Controlled Foreign Corporation (CFC)

Without special rules, a parent company could place passive income such as interest or royalties in a subsidiary in a low-tax country and leave it there untaxed at home. CFC rules stop this by attributing certain profits of the foreign company to its controlling shareholders, who then pay tax on them currently, even if no dividend is paid. A company counts as controlled when residents hold more than a set share of votes or capital, which varies by country. Rules typically apply to low-taxed or mainly passive income, with exemptions for genuine business activity. Many countries have them, and they were strengthened under the OECD base erosion work. Groups with foreign subsidiaries monitor them in their tax compliance. Deferral is what these rules target: profit left in the subsidiary stays out of home tax until it is paid up.

A trading group sets up a subsidiary in a low-tax country to hold licences for its brand. Royalties from group companies build up there, and none are paid out. Because the parent controls the subsidiary and the income is passive and lightly taxed, the parent's home country taxes those royalties on the parent each year.