Interaction of the best practice approach with controlled foreign company rules under Action 3
- 202. The fixed ratio rule and group ratio rule should be effective in addressing base erosion and profit shifting involving excessive interest deductions and interest used to finance the production of tax exempt income. A country may also introduce controlled foreign company (CFC) rules in accordance with the recommendations under Action 3 (Designing Effective Controlled Foreign Companies Rules (OECD, 2015)), to address situations where an entity makes an interest payment which is deductible under the fixed ratio rule and group ratio rule, but the payment is made to a CFC which is subject to a low rate of tax.
- 203. Where a country applies CFC rules alongside interest limitation rules, CFC income which is subject to tax on the parent company may be included in the calculation of the parent’s EBITDA when applying the fixed ratio rule and group ratio rule. Where this CFC income includes interest income or expense, the country should consider including the interest in the calculation of the parent’s net interest expense and excluding that interest from the calculation of the parent’s EBITDA.
- 204. The best practice approach in this report should also reduce the pressure on a country’s CFC rules, by encouraging groups to spread net interest expense between group entities so that there is a greater link to taxable economic activity. This should reduce the level of net interest income arising in CFCs, as groups are likely to reduce the level of intragroup interest payments, and increase the alignment of net interest expense and EBITDA within the group.