renowned book “The Wealth of Nations”.145 Even

nowadays, countries still rely on those principle, at least to a certain degree and in modified ways.

As already mentioned in the beginning, legislators when drafting or revising CFC Rules need to

balance the effectiveness of the rules with the reduction of administrative and compliance burdens

(thus, the principle of efficiency).146 The same holds true for the principle effectiveness with the

prevention or elimination of double taxation.147 Due to different taxation systems within countries

(especially, but not limited to the question of CIN vs CEN), countries show different priorities when

it comes to balancing the aforementioned aspects.

It is generally agreed, that one of the biggest advantages of CFC Rules can be their rather automated

(mechanical) application, but it is also true that if CFC Rules are too automated (mechanical) the

effectivity might suffer due to a lack of flexibility.148 Too much flexibility on the other hand might

lead to uncertainty for taxpayers, which subsequently might affect the costs for both taxpayers and

governments when applying and complying with the rules.149 While, an approach that attributes

CFC income solely on the basis of income categories/classifications may most probably lead to low

compliance costs and administrative effort, it might also be of little effectivity as it offers companies

the possibility to conduct transactions that involve other categories of income.150 Therefore, it seems

to be safe to say that finding the “right” balance between these considerations is a delicate subject.

The next section will focus on several strengths and weaknesses in the light of the principles of

efficiency and effectivity of both, the CFC Rules according to the US Subpart F and the ATAD. The

reason for choosing these 2 principles as the basis for comparison was because they best reflect the

economic aspect/approach inherent in tax laws. Economic reality and practicality is an intrinsic facet

when using, interpreting and analysing tax rules. Effectiveness is a prerequisite and safeguard for

the success of legal systems.151 The underlaying concept of the principle of effectiveness is that

taxation should produce the right amount of tax at the right time.152 Alley and Bentley state that “The

145 See Alley and Bentley. (2005) "A remodelling of Adam Smith’s tax design principles", p 586, (http://epublications.bond.edu.au/law_pubs/45). 146 See also OECD BEPS Report, Action Plan 3 - 2015 Final Report, p 11. 147 See also OECD BEPS Report, Action Plan 3 - 2015 Final Report, p 11. 148 See OECD BEPS Report, Action Plan 3 - 2015 Final Report, p 14. 149 See OECD BEPS Report, Action Plan 3 - 2015 Final Report, p 14. 150 See OECD BEPS Report, Action Plan 3 - 2015 Final Report, p 14 - 15. 151 See Accetto, Zleptnik – The Principle of Effectiveness: Rethinking Its Role In Community Law, European Public Law, Volume 11, Issue 3, Kluwer Law International 2005, p 375. 152 See Alley and Bentley. (2005) "A remodelling of Adam Smith’s tax design principles", p 599, (http://epublications.bond.edu.au/law_pubs/45).

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potential for tax evasion and avoidance should be minimised while keeping counter-acting measures

proportionate to the risks involved”.153 Hence, the principle of effectiveness is included to

accentuate the significance that governments place on collecting the full amount of tax due to

them.154 Thus, if CFC Rules are not effective (i) companies will not take them seriously and (ii) the

desired result of CFC Rules (being a deterrent mechanism) will not be achieved. On the other hand,

under the principle of efficiency, a cost-benefit analysis (hereinafter referred to as “CBA”) needs to

be conducted. “As Sen points out, the whole rationale of CBA lies in the idea that things are worth

doing if the benefits resulting from doing them outweigh their costs”.155 According to Alley and

Bentley “minimising taxpayer compliance costs and making compliance easier is thought to improve

revenue collection, it is a prime focus for tax authorities”.156 In addition, if monitoring costs are

(too) high, tax authorities might not be too keen on taking measures as the benefits will most likely

not outweigh the costs. I therefore strongly believe that these 2 principles are most suitable to

conduct the intended comparison.

3.1. Principle of Efficiency

From the taxpayers' point of view, every tax imposed entails compliance costs (i.e. costs incurred

in meeting the requirements of tax rules).157 Hence, the more complex specific tax rules are

assembled, the more compliance costs entrepreneurs will have to face (e.g. necessity for engaging

tax advisors, lawyers etc). However, administrative costs for monitoring, assessing and

administrating tax rules burden the governments.158 A higher complexity of tax rules will

automatically lead not only to higher compliance costs but also to higher administrative costs. Thus,

both parties involved, companies as well as governments, have a severe interest in keeping tax rules

as efficient and therefore, as less money consuming as possible.

➢ Subpart F

More than 50 years after the introduction of the US Subpart F legislation, these rules are now

considered to be one of the most complex tax rules aiming at preventing tax avoidance.159 The

153 See Alley and Bentley. (2005) "A remodelling of Adam Smith’s tax design principles", p 599 - 600, (http://epublications.bond.edu.au/law_pubs/45) with further reference to the OECD. 154 See Alley and Bentley. (2005) "A remodelling of Adam Smith’s tax design principles", p 600, (http://epublications.bond.edu.au/law_pubs/45). 155 See Portuese – Principle of Proportionality as Principle of Economic Efficiency, European Law Journal, Vol 19, No 5, September 2013, p 614, with further reference to Sen – The Disciplin of Cost-Benefit-Analysis. (2000) 29 The Journal of Legal Studies 931 – 952, at 934. 156 See Alley and Bentley. (2005) "A remodelling of Adam Smith’s tax design principles", p 596, (http://epublications.bond.edu.au/law_pubs/45). 157 See Miller, Oats - Principles of International Taxation, 3rd Ed, Bloomsbury Professional Ltd 2012, p 13. 158 See also Miller, Oats - Principles of International Taxation, 3rd Ed, Bloomsbury Professional Ltd 2012, p 13. 159 See Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, p 42.

http://epublications.bond.edu.au/law_pubs/45

34

numerous provisions, cross-references, definitions, exceptions etc make compliance for taxpayers

extremely challenging and therefore trigger compliance costs (e.g. constant monitoring of changes,

purchase of highly trained expert services etc).160 Especially the categorisation of specific kinds of

income as “open to abuse” might be regarded as obsolete, as the categorisation does not deal with

the question whether and to what amount the foreign income has been subject to taxation.161

An additional cost driver seems to be the Transactional Approach chosen by the US162, due to the

fact that it could increase the administrative burdens and compliance costs in relation to the Entity

Approach, requiring tax authorities to consider a larger number of (foreign) companies under their

CFC legislation.163 The OECD BEPS report alludes to the example that in case the CFC Rules set

too high a threshold when evaluating if a CFC is taxed too low and subsequently apply a

proportionate substance analysis, the set of rules might bring a multitude of companies within its

scope and this might even be enhanced if the Transactional Approach is used.164 Thus, in such

circumstances tax authorities will face high monitoring costs.

➢ ATAD

Once more, it must be stated, that harmonisation in the field of direct taxation within the European

Union can scarcely be found. Currently only 13 Member States165 apply CFC legislation, while the

other 14 Member States do not apply CFC Rules.166 Thus, at least for the 14 countries not having

CFC Rules in place, the introduction will trigger administrative and compliance costs. But also for

the other 13 Member States there will be incurring costs, due to possibly necessary adjustments of

the current set of CFC Rules in place.

In my view, the intent of reducing compliance costs for (international) companies with a

harmonised set of CFC Rules has failed (at least at this first attempt). Accordingly, at least 2

(possibly 3) variations seem to exist concerning how to include income from the CFC. As a result,

the final CFC rules implemented by Member States must be expected to vary substantially in scope

and effect, which in its turn will lead to (higher) administrative costs as well as compliance costs.167

However, this will not only lead to high(er) administrative costs and compliance costs, but will also

160 See also Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, p 42. 161 See Avi-Yonah – "Making Sense of U.S. International Taxation: Six Steps toward Simplification." Bull. for Int'l Fiscal Documentation 55, no. 9 (2001), p 496. 162 See also Avi-Yonah, Halabi - "US Subpart F Legislative Proposals: A Comparative Perspective" (2012). Law & Economics Working Papers. Paper 69, p 13. 163 See OECD BEPS Report, Action Plan 3 - 2015 Final Report, p 51. 164 See OECD BEPS Report, Action Plan 3 - 2015 Final Report, p 51. 165 See for a general overview https://www.freedomsurfer.com/cfc/. 166 See http://kluwertaxblog.com/2016/10/17/uncertainties-following-final-eu-anti-tax-avoidance-directive/. 167 See http://kluwertaxblog.com/2016/10/17/uncertainties-following-final-eu-anti-tax-avoidance-directive/.

https://www.freedomsurfer.com/cfc/

35

increase the costs for each individual Member State, which vary according to the chosen approach

(Entity or Transactional Approach). Not to forget, a large number of holding structures within the

EU might be affected and should be reviewed once implementing legislation becomes available

(take for example Ireland with a CIT rate of 12.5%168 and France with a CIT rate of 33.4%169 in

case the holding company is not able to provide proof for sufficient business activity). This again,

will lead to additional costs for internationally active entrepreneurs.

➢ Interim Conclusion

I strongly believe, that Art 7 and 8 ATAD are a compromise, as the individual Member States are

still not fully willing to decrease their sovereignty in direct tax matters. With respect to the 2

possible approaches, being the Entity Approach and the Transactional Approach, a final (reliable)

result regarding which set of rules is more efficient from an administrative point of view, is not

predictable at this point. As long as the EU Member States (after Brexit there will be one important

market player missing) have not implemented their domestic CFC Rules based on Art 7 and 8

ATAD, keeping in mind that the Member States are given at least 2 (possibly 3) different options,

which in turn lead to different cost-efficiency-ratios, the outcome will vary from country to country.

Although in my opinion, the European Commission missed the chance of introducing cost efficient

CFC Rules by restricting the options for the implementation of Art 7 and 8 ATAD for Member

States, and, therefore, increasing the efficiency level, in comparison to the too complex Subpart F

legislation, the cost-efficiency-ratio of the ATAD seems to be better balanced than the Subpart F’s

(at least in its theoretical expression). This conclusion is partly derived on the basis that ATAD

overall still provides the Members States with (more or less) clear and straightforward rules and

little leeway. Compared with the Subpart F Rules, ATAD appears to be less complex. Hence, if

implemented as suggested, taxpayers should not face too many troubles in complying with the

domestic laws and tax authorities in monitoring.

