On 1 January 2019, the Controlled Foreign Company (CFC) rules, as introduced in Finance Act 2018, became operative in Ireland for the first time. This is an anti-abuse measure designed to prevent the diversion of profits to offshore entities in low-tax or no-tax jurisdictions. It will work by subjecting the controlling Irish parent in such cases to immediate taxation unless certain conditions are met.
What does this mean?
In summary, where an Irish company (or a company that is connected with it) which carries on relevant Irish activities (see below), artificially diverts income to a non-resident company that is under its control and unless those profits are distributed back to it, the Irish company will be subject to Irish tax on them.
A credit will be available for any foreign tax suffered and if the foreign tax is greater than the Irish tax the CFC rules will not apply.
Who does this affect?
This applies to Irish companies with a CFC, where:
- there are non-genuine arrangements in Ireland to divert the profits to the CFC, and
- the essential purpose of these arrangements is the avoidance of tax.
A CFC is quite widely defined and, while there are a number of exemptions from the new rules, it is important that any Irish companies with overseas subsidiaries consider their impact.
What is a CFC?
A CFC is a company that is
- not tax-resident in Ireland, and
- is controlled by a company or companies tax-resident in Ireland.
For these purposes, a company will be deemed to be tax-resident in the country by reason of its domicile, residence or place or management. Where, using these criteria, a company is found to be tax-resident in more than one jurisdiction, a tie-breaker test applies with its place of management, followed by the place in which a majority of its assets are located, taking precedence.
For these purposes control is very widely defined, applying in cases where the Irish company possesses, or is entitled to acquire any of the following:
- a majority of the non-resident company’s share capital or the voting power in that company
- a majority of the non-resident company’s income available for distribution
- a majority of the non-resident company’s assets available for distribution to its shareholders on a winding-up of the company
- any part of the non-resident company’s share capital that would suffice to control the composition of the company’s board of directors
The last point above means that holding a “golden share” in the company may suffice for the control test to be met, even if the holder of such a share has no entitlements to any value or voting rights in the company.
By extending it to cover cases where there is an entitlement to acquire any of the above, an option to acquire shares can also suffice to create a controlling relationship in certain cases, even where the option has not yet been exercised and no shares are owned.
It should be noted that these new rules do not apply to overseas branches of Irish companies, such branches are in any case already subject to Irish Corporation Tax.
What are “relevant Irish activities”?
The definition of “relevant Irish activities” is largely based on the 2010 OECD Report on the Attribution of Profits to Permanent Establishments.
In the first instance, in relation to the CFC company, it must be shown that “relevant functions” are carried out in Ireland – this is defined as there being a significant people function or a key entrepreneurial risk-taking function carried out in Ireland.
The assets owned and risks borne by the CFC company are then examined and, if it can be shown that these assets would not have been employed nor the risks borne, were it not for the “relevant functions” being undertaken in Ireland, then the CFC rules may apply.
Who is exempt?
If the above conditions are not met, then new rules will not apply. Some of these conditions (such as the requirement that it be shown that non-genuine arrangements have been put in place for the purposes of avoiding tax) are quite subjective and it is anticipated that there will be further Revenue guidance on the matter.
There are however a number of other specific exemptions, as follows:
- Effective Tax Rate Exemption: as noted above, where the foreign tax paid by the CFC is greater than the tax which it would have paid on those profits in Ireland, the CFC rules will not apply.
- Low Accounting Profit Exemption: Where a CFC’s accounting profits are less than €75,000 the new rules will not apply. This threshold increases to €750,000 provided non-trading profits are less than €75,000. These thresholds are quite modest and illustrate the importance for companies with foreign activities to consider these new rules.
- Low Profit Margin Exemption: Where a CFC’s accounting profits are less than 10% of its relevant operating costs, these new rules will not apply; there are however anti-avoidance provisions to counter cases where arrangements are undertaken to artificially deflate profits in order to qualify for this exemption.
- Grace Period Exemption: The rules will not apply to a newly-acquired CFC for the first twelve-months post-acquisition, provided it is still owned at the end of this period and that a CFC charge does not arise for the second period. The idea behind this exemption is to give groups an opportunity to restructure in order to prevent there being a CFC.
- Transfer Pricing Regime: The CFC charge will not apply to any arrangements that are already subject to the rules on transfer pricing, as set out in S835C, TCA1997.
These new rules are potentially far-rea ching. While it may be the case that most Irish companies are not engaged in the types of activities designed to be caught by them, the fact that the legislation is so widely drafted means that it is advisable for any companies with overseas activities to consider and remain aware of these new provisions.
If you would like to discuss the tax implications of the CFC rules or any other corporate tax issue, please contact a member of our tax team.