A Study of the CFC-Legislation in the United States and Its Compatibility With International Law

Abstract: Globalization and the deregulation of currencies have had a negative impact on the domestic tax systems of states and the tax bases on which these rely. Tax policies of sovereign states have, historically, been the means of maintaining a high standard of public services why reduced tax bases could arguably be a threat to the welfare state. The proliferation of tax havens and increased use of tax deferral have led to a decrease of the domestic revenue in many countries. This problem was addressed in the United States in the 1930's and led to the creation of tax rules, which targeted accumulation of profits in corporations when they should be taxed to the shareholder directly. It indirectly started with the "&semicpersonal holding company"&semic rules, which, however, only applied to domestic corporations. Corporations avoided these rules and its current taxation by incorporating subsidiaries in tax havens and harmful preferential tax regimes, where the profits accumulated tax-free. In order to impose tax on these profits Congress introduced the "&semicforeign personal holding company"&semic rules. Since these rules mainly targeted passive income that should be taxed by an American physical shareholder, they did not hinder the use of base companies in low tax states and their accumulation of profits. Subpart F, finally, targets accumulated income in foreign corporations, which are controlled by United States shareholders, and imposes current taxation on the American shareholders. The application of the American Subpart F rules is dependent on the interpretation of voting control. In order to eliminate the possibility of avoiding current taxation, by transferring control to foreign investors, the voting control is, in practice, determined with consideration of the actual control of the corporation. The "&semiccontrolled foreign corporation"&semic regime further includes rules regarding "&semicforeign investment companies"&semic and "&semicpassive foreign investment companies"&semic. The recent proliferation of "&semiccontrolled foreign corporation"&semic regimes worldwide has raised the tax compliance requirements for corporations, which in many cases can be severe. Corporations are induced to restructure corporate groups and the ownership of foreign corporations to avoid these rules. An interesting question is whether the efforts of governments to protect the tax base, in practice, induce tax avoidance or if they are effective in protecting the tax revenue. Today the use of current taxation on foreign source income is not controversial, as it very much was in the beginning of the enactment of CFC rules. The international tax field has changed over time and with it the principles of tax law. The existence of a customary tax law is thereby an important question when addressing the compatibility with international law. Not at least when discussing the VCLT and its importance in interpreting tax treaties. While the United States considers the Convention binding as customary law in other areas, it is not applied in tax cases. An important aspect of the CFC regime is its relation to double tax treaties. If a domestic legislation, such as the CFC provisions, conflicts with an existing tax treaty, which regime has precedence? Depending on which country is at question the answer will be different. In many countries giving international obligations precedence is predominant. In the U.S. tax system, however, the last-in-time rule could lead to treaty override. Although the U.S. tax systems, concerning "&semiccontrolled foreign corporations"&semic, constitute a comprehensive regime, they still encounter problems, such as the easily manipulated concept of voting control. Over time, and as problems arise, the rules are improved and made even more aggressive. One aspect of the rules, however, is whether the United States, in its quest for revenue, is guilty of breach of international law.