3.2. Principle of Effectivity

As a starting point, one should consider that CFC Rules are generally designed to act as a

deterrent.170 This means that the main purpose of CFC legislation is to prevent tax avoidance and

profit shifting actions by companies, and, therefore, protect the tax base of the parent countries

jurisdiction, rather than generate “CFC tax revenues” for governments.171 Hence, the deterrent

168 http://wko.at/statistik/eu/europa-steuersaetze.pdf. 169 http://wko.at/statistik/eu/europa-steuersaetze.pdf 170 See also OECD BEPS Report, Action Plan 3 - 2015 Final Report, p 13. 171 See also Avi-Yonah, Halabi - "US Subpart F Legislative Proposals: A Comparative Perspective" (2012). Law & Economics Working Papers. Paper 69, p 4; see also OECD BEPS Report, Action Plan 3 - 2015 Final Report, p 13.

36

mechanism only functions, if the CFC Rules are effective and companies are aware of this

effectivity.172 I will now turn to the limitations and challenges that these 2 systems face today.

➢ Subpart F

In my opinion one of the main weaknesses of the US CFC Rules is the definition of the “United

States Shareholder” according to § 951 (b) IRC, as it needs to be jointly applied/read with the

requirements for foreign corporations to be considered a CFC. In doing so, it is striking that the

requirement of “control” of the foreign corporation is only fulfilled if at least 5 US shareholders

hold a participation of at least 10%. This opens all kinds of doors for tax planning as a foreign

corporation that, is entirely controlled by unaffiliated US shareholders, which in turn (only) hold a

participation of less than 10%, and are therefore, not considered to be a CFC for the purpose of §

951 (a) IRC.173 The income of this foreign corporation would in such a case not be subject to the

Subpart F rules.

It is noteworthy that a major actor in the US income taxation system is the so-called Check-the-Box

Regulation. The US income tax law only recognises 2 types of business entities: (i) corporations,

the income of which will be taxed generally twice, once at the entity level and once at the

shareholder level after distribution and (ii) partnerships, the income of which is not taxed at the

entity level but (only) at the partner’s level as partnerships are considered to be fiscally

transparent.174 This distinction is valid for both, US and foreign entities.175 Hence, for US income

tax purposes a business entity (i) established under the laws of or (ii) resident in a foreign country,

is qualified either as a corporation or a partnership. The regulation allows certain entities, other than

per se corporations176 to choose their status.177 Thus, partnerships may opt for being treated as a

corporation for US tax purposes. “The Check-the-Box Regulations make hybrid status as easy as

filling out a one page form.”178 MNEs broadly use the Check-the-Box Regulations and therefore

172 In the meaning of, companies are of the opinion that the profits in “CFC relevant situations” will be subjected to the parent company anyways, so that there is almost no incentive to establish companies in low tax jurisdiction without any (real) economic purpose. 173 See also Avi-Yonah, Halabi - "US Subpart F Legislative Proposals: A Comparative Perspective" (2012). Law & Economics Working Papers. Paper 69, p 9; see also Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, p 43. 174 See Lokken – Whatever happened to the Subpart F? U.S. CFC Legislation after the Check-the-Box Regulations, Florida Tax Review, Volume 7, 2005, p 195. 175 See also Lokken – Whatever happened to the Subpart F? U.S. CFC Legislation after the Check-the-Box Regulations, Florida Tax Review, Volume 7, 2005, p 195. 176 "Per Se" corporations are statutory corporations and are not allowed to choose their classification. " Per Se" corporations are defined in Reg. 301.7701-2(b) and a list is provided in Reg. 301.7701-2(b)(8). 177 See IRS: Chapter 61. International Program Audit Guidelines (https://www.irs.gov/irm/part4/irm_04-061-005.html). 178 Lokken – Whatever happened to the Subpart F? U.S. CFC Legislation after the Check-the-Box Regulations, Florida Tax Review, Volume 7, 2005, p 198.

37

mitigate the application of Subpart F successfully.179 One of the most prominent examples of the

“successful” and advantageous use of the Check-the-Box Regulations in the arena of international

taxation is the already described “Double Irish Dutch Sandwich”.180

Another major flaw of the Subpart F, seems to be the definition of foreign base company income

(“passive income”) according to § 954 (c) (1) IRC. It does not authorise the US tax authorities

(Treasury) to classify other types of income, not specifically mentioned in § 954 (c) (1) IRC, as

foreign base company income, if it would be necessary to avoid circumvention of the Subpart F

rules.181 This rigid system thus, leaves a lot of leeway for MNEs to structure payments or the flow

of funds in such way (e.g. using a different underlying legal basis for the payment) that it will not

fall under § 954 (c) (1) IRC.

With the implemented Subpart F rules in place, the US breaches the shielding effect with regard to

foreign corporations, and, therefore, attain their (international tax) policy goal of CEN.182 According

to Trennheuser, instead of preventing base erosion US corporate groups are hence induced to

relocate their headquarters abroad, in order not to lose their international competitiveness. Jürgen

Schrempp, former CEO of DaimlerChrysler AG, admitted before the US finance committee, that

one of the main reasons for the “new company” (DaimlerChrysler AG) not having its headquarter

in the US after the merger of Daimler Benz AG and Chrysler, was the US Subpart F legislation.183

➢ ATAD

An interesting development to observe, will be the element of the effective tax rate in the ATAD,

which of course inevitably leads to a comparison between the effective tax rates of the residence

country of the parent company and the residence country of the CFC. Bearing in mind that statutory

CIT rates are not harmonised within the EU, the effective tax rates vary even more between the

Member States. This of course opens the doors for tax planning. MNEs could easily structure their

business in a way that an entity with a negative taxable income will be the controlling entity (in such

scenarios the effective tax rate is 0%).184 In this respect for example Germany (like the US a country

179 See also Altshuler, Shay, Toder – Lessons the United States Can Learn from Other Countries’ Territorial Systems for Taxing Income of Multinational Corporations (January 21, 2015), p 13. 180 See for an explanation of the “Double Irish Dutch Sandwich” already p 3 - 4 of this thesis and also Annex B. 181 See also Lokken – Whatever happened to the Subpart F? U.S. CFC Legislation after the Check-the-Box Regulations, Florida Tax Review, Volume 7, 2005, p 205. 182 See Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, p 43. 183 See Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, FN 135 with further references. 184 See Navarro, Parada & Schwarz – The Proposal for an Anti-Avoidance-Directive: Some Preliminary Thoughts, p 16.

38

with a very long history of CFC legislation) uses a 25% effective tax rate threshold185 (it has to be

stated, that credits/refunds for taxes actually paid by the CFC, even if not the CFC itself but the

shareholder has the right to obtain the credit/refund, are taken into account)186; this situation might

lead to the application of CFC Rules when thinking of, for example, Irish or Maltese companies. As

a result, CFC Rules are already applied within the EU (meaning for companies situated in EU

Member States) but will probably be applied more widely after implementation of the new EU CFC

Rules.

Looking at the issue from another angle, countries might either reduce their statutory CIT rate or

introduce special tax incentives such as e.g. accelerated depreciation possibilities to attract

companies respectively and to convince companies to keep being established in the Member States

territory. With such actions, the 50% threshold stipulated in Art 7 (1) (b) ATAD could be

circumvented, and therefore controlled companies might fall through the grid. In my opinion, as

long as there is no harmonisation of CIT systems within the EU, tax competition will further

increase.

Another divergence can be found in discussions surrounding the term “non-genuine arrangements”

in Art 7 (2) (b) ATAD. The term is conflicted because the Court of Justice of the European Union

(hereinafter referred to as “CJEU”) established the requirement of “wholly artificial

arrangements”187 in its landmark decision Cadbury Schweppes188. This approach has also been

adopted by the EFTA Court in the Olsen decision.189 It seems that both terms lack clarity and will

lead to uncertainty. This, will lead to discussions between taxpayers and tax authorities as the term

“non-genuine” as defined in Art 7 (2) (b) needs to be interpreted and, therefore, leaves room for

multiple arguments and positions.190

➢ Interim Conclusion

As shown above, both set of rules, Subpart F and the ATAD, bring to light (different) challenges.

The in some parts already outdated Subpart F legislation reveals how easy it is for companies with

good tax advisors to avoid the application of the US CFC Rules. Not only the fact that all types of

income that are not specifically mentioned as Subpart F income according to § 952 IRC, are not

185 See § 8 (3) Außensteuergesetz. 186 See Trennheuser - US-amerikanische Subpart F-legislation und deutsche Hinzurechnungsbesteuerung, p 74 – 75. 187 See further also Schön – Taxing Multinationals in Europe, Max Planck Institute, 2012, p 23. 188 C-196/04 - Cadbury Schweppes plc, Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue, judgment of 12.9.2006. 189 Joined Cases E-3/13 and E-20/13, Fred. Olsen and Others and Peter Olsen and Others; see also Navarro, Parada & Schwarz – The Proposal for an Anti-Avoidance-Directive: Some Preliminary Thoughts, p 17. 190 See further Navarro, Parada & Schwarz – The Proposal for an Anti-Avoidance-Directive: Some Preliminary Thoughts, p 17.

39

subject to Subpart F, but also the interplay with the Check-the-Box Regulation, makes the US

Subpart F legislation arbitrary.191 MNEs have the tools to decide by themselves if they want to be

subject of Subpart F or not, by creating hybrid entities. The EU CFC Rules clearly suffer from the

(general) lack of direct tax harmonisation within the EU, as there is no common CIT rate. The

different CIT rates within the 27 (after the Brexit 26) Member States might lead to a tax rate race to

the bottom, as governments want to attract MNEs and convince them to conduct their business in

the Member States territory. In conclusion, Subpart F shows a larger number of loopholes,

ineffective mechanisms and opportunities for companies to circumvent the application of the CFC

Rules and, therefore, appears to be less effective than Art 7 and 8 ATAD (at least in its theoretical

expression). Of course, as a matter of fairness, it has to be noted that possible loopholes of the ATAD

CFC Rules can only be uncovered after their introduction; on paper Subpart F seems to only be

sporadically effective.

4. Taxation in the International Arena (Overview)

4.1. The Legal Concepts of International Tax Law

It should be acknowledged at this point, that this thesis discusses only a small fragment of the legal

and economic principles, since the framework does not allow a more extensive exploration of this

topic. As CFC Rules only affect cross-border transactions, the basic framework of international

taxation needs to be considered, as it is of particular significance. In simple terms, international

taxation deals with 4 core issues192:

(i) taxation of foreign income of residents;

(ii) taxation of domestic income of non-residents;

(iii) prevention of the double taxation ensuing from the parallel exercise of taxing jurisdiction

by 2 states concerning the same tax base, and

(iv) prevention of international tax avoidance.

