On July 19, 2013, the OECD presented an action plan with 15 action points to deal with base erosion and profit shifting (“BEPS”). On April 3, 2015, a discussion draft was released which deals with Action 3: strengthening controlled foreign company (“CFC”) rules. The discussion draft intends to provide stakeholders with substantive options for analysis and comment and is addressed below.

The essence of Action 3 (Action Plan July 2013)

Action 3 of the BEPS Action Plan recognises that groups can create low-taxed non-resident affiliates to which they shift income and that these affiliates may be established in low-tax countries wholly or partly for tax reasons rather than for non-tax business reasons. CFC rules combat this by enabling jurisdictions to tax income earned by foreign subsidiaries where certain conditions are met. However, some countries do not currently have CFC rules and others have rules that, according to the OECD, do not always counter BEPS situations in a comprehensive manner.

There is interaction with many of the other BEPS Action items, including Action 1 (addressing the tax challenges of the digital economy), Action 2 (hybrid mismatch arrangements), Action Item 4 (interest deductions), Action Item 5 (countering harmful tax practices) and Action 8-10 (transfer pricing).

Discussion Draft (April 2015)


The discussion draft under BEPS Action 3 focuses on developing recommendations for the design of CFC rules to combat base erosion and profit shifting. It considers all the constituent elements of CFC rules and breaks them down into seven “building blocks” that are considered necessary for effective CFC rules. The majority of these building blocks include recommendations, and the building block that does not yet include a recommendation discusses possible options that could be included in effective CFC rules. The discussion draft also identifies specific questions for which input is required.

Building blocks

The seven building blocks and some of the recommendations are: 

  • Definition of a CFC (recommendation: broad definition, including corporate entities, partnerships, trusts and permanent establishments; issues include: transparent entities);
  • Threshold requirements (recommendation: include a low-tax threshold, based on the effective tax rate; issues include: fragmentation of operations; anti-avoidance condition);
  • Definition of control (recommendation: CFC rules should at least apply both a more than 50% legal and an economic control test);
  • Definition of CFC income (no recommendations yet, only several possible options are discussed on which divergent views appear to exist; issues include: substance tests, income attribution);
  • Rules for computing income (recommendation: use the rules of the parent jurisdiction, specific rules on the offset of CFC losses are necessary);
  • Rules for attributing income (various recommendations on how and when to attribute income to the appropriate shareholders in the CFC and the applicable tax rate);
  • Rules to prevent or eliminate double taxation (recommendations: allow a credit for foreign taxes actually paid and exempt dividens and gains on disposition of CFC shares from taxation; issues include: relief from double taxation in multiple jurisdictions).

Secondary rule?

Some countries have proposed that in addition to CFC rules (the “primary rule”), countries could introduce further rules (the “secondary rule”) that applied to income earned by CFCs that did not give rise to sufficient CFC taxation in the parent jurisdiction. Such secondary rules would introduce a secondary form of taxation in another jurisdiction (for example the source country of the income earned by the CFC). Currently, several options are being considered.

Next steps

Interested parties are invited to comment on this discussion draft. Submissions close on May 1, 2015. All comments will be made publicly available. A public consultation meeting on Action 3 will be held at the OECD Conference Centre on May 12, 2015. The Action Plan calls for the work to be completed by September 2015 and the recommendations ultimately agreed upon are expected to be delivered to the G20 Leaders and Finance Ministers in late 2015, along with other 2015 BEPS deliverables.

Final remark from a Dutch and EU perspective

Currently, the Dutch corporate tax system does not include a specific CFC rule, perhaps other than the mandatory annual revaluation of certain low-taxed passive investment participations and the non-exemption of low-taxed foreign passive investment permanent establishments. Although the discussion draft and its recommendations are subject to consultation, it appears clear that once the work is completed and consensus is achieved, Dutch tax law could be subject to change in this respect. As the discussion draft points out, the final recommendations will have to take account of EU law, in particular the case law of the EU Court of Justice.

If you would like more information on this topic, we will naturally be happy to be of assistance.

Click here to download the memorandum in pdf format