“CFC Regime” of Indonesia: Should Indonesia Follow the OECD Recommendations on Designing CFC Rules?

The New “CFC Regime” of Indonesia: Should Indonesia Follow the OECD Recommendations on Designing CFC Rules?

Edwin Larona Sihaloho

ANR: u912536 / 2014169

Master Thesis

International Business Tax Economics Tilburg School of Economics and Management

Tilburg University

Supervisor: Dr. Cihat Öner L.L.M

Second Reader: Prof.Dr.Mr. Daniël S. Smit

February 2019

The New “CFC Regime” of Indonesia: Should Indonesia Follow the OECD Recommendations on Designing CFC Rules?

Tilburg University

Master Thesis – International Business Taxation: Track Economics

Supervisor: Dr. C. Öner L.L.M

Second Reader: Prof.Dr.Mr. Daniël S. Smit

Tilburg University, February 2019

Preface and Acknowledgement This thesis discusses the new CFC regime implemented in Indonesia in comparison with the international standard provided in BEPS Action Plan 3 “Designing Effective CFC Rules” in order to find whether the new rules are justified from legal and economic perspective, as a base for recommendation for the forthcoming tax reform. With this study, I hope can give valuable insight on the interactive of controlled foreign company in Indonesia after the release of Base Erosion and Profit Shifting Project.

I would give my sincere gratitude to my supervisor, Dr. Cihat Öner, LLM for invaluable support, guidance, and encouragement which are very helpful in completion of this master thesis. I would also thank Prof.Dr.Mr. Daniël S. Smit, my lecturer and also my second assessor, for broadening my perspective in international business taxation.

I also want to express my gratitude to my fellow SPIRIT/FETA awardee Agus and the honorary Mbak Tika for their support and encouragement. Also, I would like to thank Pak Ganti and all PPSDM-SPIRIT Ministry of Finance Committee who fully support my study, the PPI Tilburg for the warm friendship, Bagus, Rian, Mas Andrie, and Qivi for the discussion and additional information regarding the topic of this thesis.

Last but not least, I would like to thank my family for their support and prayers, mamak tersayang Tasnia Masnun, Indra, Imran and Reza, and foremost my dear wife, Suci Ramadhani, and my sons Athaillah M Adskhan and Wildan M Harits whom I truly indebted for all the time we have missed. I learn and I am ready to move on. Thank you ya Allah, thank you for always be with us.

Edwin Larona Sihaloho Tilburg, February 2019

Abstract

CFC rules are topical in the current international tax agenda particularly following the OECD recommendations, in their report on addressing BEPS, motivating countries to incorporate and strengthen CFC regimes. This anti-avoidance legislation is often seen as a primary rule to tackle base erosion and profit shifting (BEPS) which applied with certain potential risk. At the relatively same time, following the success of a tax amnesty program in 2016, Indonesia is on the verge of comprehensive tax reform which might change the international tax systems in Indonesia entirely.

The incorporation of a new CFC regime in 2017 raises a question whether Indonesia is on the right track in its effort to battle tax avoidance while keeping the investment climate in Indonesia intact. Tax avoidance may be minimized by pursuing the development of fair and appropriate international tax standards, by imposing tax burdens that are consistent with these standards, and by cooperating with other countries in the assessment and collection of tax on the taxpayers. Consequently, this thesis evaluates to what extent PMK 107 complies with the international standards based on the OECD approach as a base for argument if Indonesia should amend their domestic regulation.

To answer this question, the author assesses the concept of CFC rules in general, the goals of international taxation, and the OECD approach on designing CFC rules as the representation of international standard, and similar regulation in other countries and compare them with PMK 107. Furthermore, the author evaluates the legality of the rules and the economic benefit of the new regime.

iii

Table of Content

Preface and Acknowledgement ...... ii Abstract ...... iii Table of Content ...... iv List of Abbreviation ...... vi List of Tables and Figures ...... vii Chapter 1 - Introduction ...... 1 1.1. Background to Research Area ...... 1 1.2. Motivation to Study ...... 2 1.3. Research Question ...... 4 1.4. Methodology and Materials ...... 4 1.5. Delimitation ...... 5 1.6. Benchmark ...... 5 1.7. Structure of the Thesis ...... 5 Chapter 2 - CFC Rules and the Goals of International Tax Policy ...... 6 2.1. The Underlying Reasons for Adopting CFC Rules ...... 6 2.2. Issues in Implementing CFC Rules ...... 8 2.3. Establishment of CFC Rules and the Goals of International Tax Policy ...... 9 2.4. Summary and Remarks ...... 12 Chapter 3 – BEPS Action Plan 3 - Designing Effective CFC Rules ...... 13 3.1. Introduction ...... 13 3.2. CFC Definition ...... 14 3.2.1. Type of Entity to be considered as CFC ...... 14 3.2.2. Definition of (Sufficient) Control ...... 15 3.3. CFC Threshold and Exemption ...... 16 3.4. Definition of CFC (Attributable) Income ...... 18 3.4.1. Categorical Analysis ...... 19 3.4.2. Substance Analysis ...... 19 3.4.3. Excess Profit Analysis...... 20 3.4.4. Transactional or Entity Approach ...... 20 3.5. Calculation of Attributable Income according to the OECD ...... 21 3.6. Rules for Attributing Income ...... 22 3.7. Rules to Eliminate “Double Taxation” ...... 23 3.8. Interim Conclusion ...... 23 Chapter 4 – Indonesian New CFC Rules ...... 26 4.1. Introduction ...... 26

4.1.1. The justifications for Establishment of CFC Rules in Indonesia ...... 26 4.1.2. Development of CFC Rules in Indonesia ...... 29 4.2. CFC Definition in PMK 107 ...... 33 4.2.1. Type of entity to be considered as a CFC ...... 33 4.2.2. Control Definition in PMK 107 ...... 34 4.2.3. Limitation of CFC Rules to Non-Listed Foreign Entity ...... 36 4.3. Threshold and Exemption in Indonesian CFC Rules ...... 37 4.4. Definition of CFC Income...... 38 4.5. Calculation of Indonesian CFC Income (the Deemed Dividend) ...... 39 4.6. Rules for Attributing Income ...... 39 4.6.1. CFC Rules Participant ...... 39 4.6.2. CFC Attributable Income ...... 40 4.6.3. Time of Income Attribution in Participant Tax Return ...... 40 4.6.4. Treatment of CFC Income ...... 41 4.6.5. Tax Rate on CFC Income ...... 42 4.7. Rules to Prevent and Relief for Double Taxation ...... 42 4.8. Compatibility of PMK 107 and Tax Treaties ...... 43 4.9. CFC Rules and National Tax Revenues ...... 45 4.10. Interim Conclusion ...... 46 Chapter 5 - Conclusions and Recommendations ...... 48 5.1. Conclusions ...... 48 5.2. Recommendations ...... 49 Bibliography ...... A Appendix ...... I

List of Abbreviation

ATAD Anti-Tax Avoidance Directive

BEPS Base Erosion and Profit Shifting

BEPS Action 3 BEPS Action Plan 3 Report on Designing Effective CFC Rules

BKPM Badan Koordinasi Penanaman Modal

(Capital Investment Coordinating Board)

BULN Non-Bursa Badan Usaha Luar Negeri Non-Bursa

(Non-Listed Foreign Entities - CFCs for the Indonesia Tax Purpose)

CFC Controlled Foreign Company

ETR Effective Tax Rate

EU European Union

G20 Group of Twenty Countries

IBFD International Bureau of Fiscal Documentation

ICIJ International Consortium of Investigative Journalists

ITL Income Tax Law

KMK Keputusan Menteri Keuangan

(Decree of Ministry of Finance)

MNE Multinational Enterprise

MoF Ministry of Finance

OECD Organization for Economic Cooperation and Development

PE Permanent Establishment

PMK Peraturan Menteri Keuangan

(Ministry of Finance Regulation)

STR Statutory Tax Rate

List of Tables and Figures

Table 4.1. Outward Investment Companies from Indonesia in 2018...... 28

Table 4.2. Offshore Entities Data in Financial Leaks ...... 28

Table 4.3. List of Black Listed Countries According to KMK 650 of 1994 ...... 31

Figure 1.1. Yearly Development of CFC Rules ...... 2

Figure 4.1. FDI Inflows to Indonesia ...... 27

Figure 4.2. FDI Outflows to Indonesia ...... 27

Figure 4.3. Development of CFC Rules in Indonesia ...... 32

Figure 4.4. Control according to PMK 107 ...... 35

Figure 4.5. Indirect Control according to PMK 107 ...... 36

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Chapter 1 - Introduction

1.1. Background to Research Area

Discussion on controlled foreign company (CFC) legislation has regained increasing attention in the current years,1 both from the law and economic perspectives,23 due to Multinational Enterprises (MNEs) tax avoidance4. As a result of media coverage, several MNEs such as Amazon, Apple, Google, and Starbucks, by exploiting their multinational operation (multi-nationality), are accused as immoral for not paying less than five percent tax of their overall income,5 causing countries to lose a major part of their primary source of revenue.6 Indeed in empirical research, differences in countries statutory tax rate or tax rate differential7 as a proxy of multi-nationality accompanied by the exploitation of tax haven8 are thought to be a significant incentive of tax avoidance. Consequently, there is a growing tendency by countries to adopt or improve their tax rules to cope with this international tax practice. The initiatives by Group of Twenty Countries (G20) and Organization for Economic Co-operation and Development (OECD) regarding tax avoidance that goes by the name Base Erosion and Profit Shifting

1 Peter Koerver Schmidt, ‘Taxation of Controlled Foreign Companies in Context of the OECD/G20 Project on Base Erosion and Profit Shifting as well as the EU Proposal for the Anti-Tax Avoidance Directive – An Interim Nordic Assessment’ (2016) 2 Nordic Tax Journal. 2 Among others, See: Peter H.Egger and Georg Wamser, ‘The impact of controlled foreign company legislation on real investments abroad. A multi-dimensional regression discontinuity design’ (2015) Journal of Public Economics 129 77-91. See also. Andres Haufler, Mohammed Mardan and Dirk Schindler,’ Optimal Policies against Profit Shifting: The Role of CFC Rules’ (2016) 5850, CESIFO Working Paper. 3 Up to the third quarter of 2018 discussion on CFC rules has shown increasing trend ever since the rules were brought into discussion by Organization for Economic Cooperation and Development (OECD) in their report regarding Harmful Tax Competition and Controlled Foreign Company Rules in 1998. See. OECD, Harmful Tax Competition: An Emerging Global Issue (OECD Publication 1998). See Also. OECD, Controlled Foreign Company Rules (OECD Publishing 1998) See Appendix 8 for this trend. 4 Tax avoidance should not be equated with tax evasion. Although the definition of tax avoidance is difficult to define precisely, it generally associated to transactions or arrangements by the taxpayers in order to minimize the amount of tax liabilities within the boundary of the text of regulation. Tax avoidance are often seen as bending the regulation by exposing loopholes in countries’ tax regulation using economically unnecessary but complex steps to obtain tax benefit. Tax avoidance is not intended by tax authorities as it is in contrast with the underlying intention of the regulation. Tax evasion, on the other hand, is reduction of tax by illegal means and is often associated with fraudulent non-disclosure or willful deceit. Tax evasion are punishable by criminal law. See: Chris Evans, ‘Containing Tax Avoidance: Anti-Avoidance Strategies’ (2008) Australian School of Taxation (Atax) The University of New South Wales 10-11 http://ssrn.com/abstract=1397468 accessed November 2018. See also: Brian J Arnold, International Tax Primer (3rd edn, Kluwer Law International 2016) 111, Definition of tax avoidance is also often unclear because court and legislator use the term incoherently. See Cihat Öner, ‘Is tax avoidance the theory of everything in tax Law? A terminological analysis of EU legislation and case law.’ (2018) 27(2) EC Tax Review, 96-112. 5 See Reuters, ‘Factbox: Apple, Amazon, Google and tax avoidance schemes’, (2013) Reuters, 22 May 2013. https://www.reuters.com/article/us-eu-tax-avoidance-idUSBRE94L0GW20130522. See Also: The Telegraph ‘Google boss says $2bn tax avoidance "is called capitalism"’, (2012) The Telegraph, 12 December 2012. https://www.telegraph.co.uk/finance/personalfinance/tax/9740985/Google-boss-says-2bn-tax-avoidance-is- called-capitalism.html 6 Corporate tax is a major source of income especially in developing country, where in some countries it could cover more than 70% of their total expected income. 7 Namryoung Lee and Charler Swenson, ‘Effects of overseas subsidiaries on worldwide corporate taxes’ (2016) 26 Journal of International Accounting, Auditing and Taxation, p. 47–59. 8 Grant Richardson and Grantley Taylor, ‘Income Shifting Incentives and Tax Haven Utilization: Evidence from Multinational U.S. Firms’ (2015) 50, The International Journal of Accounting.

(BEPS) Project encourage countries to strengthen their CFC regimes in their report on addressing BEPS9 in order to limit tax avoidance. CFC rules, which often seems as a direct counter of profit shifting10 through the exploitation of tax rate differential, are echoed as an effective solution to this issue. Countries in European Union (EU) area, following the adoption of anti-tax avoidance directive11 (ATAD) which among others oblige the introduction of CFC rules into domestic laws will adopt this regulation in their domestic law. Consequently, as can be seen in Figure 1.1., the adoptions of this complex regime are increasing and seemingly will further increase in the following next year. These show that CFC rules are becoming more and more important to discuss in international taxation context.

Figure 1.1. Yearly Development of CFC Rules

60 50 40 30 20 10 0 1960s 1970s 1980s 1990s Pra BEPS After Applied Total BEPS 2019 Adoption

Source: Author calculation based on the IBFD database 1.2. Motivation to Study

Developing countries face the same base erosion and profit shifting issue as is confronted by developed ones. Economic research even shows that the impact of BEPS is more significant in developing countries compared to their other counterparts.12 Indonesia, hence, as one developing country is also exposed to BEPS. Indeed, a recent study by Purba and Trans13 showed that MNEs in Indonesia take part in profit shifting by exploiting tax rate differential between immediate parent and subsidiaries located in Indonesia causing considerable tax loss in Indonesian tax revenue.

9 Organization for Economic Co-operation and Development (OECD), Addressing Base Erosion and Profit Shifting (OECD Publishing 2013). 10 Mitchell A Kane, ‘The Role of Controlled Foreign Company Legislation in the OECD Base Erosion and Profit Shifting Project’ (2014) June/July Bulletin for International Taxation. 11 Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market. 12 Among others, a study by Crivelli, De Mooij and Keen who examined profit shifting in developing countries over 1980 to 2013 concluded that developing countries receive bigger and more significant revenue loss from MNEs profit shifting. See. Crivelli, E., De Mooij, R. & Keen, M., 2015. Base Erosion, Profit Shifting and Developing Countries, International Monetary Fund Fiscal Affairs Department: IMF Working Paper. See Also Niels Johannesen, Thomas Tørsløv and Ludvig Wier, ‘Are less developed countries more exposed to multinational tax avoidance? Method and evidence from micro-data’ (2016) 10 WIDER Working Paper. 13 Arnaldo Purba and Alfred Tran, ‘Cross Border Profit Shifting: Evidence from Indonesia” (2017) Australian National University 1.

Indonesia is one of the prominent countries with strong economic growth that is expected to become one of the biggest economies in the future.14 As part of G20 countries and member of the OECD’s Key Partners,15 Indonesia plays an important role in the BEPS Project by supporting the process and outcome (the recommendations). To cope with BEPS issue, Indonesia has participated in the BEPS project and made several adjustments in the anti-avoidance regulation following BEPS Project action plans, although the application is not fully similar to the overall recommendations.16 With regard to CFC rules, following the OECD recommendation in BEPS Action Plan 317 and taking a reflection to pass experience, the regime was amended in 2017.18 There has been no consensus on whether the rules are going to be effective in addressing BEPS issue, since the way PMK 107 was drafted causes different interpretation from experts. Also, there has not been any case law in Indonesia regarding the compatibility of CFC rules, and tax experts have different views on this issue.

Study on CFC rules in developing country context that evaluate both economic and law perspective is rather scarce. To date, CFC regimes are implemented in more than twenty developing countries including Nepal, Indonesia, Russia, Kazakhstan, Egypt, and Brazil.19 Accordingly, this thesis will contribute to the literature in discerning how the implementation of the OECD recommendations affects anti-tax avoidance legislation in developing countries particularly Indonesia. For MNEs decision-making process, this thesis could help them evaluate an investment in Indonesia and tax issues in CFC rule implementation in the country. For countries considering adoption for CFC rules, this thesis might be beneficial as an overview for an applicable design implemented in both developed and developing countries. In the same manner, this study will enlighten Indonesian tax authorities regarding the issues that could arise from the implementation of CFC Rules in Indonesia’s legislation. This is particularly relevant because Indonesia is on the verge of comprehensive tax reform so that their policy will be more tax friendly to investors.

14 Jarryd de Haan, ‘Indonesia: Economic Developments and Future Prospects’ (2017) Strategic Analysis Paper: Future Direction International 1-8. 15 The OECD‘s key partners contribute to its work in a sustained and comprehensive manner. See http://www.oecd.org/global-relations/keypartners/#d.en.194387. 16 For instance, Indonesia has re-introduced thin capitalization rules in 2015 applying debt to equity ratio in variation with earning stripping rules as recommended by the OECD. The same manner also applied in other action plans such as Country by Country Report. See. Tengku Qivi Hady Daholy, ‘Analysis of Country-by- Country Reporting in Base Erosion and Profit Shifting (BEPS) Action 13 and Indonesia's Transfer Pricing Documentation Rule’ (Master Thesis University of Birmingham, 2017). 17 Organization for Economic Co-operation and Development (OECD), Designing Effective Controlled Foreign Company Rules, Action 3: 2015 Final Report, (OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing 2015). Hereinafter BEPS Action Plan 3. The author also interchangeably uses BEPS Action 3, the OECD, Action Plan 3 to make reference to the same report. 18 Minister of Finance Regulation Number 107/PMK.03/2017 on Determination of Deemed Dividends and its base of Calculation by Domestic Taxpayers for Shares Participation in An Overseas Business Entity Other than A Business Entity Trading Its Shares in The Stock Exchange. (id) 19 See appendix 6 for complete list of developing countries with CFC rules.

