To protect their tax bases, countries implement rules to prevent multinational companies and wealthy individuals from shifting profits to low-tax jurisdictions.
Characteristics of Tax Havens
Tax havens (or low-tax jurisdictions) are territories that offer:
  • Zero or nominal effective tax rates on foreign-sourced income.
  • Strict bank secrecy and a lack of effective exchange of financial information with foreign tax authorities.
  • A lack of “substantial economic activity” requirements, allowing shell companies to register without maintaining physical operations.

Controlled Foreign Corporation (CFC) Rules
CFC rules are anti-avoidance measures designed to prevent residents from deferring domestic tax by routing income through foreign subsidiaries located in tax havens.
+------------------+     Owns >50% Shares     +-------------------+

| Domestic Parent  |------------------------->| Foreign Subsidiary|
| (High Tax State) |                          |    (Tax Haven)    |
+------------------+                          +-------------------+
        ^                                               |

        |          Deems and Taxes Undistributed        | Earns Passive
        +-----------------------------------------------+ Income (Interest)
                   CFC Rules Apply Globally

  • The Trigger: A foreign company is classified as a CFC if domestic residents hold a controlling interest (usually more than 50% of voting rights or shares).
  • The Tax Treatment: If the CFC earns passive, easily shiftable income (such as interest, dividends, royalties, or rental income) in a tax haven, the domestic country ignores the foreign corporate shell. It attributes that income directly to the domestic parent company, taxing it in the current financial year even if no dividends are officially distributed.

 
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