In line with other anti-avoidance rules introduced in Nigeria over the years since the publication of the OECD BEPS action plan, Nigeria is currently proposing the introduction of a controlled Foreign Corporation/Company (CFC) Rule. In this short article, we simplify the concept of a CFC Rule while highlighting the potential impact of these rules on Multinationals controlled by a Nigerian Company.

What is a CFC Rule?

Simply, a CFC Rule is an anti-avoidance rule designed to prevent multinational companies from shifting profits to subsidiaries located in low-tax jurisdictions in order to avoid paying taxes in higher-tax jurisdictions where the parent company is located/resident. The Rule aims to prevent tax deferral on foreign source income of resident companies, accrued, brought into or received as income in the recipient’s jurisdiction of residence.

Usually, to avoid tax, a resident company which controls a foreign subsidiary may defer tax payable on such income until it is repatriated to the home jurisdiction. However, by the CFC Rule, once a foreign subsidiary is considered a CFC, the income earned by the subsidiary may be subject to taxation in the parent company’s home jurisdiction, even if the income is not repatriated to the parent company. They require that the undistributed income of foreign subsidiary companies be attributed to the resident shareholder and taxed as if the profit had been distributed. These rules generally apply when the foreign subsidiary is located in a low tax jurisdiction or a jurisdiction with a tax rate that is lower than the home jurisdiction’s tax rate.

Importantly, a CFC is an entity registered and conducting business in a different jurisdiction than the jurisdiction of its controlling owners. A foreign entity is usually considered as a CFC where more than 50% of its shareholding or voting rights are controlled by a resident of another jurisdiction.

The specific CFC rules and the tax treatment of CFC income may vary depending on the local tax legislation in the relevant jurisdiction. For instance, the United States, maintains a “current inclusion” system, which requires the parent company to include the CFC’s income in its tax return for the year in which the income is earned while the United Kingdom adopts a “deferral” system, which allows the parent company to defer the tax on the CFC’s income until it is repatriated to the parent company. However, the application of a CFC Rule, is generally triggered by a combination of the control of foreign subsidiary by a resident entity; the presence in a jurisdiction with a lower tax rate than the home country; and passive income earned by subsidiaries (while some jurisdictions apply the Rules to also active income).

Objectives of the CFC Rule

Preventing Tax Evasion and Deferral: They aim to disincentivize companies from earning income in lower tax jurisdictions by subjecting that income to domestic tax. This prevents the indefinite postponement of taxation on foreign-source income by retaining earnings in the foreign corporation or by using them in non-taxable ways, such as loans.

Ensuring profits are taxed where value is created: The goal is to ensure that profits are taxed where economic activities take place and value is created. Without the Rules, companies may shift profits to subsidiaries in Countries with little or no tax and avoid paying taxes in Countries real economic activities take place.

Countering Profit Shifting: CFC rules address the risk that taxpayers with a controlling interest in a foreign subsidiary can strip the tax base of their country of residence by shifting income into a CFC resident in a low or no tax jurisdiction. This prevents the use of foreign subsidiaries in low-tax jurisdictions to erode the parent company’s tax base.

Features of the CFC Rule

• Control Test: A set of rules defines when a foreign entity is considered a CFC, usually based on an ownership threshold for domestic shareholders.
• Attributable Income: Rules determine how income is attributed to a CFC. This generally includes income from investment or passive sources
• Deemed Dividend Inclusion: The rules typically require that certain classes of taxpayers currently include in their income certain amounts earned by foreign entities they control, even if no dividends are actually distributed.
• Preventing Double Inclusion: Most CFC rules permit the exclusion from taxable income of dividends paid by a CFC from earnings previously taxed to members under the CFC rules.

Exemptions and Exceptions

Notwithstanding the above, it is important to note that not all foreign subsidiaries are subject to CFC Rules, especially where the foreign subsidiary is engaged in substantial business/economic activities such as manufacturing or the provision of services. Similarly, some jurisdictions only apply the CFC Rules if the income of the foreign subsidiary is already subject to a foreign income tax exceeding a certain percentage of the home jurisdiction’s tax rate.

Nigeria’s Tax Bill Proposal on CFC

Following the path of jurisdictions which have historically enacted CFC Rules, such as the US, France, the UK, Germany, etc., Nigeria is proposing to establish a CFC Regime, subject to the promulgation of the Nigerian Tax Bill. The proposed CFC Rule applies to a Nigerian company which controls a foreign company and appears to target only passive income. The proposed rule states that if a foreign company controlled by a Nigerian company has not distributed profits in a year, the portion of those profits attributable to the Nigerian company, which could have been distributed without detriment to the company’s business, will be construed as distributed and included in the Nigerian company’s profits for tax purposes. This means these profits will be subject to tax in Nigeria, protecting the country’s tax base.

Also, it further states that where a non-resident company which is a subsidiary of a Nigerian company pays a tax lower than the minimum tax rate, the Nigerian parent company would be required to pay an amount to bring the tax payable to the minimum rate.

However, the provision does not define what constitutes a CFC and fails to establish exemptions or thresholds to limit its scope. There is also ambiguity on how the “profits that could have been distributed without detriment to the company’s business” will be determined by the tax authority. This could lead to uncertainty and potential difficulties in implementation. The Bill indicates that the proposed Nigeria Revenue Service will provide detailed rules for the implementation of the proposed CFC regime to provide clarity and direction to taxpayers.

Conclusion

In conclusion, CFC rules can have a significant impact on multinational companies, as they can increase the overall tax burden on foreign subsidiaries and limit the ability of companies to take advantage of lower tax rates in other countries. While the final/harmonized draft of the Bill is currently awaiting assent by the President, Nigerian companies with foreign subsidiaries need to keep the potential implications of the implementation of a CFC Rule in view and obtain competent legal and tax advise on its implications upon promulgation.