1.3. Research Question

This study aims to evaluate if the newly implemented CFC regulation in Indonesia could answer past problems and comply with the recent developments in the international area. In particular, this research intends to answer the following question: Should Indonesia change its CFC policy to be more aligned to the BEPS Action Plan 3 recommendation in order to be more effective and at the same time accommodating to the taxpayers? In order to answer the research question, the following sub-research question will be addressed: - How should countries design their CFC rules according to BEPS Action Plan 3? - To what extent does Indonesia comply with international standard on designing CFC rules? Another purpose of this thesis is to discover which feature of CFC rules in Indonesia that could be improved by looking at international standard. Not a single regulation is considered perfect as the environment and people to which the regulation applied are constantly changing. Nevertheless, the regulation could evolve over time to provide the best solution for a stakeholder in the international tax area. In other words, CFC rules, as with other rules, could be set both for the benefit of governments and taxpayers. It is important to notice that BEPS Action 3, also other the OECD recommendations are not legally binding. It is also not part of minimum standard encouraged by the OECD to be implemented by a country participating in the BEPS Project. 1.4. Methodology and Materials

This research seeks to answer a hypothetical question rather than prove or disprove a hypothesis. Accordingly, this study will use a qualitative method by performing analysis on case studies, theoretical discussions and literature review. The data mainly consist of the articles, published papers, textbooks, commentaries and other literature, supported by case law both in an international context and in Indonesia. This study will be interpretative and descriptive in nature. The same as other tax research that uses a multi- disciplinary approach, the conclusion will be highly influenced by the author’s insight.20 For the purpose of this thesis, the author will elaborate the OECD’s BEPS Action Plan 3: Designing Effective CFC Rules21 (hereinafter BEPS Action 3) in order to provide an overview of overall approach by CFC implementing countries. Furthermore, this research will focus on the impact of CFC rules on economic and legal. Following Pinskaya, Malis and Milogolov22, comparative analysis on the most relevant characteristic of CFC rules will be conducted where appropriate. The materials are collected from countries international tax highlights, IBFD’s countries tax key features and guidance to controlled foreign companies provided in tax authorities website.

20 Margaret McKerchar, ‘Philosophical Paradigms, Inquiry Strategies and Knowledge Claims: Applying the Principles of Research Design and Conduct to Taxation’ (2008) eJournal of Tax Research. Can be accessed at http://worldlii.austlii.edu.au/au/journals/eJTR/2008/1.html accessed 07 September 2018. 21 OECD (n 17). 22 Milyausha R Pinskaya, Nina I Malis and Nicolai S Milogolov, ‘Rules of Taxation of Controlled Foreign Companies: A Comparative Study’ (2014) Vol 11 No.3, Asian Social Science.

1.5. Delimitation

Taxation is a social construct that can be studied through many and various disciplinary lenses.23 Among others, law, economics and accounting science play the major role in tax research. In this thesis, the author takes the assumption that the reader has a background in tax law, accounting and economics so that the basic concept of these disciplines are not explained and discussed in detail. The major concern of the research question is to evaluate Indonesian CFC rules. In other words, the basis for this thesis is Indonesian CFC rule and Indonesian tax systems. Also, as a point of reference, the author will elaborate BEPS Action Plan 3. It is, however, not like this thesis to make a thorough analysis of BEPS action plans, international tax law cases and international taxation principles. A minor reference to other countries’ tax systems and case law are consulted when necessary to provide a comprehensive analysis. 1.6. Benchmark

As has been mentioned before, the purpose of the study is evaluating Indonesia new CFC regime in comparison with the OECD approach. Accordingly, the point of reference form this master thesis is the perspective of the OECD in designing CFC rules. The author also observes the benchmark to provide a critical analysis of this complex regime. 1.7. Structure of the Thesis

This thesis consists of five chapters with the first chapter as the introduction of the research. The second chapter presents an overview of CFC regulation, particularly regarding the justification and issues that arise with the establishment of this complex legislation. In the third chapter, BEPS Action Plan 3 is analysed following the structure presented in the report. In the fourth chapter, the main focus of this thesis, CFC rules of Indonesia, is presented. History and problems of past design will be elaborated, including narration of ineffectiveness of CFC rules to cope with tax avoidance in Indonesia. The current CFC rule is presented and analyse interpretatively supported by empirical data where possible. The discussion also presents a comparative approach between Indonesian CFC rules with BEPS Action 3 taking into account BEPS Action 3 elements (building blocks). Chapter five will be the conclusion and recommendation for the government and suggestions for further research.

23 Jane Frecknall-Hughes, ‘Research Methods in Taxation History’ (2016) Review of Behavioral Economics: Vol. 3: No. 1, 5-20.

Chapter 2 - CFC Rules and the Goals of International Tax Policy

The purpose of this master thesis is to analyze Indonesian CFC rules based on international standards. This chapter describes the need for CFC rules in general, and issues in implementing CFC rules. Subsequently, the author discusses ideal CFC rules by taking into account general goals in implementing international tax rule.

2.1. The Underlying Reasons for Adopting CFC Rules The integration of the economy and market has resulted in a shift from country-specific operating models to global models based on matrix management organizations and integrated supply chains that centralize several functions at a regional or global level.24 Moreover, the use of information and technology in business has led to the increasing importance and mobility of intangible assets and the decreasing relevance of companies’ physical presence.25 At the same time, globalization of trade and investment has encouraged countries to implement a tax policy that enables them to increase tax revenue while attracting investment inflows.26 Such conditions create a wide range of tax rates, technicalities and mismatches among countries’ tax system and provide MNEs opportunities to avoid tax their profit by incorporating subsidiaries in an attractive location, in most cases includes tax haven.27 The subsidiaries are considered to be (financially) controlled by resident taxpayers28 of high tax jurisdictions and are therefore often referred to as controlled foreign companies (CFCs) from the perspective of the residence’s State of the controlling taxpayers.2930 Previous empirical research suggested Multinational Enterprises (MNEs) whose affiliates located in low tax countries have higher pre-tax profit but lower tax burdens which indicates the existence of tax avoidance.31 This implies such incorporations are often conducted, but not always, for tax purposes. To counter such tax avoidance, several countries treat a CFC as a taxable company in the state of residence of the controller. The opportunity to avoid domestic taxation using through CFC rest on fundamental features of countries’ tax systems. Firstly, most countries treat companies as separate legal entities, independent of their

24 OECD (n 9) 25. 25 Anne Schäfer and Christoph Spengel, ‘International Tax Planning in the Age of ICT’ (2004) No. 04-027 ZEW - Centre for European Economic Research Discussion Paper 2-4. Available at SSRN: https://ssrn.com/abstract=552061 or http://dx.doi.org/10.2139/ssrn.552061 26 Organization for Economic Co-operation and Development, Harmful Tax Competition: An Emerging Global Issue (OECD Publication 1998). 27 The broadest definition of tax haven could be defined as “any jurisdiction whose tax laws interact with those of another enabling the avoidance of taxation in that other jurisdiction”. It is also applicable that tax haven constitute “a jurisdiction with no or very low effective taxation on all types of income or on income stemming from sources that are easily diverted to a CFC established in such a jurisdiction.” Błażej Kuźniacki, Controlled Foreign Companies and Tax Avoidance: International and Comparative Perspectives with Specific Reference to Polish Tax and Constitutional Law, EU Law and Tax Treaties (2017) 27. 28 Tax resident (or resident) is resident for tax purpose and is not the same as civil resident. Tax resident for company for instance might be based on place of incorporation or place of effective management, while for individual might be based on place of birth or nationality. Each country might have different criteria for tax resident. It is beyond this thesis scope to cover discussion of tax resident. See. Arnold (n 4) 15-21. 29 Kuźniacki, (n 27) 4. 30 In this thesis the controller, resident taxpayers, CFC participant and the shareholders refers to the same term and are used interchangeably. 31 Clemens Fuest and Nadine Riedel, ‘Tax Evasion and Tax Avoidance in Developing Countries: the Role of International Profit Shifting’ (2010) Oxford University Centre for Business Taxation.

shareholders.32 The profit of a company is not taxed at the level of the shareholders until the time of distribution, for instance, in the form of dividends or when the shares in the company are sold.33 Second, income on resident and non-resident are taxed differently.3435 Residents are taxed on income arising within the residence country (domestic income) or on income from domestic and abroad (worldwide/global income) since it is perceived that they have economic and social connections with the country.36 Non-resident (foreigners) are only taxed on the domestic source income based on the link between the income and the country imposing the tax.37

These two features interact and provide the opportunity for tax avoidance. CFC as an independent non- resident entity, cannot be taxed directly as there is no sufficient nexus to domestic country. Hence, resident taxpayers have incentives to avoid domestic tax by exploiting their influence in the CFC. They could determine when to distribute CFC’s income or when to sell its shares in order to postpone current taxation on the net income or gain accrued by the taxpayers.38 Such postponement is called tax deferral which could reduce the tax base of a country which taxes their resident on worldwide income (implementing worldwide tax systems such as the US and Indonesia).39 If domestic countries exempt foreign dividend (adopting territorial tax systems) and capital gain, the foreign income could never be taxed and thus avoided domestic tax completely.40

32 Companies has their own legal right and liabilities including tax liabilities which thus causes companies as separate taxpayers from their shareholders (owners). While the company is given legal right, e.g. to conclude legal contract, the company also shields the shareholders from legal liabilities. Lynne Oats, Angharad Miller and Emer Mulligan, Principles of International Taxation (6th edn, Bloomsbury Professional 2017) para 1.12. 33 This tax treatment is called classical corporate tax system. See Oats, Miller and Mulligan (n 32) para 1.12. The separate entities treatment for taxation can be justified for administrative reasons and respective other countries sovereignty. A high compliance and administrative cost might arise if companies’ activities are taxed at the level of the shareholders. 34 Countries might have differences in determining resident for tax purposes, both for individuals and legal entities. The tax residence of an individual is typically determined by reference to the location of the individual’s income- producing activities, family, visa and immigration status or actual physical presence are typically relevant factors for determining residence of individuals. By contrast, the tax residence of a company is typically determined by reference to the company’s place of incorporation, the place of effective management or both. See. Arnold (n 4) 17-21. 35 As a general common principle in international taxation, a country could levy tax if there is sufficient nexus either between the country and the income (or the activities generating the income) or between the country and the person (both individuals and entity) earning the income. Arnold (n 4) 15. 36 Arnold (n 4) 15-20. 37 It might be not economically efficient to tax non-resident on their worldwide income due to high administrative audit cost and based on international law rule, a country cannot enforce its law in the territory of another country. Reuven S. Avi Yonah and Oz Halabi, ‘US Subpart F Legislative Proposals: A Comparative Perspective’ (2012) Law and Economic Working Papers 2; See also. Michael Lang, Introduction to the Law of Double Taxations Conventions (2nd edn, Linde IBFD 2013) 27. Such limitation restricts and at the same time secure countries’ sovereignty to tax their taxpayers. Also, it will protect taxpayers from taxation that is levied randomly; Daniel Sandler, Tax Treaties and Controlled Foreign Company Legislation: Pushing the Boundaries (2nd edn, Kluwer Law International 1998) 3. 38 Avi Yonah and Halabi (n 37) 2. 39 Ibid. There are some arguments, however, raise for keeping deferral. Deferral is perceived as the most appropriate way to encourage foreign investment and it is needed to attract source countries to enter to bilateral treaties to investor countries. See. Organization for Economic Cooperation and Development, Controlled Foreign Company Rules (OECD Publishing 1998) 16-17. In relation to this CFC rules may contradict with tax treaties. 40 Schmidt (n 1) 88.

CFC rules can be defined as anti-avoidance measures designed to combat the diversion of income into low tax jurisdiction (profit shifting), or the deferral of the remittance of income by leaving it in low tax jurisdictions (base erosion).41 Other than CFC rules, general anti-avoidance rules (GAARs) and other specific anti-avoidance rules (SAARs) such as transfer pricing rules and thin capitalization rules are generally considered to prevent tax avoidance via CFCs. However, those rules are believed have limited impact on preventing BEPS and do not address the core problem of CFC such as the unlimited deferral and profit shifting.42 The core of CFC rules is addressing the multi-nationality of large companies which have access to tax rules in different countries and have sufficient resources to exploit the benefit of mismatches and disparities among tax systems. It is important to mention, however, that this regime is not intended to interfere with the ability of domestic taxpayers to compete internationally43 or even more to foreclose taxpayers to carry legitimate cross-border business. Consequently, it is essential for countries to define low taxation to determine whether CFC rules should apply because the benefit of deferral and profit shifting is higher if CFCs are situated in low tax country or low taxation on CFC income.44 It is rather irrational to tax CFCs if tax avoidance risk is very low or not exist. This low taxation criteria, thus, “link(s) into the evaluations of the CFC rules’ effectiveness in the prevention of tax avoidance via CFC.”45 2.2. Issues in Implementing CFC Rules Taxation of CFC income take place at the level of controllers’ state, and the same income may also be taxed in the CFC’s state. Therefore the application of CFC rules might lead to international double taxation because the same income is taxed more than once in different jurisdictions.46 (Economic) double taxation due to the application of CFC rules is considered more severe and harmful on international business than juridical double taxation because the controller must pay taxes even though the income has not been distributed. As the consequence of possibilities of double taxation, CFC rules are often associated as the tax rules that lower corporate competitiveness and in turn dampen countries capabilities to attract investment.47 To solve this

41 Philip Baker, ‘CFC Aspects of Intellectual Property’ in Włodzimierz Nykiel and Adam Zalasiński, Tax Aspects of Research and Development within the European Union (Wolters Kluwer 2014) 135-144, 135. A country tax base could be described as the number of persons and the amount of profit that a country is permitted to tax. The reduction of profits and gains that a country can tax is commonly referred to base erosion. The reduction of the tax base is performed by attributing profit (income) out of controller jurisdictions to tax haven. This is generally called profit shifting. The consequence of profit shifting is the erosion of the tax base of a country. Consequently, base erosion and profit shifting activity therefore frequently overlap. See Lynne Oats, Angharad Milled and Emer Muligan, Principles of International Taxation (6th edn, Bloomsburry 2017) para 2.1.4 – 2.1.5 See Also Appendix 9 for a graphic describing the overlap of base erosion and profit shifting. 42 This, however, does not mean that solely relying on CFC rules would solve base erosion and profit shifting (BEPS) issue. 43 Hans-Jorgen Aigner, Ulrich Scheuerle, and Markus Stefaner, ‘General Report’ in Michael Lang, Hans-Jorgen Aigner, Ulrich Scheuerle, and Markus Stefaner, CFC Legislation, Tax Treaties and EC Law (Eucotax Kluwer Law International 2004) 22. 44 Schmidt (n 1) 88-89. 45 Kuźniacki, (n 27) 26. 46 Aigner, Scheuerle, and Stefaner, (n 41) 24. This is called economic double taxation. In contrast, juridical double taxation takes place when item of income is taxed more than once at the hand of the same taxpayers. 47 Błażej Kuźniacki, 'The Need to Avoid Double Economic Taxation Triggered by CFC Rules under Tax Treaties, and the Way to Achieve It' (2015) 43 Intertax, Issue 12, pp. 758–772. For this reason, CFC rules are included as

issue, CFC rules are generally (and should) grant sufficient tax credit for taxes paid in foreign countries against the taxes charged in the domestic state.48

It has been argued that CFC legislation could breach double tax treaties on article 7(1) concerning taxation of business profit due to the application of the piercing the veil approach,49 or article 10(5) concerning taxation of dividend with regard to the deemed dividend approach.50 This means CFC taxation override foreign countries sovereignty in (not) imposing taxes in their territory and cause an unfair allocation of taxing rights between foreign countries and the states applying CFC rules.51 Experience of countries case law has been inconsistent regarding this issue, but so far most cases are in favor of the tax authorities.52 Consequently, despite not undisputed, the majority of scholars argue that CFC rules are compatible with tax treaties.53 The OECD, for instance, takes the position that CFC rules are not inconsistent with tax treaty, as shown in the Model Tax Convention Commentary in article 1 since the 2003 version and the recent BEPS Action Plan report.54 In addition, insofar as CFC rules are applied to low tax countries which decide to surrender their taxing right deliberately, such as tax haven, it is difficult to rely on fairness criteria as these countries often seen as performing harmful tax competition to other countries.55 2.3. Establishment of CFC Rules and the Goals of International Tax Policy Taxation should bring benefit instead of becoming a burden to society. The urge to follow tax principles are important in designing tax rules because only when tax principles are upheld that “effective taxes are implemented in a manner which satisfies the stated purposes of a tax system.”56 Scholars have proposed

a factor in calculating countries tax attractiveness index. See. Sara Keller and Deborah Schanz, ‘Measuring Tax Attractiveness across Countries’ (2013) Arqus-Diskussionsbeiträge zur quantitativen Steuerlehre, No. 143. Kiel: Leibniz-InformationszentrumWirtschaft in Magdalena Małgorzata Hybka, ‘Legislative Proposal for a Controlled Foreign Companies Regime in Poland from an International Perspective’ [2014] 38 (4) Financial Theory and Practice 465-487. 48 The extent of tax credit should not exceed the domestic dividend tax. See. Aigner, Scheuerle, and Stefaner (n 41) 23. 49 In the-piercing-corporate-veil approach, the domestic countries override separate legal entities principle. The CFC is treated as a kind of transparent entity which is disregarded for tax purposes. See. Alexander Rust, ‘CFC Legislation and EC Law’ (2008) 36(11) Intertax 493. See Also Daniele Canè, ‘Controlled Foreign Corporations as Fiscally Transparent Entities. The Application of CFC Rules in Tax Treaties’ (2017) November World Tax Journal 521-563, 528. See Also Aigner, Scheuerle, and Stefaner, (n 41) 23. 50 Under deemed dividend approach, CFC legislation is structured so that domestic country does not tax foreign company directly but the rules tax CFC participant on an imaginary dividend of the CFC. This approach recognizes the corporate status of the CFC but disregards the timing of dividend distributions. Consequently, the CFC participants are deemed to have received a dividend distribution at the first possible moment (even though the distribution has not actually taken place). See. Canè, (n 49) 528. See Also. Rust, (n 49) 493. 51 Kuźniacki, (n 27) 41 52 See. Błażej Kuźniacki, ‘Tax Treaty Interpretation by Supreme Courts: Case Study of CFC rules’ can be accessed at http://www.ibdt.com.br/material/arquivos/Palestras/B_Kuzniacki_Supreme_Courts_Case_law_CFC_rules_and_ tax_treaties_version%20from%20Sept_final.pdf 53 Schmidt, (n 1) 103. 54 Organization for Economic Co-operation and Development, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action 6, Final Report (OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing 2015). 55 Kuźniacki, (n 27) 42. 56 Clinton Alley and Duncan Bentley, ‘A Remodeling of Adam Smith’s Tax Design Principles’ (2005) 2 Australian Tax Forum 579-624, 586.