In general, a basic distinction is made between non-residents (generally taxation arises only when

generating [domestic] source income) and residents (generally taxable for their complete world

income).

This being said, different types of cross-border business activities therefore also lead to different

taxable outcomes in source countries. Non-residents are generally faced with limited tax liability at

the source (territoriality taxation) of income from direct business activities193 and in some situations

191 For an example, how easy it is to circumvent Subpart F via Check-the-Box schemes, see inter alia Altshuler, Shay, Toder – Lessons the United States Can Learn from Other Countries’ Territorial Systems for Taxing Income of Multinational Corporations (January 21, 2015), p 13 – 14. 192 See Terra, Wattel – European Tax Law, p 451. 193 E.g. dividend income from holdings usually > 10%.

40

also from direct investments194.195 Hence, if a non-resident establishes a subsidiary or a non-

transparent entity in the source country he will be subject to unlimited tax liability.196 By contrast,

worldwide taxation197 is applied to residents. The basic underlying idea of this concept is the direct

benefit principle (i.e. all residents generally benefit from social, cultural, economic and physical

infrastructure etc).198 The underlying idea for limited source taxation of non-residents is more or

less the idea of a compensation for the possibility to earn income offered by the source state.

In conclusion, one can state that source taxation focuses on income that was generated within a

certain territory, while residence199 taxation focuses on the taxpayer and her/his overall ability to

pay.200

4.2. The Economic Concepts of International Tax Law / The Aim of Tax Neutrality

From a tax policy perspective, taxes should not distort the (economic) decision making process,

hence, taxes should be “neutral”.201 For the purpose of avoiding (international) double taxation,

residence and source countries generally have to agree on the concrete allocation of taxing rights on

cross-border transactions. The 2 commonly used methods are the credit method, which deducts the

foreign tax from the domestic tax on worldwide income and the exemption method which eliminates

the foreign income from the domestic tax base.202 Consequently, the (complete) exemption of

foreign income from domestic taxation leads to capital import neutrality (hereinafter referred to as

“CIN”) as the taxpayer is just confronted with taxation in the source country. On the other hand,

capital export neutrality (hereinafter referred to as “CEN”) is achieved when crediting the foreign

tax paid against the domestic tax.203

194 E.g. income via PE at source or from a transparent entity. 195 See Endress/Spengel, International Company Taxation and Tax Planning, Kluwer Law International, §8.01 [A], p 281. 196 See Endress/Spengel, International Company Taxation and Tax Planning, Kluwer Law International, §8.01 [A], p 281. 197 I.e. worldwide / total income. 198 See also Terra, Wattel – European Tax Law, p 452. 199 For an overview about the developments of corporate residence see inter alia Harris – Corporate Tax Law: Structure, Policy and Practice (Cambridge Tax Law Series), 2013, p 35 – 36. 200 See Terra, Wattel – European Tax Law, p 452. 201 See also Kofler - Indirect Credit versus Exemption: Double Taxation Relief for Intercompany Distributions in BULLETIN FOR INTERNATIONAL TAXATION FEBRUARY 2012, p 77. 202 See Endress/Spengel, International Company Taxation and Tax Planning, Kluwer Law International, §7.02 [E], p 222. 203 For more concepts of neutralities, such as National Neutrality, Capital Ownership Neutrality or Market Neutrality see inter alia Weisbach - The Use of Neutralities in International Tax Policy; Schön – International Tax Coordination for a Second-Best World (Part I), World Tax Journal – IFA Congress Issue – September 2009.

41

In summary, CEN’s starting point is the investor. It aims at ensuring that for the investor the choice

between domestic and foreign investments is not distorted by tax considerations.204 By contrast,

CIN’s emphasis is put on the investment in a given jurisdiction itself as it ensures that investments

shall bear no different tax burden for domestic and foreign investors.205 Capital export neutrality is

thought to support either a purely residence-based system or a worldwide source-based taxation with

an unlimited foreign tax credit, while CIN is thought to support taxation by the source country with

the residence country exemption foreign source income.206 The final choice of countries between

CEN and CIN seems to be influenced by the size and the economic environment of their own

economy; economies with a stronger autonomy tend to follow CEN while “more open” economies

appear to prefer CIN.207

The international tax system of the United States of America is consistent with CEN208, it is also

one of the few remaining countries209, which taxes its MNEs on their worldwide income, while the

27 Member Counties within the EU are (generally) free to choose their (international) tax approach

due to their tax sovereignty210.211 As Schön states “the ECJ is agnostic when it comes to the

antagonism between CEN and CIN”.212

4.3. Alternative Approach (2nd best solution)

The international aspect of income taxation is the area where one can find the highest convergence

between national systems, because this is where tax systems interact directly with each other.213 The

economic starting point is the concept of neutrality, aiming at the situation in which investors

decisions are not distorted by tax considerations.214 In the ideal world (first best solution), this

concept would mean full harmonisation of tax laws and tax rates (around the world), hence leading

204 See Schön – International Tax Coordination for a Second-Best World (Part I), World Tax Journal – IFA Congress Issue – September 2009, p 71. 205 See Schön – International Tax Coordination for a Second-Best World (Part I), World Tax Journal – IFA Congress Issue – September 2009, p 71. 206 See Weisbach - The Use of Neutralities in International Tax Policy, p 3. 207 See Kemmeren – The Principle of Origin in Tax Conventions, p 111. 208 See Avi-Yonah, Sartori – International Taxation and Competitiveness: Introduction and Overview (May 3, 2012). Tax Law Review, Vol. 65, 2012; U of Michigan Law & Econ Research Paper No. 12-014, p 317. 209 See Altshuler, Shay, Toder – Lessons the United States Can Learn from Other Countries’ Territorial Systems for Taxing Income of Multinational Corporations (January 21, 2015), p 10. 210 See also Schön – Taxing Multinationals in Europe, Max Planck Institute, 2012, Abstract. 211 See inter alia Terra, Wattel – European Tax Law, p 24; also Schön – Taxing Multinationals in Europe, Max Planck Institute, 2012, p 8. 212 See Schön – Taxing Multinationals in Europe, Max Planck Institute, 2012, p 10. 213 See also Avi-Yonah, Halabi - "US Subpart F Legislative Proposals: A Comparative Perspective" (2012). Law & Economics Working Papers. Paper 69, p 4. 214 See Schön – International Tax Coordination for a Second-Best World (Part I), World Tax Journal – IFA Congress Issue – September 2009, p 78.

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to a flawless level playing field irrespective of the location of the residence of taxpayers and

irrespective of the sources of income.215 As Schön mentions, this ideal solution is unrealistic due to

political and theoretical reasons.216 According to Weisbach, unless tax rates and the tax base are the

same in all countries, it is impossible to achieve both CEN and CIN217 at the same time.218 Hence, it

appears that a central feature of international tax policy is that the policy choice is framed as picking

one of the competing neutralities (CEN or CIN)219.

Although CEN is regarded as fostering efficiency220 and considered being “superior” than source-

based taxation in achieving the ultimate goal of neutrality, one of the main reasons why I consider

CEN as not being the optimal choice for international tax allocation is the fact that the dominant

feature of “residence” is easily to manipulate221 (e.g. corporations that can easily shift around their

headquarters; the possibility to establish subsidiaries in low-tax countries which in turn retains their

profits).222 CIN on the other hand, is considered to promote competition223.224 As I am a strong

supporter of the concept of “let the market decide”, CIN is more appealing to me as it leads to a

level playing field in the relevant market unlike CEN which will (most probably) lead to the situation

that residents of high tax countries will be discouraged to invest in low(er) tax countries due to their

competitive disadvantage of lower after tax returns.225

Hence, in my view, a change from CEN to CIN, from residence-based taxation to territoriality-based

taxation (thus, exempting foreign sourced income entirely) needs to be adopted within the

215 See Schön – International Tax Coordination for a Second-Best World (Part I), World Tax Journal – IFA Congress Issue – September 2009, p 78. 216 See – The Principle of Origin in Tax Conventions, p 74; see also Schön – International Tax Coordination for a Second-Best World (Part I), World Tax Journal – IFA Congress Issue – September 2009, p 78. 217 For CEN and CIN within the European context see also Terra, Wattel – European Tax Law, p 129 - 139. 218 See Weisbach - The Use of Neutralities in International Tax Policy, p 4; see also Schön – Taxing Multinationals in Europe, Max Planck Institute, 2012, p 7 – 8. 219 For a comprehensive overview of CEN/CIN and the Fundamental Freedoms see Schön – Taxing Multinationals in Europe, Max Planck Institute, 2012. 220 See Kemmeren – The Principle of Origin in Tax Conventions, p 75. 221 See further Avi-Yonah – Beyond Territoriality and Deferral: The Promise of 'Managed and Controlled' (August 12, 2011). U of Michigan Public Law Working Paper No. 248. 222 See Schön – International Tax Coordination for a Second-Best World (Part I), World Tax Journal – IFA Congress Issue – September 2009, p 80. 223 For a deeper evaluation of the notion “competitiveness” see Avi-Yonah, Sartori - International Taxation and Competitiveness: Introduction and Overview (May 3, 2012), Tax Law Review, Vol. 65, 2012; U of Michigan Law & Econ Research Paper No. 12-014. 224 See Kemmeren – The Principle of Origin in Tax Conventions, p 75. For counter-arguments see inter alia Schön – International Tax Coordination for a Second-Best World (Part I), World Tax Journal – IFA Congress Issue – September 2009, p 81 and Weisbach - The Use of Neutralities in International Tax Policy, p 4. 225 See inter alia Avi-Yonah, Sartori - International Taxation and Competitiveness: Introduction and Overview (May 3, 2012), Tax Law Review, Vol. 65, 2012; U of Michigan Law & Econ Research Paper No. 12-014, p 315 - 316; see also Kemmeren – The Principle of Origin in Tax Conventions, p 75.

