Introduction

Ireland introduced controlled foreign company (“CFC”) rules for the first time as part of Finance Act 2018. These rules apply for accounting periods commencing on or after 1 January 2019.

Although CFC rules are typically associated with countries which have high tax rates or exemptions for foreign income, the Anti-Tax Avoidance Directive (“ATAD”) requires each EU Member State to implement CFC rules into domestic legislation by January 2019. CFC rules are an anti-base erosion measure and are aimed at preventing the artificial diversion of profits to subsidiaries located in low tax jurisdictions.

The new Irish rules are designed to re-attribute undistributed income of a CFC to an Irish group company which is generated from activities carried on by an Irish group company. Such income forms part of the taxable income of the Irish company.

The new Irish CFC rules are complex and the purpose of this article is to provide a high level guide to the CFC rules and its exemptions for groups headquartered in Ireland.

What is a CFC?

A CFC is a company which is tax resident outside of Ireland and is controlled by a company or companies tax resident in Ireland. Ireland has structured its rules to include the effective tax rate test outlined in ATAD as an exemption which in effect means that where the foreign tax paid is at least 50 percent of the hypothetical Irish tax on the entity then by definition there should be no CFC charge. See below for further details on the application of the effective tax rate test and other potential exemptions.

A broad definition of the term “control” has been included in the Irish CFC rules. This definition is largely based on the existing close company rules with some additional tests relating to the ability to control the composition of the board of directors of the company and other criteria. Interestingly, the extent to which a company may be deemed to control a CFC under Irish CFC rules exceeds the minimum requirement set out under ATAD.

Given this wide-ranging definition of control, significant care should be taken in determining whether joint ventures and other similar investments are controlled by companies’ tax resident in Ireland.

The Charge to Tax

A CFC charge exists where a CFC has undistributed income which can be reasonably attributed to “relevant Irish activities”.

As a CFC charge arises only where a CFC has undistributed income, the definition of “undistributed income” is a key concept of the rules. Essentially, undistributed income is the CFC’s profits before tax for an accounting period excluding capital gains or capital losses and dividends that would be exempt from the charge to Irish tax if the CFC was tax resident in Ireland. Hence, a CFC charge may not arise in respect of capital gains of a CFC or income which would amount to franked investment income if the CFC was tax resident in Ireland.

Provided a number of conditions are satisfied, distributions by a CFC reduce the amount of undistributed income within the scope of the CFC rules. It is important to highlight that in the case of a distribution by a CFC to a person resident outside of Ireland, these conditions include that the recipient is tax resident in an EU Member State which imposes a tax that generally applies to distributions receivable from outside of that EU Member State and the distribution has been subject to tax. For example, a dividend paid to a company which is tax resident outside of the EU may not reduce the amount of the CFC’s distributable income for the purposes of CFC.

Where a CFC has undistributed income, it is necessary to consider whether such income can be reasonably attributed to relevant Irish activities. Relevant Irish activities are significant people functions (“SPF”) and key entrepreneurial risk taking (“KERT”) functions performed in Ireland on behalf of the CFC relating to:

• the legal and beneficial ownership of the CFC’s assets; or
• the assumption and management of the CFC’s risks.

The meaning of SPFs and the KERT functions is aligned with the 2010 OECD Report on Profit Attribution to Permanent Establishments. Accordingly, the CFC rules may require groups to perform a functional analysis to establish whether the CFC’s income could be attributable to relevant Irish activities.

Where an exemptions from a CFC charge is not applicable (outlined below), the chargeable company is the company in which these “relevant Irish activities” are performed. Whether the income will be taxable at 12.5% or 25% will depend on the nature of the income in the entity which performs the relevant Irish activities. To ensure that the income is not subject to double taxation, a credit for foreign tax paid is available against a CFC charge.

Exemptions from a CFC Charge

The undistributed income of a CFC is exempt from a CFC charge in a number of circumstances. In total, there are eleven exemptions set out in the Irish CFC rules which may be applied in any order. A group may rely on the most relevant exemption applicable.

The primary two exemptions means there should be no CFC charge where (i) the essential purpose of the arrangement is not to obtain a tax advantage and (ii) the company does not have any non-genuine arrangements in place.

1. Essential purpose

This exemption provides that a CFC charge does not arise to the extent that the CFC did not at any time hold assets or bear risks under an arrangement where the essential purpose of the arrangement was to secure a tax advantage.

2. Non genuine arrangements

This exemption applies where a CFC does not have any non-genuine arrangements in place during the accounting period. A company is considered to have non-genuine arrangements in place where:

1. the CFC would not own the assets or would not have borne the risks which generate its undistributed income but for relevant Irish activities undertaken in relation to those assets & risks; and
2. it would be reasonable to consider that the relevant Irish activities were instrumental in generating that income.

Other Exemptions from a CFC Charge

As the purpose of CFC legislation is to prevent diverting profits to low tax jurisdictions, the Irish CFC rules include an exemption from the CFC charge where an effective tax rate test is satisfied. A CFC charge does not arise under this exemption where the foreign tax paid or borne by the CFC for an accounting period effectively equates to 50% or more of the tax that would be payable in Ireland for that accounting period. It is important to note that the calculation of the effective tax rate is computed by reference to Irish tax rules and the amount of foreign tax may be required to be adjusted in particular circumstances. Groups should bear this in mind, even where the headline tax rate in the CFC jurisdiction is close to, equal to or higher than the Irish headline tax rate.

The Irish CFC rules also include a number of de minimis exemptions from a CFC charge. Subject to certain anti-avoidance rules, these exemptions ensure there is no CFC charge where the CFC has low accounting profits or a low profit margin or where the relevant Irish activities are negligible in the context of the activities of the foreign entity.

In addition, the Irish CFC rules provide that a CFC charge does not apply to undistributed income arising from arrangements under which relevant Irish activities are performed whereby either (i) it would be reasonable to consider that such arrangements would be entered into by persons dealing at arm’s length or (ii) the arrangements are subject to Irish transfer pricing rules.

Lastly, an exempt period may apply on the acquisition of a new CFC where conditions are satisfied.

Conclusion

The introduction of the CFC rules amount to a fundamental change in Irish tax legislation that will impact all Irish groups with overseas operations. The Irish CFC rules are complex in nature and introduce a number of new concepts, such as SPF and KERT functions, into Irish tax legislation.

For accounting periods commencing on or after 1 January 2019, Irish groups will need to consider how they are going to approach the task of assessing the CFC status of overseas subsidiaries. This may require a significant effort for Irish groups to establish whether distributable income of subsidiaries are subject to a CFC charge and groups may have to revisit their overall tax strategy.

Colin Smith is a tax partner with PWC

Email: colin.p.smith@pwc.com

Cathal Barrett is a tax consultant with PWC

Email: cathal.barrett@pwc.com