A proposal to reform income anti-tax-deferral regimes

Abstract

This paper argues that despite the existence of CFC rules, their scope and effectiveness is limited and these limitations are likely to be further exacerbated by business that is conducted over electronic networks, like the Internet. Two related problems exist with the scope and effectiveness of CFC rules. First, these rules are limited by their underlying design features, including that they only typically apply to foreign ‘companies’, and then only to those that are ‘controlled’ by residents. Even if these limitations are overcome, the rules usually only apply to ‘tainted’ income (passive income and sometimes foreign base company sales income) but not usually to active business income. This disparate treatment which applies among categories of income can lead to difficult characterisation issues and inevitable tax planning activities. Secondly, CFC rules may not be well-equipped to accommodate emerging challenges, including the increased use of hybrid entities, which can be used to avoid the operation of CFC rules. The onset of electronic commerce is likely to intensify these challenges. The existence of these concerns suggests that a review of CFC rules is needed. It will be argued that ending deferral of income altogether may best address the expressed concerns and therefore represent the ideal solution to the problems with CFC rules.However, in the face of international competitiveness concerns, as well as political realities, it is recognised that this is an unlikely outcome. Therefore, if CFC rules are to remain effective, their scope needs to be extended, both in terms of the number of countries that should consider adopting such rules, and also in terms of extending the operation of these rules to ensure that harmful tax practices that may be carried on by preferential tax regimes are within the scope of the rules. Also, it is argued that for CFC rules to remain effective, they need to be strengthened through the adoption of supporting rules. Finally, and perhaps most significantly, it is argued that supplementary measures at the multilateral level are needed. There is currently no international tax body that can take this work forward in a truly multilateral way. One possibility might be to establish a World Tax Organisation to assume this responsibility. The role of such an organisation would not be to impose tax or to collect tax; rather such an organisation could represent a forum where emerging problems, such as electronic commerce and harmful tax competition, can be discussed in a coordinated and inclusive multilateral way that would extend beyond just OECD countries.