43

international tax arena.226 Also from an economical point of view, in my opinion, CIN makes more

sense as it reduces compliance costs, administrative burdens, and afflictions of proof for both tax

authorities and companies. One of the characteristics of the credit system (and therefore also a CEN

system) is the administrative cumbersomeness. As a first step the attributable domestic tax needs to

be calculated (for limitation purposes) and as step 2, the foreign tax needs to be established (for

credit purposes).227 Hence, either foreign tax law or a special domestic system needs to be applied;

as Terra and Wattel correctly point out, the latter case is in particular complex where further tier

credit for underlying tax is to be expanded.228 If one takes a multi-tier indirect credit system as an

example, it becomes clear that such a system is particular complex and administratively

cumbersome for parent companies.229 The parent company needs to demonstrate the sum of the

ultimate foreign CIT attributable to the (re)(re)distributed eventual foreign profit of foreign

(sub)(sub)subsidiaries.230

Source taxation which adheres to CIN comes to mind first when speaking about territoriality-based

taxation. The idea of source taxation leads to the conclusion that taxation of income received by a

person from a person of another state is justified based on the strong connection to the territory

where the other person or property is physically located.231 Therefore, the justification is grounded

in the idea that the income physically “appears” in the state of the other person/property. This

diverges when applying the principle of origin (which also adheres to CIN), as a causal link between

the generation of income and the location (territory) in which the income is generated is pivotal.232

This small, but significant difference leads to different allocations of income. Thus, if income is not

produced within a territory, but still physically appears in that territory, taxing rights would be

allotted to this territory under the principle of source, whereas a different allocation would occur

when applying the principle of origin.233

I will now provide one basic example of how origin taxation would work when dealing with loans,

as loans and, respectively the interest payments, are generally considered as “passive income” in

terms of CFC legislation. As already depicted above, the possibilities of MNEs to shift profits, inter

226 Other authors are on the opinion that the difference between worldwide taxation and territorial based taxation (in practice and when exceptions and anti-avoidance rules are also taken into account) are far less significant than always proclaimed, see inter alia Altshuler, Shay, Toder – Lessons the United States Can Learn from Other Countries’ Territorial Systems for Taxing Income of Multinational Corporations (January 21, 2015). 227 See Terra, Wattel – European Tax Law, p 133. 228 See Terra, Wattel – European Tax Law, p 133. 229 See Terra, Wattel – European Tax Law, p 312. 230 See Terra, Wattel – European Tax Law, p 312. 231 See also Kemmeren – The Principle of Origin in Tax Conventions, p 33. 232 See also Kemmeren – The Principle of Origin in Tax Conventions, p 36. 233 See further Kemmeren – The Principle of Origin in Tax Conventions, p 36.

44

alia, via loan agreements to low tax jurisdictions under the current international taxation regime, are

one of the key elements why CFC Rules are (still, and apparently more than ever) needed.

For example234, Person 1, resident of Country A (e.g. CIT rate of 15%), has granted an interest-

bearing loan to Entrepreneur 2, resident of Country B (e.g. CIT rate of 25%)235. When applying

origin-based taxation, the interest actually paid has been created in Country B through the activities

of Entrepreneur 2.236 The value adding activities (the “real” intellectual work) need to be attributed

to Entrepreneur 2 and subsequently the tax jurisdiction needs to be allocated to Country B and not

Country A, as the ability to pay the interest has been produced solely based on the fact that

Entrepreneur 2 has utilised the loan within his entrepreneurial organisation.237 Instead, Person 1s

contribution to the emergence of the interest might be seen as not very large (e.g. net banking

transfer of funds within 5 minutes). Therefore, when applying consistent origin-based taxation, the

need for using CFC Rules would disappear, since taxation of the interest paid from the high-tax

jurisdiction to the company established in the low-tax jurisdiction would take place at the high-tax

jurisdiction as the economic activity, which adds the value, takes place there.238

It becomes apparent, that a major “flaw” of an origin-based taxation concerning the allocation of

taxing rights, is the fact that a person who conducts her/his income generating activities in a

multitude of countries needs to be taxed in each of these countries.239 To moderate this “flaw”

Kemmeran suggests to only allocate tax jurisdiction in case of sufficient economic relationship.240

However, Schön argues that any proposal which calls for a fundamental change of countries national

tax system (hence, also including their international tax orientation) in order to pave the way for an

improved international regime would most likely miss the chance of real-world success.241 In my

view, the argument that all tax treaties have to be renegotiated and, therefore, altered in order to

implement origin-based taxation is not valid anymore as more than 100 jurisdictions have concluded

negotiations on a multilateral instrument (hereinafter referred to as “MLI”)242 that will expeditiously

234 The example depicted is derived from Kemmeren – The Principle of Origin in Tax Conventions, p 39 – 40. 235 For simplification reasons, assumption has been made that Entrepreneur 2 is only active in Country B. 236 See Annex C. 237 See further Kemmeren – The Principle of Origin in Tax Conventions, p 39 – 40. 238 For further examples, especially regarding a company conducting its sales via companies established in different countries, on how allocation functions based on the origin principle see Kemmeren – The Principle of Origin in Tax Conventions, p 40. 239 See also Kemmeren – The Principle of Origin in Tax Conventions, p 42. 240 See Kemmeren – The Principle of Origin in Tax Conventions, p 42 - 43. 241 See Schön – International Tax Coordination for a Second-Best World (Part I), World Tax Journal – IFA Congress Issue – September 2009, p 85. 242 Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-BEPS.pdf).

http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-BEPS.pdf

http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-BEPS.pdf

45

implement a series of measures to update international tax rules and lessen the opportunity for tax

avoidance by multinational enterprises.243 Of course, not all of this 100 jurisdictions are actually

going to sign the MLI.244 Nevertheless, starting with a limited number of countries/jurisdiction can

lead (at least to a certain degree) to harmonisation. The so-called Foreign Account Tax Compliance

Act245 (hereinafter referred to as “FATCA”), which establishes the obligation of banks to provide

the IRS with relevant information about US account holders, might also serve as an example that

sometimes “starting small” (just 1 country) might lead to harmonisation at international level.

5. Conclusion

Back in the days, taxation, and respective efficient tax structuring/planning, had a completely

different status than it has now. Taxation in general, tax rates, tax incentives and, the overall tax

burden are becoming the main drivers for decision-making of companies. The position of CFOs was

barely established and if so, CFOs were just considered as sheer accountants. I think, nowadays, we

can no longer imagine everyday (corporate) life without taxation being a main topic in board

meetings, shareholder’s general meetings and the daily press. The various tax scandals in recent

years, such as the Panama Papers and the MNEs paying less or almost no corporate income tax

increased public awareness. The rise of “tax shaming” in the sense of a growing culture of naming

and shaming companies seems to have become the new norm.246 As was already described, the

whole discussion about tax avoidance, tax evasion etc lacks clear and commonly accepted

definitions, which leads to populist statements rather than constructive and creative suggestions for

solutions.

This development did go hand in hand with governments adopting and establishing new anti-

avoidance rules. Due to the aforementioned tax scandals and the general discourse of BEPS, the

public perception of MNEs not paying their fair share, deploying solely tax driven structures and

exploiting loopholes, as well as the additional perception that governments allow them to do so,

CFC Rules, which already did sink into oblivion, were brought back to life. In my view, the OECD

BEPS report certainly played an important role with regard to CFC Rules. This kind of public

discourse is present all around the world and a constant companion of the US international tax

policies and, therefore, also largely affects the US Subpart F regulations. The same applies (now) to

the EU, particularly since the presentation of the ATAD (and in particular Art 7 and 8 ATAD).

243 http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm. 244 On June 7, 67 countries signed the MLI (https://www.oecd.org/tax/treaties/multilateral-instrument-BEPS-tax-treaty-information-brochure.pdf). 245 The aim of FATCA is to increase tax honesty of persons subject to US taxation. 246 See Google, Amazon, Starbucks: The rise of 'tax shaming' (http://www.bbc.com/news/magazine-20560359).

http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm

http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm

46

As highlighted, CFC Rules are highly automated/mechanical anti-avoidance rules with the aim of

re-attributing the income of low-taxed controlled (foreign) subsidiaries to its parent company.

Subsequently, the parent company becomes taxable on this attributed income in the country where

it is resident for tax purposes, although the income of the foreign subsidiary has not been distributed

(no repatriation of funds is required to trigger this attribution). In other words, CFC Rules lead to

(immediate) taxation of income of a CFC in the hands of its shareholder even though no flow of

money occurred. Hence, it is of utmost importance that CFC Rules are in line with both the principle

of efficiency and the principle of effectivity in order to prevent BEPS.

As discussed earlier, a final (reliable) result regarding which set of rules is more efficient from an

administrative burden point of view, is not predictable at this point of time due to the choices the

Member States have to take in future. Even though, the European Commission missed the chance

of keeping administrative as well as compliance costs as efficient as possible (e.g. restricting the

options for implementation of Art 7 and 8 ATAD) and, therefore, increasing the efficiency level,

compared to the “tax jungle” called Subpart F with all its provisions, cross-referencing, definitions,

exceptions and the Transactional Approach chosen, the cost-efficiency-ratio of the ATAD seems to

be better balanced than the Subpart F’s. This leads to the conclusion that the ATAD CFC Rules are

more likely to reduce BEPS as tax authorities need to invest (i) less time to monitor possible

situations which might trigger the application of CFC Rules, (ii) less money as the monitoring is

less demanding compared to the Subpart F Rules, (iii) companies are aware of these circumstances

and, therefore, might not want to take the risk (deterrent mechanism works).

The same result is achieved when the 2 set of rules are examined within the light of the principle of

effectivity. As pointed out, both Subpart F and the ATAD, disclose limitations. The Subpart F

legislation reveals in some parts that it can be seen as outdated and allows companies (easily) to

avoid the application of the US CFC Rules. Especially, the interplay with the Check-the-Box

Regulation makes the US Subpart F legislation futile. Nontheless, the EU CFC Rules clearly suffer

from the lack of direct tax harmonisation within the EU. The different CIT rates within the 27 (after

the Brexit soon 26) Member States will add fuel to the fire that is the tax rate race to the bottom. As

discussed, Subpart F appears to be less effective than Art 7 and 8 ATAD. In my view, taking all the

factors mentioned into account, in the current situation Subpart F appears to be less efficient, as it

causes (inter alia) high monitoring costs for both, tax authorities and companies. The same holds

true with regard to effectiveness when it comes to prevent base erosion and profit shifting. This

again leads to the result, that the ATAD CFC Rules are better developed when it comes to reduce

BEPS as tax authorities are not limited to a given list of items constituting “passive income” which

in turn triggers the CFC Rules to be applied only when subsumed under one of these items (and in

case all the additional requirements are also fulfilled). Furthermore, the set of rules is not being

47

applied ad absurdum with a framework such as the Check-The-Box-Regulation which disallows tax

authorities to qualify situations as relevant in sense of CFC legislation, based on a choice of the

parent company itself. In conclusion, the EU CFC Rules achieve the goal of preventing base erosion

and/or profit shifting more effective than the Subpart F legislation and at the same time also

constitute an economic reasonable set of rules.

