Controlled foreign company (CFC) is a company in a low tax country
Controlled foreign company (CFC) is established in a country with lower taxation than the home country of the owners. CFCs are used in tax planning because when transferring assets to a foreign company it’s possible to utilize tax rates that are lower than in the home country. Foreign income like dividends, interests, royalties and capital gains are typically directed to CFCs.
Without special rules the home country of the owners would have right to tax income related to the CFC only when it’s sharing profits or when the owners are selling their shares. Therefore, taxes paid to the home country of the owners would be significantly lower than what they would have been in a situation where there was no CFC and the income of the CFC was paid directly to the owners. To change this, many countries including Finland have special rules concerning CFCs. And because of EU law all EU countries have CFC legislation as of 2019.
It’s possible to tax income of a CFC also based on the general anti avoidance rule but the threshold to apply the general anti avoidance rule is higher and intention of tax avoidance is required.
CFC legislation is applied when tax rate is under 12 % and required level of control is exceeded
According to Finland’s CFC legislation income of a CFC may be taxed as income of the owners if the CFC is taxed with a tax rate under 12 % in its home country which means that the level of effective taxation is less than 60 % of the level of taxation in Finland. In addition, the taxpayer in Finland needs to have control of the CFC. Required level of control is owning together with related parties at least 25 % of the voting rights, capital or right to return of the foreign CFC. Therefore, CFC legislation will not be applied as far as small ownerships are concerned.
CFC legislation is not applied when company is carrying on economic activities
The most central exception to the application of CFC legislation is carrying on economic activities. These kinds of activities are out of the scope of the CFC legislation because in these cases the business isn’t established in a certain country primarily because of the tax benefits.
Company established in the European Economic Area isn’t considered to be a CFC if it carries on actual economic activities there. Business with personnel, premises, equipment and assets is typically considered to be economic activity.
Company established outside the European Economic Area isn’t considered to be a CFC if the income of the CFC consists mainly of industrial production activities, activities equivalent to it or shipping activities. This exception concerns activities where material or immaterial goods or services are developed or produced to be sold on the market. For companies established outside the European Economic Area there also needs to be functional exchange of information with the home country of the company and EU can’t have listed the jurisdiction as non-cooperative.
CFC legislation needs to be taken into account when planning the ownership structure
When planning how to organize an international ownership structure, it’s advisable at an early stage to take into account tax burden caused by each option. It should be evaluated if CFC legislation of Finland or another country is applied. Our tax experts with extensive experience of international taxation take care that the options are feasible in taxation. We have the help of our worldwide Nexia International network.
