The Taxation of Controlled Foreign Corporations

In 1987, New Zealand taxpayers could avoid tax by establishing foreign corporations in which they held a controlling shareholding in low tax jurisdictions. This avoidance could occur in two ways. First, through using the foreign corporation to intercept passive income, such as interest or royalties, that would otherwise be taxed to the shareholders. Secondly, by using a foreign corporation as an investment vehicle for accumulated profits, thus sheltering investment income that would otherwise accrue to the shareholders. Six countries, the United States of America, Canada, France, the Federal Republic of Germany, and Japan, were sufficiently concerned about these problems to enact controlled foreign corporation legislation. Broadly, these countries adopt two methods to determine which income will be subject to taxation: the transactional approach and the jurisdictional approach. The jurisdictional approach is simple, relative to the transactional approach, but for all countries, the legislation is complicated. The author compares the relative merits of each country's legislation, concluding that the United Kingdom offers the most satisfactory model with the lowest compliance and administrative costs. In 1993, New Zealand adopted controlled foreign company legislation modelled on the United Kingdom's approach