several principles in designing ideal tax policy. Adam Smith, for instance, has described four fundamental principles of the ideal tax system which is still relevant today: equity, certainty, convenience and efficiency.57 Stiglitz58 described five accepted properties of a good tax system. In his point of view, tax rules should represent efficiency, administrative simplicity, flexibility, political responsibility and fairness. Alley and Bentley compiled several tax principles proposed by expert and proposed a set of principle which consists of equity and fairness, certainty and simplicity, efficiency, neutrality and effectiveness.59 In relation to this, in designing international tax rules, such as CFC rules, several tax-experts have argued that country should attempt to achieve four general goals of tax systems.60 CFC rules should not be applied merely focusing on revenue maximizations, but should also attempt to promote equality, to enhance economic competitiveness and to achieve economic neutrality. To obtain fair tax revenue from cross-border transactions in order to increase national wealth is in the heart of tax policy. Well designed CFC rules could ensure country to obtain fair tax revenue by protecting the tax base instead of merely broadening the tax base. Nevertheless, a fair tax would consider taxpayers perspective, 61 particularly with regard to high tax burden due to double taxation. Consequently, CFC rules should provide sufficient relief for double taxation. Also, it should be administrative and compliance cost friendly. Subsequently, the perception of equity (fairness) is essential to encourage taxpayers to comply with tax rules.62 There is a broad definition of fairness; however, economically, there are two forms of fairness/equity. The first one is called horizontal equity. This concept of fairness is achieved by imposing equal tax burdens on domestic and foreign taxpayers with the same level of income regardless of the source of the income. The second form is called vertical equity, which concerns the taxpayers’ ability to pay. In vertical equity view, higher-income earners should pay a higher tax.63 Ideally, CFC rules should (only) address resident taxpayers with sufficient financial capacity. Third, promoting economic growth and enhancing the competitiveness level of the domestic economy are the third consideration in adopting international tax rules.64 Economic growth might be stimulated by attracting investments. An excessive tax could lower taxpayers’ competitiveness in competing at the domestic and global market. In turn, this could lead to an unfavourable competitive position for countries in attracting investments. A very broad application of CFC rules should be avoided as it could “lead to a

57 Alley and Bentley, (n 57) 586. 58 Joseph E. Stiglitz, Economics of the Public Sector (3rd edn, WW Norton & Company 1999) 457-458. 59 Alley and Bentley, (n 57) 586. 623. 60 Arnold, (n 4) 4-7; Roy Rohatgi, Basic International Taxation (Second Edition) Volume One Principles of International Taxation (2005) Richmond Law & Tax Ltd, United Kingdom 1 61 S.A. Stevens, ‘The Duty of Countries and Enterprises to Pay Their Fair Share’ (2014) 42(11) Intertax 702–708. 62 Filip Debelva, 'International - Fairness and International Taxation: Star-Crossed Lovers?' [2018] 10(4) World Tax Journal. 63 Arnold (n 4) 4-5 64 Arnold (n 4) 5.

contraction of overseas business activities of domestic companies and reduced economic development.”65 Limitations on capital outflows, such as very broad CFC taxation, may discourage capital inflows.66 The last main goal of international taxation would be to achieve an equitable balance between capital neutrality principles. While in the domestic context, capital neutrality typically plays a minimal role,67 in the global context, capital neutrality principles have a prominent role in determining international tax policy.68 The importance of capital neutrality principles, aside from guidance for policy simplification, is to avoid economic distortion due to different tax treatment between domestic and cross-border transactions.69 CFC rules should consider capital export neutrality and capital import neutrality. This could be attained by following the general principle of jurisdiction to tax with regard to cross-border transactions which attain the primary taxing right to source country and the secondary right to the resident country. Among the other goals, the perception of fairness is the keystone in the international tax system.70 Since international tax involves more than one country, the fairness of international tax should be seen from the interaction of the cumulative effects of the tax laws of concerned countries. According to Arnold, 71 the concept of fairness can be achieved by “contributing to the development of fair and appropriate international tax standards, by imposing tax burdens that are consistent with these standards, and by otherwise cooperating with other countries in the assessment and collection of tax on their residents.” Taking into account the implementation of CFC rules in other countries and a general standard of CFC taxation is then crucial in designing CFC rules. Alignment, CFC rules with international standard and norms, will enhance countries competitiveness as an attractive investment location.72 Moreover, CFC rules are known as the most complex regulation which effectiveness are connected to the underlying design features.73 It has been argued that states should consider the principle of simplicity and certainty in designing CFC rules in order to strengthen the effectiveness and efficiency.74 An overly complex regulation would hamper taxpayers in fulfilling their tax obligations, bring uncertainty to the rule implementation and increase compliance and administrative cost, which in turn lower the overall effectiveness of CFC legislation.75

65 OECD, Tax Policy Studies Tax Effects on Foreign Direct Investment: Recent Evidence and Policy Analysis (OECD Publishing 2007) 22. 66 Arnold (n 4) 6. 67 David A. Weisbach, ‘The Use of Neutralities in International Tax Policy’ (2014) 3 Coase-Sandor Working Paper Series in Law and Economics 9 can be accessed at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2482624. 68 Arnold (n 4) 5. 69 Weisbach (n 67) 697. 70 Debelva (n 62). 71 Arnold (n 4) 5. 72 Anung Andang Wiratama, ‘Indonesia - The Controlled Foreign Company Rule’ (2013) May/June Asia-Pacific Tax Bulletin 184-189, 185. 73 Dale Pinto, ‘A Proposal to Reform Income Anti-Tax-Deferral Regimes’ [2009] 12(2) Journal of Australian Taxation 41-75. 74 See Reuven S. Avi Yonah and Oz Halabi, ‘US Subpart F Legislative Proposals: A Comparative Perspective’ (2012) Law and Economic Working Papers 14. 75 Wiratama (n 72) 185.

2.4. Summary and Remarks CFC rules are implemented to cope with MNEs’ global operations which with the advance of information and technology provide them opportunities to exploit the existence of tax haven as well as technicalities and mismatches in countries tax systems in order to minimize tax liabilities. In particular, CFC rules are intended to address base erosion (in term of deferral) and other profit shifting issues which are considered harmful to the government, society and fair business competition.

The establishment of CFC rules does not mean to interfere with MNEs legitimate business activities in foreign countries. Consequently, CFC rules should only apply if high risk of tax avoidance is present. In addition, since CFC taxation comprises of foreign income taxation at the level of resident taxpayers countries, there are chances of double taxation. Double taxation is a threat to economic growth and it is advisable that CFC rules provide sufficient double tax relief.

In designing CFC legislation, countries are expected to consider principles of proper taxation and the goal of international taxation. Ideally, CFC rules, with respect to its function as anti-avoidance tools, should not merely focus on revenue considerations but should attempt to promote equality, to enhance economic competitiveness and to achieve economic neutrality. CFC rules should also be set to represent convenience, certainty and efficiency in taxation while keeping simplicity in the design.

Chapter 3 – BEPS Action Plan 3 - Designing Effective CFC Rules

3.1. Introduction Since first introduced by the United States in 1962 by the name of Subpart F rules, CFC rules have received some attention in international tax area because the rules attempt to limit abusive tax practice. Initially, this regime did not get much appreciation with only four adoptions both in the 1970s and in the 1980s, which all of them are incorporated by developed countries. With the growth of international trade and the rise of information and technology in the 1990s, the numbers of adoption grew. Some capital exporting developed countries supported with their tax administrations capacity further implemented the rules and interestingly, some developing countries despite being known as capital importers decided to adopt this regime. Following these adoptions and in response to pressures created by the increasing globalization of the world economy, the OECD recommended countries to adopt and to coordinate the implementation of these rules as their primary recommendation to counter harmful tax competition in its report titled “Harmful Tax Competition: An Emerging Global Issue” in 1998. Some developing countries, even those that have no parent MNEs,76 thus implemented this regime to prevent tax avoidance. According to the OECD, the existing regimes, however, are considered cannot keep pace with changes in the international business environment such as the growing importance of the global value chain as a new business model and thus cannot comprehensively counter MNEs tax avoidance.77 Accordingly, the OECD, in the BEPS Project, suggest countries strengthen CFC rules so that the new regimes would capture all types of income that gives rise to BEPS/tax avoidance concerns.78 The recommendations on strengthening (which can also mean to adopt) CFC rules were based on the fact that MNEs can create low-taxed non-resident affiliates to which they shift income.79 These individual units of MNEs perform its activities as a single integrated enterprise which operates within an overall framework of MNEs policies and strategies. The OECD80 has observed through several studies that there is a segregation between the location of business activities and investment take place and the location where the profits for tax purposes are reported. It has been argued in the previous chapter that, notwithstanding its intricate features, CFC regime ideally attempt to follow the international standards, both in cross border transaction and the application of CFC rules. This is essential to preserve the concept of fairness in international taxation. This chapter will elucidate the OECD recommendations in designing CFC rules to illustrate international standard in incorporating the CFC regime. The recommendations are presented in the form of building blocks which the OECD argued if implemented will ensure countries to “have rules that effectively prevent

76 Some CFC countries, however, do not have any parent MNE which constitute potential attributable taxpayers. See appendix 7 for List of Countries with MNEs parent/shareholders in 2010. In addition, appendix 5 shows that in 2008 some countries may not have potential attributable taxpayers for CFC rules. 77 The strong point and at the same time the weakness in CFC rules are they are relatively mechanical. 78 The OECD: BEPS - Frequently Asked Questions; Action 3 – Strengthening Controlled Foreign Companies Rules. http://www.oecd.org/ctp/beps-frequentlyaskedquestions.htm accessed December 2018. 79 Organization for Economic Co-operation and Development, Action Plan on Base Erosion and Profit Shifting (OECD Publishing 2013) 16. 80 Organization for Economic Co-operation and Development, Addressing Base Erosion and Profit Shifting (OECD Publishing 2013) 15-20.

taxpayers from shifting income into foreign subsidiaries.”81 The building blocks include several options which the OECD describe and then discuss to show the benefit and weakness of available options. They are: Defining a CFC, Limitation to CFC Rules, Determining CFC Income, Computing CFC Income, Attributing CFC Income and Relief for Economic Double Taxation on CFC Income. In addition, the author assesses to what extent the members of BEPS inclusive frameworks CFC regime comply with the overall recommendations as a point of reference for the comparison with Indonesia. As further will be elaborated, the OECD recommendations on strengthening CFC rules may not necessarily mean as what always echoed. 3.2. CFC Definition

As the first building block, the OECD recommends countries to define a CFC broadly by taking two elements into consideration, the type of foreign entities and the definition of control. 3.2.1. Type of Entity to be considered as CFC

Ideally, a CFC should only consist of foreign entities that are treated as separate taxable entities for domestic tax purposes, such as corporations, because deferral of domestic tax may be realized if entities treated in such ways.82 The OECD, however, encourages countries to set broad definition for foreign entities to be considered as a CFC. BEPS Action Plan 3 considers all foreign entities to be CFC, not only bound to foreign subsidiaries (companies), but also transparent entities such as partnership and trust as far as their income raise BEPS concerns.83 The determination of whether transparent entities derived income which raises BEPS concern is not clearly defined, but the OECD gives some examples such as when the foreign entities are regarded as transparent in their jurisdiction but are taxable entities in the parent country and when foreign entities are owned by another CFC but not taxable in the parent country. Similarly, permanent establishments (PEs) should be considered as CFCs in two circumstances, when a foreign entity has a PE in another country and the parent country exempt the income of that PE. The OECD also recommends providing provision to tackle hybrid instruments and hybrid entities, particularly in an intragroup payment insofar as the payment is not included in CFC income and the payment would have been included in CFC income had the parent jurisdiction classified the entities and the arrangement in the same way with CFC jurisdictions.8485 The OECD seemingly wishes to underline the US

81 OECD (n 17) 9. See Also. Åsa Johansson, Øystein Bieltvedt Skeie and Stéphane Sorbe, ‘Anti-Avoidance Rules Against International Tax Planning: A Classification’ (2016) Economics Departments Working Papers. 82 Aigner, Scheuerle, and Stefaner (n 41) 18. 83 Whether CFC income raises BEPS concern is leave out to countries to determine. Considering the definition of BEPS/tax avoidance is really subjective because basically any tax planning could be considered tax avoidance if the end result is reduction of potential tax revenue which are not intended in any jurisdictions, this recommendation effectively means all type of foreign entities should be included as CFC. 84 This is a case which is found in the US CFC rules, the subpart F rules which has been considered weak due to the application of check the box rules. 85 OECD (n 17) para 29-33.

check the box rules86 which hamper the effectiveness of the US CFC rules and thus encouraging countries to avoid similar rules or at least to provide prevention of such rules.87 3.2.2. Definition of (Sufficient) Control

In defining CFC, BEPS Action Plan 3 requires a determination of the type of control and the level of control to ascertain the existence of sufficient control in the foreign entities. In its final report on BEPS Action Plan 3, the OECD considers four control tests to determine the existence of influence to be applied in CFC rules. They are the legal control, the economic control, the de facto control and the control based on consolidation. The legal control test is mechanical and relatively simple to apply as it focuses on “a resident’s holding of share capital to determine the percentage of voting rights held in a subsidiary”.88 The share capital may be based on total issued shares and/or shares with voting right.89 The OECD considers relying on legal control is not sufficient. The reason is the legal control is prone to circumvention using artificial share terms and structures.90 Economic control test, on the other hand, is not based on holding the majority of shares but looks at the entitlement of profits, capital and assets distributions in certain circumstances such as share disposal, CFC dissolution and liquidation. Consequently, control is established even if the shareholder for the minor holding of shares.91 The OECD considered indirect ownership as an economic control if the control threshold is met at each level in the chain of ownership.92 Depending solely on economic control is also considered insufficient as it is mechanical and open to circumvention. 93 De facto control requires significant analysis based on facts and circumstances and very subjective in its assessment as it does not depend on the legal and economic criteria.94 De facto control complements legal and economic control test, but it is considered costly, complex and bring uncertainty due to subjectivity. It also remains open to circumvention and relatively difficult to prove.95

86 Under check the box rules, any entity not classified as a corporation (non-tax transparent) according to the US tax law but may be regarded as may elect to be taxed as partnership (transparent entities) and thus taxed at the level of its partners. Accordingly, by incorporating structures that 87 In the author view, however, such hybrid rules are unnecessary because check the box rules is different from CFC rules and it is the interaction between subpart F rules and the former rules that render the effectiveness of the US subpart rules, not the US rules itself. Such hybrid is very complex, administratively burdensome and might be too costly developing countries. Among surveyed countries only Australia (IBFD, Australia – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 8 October 2018) and Israel include such provisions (IBFD, Israel – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 1 March 2018). 88 OECD (n 17) para 35, 23-25. 89 Before the BEPS project, the legal control is often used as the only test in determining control. See: Aigner, Scheuerle, and Stefaner, (n 41) 18. 90 OECD (n 17) para 35, 23-25. 91 Ibid. 92 Ibid para 47-48, 29. 93 Ibid para 35, 24. 94 OECD (n 17) para 35, 23-25. 95 Ibid 24.

Control based on consolidation is established based on the fact that a non-resident company being consolidated in the financial report of the resident company based on financial reporting standard implemented in the resident country.96 In particular, the OECD highlights the importance, at the minimum, to implement both legal and economic control simultaneously because they are relatively easy to apply, raise limited administrative and compliance burden. The OECD also recommends supplementing these two control tests with the adoption of de facto or/and control based on consolidation when a country does not have issues with complexity and compliance cost.97 The OECD recommends treating a foreign entity as controlled when a resident hold more than 50% control, but it does not prohibit countries to apply a lower threshold such as exactly 50% or even lower since the OECD takes the view that even minority shareholders can exert influence in certain situations, for instance when shareholders are acting together to control the CFC.98

Consequently, in order to assess whether minority shareholders are acting together to exercise control, the OECD suggested to adopt one of the three approaches, the acting-in-concert approach, the related party approach and concentrated ownership requirement.99 The first approach is a fact-based analysis by looking at the occurrence of influence by all shareholders of the CFC, including ownership by non-residents. The second approach is similar to the acting-in-concert approach but only consider related party situation. The third approach only views concentrated ownership at the level of the domestic country, (the country implementing CFC rules or concerned country).100 3.3. CFC Threshold and Exemption

In the second building block, BEPS Action Plan 3 highlights the importance of having threshold and limitation of CFC rules to make the regimes more targeted and thus more effective with less administrative burden.101 In the author view, the existence of ample limitation is also important to ensure the function of CFC rules as specific anti-avoidance rules which act as deterrent measures. The final report discusses three options in limiting the application of CFC rules: de minimis threshold, the anti-avoidance requirement and the tax rate exemption. The latter approach is recommended because the OECD perceive it can concentrate tax authorities’ efforts on situations with the most risk of tax avoidance using CFCs.102 In relation to this, analysis of BEPS action plan implementation in members of inclusive framework showed that roughly three-fifths (24 countries) have implemented this recommendation.103 Although this approach receives several critics because of its high administrative cost, complexity and

96 Ibid. 97 Ibid para 36, 25. 98 Ibid para 37, 25. 99 Ibid, 24. 100 On the last approach, the OECD gives examples of the US CFC rules which consider control if the ownership is more than 10% individually and the ownership by limited number of shareholders which can be found in Australian and Canadian CFC rules. Again, countries can choose which approach they prefer but the OECD seems to favor the concentrated ownership. 101 OECD (n 17) para 33, 50. 102 Oats, Miller and Mulligan (n 32) para 17.12 103 See Appendix 10.

compliance burden, the OECD recommends the application to make CFC rules more targeted to companies that benefit from low foreign taxes. Interestingly, according to the OECD, tax rate exemption provides greater certainty for the taxpayers and may reduce the overall administrative burden.104 Under the minimis-threshold, foreign entities would be denied as CFCs if their income does not surpass a certain threshold.105 The application of CFC legislation is administratively costly because the burden of proof falls in government and if there is hardly any additional income upon the application of CFC rules, the result will not be proportionate to the effort.106 Additionally, this limitation is open to circumvention by splitting groups’ income among CFCs so that it falls below the threshold (fragmentation). The OECD does not recommend the minimis-threshold, but if countries decide to implement this limitation, the OECD recommends supplementing it with anti-fragmentation rules.107 In the case of anti-avoidance requirement,108 CFC rules should apply mainly if there is a tax avoidance motive for the existence of the CFC. BEPS Action 3 claims that this limitation raises high administrative and compliance burden and is not necessary if CFC income is appropriately targeted. Consequently, the report avoids discussing the anti-avoidance requirement.109 The tax rate exemption is highly advocated by the OECD. CFC rules should not apply to foreign companies that are ‘subject to an effective tax rate that is sufficiently similar to the tax rate applied in the parent jurisdiction’. This means CFC rules should only apply to CFCs with low taxation in order to ensure equity. Additionally, this limitation could be supported with the inclusion of white list countries exemption.110 To determine the low taxation, the benchmark and CFCs’ ETR are discussed. In the case of the first, the benchmark would compare the tax rate in CFC jurisdiction either to a predetermined fixed rate or to a percentage of the parent jurisdictions’ tax rate. BEPS Action 3 does not provide a specific recommendation on the level of low taxation and refers to the application of the German, Finnish and UK CFC rules which define 25% tax rate (Germany), payment of less than 60% (Finnish) and less than 75% of corresponding parent countries tax (UK) as low taxations.111 This is part of the flexibility in the overall recommendations. In determining CFCs’ ETR, the CFCs paid tax and the income (tax base) are further discussed. The reason for using ETR instead of statutory tax rate (STR) is because ETR would be more accurate in determining low taxation, despite the higher complexity and administrative burden.112 In calculating the ETR, the OECD recommends that CFC taxes (numerator) should be either actual taxes paid or could also include taxes paid that are comparable to CIT in the parent jurisdictions. Similarly, the income measured should be either the tax base in the parent jurisdiction had the CFC income been earned

