caused by havens and preferential regimes is a common goal of at least a substantial group of OECD countries. Third, that collective measures are the most effective path toward that common goal.
That income qualifies for Australia’s active income exception, whereas under the Japanese CFC rules, Ireland is a tax haven and royalties are always attributable.
The Model
The model is likely to have a mildly positive effect on the revenues of countries in the group. The essence of this model is that it produces no less tax revenue, but features fewer and substantially simplified rules and calculations. Compliance and administration savings may be positive. The model’s concessional items list protects against lowtaxed income from group countries slipping through the net. A collective form may also be more effective in targeting some of the loopholes and arbitrage opportunities within and among CFC regimes. Attitudinal change also provides benefits. The word “foreign” in ‘CFC’ may subtly cast foreign source income as guilty until proven innocent. International tax harmonization and comity have increased substantially since 1962. The prima facie attribution of any foreign-source income that can occur under many current CFC regimes, along with complex CFC compliance requirements, creates legitimate irritation among corporations engaged in business overseas not primarily motivated by tax considerations. There is, however, no intention to deride existing CFC regimes; it is the success and wide adoption of CFC regimes since 1962 that has now closed the need for their broad application. In some ways, historical broad-application CFC legislation could be seen as an example of successful legislation—that which eventually obviates the need for itself. The collective and reciprocal nature of the model addresses many “competitiveness” concerns of countries with powerful multinational corporations, previously a sticking point preventing CFC reform. The prospect of, for example, a German IT company being allowed to defer Dutch source income while a U.S. IT company must pay current tax on its Dutch source income is eliminated through reciprocity and uniformity.
The heart of the model is that among the group there shall be deferral (or exemption, in territorial systems) of undistributed foreign business income of CFCs resident in any of the other group countries. The group could comprise the United States, Canada, the United Kingdom, France, Germany, Italy, Norway, Sweden, Finland, Japan, Australia and New Zealand, and efforts to expand the list for legitimate reasons should be made. It is true that under the current CFC regimes of the above twelve countries, most of the income in question would not ultimately be attributable. That result, however, is arrived at through wildly varying mechanisms. Additionally, many of these mechanisms, like thresholds of notional tax payable, require inefficient duplication and calculation. To account for small or irreconcilable differences among respective tax systems of group countries, exceptions to exemption or deferral can be adopted for specific items of income taxed concessionally or not at all in other group countries. The main determinant of attribution is the residence of the CFC, not the source of its income. That is a relatively simple approach in the face of multitier multinationals, and the reciprocal nature of the model means it is also effective. A three-tier example illustrates this. Consider a Japanese entity with an Australian CFC (CFC 1), which in turn has a CFC (CFC 2) in a nongroup country. CFC 2’s income would be exempt from attribution in Japan, indeed in any group country other than Australia. That is because, under the model, Australia is the first and only jurisdiction to attribute/tax this income, applying the common CFC rules described herein. Ideally, all of the income of nongroup CFCs should be presumptively attributable and subjected to a high-tax kick-out. There should be a reasonably high degree of uniformity among group countries of the rules by which nongroup country CFC income is attributed. Without this, differences could be exploited and the rule representing the lowest common denominator in any given circumstance would effectively apply across the group. That possibility inheres, for example, in the three-tier example described above. The Australian entity may have been interposed solely to replace the Japanese CFC rules with those of Australia because, for example, the third-tier entity is earning active royalty income in Ireland. AUTUMN 2006
Benefits of the Model
The Group The 12 countries suggested as a starting point for the group are the United States, Canada, the United Kingdom, France, Germany, Italy, Norway, Sweden, Finland, Japan, Australia and New Zealand. That is already a substantial list, but since inclusiveness is the most important feature of the group, other countries should be considered. To join the reciprocal group, countries must be prepared to modify their CFC rules to, or toward, the consensus model devised by the group. A country’s willingness to do
this, and to make consequential amendments to its other tax laws like its corporate income tax rates and preferential tax regimes, has to be weighed by the country against the benefits of joining the reciprocal scheme. Certainly, those non-group countries—income from which is consistently subject to the high-tax kick-out after prima facie attribution—might campaign for group membership and make the necessary reforms. A major benefit of group-country residence is being excused from having to do the calculations at all. Countries that pointedly maintain or develop tax laws substantially different from the group norm, such as Ireland, Hong Kong and the Netherlands, present one of the biggest knots in the model. Those nations have developed, diverse economies, and so offer potential nontax investment attractions. However, their effective rates of tax on business or on particular entities are significantly lower than the group average and appear to distort investments toward those countries, thus perpetrating the inefficiency mischief at which antihaven measures are directed. So one could ask, why should interests in those countries be exempt from the same sort of attribution that would hit interests in Vanuatu and Barbados? Developed economies such as Ireland are more able than many “blacklisted” tax havens to bear the cost of restructuring to absorb the withdrawal of foreign investment. This is an issue for discussion.
Conclusion Of all the conceivable ways to structure an attribution system to target tax havens and preferential regimes, a reciprocal, jurisdiction-based scheme has much to recommend it. The potential efficiencies from largely replacing 12 or more cacophonous CFC regimes with one system, and categorizing income by jurisdiction rather than by a dizzying array of transactions, are considerable. The frank identification of countries that use tax rates and regimes as incentives to divert capital may lead these countries to reform to reap the benefits of the reciprocal scheme. On a practical front, design and technical analyses of this model will surely spur new dilemmas, even before the complications of political deal-making. However, those considerations do not derogate from the vision of the article—to propel an awareness of CFC developments in Australia into an idea for reform that has a clear antihaven philosophy, a dream of simplicity and a multilateral perspective. ■ The author would like to thank David Rosenbloom, Ruth Mason and the rest of the tax faculty for their support and suggestions. THE LAW SCHOOL
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