When analysing the principles in international taxation, it becomes clear that residence is the key

player. As outlined in previous sections, I recommend a change from CEN to CIN, hence, from

residence-based taxation to territoriality-based taxation. The examples I provided, show that this

switch would lead to “fair” taxation as taxation would take place where value is added or created

and not where companies are resident. However, realistically proposals calling for fundamental

change of tax systems would most likely not be realisable and, therefore, miss the chance of real-

world success. In my view, a very inglorious example is the CC(C)TB at EU level. It should be

noted at this point, that Member States are still not willing to “sacrifice” any of their tax sovereignty

in direct tax matters even for the “big goal” (being no double taxation but also no non-taxation, a

level playing field for companies and the situation where only economic reasons are decisive and

not tax issues influence structures). The chance of introducing a common CIT within the EU has

been left unexploited and this is clearly a wasted opportunity for further tax harmonisation within

the EU. As pointed out, sometimes an initiative supported by just a small number of countries might

serve as the basis for unified rules, thus, harmonisation. FATCA might serve as an example and

possibly also the MLI could serve as such an example in the future.

Overall, I strongly believe that CFC Rules will remain a constant companion as long as residence is

the decisive factor for allocating tax jurisdictions in international taxation.

48

6. Bibliography

A

- Accetto, Zleptnik – The Principle of Effectiveness: Rethinking Its Role In Community Law,

European Public Law, Volume 11, Issue 3, Kluwer Law International 2005.

- Alley and Bentley. (2005) "A remodelling of Adam Smith’s tax design principles"

(http://epublications.bond.edu.au/law_pubs/45).

- Altshuler, Shay, Toder – Lessons the United States Can Learn from Other Countries’ Territorial

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7. Appendix

ANNEX A

19.7.2016 EN Official Journal of the European Union L 193/1

COUNCIL DIRECTIVE (EU) 2016/1164

of 12 July 2016

laying down rules against tax avoidance practices that directly affect the functioning of

the internal market

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty on the Functioning of the European Union, and in particular Article

115 thereof,

Having regard to the proposal from the European Commission,

After transmission of the draft legislative act to the national parliaments,

Having regard to the opinion of the European Parliament (1),

Having regard to the opinion of the European Economic and Social Committee (2),

Acting in accordance with a special legislative procedure,

Whereas:

(1) The current political priorities in international taxation highlight the need for ensuring that tax is paid where profits and value are generated. It is thus imperative to restore trust in the fairness of tax systems and allow governments to effectively exercise their tax sovereignty. These new political objectives have been translated into concrete action recommendations in the context of the initiative against base erosion and profit shifting (BEPS) by the Organisation for Economic Cooperation and Development (OECD). The European Council has welcomed this work in its conclusions of 13-14 March 2013 and 19-20 December 2013. In response to the need for fairer taxation, the Commission, in its communication of 17 June 2015 sets out an action plan for fair and efficient corporate taxation in the European Union.

(2) The final reports on the 15 OECD Action Items against BEPS were released to the public on 5 October 2015. This output was welcomed by the Council in its conclusions of 8 December 2015. The Council conclusions stressed the need to find common, yet flexible, solutions at the EU level consistent with OECD BEPS conclusions. In addition, the conclusions supported an effective and swift coordinated implementation of the anti-BEPS measures at the EU level and considered that EU directives should be, where appropriate, the preferred vehicle for implementing OECD BEPS conclusions at the EU level. It is essential for the good functioning of the internal market that, as a minimum,

http://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:32016L1164&from=DE#ntr1-L_2016193EN.01000101-E0001


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Member States implement their commitments under BEPS and more broadly, take action to discourage tax avoidance practices and ensure fair and effective taxation in the Union in a sufficiently coherent and coordinated fashion. In a market of highly integrated economies, there is a need for common strategic approaches and coordinated action, to improve the functioning of the internal market and maximise the positive effects of the initiative against BEPS. Furthermore, only a common framework could prevent a fragmentation of the market and put an end to currently existing mismatches and market distortions. Finally, national implementing measures which follow a common line across the Union would provide taxpayers with legal certainty in that those measures would be compatible with Union law.

(3) It is necessary to lay down rules in order to strengthen the average level of protection against aggressive tax planning in the internal market. As these rules would have to fit in 28 separate corporate tax systems, they should be limited to general provisions and leave the implementation to Member States as they are better placed to shape the specific elements of those rules in a way that fits best their corporate tax systems. This objective could be achieved by creating a minimum level of protection for national corporate tax systems against tax avoidance practices across the Union. It is therefore necessary to coordinate the responses of Member States in implementing the outputs of the 15 OECD Action Items against BEPS with the aim to improve the effectiveness of the internal market as a whole in tackling tax avoidance practices. It is therefore necessary to set a common minimum level of protection for the internal market in specific fields.

(4) It is necessary to establish rules applicable to all taxpayers that are subject to corporate tax in a Member State. Considering that it would result in the need to cover a broader range of national taxes, it is not desirable to extend the scope of this Directive to types of entities which are not subject to corporate tax in a Member State; that is, in particular, transparent entities. Those rules should also apply to permanent establishments of those corporate taxpayers which may be situated in other Member State(s). Corporate taxpayers may be resident for tax purposes in a Member State or be established under the laws of a Member State. Permanent establishments of entities resident for tax purposes in a third country should also be covered by those rules if they are situated in one or more Member State.

(5) It is necessary to lay down rules against the erosion of tax bases in the internal market and the shifting of profits out of the internal market. Rules in the following areas are necessary in order to contribute to achieving that objective: limitations to the deductibility of interest, exit taxation, a general anti-abuse rule, controlled foreign company rules and rules to tackle hybrid mismatches. Where the application of those rules gives rise to double taxation, taxpayers should receive relief through a deduction for the tax paid in another Member State or third country, as the case may be. Thus, the rules should not only aim to counter tax avoidance practices but also avoid creating other obstacles to the market, such as double taxation.

(6) In an effort to reduce their global tax liability, groups of companies have increasingly engaged in BEPS, through excessive interest payments. The interest limitation rule is necessary to discourage such practices by limiting the deductibility of taxpayers' exceeding borrowing costs. It is therefore necessary to fix a ratio for deductibility which refers to a taxpayer's taxable earnings before interest, tax, depreciation and amortisation (EBITDA). Member States could decrease this ratio or place time limits or restrict the amount of unrelieved borrowing costs that can be carried forward or

54

back to ensure a higher level of protection. Given that the aim is to lay down minimum standards, it could be possible for Member States to adopt an alternative measure referring to a taxpayer's earnings before interest and tax (EBIT) and fixed in a way that it is equivalent to the EBITDA-based ratio. Member States could in addition to the interest limitation rule provided by this Directive also use targeted rules against intra-group debt financing, in particular thin capitalisation rules. Tax exempt revenues should not be set off against deductible borrowing costs. This is because only taxable income should be taken into account in determining how much interest may be deducted.

(7) Where the taxpayer is part of a group which files statutory consolidated accounts, the indebtedness of the overall group at worldwide level may be considered for the purpose of granting taxpayers entitlement to deduct higher amounts of exceeding borrowing costs. It may also be appropriate to lay down rules for an equity escape provision, where the interest limitation rule does not apply if the company can demonstrate that its equity over total assets ratio is broadly equal to or higher than the equivalent group ratio. The interest limitation rule should apply in relation to a taxpayer's exceeding borrowing costs without distinction of whether the costs originate in debt taken out nationally, cross-border within the Union or with a third country, or whether they originate from third parties, associated enterprises or intra-group. Where a group includes more than one entity in a Member State, the Member State may consider the overall position of all group entities in the same State, including a separate entity taxation system to allow the transfer of profits or interest capacity between entities within a group, when applying rules that limit the deductibility of interest.

(8) To reduce the administrative and compliance burden of the rules without significantly diminishing their tax effect, it may be appropriate to provide for a safe harbour rule so that net interest is always deductible up to a fixed amount, when this leads to a higher deduction than the EBITDA-based ratio. Member States could reduce the fixed monetary threshold in order to ensure a higher level of protection of their domestic tax base. Since BEPS in principle takes place through excessive interest payments among entities which are associated enterprises, it is appropriate and necessary to allow the possible exclusion of standalone entities from the scope of the interest limitation rule given the limited risks of tax avoidance. In order to facilitate the transition to the new interest limitation rule, Member States could provide for a grandfathering clause that would cover existing loans to the extent that their terms are not subsequently modified, i.e. in case of a subsequent modification, the grandfathering would not apply to any increase in the amount or duration of the loan but would be limited to the original terms of the loan. Without prejudice to State aid rules, Member States could also exclude exceeding borrowing costs incurred on loans used to fund long-term public infrastructure projects considering that such financing arrangements present little or no BEPS risks. In this context, Member States should properly demonstrate that financing arrangements for public infrastructure projects present special features which justify such treatment vis-à-vis other financing arrangements subject to the restrictive rule.

(9) Although it is generally accepted that financial undertakings, i.e. financial institutions and insurance undertakings, should also be subject to limitations to the deductibility of interest, it is equally acknowledged that these two sectors present special features which call for a more customised approach. As the discussions in this field are not yet sufficiently conclusive in the international and Union context, it is not yet possible to

55

provide specific rules in the financial and insurance sectors and Member States should therefore be able to exclude them from the scope of interest limitation rules.

(10) Exit taxes have the function of ensuring that where a taxpayer moves assets or its tax residence out of the tax jurisdiction of a State, that State taxes the economic value of any capital gain created in its territory even though that gain has not yet been realised at the time of the exit. It is therefore necessary to specify cases in which taxpayers are subject to exit tax rules and taxed on unrealised capital gains which have been built in their transferred assets. It is also helpful to clarify that transfers of assets, including cash, between a parent company and its subsidiaries fall outside the scope of the envisaged rule on exit taxation. In order to compute the amounts, it is critical to fix a market value for the transferred assets at the time of exit of the assets based on the arm's length principle. In order to ensure the compatibility of the rule with the use of the credit method, it is desirable to allow Member States to refer to the moment when the right to tax the transferred assets is lost. The right to tax should be defined at national level. It is also necessary to allow the receiving State to dispute the value of the transferred assets established by the exit State when it does not reflect such a market value. Member States could resort to this effect to existing dispute resolution mechanisms. Within the Union, it is necessary to address the application of exit taxation and illustrate the conditions for being compliant with Union law. In those situations, taxpayers should have the right to either immediately pay the amount of exit tax assessed or defer payment of the amount of tax by paying it in instalments over a certain number of years, possibly together with interest and a guarantee.