104 OECD (n 17) para 33, 61. 105 Ibid para 53, 33. For the application of de minimis threshold please refer to OECD (n 17) para 54-58 106 Oats, Miller and Mulligan (n 32) para 17.21. 107 OECD (n 17) para 59, 36. 108 Also called motive test. 109 OECD (n 17) para 60, 36. 110 Ibid para 51, 33. 111 OECD (n 17) para 63-64, 37. 112 Ibid para 65, 37.

there or the tax base computed according to an international accounting standard such as IFRS113 with adjustments made to reflect the tax base reductions that result in low taxation of the CFC income.114 BEPS Action 3 also notes that the ETR could be computed broadly (on an entity-by-entity basis or a country-by- country basis by aggregating income within a country) or narrowly (on an item-of-income basis) and highlights the administrative complexity and compliance burden in each approach. With regard to the inclusion of list exemption, there might be good reasons to suppose that some countries are frequently used to deter/avoid taxation while the others do not.115 Empirical research by Lejour and van’t Riet in 2017 shows that conduit companies, which are often exploited to avoid/defer tax, are typically concentrated in several countries.116 List exemption is also important to provide certainty to both tax authorities and taxpayers and, in case of white list countries, may induce countries to avoid harmful tax competition and still politically acceptable.117 3.4. Definition of CFC (Attributable) Income

The third building block concern attributable income. CFC income seems to be the most important recommendations for CFC rules. However, since the OECD acknowledged that certain flexibility is needed, so that their recommendations may be applicable by countries with various policy objectives, the definition of attributable income is not explicitly defined. The exact definition of such income is not provided, but according to the OECD, such income, among others, includes the funding return allocated under the transfer pricing rules to a low function cash box,118 income from sales services in invoicing companies and IP income.119 Instead, the OECD provides a non-exhaustive list of approaches in defining CFC income which can be applied singularly or combined, and countries are “free to choose their rules for defining CFC income” insofar as they include a definition of income which ensures income which raises BEPS concerns, is attributed to controlling shareholders.120 The list includes the categorical approach, the substance approach, the excess-profit approach and the transactional or entity approaches. The OECD underlines the necessity to capture the funding return mentioned above regardless of the approach a country uses, although they point out that the extent of inclusion depends on the effectiveness of transfer pricing rules in concerned

113 For an example of the mechanism of calculation please refers to OECD (n 17) para 66. 114 OECD (n 17) para 66, 37-38. 115 Oats, Miller and Mulligan (n 32) para 17.13. 116 Maarten van ’t Riet and Arjen Lejour, ‘Optimal tax routing: network analysis of FDI diversion’ [2018] 25(5) International Tax and Public Finance 1321-1371 117 In the author view, however, the application of white list countries should not be ancillary but dominant in the application of CFC rules in order to provide greater certainty and lower administrative burden. The application of CFC rules based on ETR requires adequate administrative capacity since it needs yearly assessment of every foreign entities which might be unsuitable for developing countries, particularly if it is applied on an item-of- income basis and without the presence of white list countries. 118 OECD (n 17) para 75, 43-44. 119 Ibid para 78. With regard to IP income, a typical example would be a situation where a company resident in a high tax country develops IP, but then transfers the IP asset to a group company in a low tax country. The transferee company is then the one which receives the royalty income, although it was not involved in the value creation. 120 OECD (n 17) para 73, 43.

countries.121 This implicitly shows that the OECD believes that transfer pricing rules must be taken into account in the application of CFC rules. 3.4.1. Categorical Analysis

Under the categorical analysis, income is classified according to the most relevant factors among the following category: legal classification, relatedness of parties and source of income.122 This approach is relatively mechanical. In the case of the first, attributable income is typically categorized as dividends, interests, royalties, or sales and service income, which are often understood as geographically mobile and thus can easily be diverted from the location where the value of the assets was created.123 The OECD underlines the need to avoid including income that is earned from “active business” in each instance of the legal classification. Although this might create difficulties and administrative burdens, it is important to focus the application limited to high BEPS risk situation.124

In the case of relatedness of parties, income is attributed insofar as it was earned from a related party. The underlying reason is the same with legal classification, such income can be relatively easy to shift among groups.125 This treatment is often believed can strengthen a country’s transfer pricing rules.126 However, while the level of success is disproportionate,127 this type of provision is also arduous to enforce.128 In the case of the source of income, where the income was really derived from, either CFC jurisdiction or from another jurisdiction, is decisive in determining attributable income. According to the OECD, the underlying principle is that income which was earned from activities undertaken from other jurisdictions is more likely to raise concerns about profit shifting compared to income that was earned from CFC jurisdiction. There are two form applicable in this regard, the anti-base-stripping rule, which treat CFC income as attributable income if it was “believed” to be earned in the parent jurisdiction such as sales to a related or unrelated party located in the parent jurisdiction, and the source-country rules, which excludes income (including mobile income) from attributable income if it was earned in CFC jurisdiction.129 3.4.2. Substance Analysis

This approach is fairly similar to the source of the income approach in the categorical analysis. Under substance analysis, activities of a CFC are evaluated based on a variety of proxies (e.g. people, premises, assets, and risks) to determine if the CFC had the ability to earn income and indeed income has been separated from the underlying economic substance.130 This approach works as an exemption mechanism.

121 Ibid para 75, 43-44. 122 Ibid 44-46. 123 Ibid. 124 Ibid. 125 Ibid para 79, 46. 126 Arnold (n 4) 125. 127 Oats, Miller and Mulligan (n 32) para 17.2. 128 Arnold (n 4) 125. 129 OECD (n 17) para 80, 45. 130 Ibid para 81-82, 47.

The OECD in the BEPS Action 3 advocates to apply this approach not as a stand-alone rule but in combination with more mechanical rules.131 In the application, substance analysis can use either an all-or- nothing (threshold) test, which excludes all CFC income if the CFC had not engaged in a set amount of activities or a proportionate analysis, which only excludes the amount of income proportionate to the number of activities. 132 According to the OECD, substance analysis is more accurate than mechanical approaches, such as legal classification, with the cost of administrative and compliance burdens. 133 Substance approach may focus on the following options: the substantial contribution (employee participation), the viable independent entity (the relationship between asset and signification function), the business premises (employee and establishment) and the nexus approach (substantial activity).134 Overall, substance analysis relies on the concept of significant people functions which clarify the fact that CFC rules and transfer pricing rules often overlap.135 3.4.3. Excess Profit Analysis

No countries implement excess profit analysis yet. This approach seeks to identify the income of the CFC which is in excess of a ‘normal return’136 from the CFC’s activities.137 According to the OECD, this approach particularly relevant in the context of IP income.138 This approach effectively admits that the transfer pricing rules is partially effective. If the transfer pricing rules operate effectively, the effectiveness of this approach is, however, questioned.139 Furthermore, this approach demands additional administrative cost to calculate excess of normal return. 3.4.4. Transactional or Entity Approach

Regardless of which analysis is used to define attributable income, the OECD encourages countries to choose either transactional or entity approach.140 Under the transactional approach, the character of each stream of income is evaluated to determine whether that stream of income is within the definition of attributable income. On the contrary, under the entity approach, CFCs that do not earn a certain amount or percentage of attributable income will not have any attributable income.141 Full income inclusion is typically considered as a constituent of entity approach. The OECD clarifies that the transactional approach is generally more accurate in capturing income, although it may increase administrative burdens and compliance costs.142

131 Ibid para 81-86, 47-48. 132 Ibid para 82, 47. 133 Ibid para 89-90, 49-50. 134 Ibid para 85, 48. 135 Oats, Miller and Mulligan (n 32) para 17.19. 136 Income derived according to risk free rate or return. 137 For the calculation method of normal return please refer to OECD (n 17) para 89-94, 49-50. 138 OECD (n 17) para 87-89,49-50. 139 Oats, Miller and Mulligan (n 32) para 17.20. 140 This view is different to the previously suggested in the discussion draft which favor transactional, which arguably would bring administrative burden to developing countries. 141 OECD (n 17) para 95. 142 Ibid para 95-97.

Despite heavily criticized for not following the basic principle of international taxation,143 the use of full inclusion is also encouraged by the OECD since such approach effectively “includes” all income that raises BEPS concern.144 Consequently, any definition could be considered as align with the recommendation. It is not surprising that the IBFD’s analysis of BEPS action plan implementation in members of inclusive framework CFC rules depicts more than 80% has implemented this recommendation.145 The recommendation, particularly with regard to the full inclusion, might raise fairness issue when countries perceive any transnational transaction as virtually abusive, particularly when it is secluded from the other building blocks. Such recommendation also may exacerbate the first and second building blocks which in some ways depend on the definition of attributable income. 3.5. Calculation of Attributable Income according to the OECD

The OECD discusses two underlying questions for computation of attributable income in the fourth building block. They are: which country’s rules should apply in calculating CFC income and whether specific rules are necessary for calculating such income.146 Under the first question, the OECD considers four options, namely applying the law of parent (shareholders) jurisdiction, the law of CFC’s jurisdiction, allowing taxpayers to choose between the first and second options, and using a common international standard such as the IFRS.147 The first option is recommended because the OECD considers the approach is consistent with BEPS concerns and would reduce administrative cost.148 The OECD further claims that the second and the third option are open to manipulation and can increase complexity and administration cost for tax authorities due to the potential application of unfamiliar rules.149 Although some tax experts believe the application of a common standard would be beneficial to counter harmful tax competition150 which often associated with the occurrence of tax avoidance,151 the fourth option is also left out because it may raise administrative and compliance cost due to the IFRS are still adopted in a limited number of countries.152 Regarding the second question, the OECD recommends countries to incorporate a specific rule limiting the offset of CFC losses so that such losses can

143 Guillermo O. Teijeiro, ‘BEPS Action 3: Public Discussion Draft on Strengthening CFC Rules: A Legal Critique to the Possible Implementation of a Full-income CFC System’ http://kluwertaxblog.com/2015/04/09/beps-action- 3-public-discussion-draft-on-strengthening-cfc-rules-a-legal-critique-to-the-possible-implementation-of-a-full- income-cfc-system/ 144 OECD (n 17) para 75. 145 See Appendix. 10 146 OECD (n 17) para 99. 147 OECD (n 17) para 100, 57. 148 Ibid para 99-101, 57-58. 149 It is, however, debatable if the administrative burden would be lower with the full income inclusion methods because in one instance of the full inclusion method, the base for attributable income includes all income of CFC regardless of its source. Consequently, using parent jurisdiction country rules means that the shareholder’s country should calculate all income, including tax incentives that may be given in CFC’s country but are not allowed in shareholder’s country. 150 Eva Palaticka, ‘Implementation of a CFC Rule: Rules to Compute and Attribute Income’ in Erik Pinetz and Erich Schafer, Limiting Base Erosion Series on International Tax Law Vol 104 (Linde 2017) 256. 151 See. John Christensen, Pete Coleman and Sony Kapoor, ‘Tax Avoidance, Tax Competition and Globalization: Making Tax Justice a Focus for Global Activism’ (2004) Global Tax Workshop, Finland can be accessed at visar.csustan.edu/aaba/christensen2004.pdf accessed January 2019. 152 OECD (n 17) para 100, 57.

only be used against the same CFC profits or also includes other CFCs in the same country. This is important to avoid manipulation of attributable income.153 Among BEPS inclusive framework countries that have CFC rules, more than four-fifths (31 countries) apply the first recommendation, while only slightly more than half (21 countries) implement the second recommendation.154 This is perhaps because some countries apply full inclusion approach in which attributable income is based on income after tax of CFCs. Unfortunately, details of using parent country rules are not specifically defined by the OECD. Consequently, insofar as a country describes the mechanism for calculation in its CFC rules, but nevertheless refers to profit calculation in CFC countries such as found in Indonesian CFC rules, it would be considered as aligned with the OECD recommendation.155 3.6. Rules for Attributing Income

The fifth building block concern mechanism to attribute CFC income to appropriate resident taxpayers. In order to appropriately attribute CFC income to the appropriate shareholders, the OECD divides the recommends into five sub-recommendations. They are determining which taxpayers should have income attributed to them, determining how much income should be attributed, determining when the income should be included in the returns of the taxpayers, determining how the income should be treated (either to adopt deemed dividend approach or piercing the veil approach) and determining what tax rate should apply to the income.156 The third and the fourth recommendation are basically left for countries to decide as long as they are coherent with their domestic law.157 Under the first sub-recommendation, the best practice would be to tie the attribution threshold to the control threshold or to use “another” attribution threshold that attributed income to, at the minimum, taxpayers who could influence the CFC.158 The first is particularly relatable in the context of concentrated legal control. Apart from lowering administrative and compliance burden and such attribution could advocate legal certainty.159 The second perhaps more appropriate for the context of de facto control. Among BEPS inclusive framework countries that have CFC rules, 27 countries have tied the attribution threshold to the minimum threshold.160 Under the second sub-recommendation, the amount of income attributed to each shareholder should be calculated by reference to the proportion of ownership and the actual period of ownership. This is important to advocate fairness.161 It might be administratively burdensome for tax authorities in the parent countries to determine the actual period of ownership because they need to clarify it to tax authorities in CFCs’ countries.

153 Ibid para 99, 57. 154 See appendix 10. 155 IBFD, Indonesia – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 1 August 2018. 156 OECD (n 17) para 109-110, 61. 157 Ibid para 117-118, 63. 158 Overall, this might be indecorous recommendation because in the explanation effectively “any” method of attribution is accepted by the OECD. The OECD also does not clearly address what it means by minimum threshold or what level would be sufficient to constitute minimum threshold. 159 OECD (n 17) para 113-114, 61-62. 160 See appendix 10. 161 OECD (n 17) para 115-116, 62-63.

Consequently, only around half (21 countries) among BEPS inclusive framework countries with CFC rules have applied this recommendation.162 The final sub-recommendation is to apply the tax rate of the parent country, which is administratively easy to implement. The OECD also notes that countries could consider a “top-up tax” which is calculated according to the difference between the actual tax paid by the CFC in its jurisdiction and a threshold set by the parent if a country implements the concept of minimum tax for determining CFC.163 3.7. Rules to Eliminate “Double Taxation”

Since double taxation could pose an obstacle to international competitiveness, growth, and economic development, the OECD considers that it is a fundamental policy to ensure that CFC rules do not “lead to” double taxation.164 In this last building block, the mechanisms recommended by the OECD is to provide an ordinary tax credit relief, as a relief for taxes paid by the CFC itself (which may include withholding taxes) and CFC tax assessed on intermediate companies. This relief address situation where the attributed income is also subject to foreign taxes and situations where CFC rules in more than one jurisdiction apply to the same CFC income. As been observed by the OECD, following this recommendation may cause countries to change their tax relief.165 However, this element is essential to ensure taxes are implemented in a manner which satisfies the goal of international taxation. The OECD also recommends exempting dividends and gains on dispositions of CFC shares if those income has previously been subject to CFC taxation, insofar as it coherent with countries domestic law. Besides, the OECD leaves out relief for other situation giving rise to double taxation, for instance in the interaction of CFC rules and transfer rules, for countries to consider.166 3.8. Interim Conclusion

The OECD provides recommendations on CFC rules in the form of building blocks with broad flexibility so that such recommendations can be implemented in all jurisdiction, regardless if they implement worldwide tax system or territorial tax systems. CFC rules might be different entirely, but they are based on the same principle which is as defensive measures designed to avoid perceived abuses. As been observed by Brauner,167 this is a challenging attempt because incorporation of CFC is not merely to get the benefit of long-time deferral but the potential benefit in the change of countries tax rate. Furthermore, the objective of incorporation of CFC rules might be different between countries with a worldwide tax system and territorial tax systems.

162 See Appendix 10. 163 OECD (n 17) para 119-120, 63-64. 164 Ibid para 121-123. This term, however, may not be accurate because in the application the OECD only provide relief and not prevention of double taxation. 165 OECD (n 17) para 131-134, 68. In addition, in the author’s view, this could exacerbate countries relief provisions because they may need to implement separate/interchangeable dividend and capital gain relief provision. 166 Ibid para 123, 65. 167 Yariv Brauner, ‘What the BEPS’ [20140] 2 (16) Fla. Tax Rev. 55-115, 87.

Nevertheless, the recommendations showed that CFC rules should be designed as preventive measures which should be balanced between taxing the resident taxpayers and giving the opportunity for them to operate if foreign jurisdictions as long as there is an acceptable economic reason to such activities. All building blocks, especially the third building blocks, which limit the application of CFC rules based on effective tax rate exemptions, shows that CFC rules should be operated as its original function, which is as anti-abuse rules. Due to the purpose of the BEPS project which among others is to provide a flexible recommendation, the recommendations seem very broad and relatively vague. Despite the OECD argued if their recommendation implemented will ensure countries to “have rules that effectively prevent taxpayers from shifting income into foreign subsidiaries,”168 they OECD never discuss how such recommendation which seems to contradict with the claim. Furthermore, as can be seen in the change of the title of the report, the OECD has shifted their view from wanting to provide stricter rules to be ideal rules. There are differences between strengthening CFC rules and designing “effective” CFC rules, the same as there are many economic reasons to incorporate controlled entities in foreign jurisdictions.169 Furthermore, the OECD exerts that the recommendation was not a minimum standard which means that there is no requirement (implementation duty) for countries take part in BEPS project to adopt the recommendation and countries should determine whether the recommendation suitable to their international tax policy.170 Consequently, CFC regimes in members of BEPS inclusive frameworks, including Indonesia, have in many ways are already in line with the OECD broad recommendations.171 This is not only foster tax competition and lead to mismatches that originally desired to be tackled by the BEPS project.172 Nevertheless, most recommendations suggest that countries should to take their own decision in determining the best practice based on their own tax policy insofar as they should cooperate to other countries. This is an indication that countries should not bluntly strengthen their CFC rules but should consider other objectives such as taxpayers’ competitiveness, compliance and administrative burden. In the author’s view, thus, the OECD clarify the function of CFC rules as specific anti-avoidance rules which supposedly relevant in abusive situations. In addition, what the OECD advocates as the policy objectives - CFC rules as preventive measures, the interaction with transfer pricing rules, the balance between taxing MNEs and administrative and compliance burden and the elimination of double taxation - are essentially fostering the goals of international taxation.

