Tax Evasion Potential of Foreign Parent Groups primarily operating in U.S. Analyzed by GAO

A new report by the Government Accountability Office (GAO) has analyzed the prevalence of, and potential tax advantages or abuse stemming from, foreign-parented corporate groups with U.S. subsidiaries that conduct the majority of their worldwide operations in the U.S.
 
Although information on the subject was limited, GAO concluded that this structure may provide an advantage because foreign-controlled domestic corporations (FCDC ) and their foreign parents may not be subject to the anti-deferral rules applicable to U.S. parent corporations and their foreign subsidiaries. 
 
The FCDC ownership structure could provide a tax avoidance or evasion advantage relative to a structure where U.S. parents own foreign subsidiaries. According to IRS officials, the FCDC structure could confer a tax advantage because certain rules that can limit potential abuse by U.S. parent companies and their foreign subsidiaries may not apply to FCDCs and their foreign parent companies.
 
These rules (called anti-deferral rules) make immediately taxable to U.S. corporations certain types of income such as interest, rents, and royalties of their foreign subsidiaries. These types of income tend to be easily movable from one taxing jurisdiction to another and hence more amenable to transfer pricing abuse.
 
The standard to be applied is that of a taxpayer dealing at arm's length with an uncontrolled taxpayer. The arm's length result of a controlled transaction must be determined under the method that provides the most reliable measure of an arm's length result.

The GAO states in its report that a multinational corporate group, whether U.S.-owned or foreign-owned, can generally shift income to subsidiaries in low-tax countries to avoid or evade U.S. taxes, even if the majority of their economic activity is in the U.S. However, use of a foreign-controlled domestic corporation (FCDC) structure can provide a tax avoidance or evasion advantage over structures where U.S. parents own foreign subsidiaries.

GAO observed that many corporate groups with U.S. owners achieve the FCDC structure by forming a new foreign corporation in a low-tax country that becomes the owner of the corporate group. This transaction is known as an “inversion,” and it is typically used to reduce the group's overall tax liabilities. Foreign ownership can also occur via takeovers or mergers by foreign corporations, foreign corporations with U.S. subsidiaries incorporating overseas at the onset, or foreign corporations expanding their operations and establishing new subsidiaries in the U.S.

The primary advantage of the FCDC structure is that, unlike U.S. parent companies and their foreign subsidiaries, the anti-deferral rules generally don't apply to an FCDC structure. Rather, the anti-deferral rules only apply to an FCDC if it is also the owner of a CFC, or to the foreign parent of an FCDC if the foreign parent is itself a CFC.

However, with respect to tax evasion through transfer pricing abuse, FCDC structures don't provide any particular advantage since they are subject to the same rules as U.S. corporations with foreign subsidiaries.

GAO emphasized that data on foreign-owned but essentially U.S.-based corporate groups was extremely limited, and noted that it was unable to describe how they came to adopt this structure “without basic information.” GAO stated the Form 5472 doesn't provide information from which GAO can ascertain the percentage that a group's business in one particular country represents of its worldwide business, and it further doesn't contain information on intermediary parties to an FCDC structure. Form 5472 could, however, be revised to better identify and understand FCDCs. 

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