A Comparison of Korean and the U.S. CFC Rules and Its Policy Implications

Abstract

With respect to the approach to Controlled Foreign Corporation (CFC) legislation, Korea applies the entity approach targeting the corporations in a tax haven, whereas the United States uses a transactional approach targeting deferral only for certain types of tainted income. This study compared the CFC rules of Korea with those of the U.S. and developed following policy implications. For lack of constructive ownership rules, the 20 percent ownership threshold under Korean CFC rules can be easily circumvented by splitting ownership among related parties. Therefore, constructive ownership rules should be introduced in the Korean LCITA in determining the 20 percent ownership threshold. Under Korean CFC regime, the distributable retained earnings of a CFC, which is subject to current taxation in Korea, is computed under the generally accepted accounting principles of the resident state of the CFC. Although the amount of unappropriated retained earnings should be computed under the Korean accounting standards where the accounting principles generally accepted in the resident state are remarkably different from the Korean accounting standards, there is no detailed provisions for judging the ‘remarkably different’. In order to promote taxpayers’ predictability, the legislation of detailed provisions for computing the distributable retained earnings of a CFC is needed. The amount of indirect foreign tax credit on the deemed distributions from second tier subsidiary is only half of the pro rata portion of second tier subsidiary’s deemed paid foreign tax. It is difficult to find any reasonable reason to reduce the indirect foreign tax credit on the deemed distributions from second tier subsidiary by half and to restrict the indirect foreign tax credit on the deemed distributions from third tier subsidiary. Therefore, it would be better to allow the indirect foreign tax credit on the deemed distributions from second and third tier subsidiaries without reduction and restriction. Under the Korea tax law, the CFC rules do not apply to a CFC that has fixed facilities located in a tax haven and is substantially engaged in business through the facilities. However, ‘substantially engaged in business’ standard has no specific guideline in the Korean tax law, which causes uncertainty in judging the active business exception. Thus, a specific guideline should be included in the tax law to reduce the uncertainty.