CFC rules should function as a preventive measure instead of tax revenue gatherer or even punishment to taxpayers who want to broaden their market because it is not proportionate to tax MNEs if there is no risk

168 OECD (n 17) 9. 169 Furthermore, the OECD implicitly imply that the “effective” CFC rules should be seen according to each countries perspective which bring into question the appropriateness in strengthening CFC rules in the first place. 170 Which means that countries could cherry-pick the recommendations, and thus foster tax competition. 171 See Appendix 10. 172 The same view is shared by Panayi who believes Action 3 is only a menu of approaches that could lead to another form of tax competitions. See Christiana HJI Panayi, Advanced Issues in International and European Tax Law, (2015) Bloomsbury Publishing 66.

of tax avoidance. This might be relevant to boost the economy. According to Dharmapala,173 unilaterally strengthen CFC rules might bring unintended economic consequences to the concerned country. In addition, stricter CFC rules might cause a heavy burden to companies’ competitiveness, and it is essential to reflect on other countries CFC regimes.

173 Dhammika Dharmapala, ’Base Erosion and Profit Shifting: A Simple Conceptual Framework’ (2014) University of Chicago Coase-Sandor Institute for Law & Economics Research Paper No. 703.

Chapter 4 – Indonesian New CFC Rules

4.1. Introduction

This chapter will discuss if potential issues in Indonesian new CFC rules. To do so, the author will first delineate precondition that encourages Indonesia to adopt anti-avoidance regulation. Subsequently, the author describes the journey of Indonesian CFC rules in brief and compare the current and the previous legislation in order to understand potential issues with the newly implemented CFC regime. Subsequently, analysis of the element of the newly implemented CFC rules is performed by comparing it with general approach, countries application and the OECD recommendation. The author will also consult tax experts’ opinions with regard to the effectiveness of CFC rules. The last part will conclude. 4.1.1. The justifications for Establishment of CFC Rules in Indonesia

Indonesia applies a worldwide taxation system. Under article 4 of Indonesia Income Tax Law,174 Indonesia is entitled to tax income, which is defined as an increase in economics capacity received by or accrued by a taxpayer from Indonesia as well as from offshore, which may be utilized for consumption or increasing the taxpayer's wealth, in whatever name and form. Under ITL, if Indonesia resident taxpayers are carrying business through a branch (permanent establishment or PE), they will be taxed on their domestic and foreign income obtained through the PE. However, if the taxpayers run business abroad through a subsidiary, in general, there will be no immediate tax in Indonesia since the tax will be deferred until such income is distributed in the form of dividends to the shareholders (Indonesia taxpayers). For tax purposes, different from the branch, by prioritizing the formal legality concept, overseas subsidiaries are treated as a separate taxable person from the parent company. As such, there are opportunities for Indonesia-based taxpayers to defer or to avoid Indonesian corporate taxation.

As part of developing countries175 which has a large area and big population176 Indonesia relies on investment both from domestic and foreign investors to support its economic growth.177 Industrial estate infrastructure and economic support sectors can spend a large budget. Indonesia, unfortunately, often does not have enough savings to fund the development from its own pocket. This is to say economic development sometimes relies on foreign investment instead of domestic investment. It does not mean that, however, domestic investment realization is not important. Domestic investments represent domestic trust. This trust often used as a

174 Republic Indonesia Law Number 7 of 1983 concerning Income Tax, which has been amended several times with the latest by Law of the Republic of Indonesia Number 36 of 2008 (id), is the highest legislation regarding income taxation in Indonesia. For further references, it will be referred as Income Tax Law. 175 For the fiscal year 2019, the World Bank classifies Indonesia as part of lower-middle-income economies based on gross national income (GNI) per capita. https://datahelpdesk.worldbank.org/knowledgebase/articles/906519- world-bank-country-and-lending-groups accessed 10 October 2018. 176 Indonesia is considered as one of the most populous countries in the world. See. United Nations, ‘World Population Prospects: The 2015 Revision, Key Findings and Advance Tables’ (2015) ESA/P/WP.241 Working Paper, 23. 177 One of the main reasons why Indonesia needs foreign investors is the power of public consumption. Based on Harrod-Domar economic model, economic growth are determined mostly by the availability of capital and savings. Increasing the saving ratio in developing countries is relatively hard due to their low propensities to save and the ratio of capital to output typically high so that developing countries depend more on investment to boost their economic growth. See. https://en.wikipedia.org/wiki/Harrod%E2%80%93Domar_model.

benchmark in determining the sustainability of the investment climate. It is expected that the trust will spread to foreign investors to put their investment in Indonesia. Therefore, Indonesia should provide a business- friendly environment to both from domestic and abroad. Indonesia supports its residents to enlarge their market to foreign countries and to utilize business opportunities therein. Indonesia maintains free capital flow particularly after the Asian financial crisis at the late of 20th century.178 Accordingly, since the end of Asia financial crisis capital flow from and to Indonesia has shown an increasing trend. With regard to foreign direct investment to Indonesia, the number rises from over USD 145 million in 2002 to over USD 9 billion in 2008. The figure decreased to USD 4 billion following the great economic recess in 2008, but the increasing trend continues ever since. In 2014, foreign investment in Indonesia reached USD 25 billion. Similarly, since 2004 investment from Indonesia showed increasing trend reaching a little less than USD 6 billion in 2008. The number continues to grow after the decrease in 2009 to reach USD 9 Billion in 2015. However, following the tax amnesty program in 2016 the capital flow in Indonesia drop significantly. Figure 4.1. FDI Inflow to Indonesia (USD) Figure 4.2. FDI Inflow to Indonesia (USD)

FDI Inflow FDI Outflow 30,000,000,000 15,000,000,000 25,000,000,000 10,000,000,000 20,000,000,000 15,000,000,000 5,000,000,000 10,000,000,000 - 5,000,000,000 2004 2006 2008 2010 2012 2014 2016 (5,000,000,000) -

(5,000,000,000) (10,000,000,000)

2002 2004 2006 2008 2010 2012 2014 2016 (10,000,000,000) 2000 (15,000,000,000)

Source: Author based on World Bank Data179 Several Indonesia based MNEs have spread their wings to other jurisdictions in various sector such as manufacturing, mining, banking, trading, holding companies etc. Five biggest countries in which Indonesia shareholders invest are Malaysia (100 companies), Singapore (100 companies), Thailand (100 companies), British Virgin Island (43 companies) and Netherlands (41 companies).180 The following table shows outward investment companies from Indonesia.

178 Hidayat Setiaji, ‘Indonesia Douses Talk of Capital Control’ Jakarta Globe, November 18, 2015. https://jakartaglobe.id/business/indonesia-douses-talk-capital-control/ assessed 16 December 2018. 179 World Bank Data Foreign Direct Investment - https://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD?end=2018&locations=ID&start=1999 accessed Nopember 2018 180 Badan Koordinasi Penanaman Modal (BKPM) Outward Investment https://www3.investindonesia.go.id/en/invest-with-us/outward-investment#cc1401 Accessed Nopember 2018.

Table 4.1. Outward Investment Companies from Indonesia in 2018

Region Companies Region Companies

America 87 Middle East and Africa 39

Asia 68 Pacific Countries 18

Europe 59 South East Asia 359

Source: Author based on BKPM data.181 Meanwhile, several serial financial information leaks around the world, such as the Panama Papers, Offshore Leaks, or Paradise Papers, showed the use of offshore companies and trust is sometimes to avoid tax.182 It was recorded there that hundreds of intermediary entities from Indonesia were linked to countries without corporate taxation such as the Bahamas or British Virgin Island.183 Notwithstanding there are legitimate uses for offshore companies and trust, several names and entities in the documents do not report their operation and affiliation to Indonesia company and thus to tax authorities. Table 4.2. Offshore Entities Data in Financial Leaks

Source Entities Intermediaries Officers Low Tax Countries Entities

Bermuda 5 Offshore Leaks 43 516 1903 British Virgin Islands 51

Cayman Islands 10 Panama Papers 28 14 1038 Cook Islands 6

Paradise Papers – Panama 1 15 - 99 Appleby Samoa 2

Paradise Papers - Malta Seychelles 2 - - 9 corporate registry Singapore 4

Total 86 530 3049 Total 81

Source: Authors based on data from International Consortium of Investigative Journalists (ICIJ) As can be seen from table one and table two, some companies do not report their existence in certain low tax jurisdiction to Indonesia government. This lack of information raise question if the companies are used for legitimate use, or at the least not incorporated mainly for tax consideration. The more capital flow among countries, however, the higher the risk of tax avoidance and the loss of tax revenue. Research by Huizinga and Laeven184 found that the reduction of corporate tax revenue is

181 Ibid. 182 GUE/NGL Members of the European Parliament, Panama Papers: Dirty money and Tax Tricks: How the rich, the powerful and criminals rip us off! Can be assessed at www.guengl.eu/uploads/publications- documents/dirtymoneyandtaxtricks.pdf assessed 18 December 2018. 183 The International Consortium of Investigative Journalists, Offshore Leaks Database. Can be Accessed at https://offshoreleaks.icij.org 184 Harry Huizinga and Luke Laeven, ‘International profit shifting within multinationals: A multi-country perspective.’ (2008) 92(5), Journal of Public Economics, 1164-1182.

incentivized among others by the variation of tax rate among countries. With regard to Indonesia, a study by Purba and Trans185 in 2017 on MNEs affiliates in Indonesia showed that a one percentage point reduction in MNE parent’s tax rate decreases reported a taxable profit by 2.9% which mean for every IDR 1000 there is a potential loss of IDR 6.25.186 Also, they observed that there is an increasing trend of profit shifting by MNEs subsidiaries particularly before the OECD BEPS project, but the trend continues after two years. In addition, ever since the great recess in 2008, Indonesia never met its tax revenue target. The realization of tax revenues in 2009 was only 94,5% or IDR 545 trillion from the target of IDR 577 trillion. In 2010 the realization was 94.9% or IDR 628 trillion from the target of IDR 662 trillion. In 2011 the realization was 97.3% or IDR 743 trillion from the target of IDR 764 trillion. Furthermore, in 2012 the realization was 94.5% or IDR 836 trillion from the target of IDR 885 trillion. In 2013 the realization was 92.6% or IDR 921 trillion from the target of IDR 995 trillion. In 2014 the realization was 91.9% or IDR 985 trillion from the target of IDR 1,072 trillion, while in 2015 the realization was 81.5% or IDR 1,055 trillion from the target of IDR 1,294 trillion.187 Accordingly, Indonesia saw a need to improve their anti-avoidance legislation particularly strengthening their CFC regime as suggested by the OECD. 4.1.2. Development of CFC Rules in Indonesia

The need to introduce anti-avoidance legislation is not new in Indonesia. Ever since its second tax reform in 1994, Indonesia recognized that the development of the business could significantly affect tax revenue. Consequently, Indonesia introduced several anti-avoidance regulations in its tax law in article 18 which serves as a provision to counter tax avoidance in related party transactions.188 This article gives the Ministry of Finance (MoF) authorities to stipulate several anti-tax abuse regulations so that the rules can be enforced. Without specific Ministry of Finance Regulation (Peraturan Menteri Keuangan - PMK) describing the details of the rules could not be effectuated.

CFC rules are introduced under article 18 paragraph 2 of ITL. Despite ITL has been amended several times article 18 para 2 remains the same. Article 18 paragraph 2 mentions that: The Minister of Finance is authorised to determine as for when dividends accrued by resident taxpayers on participation in an offshore business entity other than listed companies provided that one of the following conditions be met; a. the amount of investment by the resident taxpayer is at least 50% (fifty per cent) of the total paid up shares [in the offshore business entity]; or

185 Purba and Tran (n 13). 186 Indonesia tax rate 25% times 29 equals to 7.25 rupiah 187 Ministry of Finance, Portal Data APBN Kementerian Keuangan Republik Indonesia - Dataset can be accessed at http://www.data-apbn.kemenkeu.go.id/Dataset. (ID). 188 Article 18 of Income Tax Law covers all provision regarding related party transactions and functions as anti- avoidance rules. In this article one can find thin capitalization rules, arm length principle, CFC rules and other related party provision.

b. together with other resident taxpayers own equity participation of at least 50% (fifty per cent) of the total paid up shares [in the offshore business entity].189 The elucidation of Article 18 para (2) does not give further explanation with regard to this paragraph where it only describes the underlying reason for the enactment of this regime which is to minimize tax avoidance in term of long-term deferral and the need for Ministry of Finance to determine the time and the base of calculation for CFC rules. In other words, Indonesian CFC rules can be considered meaningless without specific rules by the Ministry of Finance. Since the introduction of CFC rules in ITL, Indonesian CFC rules have been amended twice. The first rule that regulates CFC legislation in Indonesia is Ministry of Finance Decree Number KMK- 650/KMK.04/1994 (hereinafter KMK 650).190 The rules were rather subtle and received several critics by scholars as it is considered consist of uncertainties especially with regard to CFC income and mechanism.191 KMK 650 mainly consisted of description of the time of dividend distribution which is at the end of the fourth month following the end of deadline for the obligation to submit an annual income tax return by the foreign entities or at the end of the seventh months following the end of the tax year concerned in case that the foreign entities have no obligation to submit an annual income tax return or there is no provision on the deadline for the submission of annual income tax return.192 If the CFC has distributed any dividend before the due time, CFC rules will not be applied.193 There are unclear descriptions of the definition of foreign entities since KMK 650 only repeated what is mentioned in article 18 para (2). But there is no definition and base of calculation for the dividend as CFC income. In other words, the definition of a CFC and its income is not clearly addressed. Similarly, foreign tax credits are also not clearly handled. The regulation, however, provided 32 blacklisted countries to which CFC rules are applicable. This designated approach lower compliance burden of the tax authorities and the taxpayers.

189 Pursuant to the amendment of Income Tax Law in 2000 and 2008, the wording of article 18 paragraph (2) is remain the same. 190 Ministry of Finance Decree (Keputusan Menteri Keuangan – KMK) Number KMK-650/KMK.04/1994 concerning the Stipulation of the Acquisition Time of Dividend for Investment in Foreign Business Entities other than Publicly Listed Companies. For further references, it will be referred as KMK 650. 191 Sisca Mireca Juniati, ‘Perlakuan Pajak Penghasilan atas Controlled Foreign Companies’ (2005) Master Thesis University of Indonesia, (id). 192 KMK 650 art 1. 193 KMK 650 art 5 para (1).

Table 4.3. List of Black Listed Countries According to KMK 650

No Jurisdictions No Jurisdictions No Jurisdictions No Jurisdictions

1 Argentina 9 Channel Island Greensey 17 Macau 25 Qatar

2 Bahama 10 Channel Island Jersey 18 Mauritius 26 St. Lucia

3 Bahrain 11 Cook Island 19 Mexico 27 Saudi Arabia

4 Belize 12 El Salvador 20 Nederland Antiles 28 Uruguay

5 Bermuda 13 Estonia 21 Nicaragua 29 Venezuela

6 British Isle 14 Hong Kong 22 Panama 30 Vanuatu

7 British Virgin Island 15 Liechtenstein 23 Paraguay 31 Greece

8 Cayman Island 16 Lithuania 24 Peru 32 Zambia

Source: Elucidation of KMK 650 In 2008, KMK 650 was amended by PMK 256/PMK.03/2008 (hereinafter PMK 256).194 This regulation twist Indonesian CFC regulation which previously used designated jurisdiction approach to global approach which applicable without any limitation. In particular, PMK 256 eliminated the blacklist countries as the boundary of CFC rules application which since 1994 were never updated. The application of black-listed countries is considered politically problematic.195 Several countries within the list have close economic relation, and some have treaties with Indonesia. For instance, Hong Kong, Mexico, Qatar, Venezuela, and Saudi Arabia have enacted tax treaties while the Bahamas and Bermuda have concluded treaties on the exchange of information.196 Indonesia, however, does not adopt a transactional approach in relation to the decision of adopting the global approach. Although PMK 256 mentioned dividend, this regime did not provide its definition but instead mention the application to after tax-income but only to a portion that is considered as the right of the resident taxpayers.197 This brings debates to several tax experts in Indonesia. For instance, Prastowo considered Indonesian CFC rules were too narrow as it is only applied for foreign dividend and did not applied to other passive income.198 In contrast, Wiratama, consider the regime was applicable to every type of income accrued by the CFC and thus was too broad as an anti-avoidance legislation.199 The regulation also did not address foreign tax credit clearly. Unchanged for almost a decade, PMK 256 received several critics by scholars. For instance, it is considered to put Indonesian MNEs at a competitive disadvantage due to its broad application. The regime not only maintained the uncertainty of CFC income but also was considered unfocused and did not represent the

194 PMK 256/PMK.03/2008 of 31 December 2008 concerning Stipulation of the Acquisition Time of Dividend by Resident Taxpayer for Investment in Foreign Business Entities other than Publicly Listed Companies. For further references, it will be referred as PMK 256. 195 Based on discussion with one of tax authorities in Indonesia. 196 IBFD, Indonesia - Corporate Taxation - Country Analyses - 7. International Aspects Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed: 1 October 2018). 197 PMK 256 Art 3 para (1). 198 See. Edi Suwiknyo, ‘Aturan Controlled Foreign Company Menguntit Transfer Pricing’ Bisnis.com (2017) 02 Mei 2017 can be accessed at ‘http://kalimantan.bisnis.com/read/20170502/244/649733/aturan-controlled-foreign- company-menguntit-transfer-pricing (id). 199 Wiratama (n 72) 189.

appropriate function as an anti-avoidance regime.200 It is considered less effective since it allows tax avoidance in case of indirectly controlled CFC, which was happened in the biggest identified tax scandals in Indonesia: the Asian Agri Case (2012) which cause loss more than IDR 1.25 trillion (approximately USD 101 million). The case was about Indonesian MNE who escaped taxation by exploiting several layers of subsidiaries located in Mauritius, British Virgin Island and Hong Kong. The group company reported no profit in the first layer of subsidiaries but reported a maximum profit in the second and third tier of subsidiaries located in no tax countries. Due to the operation of Indonesian CFC rules that are limited to directly controlled CFC, Asian Agri subsidiaries escape CFC taxation.201 This is at the same time show that transfer pricing rules in Indonesia may not be effective.202 Figure 4.3. Development of CFC Rules in Indonesia

Designated Applied Global Applied Global Approach jurisdiction Approach Applies to both Applies (only) to Applies (only) to Directly Owned CFC Directly and Indirectly Directly Owned CFC Controlled CFC Does not addressed Does not addressed Addressed FTC clearly FTC clearly FTC clearly

107/PMK.03/2017 Dividend distribution

256/PMK.03/2008 650/KMK.04/1994

Dividend distribution - - Dividend distribution does not eliminate

before due time before due time application PMK

eliminates rules PMK KMK eliminates rules Deemed dividend application application carry forward

Source: Author Based on KMK 650, PMK 256 and PMK 107 As a form of commitment of members of the Inclusive Framework on BEPS, Indonesia amended its CFC rules in 2017 by adopting several elements from BEPS Action Plan 3 to overcome BEPS practices. The currently applied CFC rules in Indonesia are MoF Regulation Number 107/PMK.03/2017 (hereinafter PMK 107) which was enacted after the release of BEPS Action Plan 3. Several notable differences are discovered. PMK 107 is more comprehensive and detailed than its predecessor. The main differences with the previous regime are that PMK 107 clarifies the application of CFC Rules to indirectly owned CFCs203 and it addresses foreign tax credit explicitly. PMK 107 “re-introduces” the deemed dividend concept despite it gives a circular definition of the term dividend.204 CFC income is not only the portion that is considered as the right