Member States could request, for this purpose, the taxpayers concerned to include the necessary information in a declaration. Exit tax should not be charged when the transfer of assets is of a temporary nature and the assets are set to revert to the Member State of the transferor, where the transfer takes place in order to meet prudential capital requirements or for the purpose of liquidity management or when it comes to securities' financing transactions or assets posted as collateral.

(11) General anti-abuse rules (GAARs) feature in tax systems to tackle abusive tax practices that have not yet been dealt with through specifically targeted provisions. GAARs have therefore a function aimed to fill in gaps, which should not affect the applicability of specific anti-abuse rules. Within the Union, GAARs should be applied to arrangements that are not genuine; otherwise, the taxpayer should have the right to choose the most tax efficient structure for its commercial affairs. It is furthermore important to ensure that the GAARs apply in domestic situations, within the Union and vis-à-vis third countries in a uniform manner, so that their scope and results of application in domestic and cross-border situations do not differ. Member States should not be prevented from applying penalties where the GAAR is applicable. When evaluating whether an arrangement should be regarded as non-genuine, it could be possible for Member States to consider all valid economic reasons, including financial activities.

(12) Controlled foreign company (CFC) rules have the effect of re-attributing the income of a low-taxed controlled subsidiary to its parent company. Then, the parent company becomes taxable on this attributed income in the State where it is resident for tax purposes. Depending on the policy priorities of that State, CFC rules may target an entire low-taxed subsidiary, specific categories of income or be limited to income which has artificially been diverted to the subsidiary. In particular, in order to ensure that CFC rules are a proportionate response to BEPS concerns, it is critical that

56

Member States that limit their CFC rules to income which has been artificially diverted to the subsidiary precisely target situations where most of the decision-making functions which generated diverted income at the level of the controlled subsidiary are carried out in the Member State of the taxpayer. With a view to limiting the administrative burden and compliance costs, it should also be acceptable that those Member States exempt certain entities with low profits or a low profit margin that give rise to lower risks of tax avoidance. Accordingly, it is necessary that the CFC rules extend to the profits of permanent establishments where those profits are not subject to tax or are tax exempt in the Member State of the taxpayer. However, there is no need to tax, under the CFC rules, the profits of permanent establishments which are denied the tax exemption under national rules because these permanent establishments are treated as though they were controlled foreign companies. In order to ensure a higher level of protection, Member States could reduce the control threshold, or employ a higher threshold in comparing the actual corporate tax paid with the corporate tax that would have been charged in the Member State of the taxpayer. Member States could, in transposing CFC rules into their national law, use a sufficiently high tax rate fractional threshold.

It is desirable to address situations both in third countries and within the Union. To comply with the fundamental freedoms, the income categories should be combined with a substance carve-out aimed to limit, within the Union, the impact of the rules to cases where the CFC does not carry on a substantive economic activity. It is important that tax administrations and taxpayers cooperate to gather the relevant facts and circumstances to determine whether the carve-out rule is to apply. It should be acceptable that, in transposing CFC rules into their national law, Member States use white, grey or black lists of third countries, which are compiled on the basis of certain criteria set out in this Directive and may include the corporate tax rate level, or use white lists of Member States compiled on that basis.

(13) Hybrid mismatches are the consequence of differences in the legal characterisation of payments (financial instruments) or entities and those differences surface in the interaction between the legal systems of two jurisdictions. The effect of such mismatches is often a double deduction (i.e. deduction in both states) or a deduction of the income in one state without inclusion in the tax base of the other. To neutralise the effects of hybrid mismatch arrangements, it is necessary to lay down rules whereby one of the two jurisdictions in a mismatch should deny the deduction of a payment leading to such an outcome. In this context, it is useful to clarify that measures aimed to tackle hybrid mismatches in this Directive are aimed to tackle mismatch situations attributable to differences in the legal characterisation of a financial instrument or entity and are not intended to affect the general features of the tax system of a Member State. Although Member States have agreed guidance, in the framework of the Group of the Code of Conduct on Business Taxation, on the tax treatment of hybrid entities and hybrid permanent establishments within the Union as well as on the tax treatment of hybrid entities in relations with third countries, it is still necessary to enact binding rules. It is critical that further work is undertaken on hybrid mismatches between Member States and third countries, as well as on other hybrid mismatches such as those involving permanent establishments.

(14) It is necessary to clarify that the implementation of the rules against tax avoidance provided in this Directive should not affect the taxpayers' obligation to comply with the arm's length principle or the Member State's right to adjust a tax liability upwards in accordance with the arm's length principle, where applicable.

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(15) The European Data Protection Supervisor was consulted in accordance with Article 28(2) of Regulation (EC) No 45/2001 of the European Parliament and of the Council (3). The right to protection of personal data according to Article 8 of the Charter of Fundamental Rights of the European Union as well as Directive 95/46/EC of the European Parliament and of the Council (4) applies to the processing of personal data carried out within the framework of this Directive.

(16) Considering that a key objective of this Directive is to improve the resilience of the internal market as a whole against cross-border tax avoidance practices, this cannot be sufficiently achieved by the Member States acting individually. National corporate tax systems are disparate and independent action by Member States would only replicate the existing fragmentation of the internal market in direct taxation. It would thus allow inefficiencies and distortions to persist in the interaction of distinct national measures. The result would be lack of coordination. Rather, by reason of the fact that much inefficiency in the internal market primarily gives rise to problems of a cross-border nature, remedial measures should be adopted at Union level. It is therefore critical to adopt solutions that function for the internal market as a whole and this can be better achieved at Union level. Thus, the Union may adopt measures, in accordance with the principle of subsidiarity as set out in Article 5 of the Treaty on European Union. In accordance with the principle of proportionality, as set out in that Article, this Directive does not go beyond what is necessary in order to achieve that objective. By setting a minimum level of protection for the internal market, this Directive only aims to achieve the essential minimum degree of coordination within the Union for the purpose of materialising its objectives.

(17) The Commission should evaluate the implementation of this Directive four years after its entry into force and report to the Council thereon. Member States should communicate to the Commission all information necessary for this evaluation.

HAS ADOPTED THIS DIRECTIVE:

CHAPTER I

GENERAL PROVISIONS

Article 1

Scope

This Directive applies to all taxpayers that are subject to corporate tax in one or more Member

States, including permanent establishments in one or more Member States of entities resident

for tax purposes in a third country.

Article 2

Definitions

For the purposes of this Directive, the following definitions apply:

(1) ‘borrowing costs’ means interest expenses on all forms of debt, other costs economically equivalent to interest and expenses incurred in connection with the raising of finance as defined in national law, including, without being limited to, payments under profit participating loans, imputed interest on instruments such as convertible bonds and zero coupon bonds, amounts under alternative financing



58

arrangements, such as Islamic finance, the finance cost element of finance lease payments, capitalised interest included in the balance sheet value of a related asset, or the amortisation of capitalised interest, amounts measured by reference to a funding return under transfer pricing rules where applicable, notional interest amounts under derivative instruments or hedging arrangements related to an entity's borrowings, certain foreign exchange gains and losses on borrowings and instruments connected with the raising of finance, guarantee fees for financing arrangements, arrangement fees and similar costs related to the borrowing of funds;

(2) ‘exceeding borrowing costs’ means the amount by which the deductible borrowing costs of a taxpayer exceed taxable interest revenues and other economically equivalent taxable revenues that the taxpayer receives according to national law;

(3) ‘tax period’ means a tax year, calendar year or any other appropriate period for tax purposes;

(4) ‘associated enterprise’ means:

(a) an entity in which the taxpayer holds directly or indirectly a participation in terms of voting rights or capital ownership of 25 percent or more or is entitled to receive 25 percent or more of the profits of that entity;

(b) an individual or entity which holds directly or indirectly a participation in terms of voting rights or capital ownership in a taxpayer of 25 percent or more or is entitled to receive 25 percent or more of the profits of the taxpayer;

If an individual or entity holds directly or indirectly a participation of 25 percent or more in a taxpayer and one or more entities, all the entities concerned, including the taxpayer, shall also be regarded as associated enterprises.

For the purposes of Article 9 and where the mismatch involves a hybrid entity, this definition is modified so that the 25 percent requirement is replaced by a 50 percent requirement.

(5) ‘financial undertaking’ means any of the following entities:

(a) a credit institution or an investment firm as defined in point (1) of Article 4(1) of Directive 2004/39/EC of the European Parliament and of the Council (5) or an alternative investment fund manager (AIFM) as defined in point (b) of Article 4(1) of Directive 2011/61/EU of the European Parliament and of the Council (6) or an undertaking for collective investment in transferable securities (UCITS) management company as defined in point (b) of Article 2(1) of Directive 2009/65/EC of the European Parliament and of the Council (7);

(b) an insurance undertaking as defined in point (1) of Article 13 of Directive 2009/138/EC of the European Parliament and of the Council (8);

(c) a reinsurance undertaking as defined in point (4) of Article 13 of Directive 2009/138/EC;

(d) an institution for occupational retirement provision falling within the scope of Directive 2003/41/EC of the European Parliament and of the Council (9), unless a Member State has chosen not to apply that Directive in whole or in part to that institution in accordance with Article 5 of that Directive or the delegate of an institution for occupational retirement provision as referred to in Article 19(1) of that Directive;






59

(e) pension institutions operating pension schemes which are considered to be social security schemes covered by Regulation (EC) No 883/2004 of the European Parliament and of the Council (10) and Regulation (EC) No 987/2009 of the European Parliament and of the Council (11) as well as any legal entity set up for the purpose of investment of such schemes;

(f) an alternative investment fund (AIF) managed by an AIFM as defined in point (b) of Article 4(1) of Directive 2011/61/EU or an AIF supervised under the applicable national law;

(g) UCITS in the meaning of Article 1(2) of Directive 2009/65/EC;

(h) a central counterparty as defined in point (1) of Article 2 of Regulation (EU) No 648/2012 of the European Parliament and of the Council (12);

(i) a central securities depository as defined in point (1) of Article 2(1) of Regulation (EU) No 909/2014 of the European Parliament and of the Council (13).

