The Global Entrepreneur's Guide to CFC Rules
Controlled Foreign Corporation rules explained — how they work, which countries enforce them, and what it means for international entrepreneurs.
CFC (controlled foreign corporation) rules are a set of legislation primarily introduced to prevent the operation of empty shell companies in low-tax jurisdictions out of countries with higher corporate taxes.
What is the Purpose of CFC Rules?
Corporate tax rates vary widely throughout the world. The industrialized nations of the West generally have high tax rates, while there are many countries with lower or even zero percent tax rates in the world.
Without CFC rules, citizens of high-tax jurisdictions could circumvent their countries' high tax rates by operating their business in low-tax jurisdictions. Especially today where business can be controlled virtually and without requiring any fixed physical location, this has become more relevant than ever.
To prevent businesses and individuals from minimizing their tax liability by taking advantage of cross-country differences in taxation, many countries have implemented various anti-tax avoidance measures.
How CFC Rules Are Being Applied
Even though CFC rules can be quite complex, they generally follow the same basic structure:
- Ownership threshold — Most Western countries consider a foreign subsidiary a CFC if one or more related domestic corporations own at least 50 percent of the subsidiary. Twenty-nine OECD countries use this standard.
- Tax test — Most Western countries view a subsidiary as taxable if the foreign jurisdiction's tax rate is below a certain threshold, and/or a certain share of the income is passive. Passive income includes earnings that don't stem from actual business activity, like interest, dividends, rental income, and royalty income.
- Income scope — Once it has been determined that the subsidiary is a CFC, countries decide what income earned by the CFC will be subject to tax. These rules vary significantly and can apply to a share of passive income or both active and passive income.
We can roughly differentiate between five levels of CFC rules:
- Category 1: Strict rules against active income
- Category 2: Strict rules against passive income
- Category 3: Soft rules against passive income
- Category 4: General tax avoidance rules
- Category 5: No CFC rules
This is not a clear categorization, and the different CFC rules are subject to regular change. A good place to find up-to-date information on the specific rules for a country is the PwC Worldwide Tax Summary.
Countries with Strict CFC Rules, Against Active Enterprises
Most OECD countries and industrialized countries have strict CFC rules that also target actively operating enterprises. Whether they are tax-liable domestically or abroad depends on the percentage of ownership and the tax rate in the country of incorporation.
| Country | Key Trigger |
|---|---|
| Belgium | More than 50% ownership + foreign tax less than half of Belgian CIT |
| Brazil | Crediting of foreign tax up to 34% |
| China | Below 12.5% corporate tax |
| Estonia | Below 12% corporate tax |
| France | 50% below French tax rate |
| Germany | Domestic management, below 25% corporate tax, passive income |
| Greece | Domestic management, below 13% corporate tax |
| UK | Domestic management |
| Israel | Domestic management, below 15% corporate tax |
| Italy | 50% below Italian tax rate |
| Japan | Below 20% corporate tax |
| South Korea | Below 15% corporate tax |
| Norway | 2/3 below Norwegian tax, more than 50% of shares |
| Portugal | Below 60% of Portuguese taxes |
| Russia | Domestic management, more than 10,000,000 Ruble income |
| Spain | Below 75% of Spanish taxes |
| Sweden | Below 12.1% corporate taxes |
| USA | More than 10% of shares, more than 50% shares of US citizens |
Countries with Strict CFC Rules, Against Passive Enterprises
| Country | Key Trigger |
|---|---|
| Australia | Min. 5% passive income of total income |
| Canada | More than 10% ownership, more than 50% voting shares, passive income |
| Denmark | More than 50% passive income of total income |
| Lithuania | Below 75% of Lithuanian taxes on passive income |
| Mexico | Less than 75% of Mexican taxes, more than 20% passive income |
| New Zealand | More than 5% passive income |
| Peru | Less than 75% of Peruvian tax |
Countries with Soft CFC Rules, Against Passive Enterprises
| Country | Key Trigger |
|---|---|
| Argentina | Min. 50% passive income |
| Indonesia | More than 50% ownership |
| Poland | More than 50% passive income, less than 25% of Polish tax, more than €250,000 revenue |
| Turkey | More than 25% passive income, less than 10% taxes, corporations only |
| Uruguay | Less than 12% taxes, individuals only |
Countries Without CFC Rules, But General Limitations
| Country | Limitation |
|---|---|
| Austria | Requires significant assets for active companies |
| Latvia | 15% withholding tax on transactions with low-tax countries |
| Malta | More than 50% passive income, less than 15% taxes |
| Netherlands | 15% withholding tax on services in countries with less than 12.5% or blacklisted |
Countries Without Any CFC Rules
To mention a few important ones: Switzerland, Ireland, Czech Republic, Slovakia, Luxembourg, Chile.
Non-Cooperating or Blacklisted Countries
Some countries don't rely on the tax rate as the primary deciding factor. They instead simply decide on a country-by-country basis, whether or not to apply CFC rules. They maintain lists of tax havens/blacklists. Companies from those countries automatically trigger the CFC rules and have to pay domestic corporate income tax. Many times additional limitations or the inability to deduct certain business expenses apply.
Some countries take the opposite approach and choose to use a whitelist instead. Their citizens can seamlessly own and operate a company and pay taxes at source, as long as it is in a country on the whitelist.
A zero percent corporate tax rate, in general, gets a country blacklisted automatically. Treaties for the exchange of tax information can lead to countries being taken off the list again. Because of that, there can be zero-tax countries that are not blacklisted.
Exceptions to CFC Rules
There are some cases in which CFC rules don't come into effect.
Exception #1: EU Freedom of Establishment
As a consequence of the scandals around offshore companies and tax havens of recent years, we might see a move from offshore to onshore. Even within the European Union, there are several models and strategies for legally optimizing tax. The EU's freedom of establishment principle can sometimes override national CFC rules if the company has genuine economic activity in the member state.
Exception #2: Permanent Establishment with Economic Substance
If the foreign entity has genuine economic substance — real offices, employees, and management in the foreign country — CFC rules often do not apply. This is because the entity is considered a legitimate business operation rather than a shell company designed for tax avoidance.
What This Means for International Entrepreneurs
For most of our clients — digital entrepreneurs who are not tax residents of high-tax countries — CFC rules are often not a primary concern. If you are a non-resident of the country where your business is incorporated (e.g., a non-US resident with a Wyoming LLC), and you are tax resident in a territorial taxation country, CFC rules typically don't apply.
However, if you are a tax resident of a country with strict CFC rules (like Germany, France, or the UK), you need to carefully consider the implications before incorporating a foreign entity.
Need help understanding how CFC rules affect your situation? Get in touch →