200 Ibid. 201 Adrianto Dwi Nugroho, ‘The Asian Agri Case (2012): The Giant Goes Berserk’ [2014] 68(8), Bulletin for International Taxation, 445-450, 445-456. 202 Albeit it can be argued that such situation constitute tax evasion instead of tax avoidance. 203 KPMG, ‘Amended Controlled Foreign Company Rules’ (2017) August Tax News Flash p.1. 204 PMK 107 art 1 para (5) mentions that “Deemed dividend which herein after called by deemed dividend is dividend which is deemed to be accrued by the resident taxpayer on its participation in Directly Controlled Non- Listed Offshore Foreign Entity (CFC)”.

of resident taxpayers but all after-tax profit of the CFC. It further addresses the income of CFC through transparent entities such as trust despite Indonesia as a civil law country does not recognize the trust concept. It also excludes real dividend distribution. In analyzing the effectiveness of PMK 107, the author will refer to the building blocks in BEPS Action 3. The author transposes the current Indonesian CFC rules into the BEPS Action 3 building block structure and then analyzes each of them to determine whether the Indonesian rules could be improved based on theoretical and sound tax principles, international norms and other countries practices which are more advanced in designing their CFC rules. 4.2. CFC Definition in PMK 107

PMK 107 retains the existing rule in which the CFC regime is only applicable to a non-listed foreign business entity (Badan Usaha Luar Negeri Non-Bursa or Non-Listed BULN) controlled by resident taxpayers.205 Resident taxpayers are considered to have control if they have capital participation directly and/or indirectly in the foreign entity. 4.2.1. Type of entity to be considered as a CFC

Most countries apply CFC rules to foreign companies.206 Similarly, Indonesian CFC regime is relevant to foreign companies controlled by resident taxpayers. BEPS Action 3, however, recommends not to limit the application of CFC rules only to legal entities but should be implemented broadly. It mentions the need to address hybrid entities, transparent entities and permanent establishment in the application of CFC rules as long as they derive income that raises BEPS concern. The types of income that raise BEPS concern are left to countries to determine. As far as foreign income does not raise BEPS concern, it might be unjust to include foreign entities in the application.207 Indonesian CFC rules, in the author view, do not take a clear position in this issue. PMK 107 does not provide what is the definition of foreign business entity in details. As such, the exclusion of listed foreign entity could be interpreted to include any other entities except the listed entity. According to Art 2 para (1) of ITL, an entity therein is defined as … a group of people and or capital that forms a unity that either conducts business or not, including corporation, limited partnership, state or local state-owned enterprise in whatever name and form, firm, kongsi, cooperative, pension fund, partnership, association, foundation, mass organization, social and political organization, or any similar organization, institution

205 PMK 107 art 1 para 2 206 The author notes that around half countries surveyed, in addition to foreign company, CFC rules are also applicable to other entities. See Appendix 10. 207 Slovak Republic, New Zealand, Korea, Turkey, Uruguay, Portugal, the US, Lithuania, Japan, UK, Greece, Egypt, Brazil, Pakistan, and Israel do not follow this recommendation. Brazil and Slovak CFC Rules are only applied to foreign PE but are not applicable to transparent entities. The current Spain CFC rules is applied to certain transparent entities, but it is planned to expand to also cover PEs.

and other forms of entity, including collective investment contract and permanent establishment. …208 Consequently, if the term business entity is not described clearly, a CFC may be interpreted to include these entities insofar as they conduct business in foreign countries. Indonesia does not recognize the concept of transparent entity for tax purposes. A partnership is regarded as tax subject similar to a corporation,209 yet the capital may not consist of shares and may not be listed in stock exchange. Other countries recognize partnership which ownership may consist of shares.210 Indonesia may need to clarify if foreign partnerships and other types of entities are included in the application to prevent tax disputes. Furthermore, although Indonesia does not recognize transparent entity concept explicitly, Indonesian Tax Law mentions “any similar organization, institution and other forms of entity” as the definition of an entity. Similarly, the OECD report also underlines the need to address trust and other transparent entities in the operation of CFC rules. Indonesia, as a civil law country, does not recognize the trust concept and it is not addressed anywhere in ITL. Nevertheless, Indonesia considers a foreign entity owned through a trust and other transparent entities as a CFC. PMK 107, however, does not address explicitly if the foreign trust is considered as a CFC. The clarification for the type of entity will be crucial in the application of CFC rules. Ideally, CFC rules should clarify the definition a business “entity” either by giving reference to the definition in the ITL or provide several criteria.211 4.2.2. Control Definition in PMK 107

CFC regime applies to resident taxpayers who have sufficient influence in the foreign entity (CFC) to make financial decision to defer income repatriation. Indonesia takes the view that control is established when resident taxpayers either individually or together with other resident-owned more than 50% of paid-up capital (shares) issued by the CFC.212 PMK 107 does not distinguish between related and unrelated parties and the level of ownership of each taxpayer owning shares of the CFC. In determining control, the paid-up capital is defined as the common share or share with voting rights. The ownership percentage is determined at the end of the fiscal year of Indonesian taxpayer. As such, PMK 107 primarily applies only legal control test in the form of capital participation despite other control definitions are also found in Indonesia Accounting Standard (PSAK 65) which are consistent with IFRS 10 on consolidated financial statements. Depending on legal control is often considered insufficient to determine control as it can be easily circumvented. Accordingly, most countries apply additional tests to specify CFCs.213 The UK, for instance, define control as holding more than 50% of profits or assets of the company aside of the shares, and voting

208 Republic Indonesia, Law Number 6 of 1983 Concerning General Provisions and Tax Procedures as Lastly Amended by the Law Number 28 of 2007 Art 1 para 2 (id). 209 Gunadi, Indonesia, in International income tax problems of partnerships (IFA Cahiers vol. 80a. 1995). 210 This structure is generally known as partnership limited by shares which could be found in Belgium, Denmark, France, Germany, Italy, Iceland and Poland. Wikipedia, ‘Partnership limited by shares’ (2018) can be accessed at https://en.wikipedia.org/wiki/Partnership_limited_by_shares 211 One can found this element for instance in German CFC rules. 212 Art 2 para (1) and Art 4 para (1) PMK 107 213 Some countries such as Slovak and Turkey, however, only apply legal control.

rights.214 Australia sets three types of test namely strict control test, assumed control test and de facto control test to conclude the existence of control.215 While the first and the second test applies formal control by calculating interest held in foreign entities, the last test relies on factual control which is the right to appoint directors.216 In this regard, the OECD recommends to apply legal and economic tests and to consider a de facto test in determining influence. Different from previous regulation which silent on indirect control, the current regime mentions explicitly that it applies both direct and indirect control. Accordingly, two types of CFC exist in Indonesian CFC rules, the Direct CFC (Direct Non-Listed BULN) and Indirect CFC (Indirect Non-Listed BULN). Direct Non- Listed BULN is established when an Indonesian taxpayer (both entities and individuals) or collectively with other Indonesian taxpayer have at the minimum 50% of the paid-up capital of the respective foreign entity. In these following situations, both foreign entities are considered as a Direct CFC to each Indonesia resident.

Figure 4.4. Control according to PMK 107

Source: Based on PMK 107 Indirect Non-Listed BULN is established if a non-listed foreign entity share capital is 50% or more owned by Indonesian taxpayers through Direct CFC(s) or Direct Controlled CFC(s) and Indirect CFC(s). An Indirect CFC is not interpreted by an effective ownership but mainly by a second-tier legal test. Based on PMK 107, if P, an Indonesian resident, owns 50% of the shares of S.Co in Country A, and S.Co owns 50% of the shares of XCo in Country B, XCo will be regarded as a CFC of P even though economically P owns 25% of XCo. As such, the CFC is regarded as a look-through-entity which economically controlled by Indonesian resident. The look through approach also applies to CFC owned through trust. The following examples illustrate Indirect CFC:

214 Delloite, Guide to Controlled Foreign Company Regimes (2015) 68-70. 215 Three control tests in Australian CFC Rules. Guidance of CFC Rules Australia See: https://www.ato.gov.au/Forms/Foreign-income-return-form-guide-2003-04/?page=12 216 Ibid.

Example 1. An Indonesian taxpayer owns at least 50% of the paid-up capital in a foreign entity at each level

Source: Based on PMK 107 Example 2. An Indonesian taxpayer cumulatively own 50% of the shares in the foreign entity

Source: Based on PMK 107

Example 3. Indonesian taxpayers cumulatively own 50% of the shares in the foreign entity

Source: Based on PMK 107 There is no explicit limitation of the indirect approach, hence, insofar as there is an investment in a foreign country there is a possibility of Indirect CFC existence. Combine with no minimum attribution control, the application of such indirect ownership seemingly considers every foreign investment as a means to avoid tax. From another perspective, this means Indonesian CFC rules perceive any act of investing abroad as tax abusive, which is unlikely. This approach despite being mentioned in the BEPS report is not necessarily recommended by the OECD. Such application, in the author view, will cause the application unfocused and cause an administrative burden for the tax authorities which bears the compliance cost of monitoring taxpayers’ obligation. This is exacerbated with the condition that Indonesia recognizes MNEs loop structures in which the indirect subsidiary may have ownership in the parent company.217 4.2.3. Limitation of CFC Rules to Non-Listed Foreign Entity

Limiting the application of CFC rules to companies listed on the stock exchange, in the author view, is improper for a few reasons. First, there is no evidence that listed companies, despite being highly regulated, are not involved in tax avoidance practices. Many researches on tax avoidance is conducted through financial data provided by listed companies.218 The giant companies, Google, Amazon, Apple, Starbucks etc. who are

217 See. Tengku Qivi Hady Daholy, ‘Analysis of Country-by-Country Reporting in Base Erosion and Profit Shifting (BEPS) Action 13 and Indonesia's Transfer Pricing Documentation Rule’ (Master Thesis University of Birmingham, 2017). 218 For instance, see Graham, ‘Taxes and Corporate Finance: A Review’ (2013) 16(4) The Review of Financial Studies 1075-1129, who review the effect of taxes on financing choices, organizational form and restructuring decisions, payout policy, compensation policy, and risk management decisions. For current empirical research in developing country context see Grant Richardson, Bei Wang, and Xinmin Zhang, ‘Ownership structure and

accused to avoid tax are listed companies. Secondly, taxpayers may incorporate a listed foreign company as its investment base but do not provide voting rights to its public shareholders. Case in point is the initial public offering of Snapchat in 2017 in which the company featured public shares with no voting rights in the US.219 Effectively, the owner/controller could determine if the company should pay dividends to public shareholders. Some countries such as Hong Kong consider responding to this type of IPO by adjusting their regulation to be more competitive220 which may further lower the effectiveness of Indonesian CFC rules. Limiting the operation of CFC rules to listed companies was found in the former UK CFC rules but has been left out. No other countries surveyed depend solely on this type of limitation anymore. Tax experts consider listed-companies exemption not practical. Therefore, it is safe to say that the exclusion of public foreign companies would hinder the application of CFC rules. 4.3. Threshold and Exemption in Indonesian CFC Rules

Ideally, the cost to exert taxation should be kept minimum as it will result in adequate revenue and will not interfere with economic decisions. Taxpayers bear compliance cost in dealing with tax requirement for instance in the form of monetary cost for paying a fee on professional tax advisor and time cost spent on record-keeping. Tax authorities bear the administrative cost of monitoring taxpayers in performing their obligation. CFC exemption and thresholds will help to focus the scope of CFC rules to foreign entities which bear higher BEPS risk and therefore make the rules more targeted and reduce the overall administrative and compliance burden. This will also reduce non-economic costs such as psychological costs of stress and anxiety arising from complying with CFC rules and potential tax audit. PMK 107, however, does not recognize exemption and threshold for CFC application, apart from exempting corporation listed in share markets. In the previous regime, CFC rules are not applicable if CFC has distributed dividends. The distribution of dividend in PMK 256 was considered weakness since MNEs can pay a minimum dividend to escape taxation.221 This is because the previous rules did not clarify what is the minimum amount of dividend required. This exclusion is not found in PMK 107. In the author view, this is problematic since such exclusion is aligned with the intention of Indonesian CFC rules as found in article 18 para 2 of ITL which is to ensure CFC to distribute its dividend to be taxed in Indonesia. In addition, it has been observed that the benefit of deferral typically exists when the effective tax rate (ETR) in a foreign country is lower than the shareholder country.222 Countries with low or no taxation are typically exploited by MNEs to escape taxation and thus carry a higher risk of tax avoidance (BEPS risk). For instance,

corporate tax avoidance: Evidence from publicly listed private firms in China’ (2016) 12(2) Journal of Contemporary Accounting & Economics 141-158. 219 See. Ken Bertsch, Council of Institutional Investors, ‘Snap and the Rise of No-Vote Common Shares’ (Harvard Law School Forum on Corporate Governance and Financial Regulation, 26 May 2017) https://corpgov.law.harvard.edu/2017/05/26/snap-and-the-rise-of-no-vote-common-shares/ 220 See. https://corpgov.law.harvard.edu/2017/05/26/snap-and-the-rise-of-no-vote-common-shares/ 221 Asrul Hidayat and Melani Dewi Astuti, ‘Indonesia A Critical Analysis of Indonesia’s New Controlled Foreign Company Rules’ (2018) 24 Asia-Pacific Tax Bulletin 1, 1. 222 Schmidt (n 1) 2.

in the Google, Apple and Facebook tax avoidance, the profits are pooled in low tax country.223 Indonesian CFC rules, however, are applicable to CFC situated in any country, even those that have solid CFC rules or countries with higher tax rate than Indonesia. This approach could hamper the establishment of business with valid economic motives. 4.4. Definition of CFC Income

Similar with article 18 para (2) ITL, PMK 107 does not explicitly regulate types of income constitute CFC income. Under article 18 (2) the Minister of Finance has the authority to deem a resident taxpayer to receive a dividend from a CFC. This means that Indonesia applies a deemed dividend approach. Based on the deemed dividend approach, only the “distributable portion” of CFC’s income should be imputed to the shareholder. In this regard, the ministry of finance is authorized to determine what the definition of a dividend is, which unfortunately is defined as the dividend that is deemed by resident taxpayers. Consequently, there are different opinions on the definition of CFC income in Indonesian CFC rules. While some scholars224 define CFC income as full inclusion, that is targeting all income, others consider only dividend income.225 In business, there is no consensus that dividend should be distributed in a certain proportion of profit, the same as in general there is no obligation that dividend should be distributed every year.226 Thereby, according to the elucidation of article 18 (2) of ITL, Ministry of Finance is also authorized to determine the base of the deemed dividend or the distributable portion of the profit. Under article art 4(2) of PMK 107 the deemed dividend is based on “earning after tax” which constitute net profit of the CFC. Furthermore, article 4(9) of PMK 107 mentions that even non-business income would be categorized as the base for CFC income calculation. As such, it is more precise to argue that CFC income in PMK 107 apply a full inclusion system which targets all type of income accrued by the CFC.

In full inclusion system, there is no separation between active and passive income. It takes the all-or-nothing approach. Consequently, income derived from active business activities which have economic substance is included from the scope of the application of Indonesian CFC legislation. This approach fosters CEN entirely, and can only be justified if Indonesia gives a full tax credit for foreign tax paid abroad. It is, however, not in line with the international tax standard as set by the UN and the OECD which primarily gives taxing right to active business profit to source country while giving secondary taxing right for passive income. Empirical research by van Hagen and Cristoph Harendt in 2017 on the impact of CFC rules on profit shifting in low tax countries found no evidence that MNEs engage in profit shifting via real investment.227 Economic substance of an active business is often associated with real investment in form of fix assets such as plant,

223 Wikipedia, ‘Bermuda Black Hole’ (2018) can be accessed at https://en.wikipedia.org/wiki/Bermuda_Black_Hole 224 Among others see: Wiratama (n 72) 189. 225 Adit P,’Menilik permasalahan dalam aturan CFC’ (ID) (Jakarta Strategic Consulting, 14 March 2017) (ID) accessed 28 January 2018. 226 This is one of the main differences between ownership by capital (share) and debt. 227 Dominik von Hagen and Christoph Harendt, ‘Impact of Controlled Foreign Corporation Rules on Post- Acquisition Investment and Profit Shifting in Targets’, vols 17-062 (2017) 30.

property and equipment.228 This implies that it might be unnecessary to target active business income for the application of CFC rules. In addition, according to Gunadi,229 a prominent Indonesia tax scholar, in Indonesian CFC is mainly used to pool passive income. Thus, in Indonesia context, it might be more relevant to limit CFC income to passive income (partial inclusion). 4.5. Calculation of Indonesian CFC Income (the Deemed Dividend)

Under article 4 of PMK 107, Indonesian taxpayers that are considered to have the Direct and/or Indirect CFC, are deemed to derive dividend from their Direct CFC. This deemed dividend is calculated based on the percentage of ownership of the Indonesian taxpayers in the Direct CFC multiplied by the net accounting profit (after tax) of the Direct CFC which consist of its own net after-tax profit and its entitlement of accounting profit (after tax) in the Indirect CFC. The calculation of CFC profit is based on the accounting standard of the foreign country (CFC jurisdiction). As such, PMK 107 apply the law of CFC jurisdiction. This approach, however, open to manipulation of the tax base. For instance, such entitlement denies any restriction of loss adjustment by the CFC, which may exploit losses arise in a different jurisdiction to offset CFC income. Also, it is not aligned with the partial income approach. Despite no consensus on this element, most countries apply parent countries rules to determine CFC income. More than half countries surveyed have implemented such loss limitation. Countries who are more advanced in CFC legislation such as France and the US include a specific rule to limit the offset of CFC losses so that the loss can only be used against the profits of the same CFC or the profits of other CFCs in the same jurisdiction. While it might seem equitable to allow deduction of CFC losses entirely and thus lower the compliance cost for MNEs, it might encourage manipulation of losses in CFC jurisdiction which severely increase administration cost for the tax authorities to detect such manipulation.230

In PMK 107, the deemed dividend can further be carried forward in calculating real dividend distribution for the period of five years since it is included in the taxpayer's tax return. For instance, the deemed dividend from the year 2018 may only be offset up to real dividend distribution in 2022. This is, perhaps, to discourage longer dividend repatriation. 4.6. Rules for Attributing Income

4.6.1. CFC Rules Participant

The operation of Indonesian CFC rules disregards the level of ownership in determining the attributable taxpayers (CFC participant), and neither does it consider if Indonesian taxpayers are related parties or not. The rules are applicable to both private individual and entities even if they only own less than 1% shares in the CFC. Accordingly, even taxpayers that do not have a significant influence on the CFC might become CFC participants. Such attribution might lead to high compliance burdens for the taxpayers since they might not have enough influence to gather information on the CFC. Similarly, tax authorities are confined to check