(6) ‘transfer of assets’ means an operation whereby a Member State loses the right to tax the transferred assets, whilst the assets remain under the legal or economic ownership of the same taxpayer;

(7) ‘transfer of tax residence’ means an operation whereby a taxpayer ceases to be resident for tax purposes in a Member State, whilst acquiring tax residence in another Member State or third country;

(8) ‘transfer of a business carried on by a permanent establishment’ means an operation whereby a taxpayer ceases to have taxable presence in a Member State whilst acquiring such presence in another Member State or third country without becoming resident for tax purposes in that Member State or third country;

(9) ‘hybrid mismatch’ means a situation between a taxpayer in one Member State and an associated enterprise in another Member State or a structured arrangement between parties in Member States where the following outcome is attributable to differences in the legal characterisation of a financial instrument or entity:

(a) a deduction of the same payment, expenses or losses occurs both in the Member State in which the payment has its source, the expenses are incurred or the losses are suffered and in another Member State (‘double deduction’); or

(b) there is a deduction of a payment in the Member State in which the payment has its source without a corresponding inclusion for tax purposes of the same payment in the other Member State (‘deduction without inclusion’).

Article 3

Minimum level of protection

This Directive shall not preclude the application of domestic or agreement-based provisions

aimed at safeguarding a higher level of protection for domestic corporate tax bases.

CHAPTER II

MEASURES AGAINST TAX AVOIDANCE

Article 4





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Interest limitation rule

1. Exceeding borrowing costs shall be deductible in the tax period in which they are incurred

only up to 30 percent of the taxpayer's earnings before interest, tax, depreciation and

amortisation (EBITDA).

For the purpose of this Article, Member States may also treat as a taxpayer:

(a) an entity which is permitted or required to apply the rules on behalf of a group, as defined according to national tax law;

(b) an entity in a group, as defined according to national tax law, which does not consolidate the results of its members for tax purposes.

In such circumstances, exceeding borrowing costs and the EBITDA may be calculated at the

level of the group and comprise the results of all its members.

2. The EBITDA shall be calculated by adding back to the income subject to corporate tax in

the Member State of the taxpayer the tax-adjusted amounts for exceeding borrowing costs as

well as the tax-adjusted amounts for depreciation and amortisation. Tax exempt income shall

be excluded from the EBITDA of a taxpayer.

3. By derogation from paragraph 1, the taxpayer may be given the right:

(a) to deduct exceeding borrowing costs up to EUR 3 000 000;

(b) to fully deduct exceeding borrowing costs if the taxpayer is a standalone entity.

For the purposes of the second subparagraph of paragraph 1, the amount of EUR 3 000 000

shall be considered for the entire group.

For the purposes of point (b) of the first subparagraph, a standalone entity means a taxpayer

that is not part of a consolidated group for financial accounting purposes and has no associated

enterprise or permanent establishment.

4. Member States may exclude from the scope of paragraph 1 exceeding borrowing costs

incurred on:

(a) loans which were concluded before 17 June 2016, but the exclusion shall not extend to any subsequent modification of such loans;

(b) loans used to fund a long-term public infrastructure project where the project operator, borrowing costs, assets and income are all in the Union.

For the purposes of point (b) of the first subparagraph, a long-term public infrastructure project

means a project to provide, upgrade, operate and/or maintain a large-scale asset that is

considered in the general public interest by a Member State.

Where point (b) of the first subparagraph applies, any income arising from a long-term public

infrastructure project shall be excluded from the EBITDA of the taxpayer, and any excluded

exceeding borrowing cost shall not be included in the exceeding borrowing costs of the group

vis-à-vis third parties referred to in point (b) of paragraph 5.

5. Where the taxpayer is a member of a consolidated group for financial accounting purposes,

the taxpayer may be given the right to either:

(a) fully deduct its exceeding borrowing costs if it can demonstrate that the ratio of its equity over its total assets is equal to or higher than the equivalent ratio of the group and subject to the following conditions:

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(i) the ratio of the taxpayer's equity over its total assets is considered to be equal to the equivalent ratio of the group if the ratio of the taxpayer's equity over its total assets is lower by up to two percentage points; and

(ii) all assets and liabilities are valued using the same method as in the consolidated financial statements referred to in paragraph 8;

or

(b) deduct exceeding borrowing costs at an amount in excess of what it would be entitled to deduct under paragraph 1. This higher limit to the deductibility of exceeding borrowing costs shall refer to the consolidated group for financial accounting purposes in which the taxpayer is a member and be calculated in two steps:

(i) first, the group ratio is determined by dividing the exceeding borrowing costs of the group vis-à-vis third-parties over the EBITDA of the group; and

(ii) second, the group ratio is multiplied by the EBITDA of the taxpayer calculated pursuant to paragraph 2.

6. The Member State of the taxpayer may provide for rules either:

(a) to carry forward, without time limitation, exceeding borrowing costs which cannot be deducted in the current tax period under paragraphs 1 to 5;

(b) to carry forward, without time limitation, and back, for a maximum of three years, exceeding borrowing costs which cannot be deducted in the current tax period under paragraphs 1 to 5; or

(c) to carry forward, without time limitation, exceeding borrowing costs and, for a maximum of five years, unused interest capacity, which cannot be deducted in the current tax period under paragraphs 1 to 5.

7. Member States may exclude financial undertakings from the scope of paragraphs 1 to 6,

including where such financial undertakings are part of a consolidated group for financial

accounting purposes.

8. For the purpose of this Article, the consolidated group for financial accounting purposes

consists of all entities which are fully included in consolidated financial statements drawn up

in accordance with the International Financial Reporting Standards or the national financial

reporting system of a Member State. The taxpayer may be given the right to use consolidated

financial statements prepared under other accounting standards.

Article 5

Exit taxation

1. A taxpayer shall be subject to tax at an amount equal to the market value of the transferred

assets, at the time of exit of the assets, less their value for tax purposes, in any of the following

circumstances:

(a) a taxpayer transfers assets from its head office to its permanent establishment in another Member State or in a third country in so far as the Member State of the head office no longer has the right to tax the transferred assets due to the transfer;

(b) a taxpayer transfers assets from its permanent establishment in a Member State to its head office or another permanent establishment in another Member State or in a third

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country in so far as the Member State of the permanent establishment no longer has the right to tax the transferred assets due to the transfer;

(c) a taxpayer transfers its tax residence to another Member State or to a third country, except for those assets which remain effectively connected with a permanent establishment in the first Member State;

(d) a taxpayer transfers the business carried on by its permanent establishment from a Member State to another Member State or to a third country in so far as the Member State of the permanent establishment no longer has the right to tax the transferred assets due to the transfer.

2. A taxpayer shall be given the right to defer the payment of an exit tax referred to in

paragraph 1, by paying it in instalments over five years, in any of the following circumstances:

(a) a taxpayer transfers assets from its head office to its permanent establishment in another Member State or in a third country that is party to the Agreement on the European Economic Area (EEA Agreement);

(b) a taxpayer transfers assets from its permanent establishment in a Member State to its head office or another permanent establishment in another Member State or a third country that is party to the EEA Agreement;

(c) a taxpayer transfers its tax residence to another Member State or to a third country that is party to the EEA Agreement;

(d) a taxpayer transfers the business carried on by its permanent establishment to another Member State or a third country that is party to the EEA Agreement.

This paragraph shall apply to third countries that are party to the EEA Agreement if they have

concluded an agreement with the Member State of the taxpayer or with the Union on the mutual

assistance for the recovery of tax claims, equivalent to the mutual assistance provided for in

Council Directive 2010/24/EU (14).

3. If a taxpayer defers the payment in accordance with paragraph 2, interest may be charged

in accordance with the legislation of the Member State of the taxpayer or of the permanent

establishment, as the case may be.

If there is a demonstrable and actual risk of non-recovery, taxpayers may also be required to

provide a guarantee as a condition for deferring the payment in accordance with paragraph 2.

The second subparagraph shall not apply where the legislation in the Member State of the

taxpayer or of the permanent establishment provides for the possibility of recovery of the tax

debt through another taxpayer which is member of the same group and is resident for tax

purposes in that Member State.

4. Where paragraph 2 applies, the deferral of payment shall be immediately discontinued and

the tax debt becomes recoverable in the following cases:

(a) the transferred assets or the business carried on by the permanent establishment of the taxpayer are sold or otherwise disposed of;

(b) the transferred assets are subsequently transferred to a third country;

(c) the taxpayer's tax residence or the business carried on by its permanent establishment is subsequently transferred to a third country;

(d) the taxpayer goes bankrupt or is wound up;


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(e) the taxpayer fails to honour its obligations in relation to the instalments and does not correct its situation over a reasonable period of time, which shall not exceed 12 months.

Points (b) and (c) shall not apply to third countries that are party to the EEA Agreement if they

have concluded an agreement with the Member State of the taxpayer or with the Union on the

mutual assistance for the recovery of tax claims, equivalent to the mutual assistance provided

for in Directive 2010/24/EU.

5. Where the transfer of assets, tax residence or the business carried on by a permanent

establishment is to another Member State, that Member State shall accept the value established

by the Member State of the taxpayer or of the permanent establishment as the starting value of

the assets for tax purposes, unless this does not reflect the market value.

6. For the purposes of paragraphs 1 to 5, ‘market value’ is the amount for which an asset can

be exchanged or mutual obligations can be settled between willing unrelated buyers and sellers

in a direct transaction.

7. Provided that the assets are set to revert to the Member State of the transferor within a period

of 12 months, this Article shall not apply to asset transfers related to the financing of securities,

assets posted as collateral or where the asset transfer takes place in order to meet prudential

capital requirements or for the purpose of liquidity management.

Article 6

General anti-abuse rule

1. For the purposes of calculating the corporate tax liability, a Member State shall ignore an

arrangement or a series of arrangements which, having been put into place for the main purpose

or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of

the applicable tax law, are not genuine having regard to all relevant facts and circumstances.

An arrangement may comprise more than one step or part.

2. For the purposes of paragraph 1, an arrangement or a series thereof shall be regarded as

non-genuine to the extent that they are not put into place for valid commercial reasons which

reflect economic reality.

3. Where arrangements or a series thereof are ignored in accordance with paragraph 1, the tax

liability shall be calculated in accordance with national law.

Article 7

Controlled foreign company rule

1. The Member State of a taxpayer shall treat an entity, or a permanent establishment of which

the profits are not subject to tax or are exempt from tax in that Member State, as a controlled

foreign company where the following conditions are met:

(a) in the case of an entity, the taxpayer by itself, or together with its associated enterprises holds a direct or indirect participation of more than 50 percent of the voting rights, or owns directly or indirectly more than 50 percent of capital or is entitled to receive more than 50 percent of the profits of that entity; and

(b) the actual corporate tax paid on its profits by the entity or permanent establishment is lower than the difference between the corporate tax that would have been charged on the entity or permanent establishment under the applicable corporate tax system in

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the Member State of the taxpayer and the actual corporate tax paid on its profits by the entity or permanent establishment.

For the purposes of point (b) of the first subparagraph, the permanent establishment of a

controlled foreign company that is not subject to tax or is exempt from tax in the jurisdiction of

the controlled foreign company shall not be taken into account. Furthermore the corporate tax

that would have been charged in the Member State of the taxpayer means as computed

according to the rules of the Member State of the taxpayer.

2. Where an entity or permanent establishment is treated as a controlled foreign company

under paragraph 1, the Member State of the taxpayer shall include in the tax base:

(a) the non-distributed income of the entity or the income of the permanent establishment which is derived from the following categories:

(i) interest or any other income generated by financial assets;

(ii) royalties or any other income generated from intellectual property;

(iii) dividends and income from the disposal of shares;

(iv) income from financial leasing;

(v) income from insurance, banking and other financial activities;

(vi) income from invoicing companies that earn sales and services income from goods and services purchased from and sold to associated enterprises, and add no or little economic value;

This point shall not apply where the controlled foreign company carries on a substantive economic activity supported by staff, equipment, assets and premises, as evidenced by relevant facts and circumstances.

Where the controlled foreign company is resident or situated in a third country that is not party to the EEA Agreement, Member States may decide to refrain from applying the preceding subparagraph.

or

(b) the non-distributed income of the entity or permanent establishment arising from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage.

For the purposes of this point, an arrangement or a series thereof shall be regarded as non-genuine to the extent that the entity or permanent establishment would not own the assets or would not have undertaken the risks which generate all, or part of, its income if it were not controlled by a company where the significant people functions, which are relevant to those assets and risks, are carried out and are instrumental in generating the controlled company's income.

3. Where, under the rules of a Member State, the tax base of a taxpayer is calculated according

to point (a) of paragraph 2, the Member State may opt not to treat an entity or permanent

establishment as a controlled foreign company under paragraph 1 if one third or less of the

income accruing to the entity or permanent establishment falls within the categories under point

(a) of paragraph 2.

Where, under the rules of a Member State, the tax base of a taxpayer is calculated according to

point (a) of paragraph 2, the Member State may opt not to treat financial undertakings as

65

controlled foreign companies if one third or less of the entity's income from the categories under

point (a) of paragraph 2 comes from transactions with the taxpayer or its associated enterprises.

4. Member States may exclude from the scope of point (b) of paragraph 2 an entity or

permanent establishment:

(a) with accounting profits of no more than EUR 750 000, and non-trading income of no more than EUR 75 000; or

(b) of which the accounting profits amount to no more than 10 percent of its operating costs for the tax period.

For the purpose of point (b) of the first subparagraph, the operating costs may not include the

cost of goods sold outside the country where the entity is resident, or the permanent

establishment is situated, for tax purposes and payments to associated enterprises.

Article 8

Computation of controlled foreign company income

1. Where point (a) of Article 7(2) applies, the income to be included in the tax base of the

taxpayer shall be calculated in accordance with the rules of the corporate tax law of the Member

State where the taxpayer is resident for tax purposes or situated. Losses of the entity or

permanent establishment shall not be included in the tax base but may be carried forward,

according to national law, and taken into account in subsequent tax periods.

2. Where point (b) of Article 7(2) applies, the income to be included in the tax base of the

taxpayer shall be limited to amounts generated through assets and risks which are linked to

significant people functions carried out by the controlling company. The attribution of

controlled foreign company income shall be calculated in accordance with the arm's length

principle.

3. The income to be included in the tax base shall be calculated in proportion to the taxpayer's

participation in the entity as defined in point (a) of Article 7(1).

4. The income shall be included in the tax period of the taxpayer in which the tax year of the

entity ends.

5. Where the entity distributes profits to the taxpayer, and those distributed profits are included

in the taxable income of the taxpayer, the amounts of income previously included in the tax

base pursuant to Article 7 shall be deducted from the tax base when calculating the amount of

tax due on the distributed profits, in order to ensure there is no double taxation.

6. Where the taxpayer disposes of its participation in the entity or of the business carried out

by the permanent establishment, and any part of the proceeds from the disposal previously has

been included in the tax base pursuant to Article 7, that amount shall be deducted from the tax

base when calculating the amount of tax due on those proceeds, in order to ensure there is no

double taxation.

7. The Member State of the taxpayer shall allow a deduction of the tax paid by the entity or

permanent establishment from the tax liability of the taxpayer in its state of tax residence or

location. The deduction shall be calculated in accordance with national law.

Article 9

Hybrid mismatches

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1. To the extent that a hybrid mismatch results in a double deduction, the deduction shall be

given only in the Member State where such payment has its source.

2. To the extent that a hybrid mismatch results in a deduction without inclusion, the Member

State of the payer shall deny the deduction of such payment.

CHAPTER III

FINAL PROVISIONS

Article 10

Review

1. The Commission shall evaluate the implementation of this Directive, in particular the

impact of Article 4, by 9 August 2020 and report to the Council thereon. The report by the

Commission shall, if appropriate, be accompanied by a legislative proposal.

2. Member States shall communicate to the Commission all information necessary for

evaluating the implementation of this Directive.

3. Member States referred to in Article 11(6) shall communicate to the Commission before 1

July 2017 all information necessary for evaluating the effectiveness of the national targeted

rules for preventing base erosion and profit shifting risks (BEPS).

Article 11

Transposition

1. Member States shall, by 31 December 2018, adopt and publish the laws, regulations and

administrative provisions necessary to comply with this Directive. They shall communicate to

the Commission the text of those provisions without delay.

They shall apply those provisions from 1 January 2019.

When Member States adopt those provisions, they shall contain a reference to this Directive or

be accompanied by such a reference on the occasion of their official publication. Member States

shall determine how such reference is to be made.

2. Member States shall communicate to the Commission the text of the main provisions of

national law which they adopt in the field covered by this Directive.

3. Where this Directive mentions a monetary amount in euros (EUR), Member States whose

currency is not the euro may opt to calculate the corresponding value in the national currency

on 12 July 2016.

4. By way of derogation from Article 5(2), Estonia may, for as long as it does not tax

undistributed profits, consider a transfer of assets in monetary or non-monetary form, including

cash, from a permanent establishment situated in Estonia to a head office or another permanent

establishment in another Member State or in a third country that is a party to the EEA

Agreement as profit distribution and charge income tax, without giving taxpayers the right to

defer the payment of such tax.

5. By way of derogation from paragraph 1, Member States shall, by 31 December 2019, adopt

and publish, the laws, regulations and administrative provisions necessary to comply with

Article 5. They shall communicate to the Commission the text of those provisions without

delay.

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They shall apply those provisions from 1 January 2020.

When Member States adopt those provisions, they shall contain a reference to this Directive or

be accompanied by such a reference on the occasion of their official publication. Member States

shall determine how such reference is to be made.

6. By way of derogation from Article 4, Member States which have national targeted rules for

preventing BEPS risks at 8 August 2016, which are equally effective to the interest limitation

rule set out in this Directive, may apply these targeted rules until the end of the first full fiscal

year following the date of publication of the agreement between the OECD members on the

official website on a minimum standard with regard to BEPS Action 4, but at the latest until

1 January 2024.

Article 12

Entry into force

This Directive shall enter into force on the twentieth day following that of its publication in

the Official Journal of the European Union.

Article 13

Addressees

This Directive is addressed to the Member States.

Done at Brussels, 12 July 2016.

For the Council

The President

P. KAŽIMÍR

(1) Not yet published in the Official Journal.

(2) Not yet published in the Official Journal.

(3) Regulation (EC) No 45/2001 of the European Parliament and of the Council of 18 December 2000 on the protection

of individuals with regard to the processing of personal data by the Community institutions and bodies and on the free

movement of such data (OJ L 8, 12.1.2001, p. 1).

(4) Directive 95/46/EC of the European Parliament and the Council of 24 October 1995 on the protection of individuals

with regard to the processing of personal data and on the free movement of such data (OJ L 281, 23.11.1995, p. 31).

(5) Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial

instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European

Parliament and of the Council and repealing Council Directive 93/22/EEC (OJ L 145, 30.4.2004, p. 1).

(6) Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund

Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No

1095/2010 (OJ L 174, 1.7.2011, p. 1).

(7) Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws,

regulations and administrative provisions relating to undertakings for collective investment in transferable securities

(UCITS) (OJ L 302, 17.11.2009, p. 32).

(8) Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and

pursuit of the business of Insurance and Reinsurance (Solvency II) (OJ L 335, 17.12.2009, p. 1).

(9) Directive 2003/41/EC of the European Parliament and of the Council of 3 June 2003 on the activities and supervision

of institutions for occupational retirement provision (OJ L 235, 23.9.2003, p. 10).

(10) Regulation (EC) No 883/2004 of the European Parliament and of the Council of 29 April 2004 on the coordination

of social security systems (OJ L 166, 30.4.2004, p. 1).

http://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:32016L1164&from=DE#ntc1-L_2016193EN.01000101-E0001



http://eur-lex.europa.eu/legal-content/EN/AUTO/?uri=OJ:L:2001:008:TOC















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(11) Regulation (EC) No 987/2009 of the European Parliament and of the Council of 16 September 2009 laying down

the procedure for implementing Regulation (EC) No 883/2004 on the coordination of social security systems (OJ L 284, 30.10.2009, p. 1).

(12) Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives,

central counterparties and trade repositories (OJ L 201, 27.7.2012, p. 1).

(13) Regulation (EU) No 909/2014 of the European Parliament and of the Council of 23 July 2014 on improving

securities settlement in the European Union and on central securities depositories and amending Directives 98/26/EC

and 2014/65/EU and Regulation (EU) No 236/2012 (OJ L 257, 28.8.2014, p. 1).

(14) Council Directive 2010/24/EU of 16 March 2010 concerning mutual assistance for the recovery of claims relating

to taxes, duties and other measures (OJ L 84, 31.3.2010, p. 1).










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ANNEX B

Source: Prof. Kemmeren – Slides Lecture 11, 4.4.2017 - Interest and royalties and capital gains (2)

and EoI and AiCoT (Course International and European Taxation).

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ANNEX C

Assumption is made that the 0.5 tax base reductions in State O is the fee for the services of the Bank.

Source: Prof. Kemmeren – Slides Lecture 11, 11.4.2017 - Interest and royalties and capital gains (2)

and EoI and AiCoT (Course International and European Taxation).

master’s thesis international business taxation ll.m

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