228 OECD (n 17) 47. 229 Gunadi in Stenny Mariani Lumban Tobing ‘Analysis Penerapan Controlled Foreign Corporation (CFC) Rules Di Indonesia’ (Thesis University of Indonesia, 2008) (ID). 230 For instances of loss manipulation in calculation of CFC Income please refer to: OECD (n 17) 58-59.

all taxpayers’ foreign investment data to figure sufficient influence on the CFCs which might lead to administrative burden and complexity. This approach differs from most CFC rules in the world which target companies that pose a high risk of tax avoidance (higher BEPS risk). The OECD recommends providing minimum control thresholds in determining attributable taxpayers despite not specifying the level of threshold. Such thresholds are claimed to lessen the administrative burden for tax authorities. Most developed countries in this regard apply 10% interest as the minimum control threshold. The US, for instance, requires its resident to hold 10% voting power at the minimum to be regarded as CFC participant. Similarly, Canada requires a minimum equity investment of 10% of any class of shares to attribute CFC income. The same minimum control requirement also found in Australia, where an Australian taxpayer considered to have associate-inclusive control interest if he owns 10% of the CFC capital. 4.6.2. CFC Attributable Income

The same with most CFC rules, PMK 107 attributes CFC income in proportion to each taxpayer’s ownership in the CFC. As mentioned before, attribution of income is based on the percentage of CFC participant ownership in the direct CFC in the profit of the direct CFC which consist of its own profit and its entitlement in the indirect CFC profit. For instance, if direct CFC is fully owned by resident taxpayers. As such the rules attribute the entire portion of income based on the ownership on the last day of the year instead of based on the actual period of ownership. Such apportionment is often found in CFC rules of developing countries but not so in developed one. Countries such as Australia, Canada, France, Germany and the US only attribute CFC income in the proportion of the actual period of ownership or influence.231 Unfortunately, the application of indirect ownership in Indonesian CFC Rules rises issue of over inclusion. Based on article 6 (1) of PMK 107, the deemed dividend can only be offset with actual dividend distribution from Direct CFC. If, for instance, an Indirect CFC distributes dividends to Direct CFC, such distribution may constitute income of the Direct CFC, yet it does not reduce profit after tax of the Indirect CFC. Accordingly, the operation of CFC rules would lead to double taxation. As such, PMK 107 may discourage dividend repatriation and contradict with its underlying objective to protect the tax base by taxing distributed dividend. 4.6.3. Time of Income Attribution in Participant Tax Return

Time of attribution is important to determine in which tax year should the CFC participant report the deemed dividend and the currency applicable to the deemed dividend. Consequently, most country, apart from Turkey, includes this provision.232 As mentioned earlier, Indonesian taxpayers are deemed to receive

231 IBFD, Australia – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 28 October 2018). IBFD, Canada – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 October 2018). IBFD, France – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 October 2018). IBFD, Germany – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 October 2018). IBFD, United States – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 October 2018). IBFD, ‘Turkey – BEPS Country Monitor’ (2018) (Last Reviewed 23 August 2018. See also. Delloite, Guide to Controlled Foreign Company Regimes (2015). See Also Appendix 10. 232 IBFD, ‘Turkey – BEPS Country Monitor’ (2018) (Last Reviewed 23 August 2018.

dividends at the maximum of the end of the fourth month after the due date for Direct CFCs to submit its tax return. However, if the Direct CFCs do not have any limit in presenting tax return or do not have any obligation to submit a tax return, the time of attribution is at the end of the seventh month after the accounting year of the CFC. As mentioned, PMK 107 only consider the time of attribution at the level of Direct CFC. As a consequence, there might be a condition where an Indirect CFC is inclined to the four-month limitation (maximum). Such condition would apply if Direct CFC has an obligation to submit tax return but not for Indirect CFC. The Indirect CFC may even put at higher burden if its financial year is preceded by the financial year of its shareholder (the Direct CFC). For instance, if the financial year-end of a Direct CFC 31 March 2019 and 30 June 2019 for the Indirect CFC, the taxpayers should also calculate the income of Indirect CFC immediately. The unavoidable unwanted situation may arise if there is four month or more time difference in the financial year-end of the Direct and Indirect CFC.

It has been argued that the time lag given in the latter case would help Indonesian taxpayers in fulfilling their obligation since the CFC might have insufficient time to provide financial statements to its parent.233 This is not necessarily true. The preparation of tax return is generally preceded by making financial statements. In some case, the tax return and the financial statements are made separately at the same time using different accounting method. Hence, the spare time of income inclusion for the second condition could not be justified. It might be more equitable to give time lag to Indirect CFC which by definition are indirectly controlled by Indonesian taxpayers and thus require higher time to obtain information regarding their foreign operation. Unfortunately, this is not addressed by PMK 107. Nevertheless, this time of attribution is aligned with the deemed dividend approach which considers taxing a CFC after its income is accrued. Under this approach, it is unlikely to attributed profit if such profit has not been accrued. One notable issue with this approach is that the real taxing moment may be manipulated albeit the constraint is limited.234 Effectively, due to the time of attribution CFC income may be taxed in the second year after being accrued by the CFC. 4.6.4. Treatment of CFC Income

Indonesian CFC rules explicitly mention deemed dividend both in art 18(2) of ITL and art 1 of PMK 107. As such, Indonesia applies deemed dividend approach, which is also adopted for instance in the US, Germany, Israel and Korea.235 The deemed dividend approach may also be found in CFC rules of Australia and New Zealand despite only implemented for several types of income.236

233 Hidayat and Astuti (n 220) 6. 234 Palaticka (n 148) 268. 235 IBFD, United States – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 October 2018). IBFD, Israel – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 June 2016), IBFD, Germany – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 October 2018). IBFD, Korea (Rep.) – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 October 2018). See also. Delloite, Guide to Controlled Foreign Company Regimes (2015). 236 IBFD, Australia – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 28 October 2018; IBFD, New Zealand – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 November 2018). See also. Delloite, Guide to Controlled Foreign Company Regimes (2015).

According to OECD commentary and subsequently the UN commentary, the operation of deemed dividend approach which tax imaginary dividend might constitute a breach of tax treaties if it is not restricted to abusive situations.237 As such, in previously mentioned countries, exemption provisions are included so that the operation of CFC is targeted to high BEPS risk situation and thus may be considered limited to certain tax avoidance situation. This is, however, as explained in the later section with regard to the compatibility of Indonesian CFC rules and tax treaties, not so in Indonesia situation. 4.6.5. Tax Rate on CFC Income

The same with most CFC rules in the world238 and the OECD recommendations, Indonesian CFC rules apply the tax rate of the parent company (Indonesian income tax rate) to CFC income. This application is considered the most appropriate approach239 not only because it is easier to implement, but it is also aligned with the capital export neutrality which constitutes worldwide taxation implemented in Indonesia. The adoption of top-up-tax rate, which resembles the minimum tax concept recommended by the OECD might be most appropriate for country preferring capital import neutrality.240 4.7. Rules to Prevent and Relief for Double Taxation

Indonesian CFC rules fall short in providing relief for double taxation. Since the rules target after-tax profit, foreign corporate tax abroad is not taken into account. This is a method of deduction for the relief of double taxation which represent national neutrality. National neutrality rarely found proponents in international tax debate because it fosters national wealth at the cost of global efficiency. To avoid double taxation, an actual dividend payment to Indonesian taxpayers can be offset by the reported deemed dividend of Direct CFC for a period of five years.241 However, dividend payment by indirect CFC to direct CFC is not taken into account in calculating deemed dividend. Similarly, there is no clarification of double tax relief upon the disposal of shares in the CFC. With only a few provision in prevention for double taxation, Indonesia-based MNEs will be less competitive compared to MNEs from other countries with laxer or no CFC rules. PMK 107 clarifies tax credit only upon dividend payment to Indonesia taxpayers. The credit is only allowed on withholding tax on the paid dividend. 242 There are computation limitations on the tax credit243 , and the

237 See section 4.8. See Also. Sara Andersson, ‘CFC Rules and Double Tax Treaties: The OECD and the UN Model Tax Conventions’ (Master Thesis Jonkoping International Business School) 17-21. 238 Currently only five countries (Poland, Korea, Uruguay, Portugal and the UK) out of 38 surveyed CFC regimes do not apply the tax rate of the parent jurisdiction to the CFC income. See. Appendix 10. 239 See OECD (n 17) Hidayat and Astuti (n 220) 6. 240 Palaticka (n 148) 268–269. 241 Minister of Finance, ‘Regulation of the Minister of Finance of Republic of Indonesia Regulation Number 107/PMK.03/2017’ (2017) Art 6 paragraph 1 and 2 (ID). Actual dividend payment after five year will cause the taxpayers to pay another tax. 242 Article 24 paragraph (1) of income tax law which states that ‘tax paid or tax payable in foreign countries on offshore income by resident Taxpayer may be credited in the same taxable year against the tax payable under this Law’. Despite the text of the article mention tax paid or tax payable, based on elucidation of the article, Tax on income paid or payable in foreign countries, which is creditable against tax payable in Indonesia is only tax imposed directly on income derived by a Taxpayer, i.e. withholding tax. 243 The limit is the lowest of income tax that should be payable or paid in the foreign country on dividends paid by the Direct CFC, based on the applicable tax treaty (i.e. treaty dividend WHT rate), or income tax that is payable

regime applies per country limitation. Also, there is no clarification upon withholding tax credit paid by Indirect CFC to the direct CFC.244 Relief for double taxation may only exist on Direct CFC but not for Indirect CFC. This might be considered unfair because the Indirect CFC income is used as the base for income calculation, but the dividend payment and the withholding tax are not taken into consideration.245 Interestingly, in the domestic situation, dividend distributed by a company to its controlling corporate shareholder is not taxed (exempt).246 As such, foreign investment is treated unfavourably compared to domestic investment. This surely does not represent equity in taxation. This raises a further question if Indonesian CFC rules reflect on capital neutrality, fairness criteria, and competitiveness. 4.8. Compatibility of PMK 107 and Tax Treaties

As mentioned in chapter two, there are different views on the compatibility of CFC rules and tax treaties. Albeit, in general, most scholars take the view that CFC rules might not necessarily contravene tax treaty provision, such claim is not undisputed.247 The debate also prevails with regard to Indonesian CFC rules. Some scholars take an immediate position that all CFC regimes, including PMK 107, are compatible with tax treaties because it functions as domestic anti-avoidance rules which are not addressed by tax treaties. The fact that the OECD commentary, particularly since the 2003 edition, mentioned CFC rules are compatible with tax treaty is used as supporting the argument for this claim.248 Indeed, the current commentary of the OECD Model Convention on Income and on Capital considers CFC legislation as not contrary to the provision of the convention since CFC rules result in a state taxing its own resident.249 Other consider the current CFC rules might be incompatible with tax treaty or at least override treaty provision due to the absence of dividend distribution on CFC rules income calculation.250 Treaties might include a provision that might implicitly mention a limitation on CFC rules.

For instance, in art 10 para 4 of the treaty between Indonesia and Germany,251 it is mentioned that Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or

or paid in the foreign country on dividends paid by the Direct CFC (presumably this would usually be the statutory dividend withholding tax (WHT) rate in that jurisdiction), or an amount calculated based on divided received from Direct CFC divided by “Eligible” Deemed Dividend multiplied by income tax on the “Eligible Deemed Dividend” 244 KPMG, ‘Amended Controlled Foreign Company Rules’ (2017) August Tax News Flash p.3. 245 Exposure for double taxation in indirect situation is considered to be high and thus needed to be addressed exclusively. See. OECD (n 17) para 48, 29. 246 Art 4 (3) of Income Tax Law. 247 Schmidt (n 1) 17. 248 Hidayat and Astuti (n 220) 2. In can be argued, however, that the OECD Model Convention and its commentary is not fully adopted in Indonesia rules. Furthermore, the change of the OECD Model and its commentary is not part of determining law mechanism in Indonesia. 249 OECD, Model Tax Convention on Income and on Capital Condensed Version (2017) para 81 to Art 1 para 3. 250 Wahyu Wibowo, ‘Anti-CFC Rules and Tax Treaty position’ https://www.linkedin.com/pulse/anti-cfc-rules- tax-treaty-position-wahyu-wibowo assessed Nopember 2018. 251 Agreement between the Republic of Indonesia and the Federal Republic of Germany for the Avoidance of Double Taxation with respect to Taxes on Income and Capital, effective 1 Jan 1992.

a fixed base situated in that other State, nor subject the company's undistributed profits to a tax on the company's undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State. [Emphasis added] This article denies the operation of CFC rules because it limits Indonesia’s taxing right with regard to actual dividend distribution by Germany resident. If for instance a German Company, as an Indirect CFC, distributes dividends to a Direct CFC elsewhere, according to this article, the distributed dividend should not bear any tax. The operation of PMK 107, however, considers the distributed dividends as the Direct CFC income and therefore included in the calculation of Direct CFC income and tax at the level of Indonesian taxpayer. Thus PMK 107 rules may contravene the German-Indonesia Tax Agreement. Also, considering that this agreement was made before the introduction of Indonesian CFC rules, it might be questioned if the article is compatible with PMK 107 which is only enacted recently.

One argument that might be used to reject this claim is that PMK 107 is applied to taxpayers instead of the dividend income. The Direct and the Indirect CFCs are only mean to determine the base of calculation for taxing Indonesian taxpayers. As such the operation of PMK 107 results in taxing Indonesia own resident, as have been asserted by the OECD. This seems a valid justification to consider PMK 107 as not incompatible with Indonesian tax treaties. However, as has been observed in the Commentary of OECD MC, including the recent change in 2017, it is implicitly asserted that CFC rules are meant to target tax abuse or artificial situation.252 It is mentioned in the OECD MC commentary that the adoption of CFC provisions is meant to address “issues” or concern related to the use of foreign-base-companies.253 The term foreign base company is generally used to deal with a foreign corporation which pays little or no tax in the country of its incorporation.254 Is there any concern with regard to little or no tax in a foreign country? From other OECD report,255 with regard to BEPS, it is known that even no taxation in the foreign country is not in itself an issue. The issue arises when low or no taxation is associated with artificiality causing the cross-border activities to go untaxed or unduly lowly taxed.256 This undoubtedly is the case of tax abuse or at the minimum tax avoidance. Consequently, in the author view, the OECD considers the application of CFC rules to be fully compatible with tax treaty provision if it is adopted to address tax abuse situation related to the use of CFCs. Accordingly, it is important to evaluate if CFC rules are used to address an abusive or artificial situation. Based on the description of the element of PMK 107 above, it is hard to say that Indonesia current CFC Rules represents anti-avoidance provision. The regime applies to all jurisdictions without specific country limitation; it does not consider differences in tax rate between Indonesia and the foreign country, it has no

252 Based on OECD work on the issue between Model Convention and Base Company in 1986, has not change since then. Accessed 20 Jan 2019. See Double Tax Conventions and the Use of Base Companies (Adopted by the OECD Council on 27 Nopember 1986. 253 OECD, Model Tax Convention on Income and on Capital Condensed Version (2017) para 81 to Art 1 para 3. 254 Ira T. Wender, ‘Problems of Foreign Base Companies’ (1960) Vol. 53, Proceedings of the Annual Conference on Taxation under the Auspices of the National Tax Association, 501-509, 501. 255 OECD (n 9) 10. 256 Ibid.

tax-abuse-related-exemption applicable and the foreign tax credit is very limited. Consequently, PMK 107 might not be considered to address tax abuse or tax avoidance situation which is the real issue with regard to CFC. In other words, PMK 107 may contravene Indonesian tax treaties. 4.9. CFC Rules and National Tax Revenues

The implementation of anti-tax avoidance policies is expected to help countries to protect country tax base instead of improving national tax revenue. Empirical research on the impact CFC rule is rarely found and is considered as a difficult task. The nature of MNEs which operate at a worldwide basis and their global structure have been the major limiting factor for conducting international empirical studies of the effectiveness of CFC rules. 257 The lack of sufficiently detailed and publicly available financial data contribute to the low research in this area.258 The dissimilar element of each CFC rules also brought issue on determining the effectiveness of the rules.259

Nevertheless, several scholars have tried to figure the relevance between CFC rules and MNEs behaviour. Studies by Altshuler and Hubbard, for instance, discovered that stricter CFC rules made it more difficult for firms to defer U.S. taxes on financial services income held in low-tax jurisdictions.260 Similarly, a study by Ruf and Weichenrieder261 figured that Germany CFC rules are effective in restricting passive investments in low-tax jurisdictions. At the global level, Mozule and Rezevska262 examined the development of CFC rules and their impact on MNEs capital structure decisions in Europe, Canada and the US. In general, their study found that CFC rules have a negative effect on CFC leverage and that CFC rules are effective in limiting profit shifting. However, as these studies showed, the impact of CFC rules on tax revenue cannot be directly evaluated. In the best of the author knowledge, research that explicitly studies the impact of CFC rules on the tax revenue has not existed yet.

Furthermore, the fact that almost all research on the impact of CFC rules on tax revenue is conducted from capital exporting countries perspectives raise a question if the rules will provide the same effect in developing countries. Indonesia is a capital importing country, and the number of Indonesia-based MNEs are relatively low. The current design is also considered may not be effective to tackle tax avoidance.263 Whether the new rules will increase Indonesian tax revenue, need more research, but if the fact that Indonesia is a capital importing country with a small number of MNEs is taken into account, it might be doubtful if CFC rules can raise significant tax revenue. Furthermore, data from the United Nations Conference on Trade

257 Peter H. Egger and Georg Wamser, ‘The impact of controlled foreign company legislation on real investments abroad. A multi-dimensional regression discontinuity design’ (2015) 129, Journal of Public Economics 77-91, 78. 258 Laura Mozule and Laura Rezevska, Development and Effectiveness of Controlled-Foreign-Company Rules Empirical evidence from European multinational companies’ (Master Thesis Norwegian School of Economics, 2016) 34. 259 Egger and Wamser, (n 256) 77-91, 78. 260 Rosanne Altshuler and R Glenn Hubbard, ‘The Effect of the Tax Reform Act of 1986 on the Location of Assets in Financial Services Firms’ (2000) National Bureau of Economic Research Working Paper 7903. Can be accessed at http://www.nber.org/papers/w7903.pdf accessed 20 April 2018. 261 Martin Ruf and Alfons J. Weichenrieder, ‘The taxation of passive foreign investment — lessons from German experience.’ (2012) Canada Journal of Economics 45 (4), 1504–1528. 262 Mozule and Rezevska (n 260) 263 Hidayat and Astuti (n 220) 6–7.

and Development (UNCTAD) in 2008264 and 2011265 shows that the number of parent-MNEs in Indonesia decreased from 313 parent corporations to 95 parent corporations after the amendment in 2008. This implies that the potential tax revenue may also decreases due to the decline of attributable taxpayers. 4.10. Interim Conclusion

Capital flows come with a potential cost of tax revenue loss. To lower the impact of revenue loss, Indonesia has adopted CFC rules even before the issue of BEPS was echoed by the OECD. Yet, with the development of international trade and exploitation of tax havens, Indonesia found that its CFC rules might not be sufficient to cope MNEs tax avoidance practices. Following the OECD recommendation, Indonesia amended its CFC rules in 2017 with several significant changes such as the inclusion of Indirect CFC, the elimination of dividend payment exemption and the inclusion of foreign tax credit provision. PMK 107 differs significantly with other countries’ CFC rules particularly with those of developed ones. Although it follows some of the OECD recommendations, features adopted in accumulation result in broad CFC rules that might not necessarily target only deferral or profit shifting but also legitimate foreign investments. The regulation is more detailed and provided comprehensive elucidation and examples of calculation. Several issues are found with regard to the institution of PMK 107. There are potential disputes on the definition of CFC in Indonesia rules due to the wording of PMK 107. The new regime seems to apply only to foreign companies but there are possibilities that it also applies to other legal entities such as a partnership. This is because Indonesia treats company and partnership similarly with regard to taxation and the operation of CFC rules considers entities which are owned through a trust or other transparent entities as CFCs. The wording of the rules might even cover all type of foreign entities. Indonesia might need to clarify this. There is also effectiveness issue with regard to control definition which is limited to formal control test. Legal control as applied in PMK 107 should be supported with other types of control such as economic control test or to follow other countries control tests so that it is least exposed to circumvention. In addition, PMK 107 is low on threshold and exemption which are essential to focus the enforcement of the rules. Application of threshold and exemption is also needed; by this way CFC rules will effectively and exclusively target artificial or unwanted situations or high tax avoidance risk. However, it is crucial for Indonesia to leave out listed entity exclusion since it is problematic and has been abandoned by other countries. There is no evidence that listed companies do not take part in tax avoidance. With regard to the definition of income, Indonesian new rules persist to target all types of income, including income which might be derived from real economic activities. This is contrary to the international standards in which CFC rules are typically targeting passive business income. Similarly, the determination of

264 United Nations Conference on Trade and Development (UNCTAD), World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge, (2008) UN, New York, 211. https://doi.org/10.18356/edb0dd86-en. 265 Annex Table 34, World Investment Report 2011. Can be accessed at: http://unctad.org/Sections/dite_dir/docs/WIR11_web tab 34.xls. UNCTAD World Investment Report 2011: Non- Equity Modes of International Production and Development, (2011), UN, New York, https://doi.org/10.18356/6c9c5276-en.

attributable taxpayers is not tied to the minimum control threshold. As a consequence, taxpayers who do not have influence are also considered as the controller of the CFCs and taxed accordingly. This is contrary to vertical equity. With regard to timing of attribution, PMK 107 continues to provide time lag so that taxpayers have sufficient time to get information from their CFCs. It might be essential to provide a time lag to facilitate Indirect CFC instead of CFCs who are not required to submit a tax return. Other issues in the new regime are the double taxation prevention and relief which are very limited which seemingly will discourage dividend repatriation and its incompatibility with tax treaties. Evaluation on the effect of PMK 107 to the tax revenue cannot be applied directly because there has not been sufficient data and research on the impact of CFC rules in developing countries. However, based on previous experience in broadening the scope of CFC rules, the number of attributable taxpayers is decreasing which means that tax revenue may not be proportionate. Overall, Indonesian CFC rules might not necessarily fulfil international tax goals in an intended manner. The regime lack clarity on its provision which may cause a dispute between taxpayers and authorities. Also, the regime promotes national neutrality, has a low preference for competitiveness and does not foster equity. Due to the operation of the new rules, Indonesia residents seemed to be punished when they invest abroad.

Chapter 5 - Conclusions and Recommendations

5.1. Conclusions Following the success of a tax amnesty program in 2016, Indonesia is on the verge of comprehensive tax reform so that their policy will be more tax friendly to investors. The incorporation of the new CFC regime in 2017 – the PMK 107 – which receive several critics by taxpayers and tax expert raises a question whether Indonesia, as a developing country which benefit greatly from foreign investment, is on the right track in its effort to battle tax avoidance. This thesis evaluates to what extent does PMK 107 comply with the international standards based on the OECD and other countries CFC regimes as an answer whether the establishment of the new anti-deferral regime is justified from the legal and economic perspective. This would serve as a base to argue whether Indonesia should amend their domestic regulation to follow the recent development in the international tax area. To answer this question, the author assesses the concept of CFC rules in general, the goals of international taxation, and the OECD approach on designing CFC rules as the representation of international standard and compare them with the PMK 107. In addition, the author evaluates the economic benefit of the new regime by considering the fact that Indonesia is a developing country with a low number of parent companies and high wealth individuals. As have been observed, controlled foreign company regime is a complex (and controversial) set of rules which define the boundary of acceptable long-term deferral (base erosion) and profit shifting. This regulation applies when tax authorities encounter probability of international tax avoidance exploiting the difference in countries tax rate. CFC rules should fulfil the element of control, the attributable income and low taxation of foreign affiliates. Upon the evaluation of BEPS Action Plan 3 Final Report, the author found that the OECD recommendations are set not to be precise in order to facilitate countries with different international tax policy to choose their best design by considering their policy objective. Nevertheless, CFC regime that is considered effective by the OECD constitutes a specific anti-abuse rule which targets a specific type of (foreign) income by considering “low” effective tax rate at the level of the foreign entities. The rules should be equipped with precise circumstances but should be flexible enough so that it not easily circumvented. The level of complexity of CFC rules structured according to the OECD recommendations depends on the level of countries BEPS concerns. Taking into account the definition of tax avoidance which is highly subjective, such regulations might be “fair” to the taxpayers and the governments because they are “proportionate” to the “potential loss” in countries’ tax base.

In contrast, the new CFC rules of Indonesia is fundamentally different from the OECD recommendations and other countries CFC regimes. PMK 107, apart from showing defects in the provision, differs in several building blocks addressed by the OECD which includes CFC definition, exemption and threshold, and relief for double taxation. It is especially so with regard to taxation on indirect CFC. Indonesia rules target all profit disregarding valid economic activity and taxation at the level of foreign affiliates, and thus

disproportionate in the application. Essentially, the new rules fail to accept that economically profit may be retained to be reinvested in the business or to be kept for specific business objectives and not used for avoiding tax. In other words, PMK 107 does not entirely represent an anti-abuse regulation. Consequently, the new CFC rules of Indonesia essentially breach international tax agreement and legally problematic. Notwithstanding the divergent views on the compatibility of CFC rules with tax treaties, according to the OECD and the proponent of the compatibility of these two legal rules, CFC rules are compatible with tax treaties in so far as the rules target abusive situation (the issue of base companies). Since PMK 107 does not represent anti-abuse rules, the regime may be considered illegal. PMK 107 is also economically problematic for Indonesia as a developing country. The fact that Indonesia- based taxpayers expressed their concern on the rules is a symptom that highlight the economic atrocities of this tax regime. CFC rules discourage (foreign) investment, and the decrease of parent MNEs in Indonesia might relate to the strengthening of CFC rules. Furthermore, the potential tax revenue might not be proportionate to the effort because the number of attributable taxpayers in Indonesia is relatively low. In addition, with the broad scope and limited double tax relief, Indonesia-based taxpayers are discouraged to invest abroad and at the same time penalize taxpayers who are already investing overseas. This is contrary to the underlying objective, for instance, will cause CFCs reluctant to distribute their dividend. Overall, the potential benefit upon the strengthening of CFC rules is disproportionate. It is evident from the discussion that CFC regime in Indonesia should follow the OECD approach so that it would be more effective and fairer to the taxpayers. The whole idea of CFC rules is that the regime serves as a specific anti-avoidance measure. It would not be legitimate to charge additional taxation for cross border business if there is no tax avoidance in place. 5.2. Recommendations This study suggests the following recommendations: First, the wording of the future regulation on CFC rules should be set to be precise to that the regulation give certainty in the application. This will lower dispute between taxpayers and tax authorities in the application. Indonesia should also consider to targets only passive income or apply for a genuine business activities exemption so that the regulation would align with the international standard of taxation on cross-border income, that is primary taxing right (business income) to source country and secondary taxing right (passive income) to residence country. Considering the low number of potential CFC, the administrative burden in term of surveillance will not necessarily increase, fairer to taxpayers and will not decrease the number of parent’ MNEs in Indonesia. The inclusion of white list countries is mandatory to lower administrative and compliance burden. With regard to future studies, similar studies on CFC Rules in Indonesia could be conducted by using a different approach, for instance combining an analysis of the literature review, a questionnaire and interview, taking the viewpoint of Supreme Court of Indonesia. This method could be adopted after the release of further regulations on CFC rules. This may represent the actual point of view if the rules are justified from the court perspective. Second, the future studies might be conducted through statistical analysis on potential

cost and benefit CFC rules as a confirmation of the interplay of CFC rules on the decrease of parent MNEs, the potential tax revenue and the impact on investment in Indonesia.

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— — Hungary – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 13 December 2018) — — Indonesia – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 1 August 2018)

— — Israel – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 1 March 2018) — — Israel – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 June 2016)

— — Italy – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 30 November 2018)

— — Japan – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 27 September 2018)

— — Kazakhstan – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 9 August 2018) — — Korea (Rep.) – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 21 August 2018) — — Korea (Rep.) – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 October 2018).

— — Lithuania – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 14 December 2018)

— — Mexico – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 14 December 2018)

— — New Zealand – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 19 October 2018) — — New Zealand – Country Analysis, Amsterdam IBFD Tax Research Platform, (Last Reviewed 1 November 2018). — — Norway – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 21 November 2018) — — Pakistan – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 1 August 2018)

— — Peru – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 13 November 2018) — — Poland – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 30 November 2018)

— — Portugal – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 22 August 2018) — — Romania – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 15 August 2018) — — Russia – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 1 August 2018) — — South Africa – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 2 August 2018)

— — Spain – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 5 November 2018) — — Sweden – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 20 November 2018)

— — Turkey – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 23 August 2018) — — United Kingdom – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 30 October 2018) — — United States – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 1 August 2018) — — United States – Country Analysis, Amsterdam IBFD Tax Research Platform (Last Reviewed 1 October 2018). — — Uruguay – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 2 November 2018) — — Venezuela – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platform, (Last Reviewed 1 August 2018)

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Appendix 1. Percentage of Countries Adopting CFC Rules

CFC Rules Without CFC Rules Category Countries % Countries % Total Developed Countries 28 39% 44 61% 72 Developing Countries 20 15% 113 85% 133 Total 48 23% 157 77% 205 % Developing to Total CFC Countries 42%

2. Distribution of Countries Adopting CFC Rules

Distribution of Countries that Implement CFC Provisions by Region (2018) 20 15 10 5 0 Africa Americas Asia Europe Middle East Oceania

Developed Country Developing Country

3. CFC Regime Based on Control Definition

CFC Countries Based on Control Definition 45 Concentrated and Related Party

35 Concentrated

25 Concentrated with minimum shareholders Direct and Indirect 15 Legal, Economic & De Facto 5 Legal, Economic & Consolidation Legal & Economic -5 Type of Control Determining Control Level of Control

4. CFC Rules based on Income Attribution

Countries based on CFC Income Attribution

All Income but without limitation on active Income, and lower tax/preverential regime

All Income but subject to lower/no tax

All Income with exemption of Active Business Test

Passive Income

5. Countries with CFC Rules based on the presence of Large MNEs or Billionaire according to Forbes 2018. Can be Accessed at https://www.forbes.com/global2000/ and https://www.forbes.com/billionaires/

Countries adopting With Billionare / Large Without Billionare / Large CFC Rules MNEs as Resident MNEs as Resident Developed Country 23 5 Developing Country 15 6

6. Developing Countries with CFC Rules based on World Bank Category 2018

Year of Year of Countries Region Countries Region Enactment Enactment Tanzania N/A Africa Tajikistan 2007 Asia Sao tome and N/A Africa China 2008 Asia Principe Egypt N/A Africa Nepal N/A Asia Mozambique N/A Africa Kazakhstan N/A Asia Cape de N/A Africa Azerbaijan N/A Asia Verde South Africa 1997 Africa Indonesia 1995 Asia Brazil 2001 Americas Romania 2018 Europe Colombia 2016 Americas Turkey 2006 Europe Venezuela 1999 Americas Russia 2015 Europe Peru 2013 Americas Saint-Martin N/A Oceania Mexico 1997 Americas

7. Countries with CFC Regime as the location of Parent and Subsidiaries calculated from Annex Table 34, World Investment Report 2011. Can be accessed at: http://unctad.org/Sections/dite_dir/docs/WIR11_web tab 34.xls

Countries Parent Subsidiaries Countries Parent Subsidiaries Tajikistan 0 4 Brazil 243 4547 Russian Federation 116 2139 Chile 130 911 Kazakhstan 7 156 Colombia 97 689 Azerbaijan 3 69 Peru 32 631 Indonesia 95 2477 Uruguay 73 372 Egypt, Arab Rep. 31 381 Venezuela, RB 54 668 Cape Verde 3 35 Mexico 171 6364 São Tomé and Príncipe 1 2 Turkey 194 2936 Tanzania 1 73 China (People's Rep.) 12000 434248 Mozambique 1 89 Korea (Rep.) 1098 1649 South Africa 231 675 Taiwan, China 1233 2049 Argentina 139 1975 Nepal 0 24

8. The Trend of Publication Regarding CFC rules in IBFD Database

Figure 1. The Trend of Studies of CFC rules 50

2005 2014 1999 2000 2001 2002 2003 2004 2006 2007 2008 2009 2010 2011 2012 2013 2015 2016 2017 2018 1998 Source: Author calculation based on international tax publication in IBFD database266

9. Base Erosion and Profit Shifting

10. Summary of Comparison of Survey on Compatibility of CFC rules Element with BEPS Action Plan 3 Recommendation

CFC Rules A B C D E F G Countries \ Category 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 China V X X V V V V X V X X V V V V Russia V V X V V X V X V X X V V V X Finland V V X V V X V X V V V V V V V Australia V V V V X V V V V V V V V V V Poland V V X V X X V V V V V V V X V South Africa V V X V V X V V V X V V V V V Kazakhstan V V X X X X X X V V X X V V V Spain V X X V V X V V V V V X V V V New Zealand V X X X X X V V V V X V V V V

266 IBFD database can be accessed at https://online.ibfd.org/kbase

Germany V V X X V X V V V X V V V V V Korea V X X V X X V X V X V V V X V Turkey V X X X V X X X X X V V X V X Indonesia V V X V X X V V V X X X V V V Romania V V X V V X V V V V V X V V V Italy V V X V V X X X V V V X V V V Peru V V X V V X V V V V V V V V V Uruguay V X X X X X V V X X X X V X V Mexico V V X V V X V V V V X V V V V France V V X V V X X X V V V V V V V Sweden V V X V V V V X V V V V V V V Portugal V X X V V X X X X X V V V X V Norway V V X V V V V X V V V V V V V United States V X X X V X V V V V V V V V V Lithuania V X X V V V V V V X V V V V V Hungary V V X V V V V V V X V X V V V Chile V V X V V X V V V X V X V V V Japan V X X V V X V V V V V X V V V Venezuela V V X X V X V V V X X X V V V United Kingdom V X X V X X V V V X X X V X X Greece V X X X X X V V X X V X V V V Colombia V V X V X X V V V V V X V V V Argentina V V X V V V V X V V V X V V X Egypt V X X X X X V V X X X X V V X Denmark V V X V X X V V V V V V V V V Canada V V X X X X V V V V V V V V V Brazil V X X X X X X X X V X X V V V Pakistan V X X V V X V V V X V X V V V Israel V X V V V X V V X V V V V V V Source: IBFD - BEPS Country Monitor 2018267

267 IBFD, China (People's Rep.) – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 5 September 2018). IBFD, Russia – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 1 August 2018). IBFD, Finland – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 13 December 2018). IBFD, Australia – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 8 October 2018). IBFD, Poland – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 30 November 2018). IBFD, South Africa – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 2 August 2018). IBFD, Kazakhstan – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 9 August 2018). IBFD, Spain – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 5 November 2018). IBFD, New Zealand – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 19 October 2018). IBFD, Germany – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 11 July 2018). IBFD, Korea (Rep.) – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 21 August 2018). IBFD, Turkey – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 23 August 2018). IBFD, Indonesia – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 1 August 2018). IBFD, Romania – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 15 August 2018). IBFD, Italy – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 30 November 2018). IBFD, Peru – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 13 November 2018). IBFD, Uruguay – BEPS Country Monitor,

Information: A – Has CFC Rules 1. Has adopted CFC rules B – Definition of CFC 2. Applies a definition of CFC that also covers certain transparent entities and/or PEs 3. Applies a definition of CFC that includes a hybrid mismatch rule 4. Applies a legal and economic control test for defining a CFC C - CFC exemptions and threshold requirements 5. Includes tax rate exemption that allows non-resident companies that are subject to an effective tax rate that is sufficiently similar to the domestic rate to be exempt from CFC rules 6. Use a whitelist countries exemption D - Definition of income 7. Specific rules defining the income which is covered by the CFC rules 8. Targeted Income E - Computation of income 9. Parent jurisdiction applies its own rules to calculate a CFC's income 10. Specific rules limiting the offset of CFC losses so that they can only be used against the profits of the same CFC or against the profits of other CFCs in the same jurisdiction F - Attribution of income 11. Attribution threshold is tied to the minimum control threshold 12. Amount of income attributed to each shareholder or controlling person is calculated by referencing both their proportion of ownership and their actual period of ownership or influence 13. Rules determining when income is included in taxpayers' returns and how it is treated in a way that is coherent with existing domestic law 14. Tax rate of the parent jurisdiction is applied to the CFC income G - Prevention and elimination of double taxation 15. CFC rules include provisions to ensure that the application of CFC rules does not lead to double taxation

Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 2 November 2018). IBFD, Mexico – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 14 December 2018). IBFD, France – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 2 October 2018). IBFD, Sweden – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 20 November 2018). IBFD, Portugal – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 22 August 2018). IBFD, Norway – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 21 November 2018). IBFD, United States – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 1 August 2018). IBFD, Lithuania – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 14 December 2018). IBFD, Hungary – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 13 December 2018). IBFD, Chile – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 17 September 2018). IBFD, Japan – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 27 September 2018). IBFD, Venezuela – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 1 August 2018). IBFD, United Kingdom – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 30 October 2018). IBFD, Greece – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 14 November 2018). IBFD, Colombia – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 4 December 2018). IBFD, Argentina – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 26 November 2018). IBFD, Egypt – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 10 August 2018). IBFD, Denmark – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 5 December 2018). IBFD, Canada – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 12 August 2018). IBFD, Brazil – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 4 December 2018). IBFD, Pakistan – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 1 August 2018, and IBFD, Israel – BEPS Country Monitor, Amsterdam: IBFD Tax Research Platfrom, (Last Reviewed 1 March 2018.