GAO 

United States Government Accountability Office

Report to the Committee on Finance, 

U.S. Senate 

INTERNATIONAL 

TAXATION 

Study Countries That 

Exempt ForeignSource Income Face 

Compliance Risks and 

Burdens Similar to 

Those in the United 

States 

September 2009 

GAO-09-934 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

September 2009

INTERNATIONAL TAXATION 

Study Countries That Exempt Foreign-Source Income 

Face Compliance Risks and Burdens Similar to Those 

Highlights of GAO-09-934, a report to The in the United States

Committee on Finance, U.S. Senate 

A debate is underway about how 

the United States should tax 

foreign-source, corporate income. 

Currently, the United States allows 

domestic corporations to defer tax 

on the earnings of their foreign 

subsidiaries and also gives credits 

for foreign taxes paid, while most 

other developed countries exempt 

the active earnings of their 

multinational corporations’ foreign 

subsidiaries from domestic tax. 

The debate has focused on 

economic issues with little 

attention to tax administration. 

GAO was asked to describe for a 

group of study countries with 

exemption systems: (1) the rules 

for exempting foreign-source 

income, and (2) the compliance 

risk and taxpayer compliance 

burden, such as recordkeeping, of 

the rules. The study countries, 

selected to provide a range of 

exemption systems, are Australia, 

Canada, France, Germany, and the 

Netherlands. For these countries 

GAO reviewed documents; 

interviewed government officials, 

academic experts, and business 

representatives; and compared tax 

policies, compliance activities and 

taxpayer reporting requirements. 

What GAO Recommends

Because changing the United States 

system of taxing foreign-source 

income is a policy decision, GAO is 

not making recommendations 

related to tax reform. GAO does 

recommend that the Secretary of 

Treasury annually report, using 

already available data, the revenue 

generated by taxing foreign-source 

corporate income. The Secretary 

agreed with our recommendation. 

The study countries exempt some corporate income, such as dividends 

received from foreign subsidiaries, from domestic tax. However, the study 

countries tax other types of foreign-source income such as royalties. 

Multinational corporations present a compliance risk because they can use 

subsidiaries to convert taxable income into tax-exempt or lower taxed 

income, eroding the domestic tax base. Although quantitative estimates of 

noncompliance do not exist, tax experts interviewed by GAO identified 

sources of compliance risk and taxpayer burden in each of the study 

countries. These issues, particularly the ones below, have also been identified 

as sources of compliance risk and burden in the United States. 

Transfer prices—the prices for transactions between related parties—can be 

manipulated to shift profits. Tax experts in the study countries said the 

growing importance of intangible property such as trademarks and patents is 

making international transactions more susceptible to transfer pricing abuse. 

In response, the study countries have all increased their scrutiny of transfer 

prices, including increased demands for documentation and more audits, 

resulting in increased compliance burden for taxpayers. Cooperative efforts 

between taxpayers and tax agencies to reduce audits, such as Advanced 

Pricing Agreements, received mixed reviews in the study countries. 

Anti-avoidance rules prevent taxpayers from moving passive income 

(interest and royalties are often passive income) to a foreign subsidiary in 

order to avoid domestic tax. Generally, the rules make such passive income, 

even if moved, taxable. Tax agencies and taxpayers reported difficulties in 

obtaining information from other countries to make complex determinations 

about whether the anti-avoidance rules apply or not. 

The United States does not report taxes paid on foreign-source income. 

Treasury officials said it would be feasible to do so. Such reporting would 

make more explicit the role international tax rules play in raising revenues 

and protecting the domestic tax base. All experts we spoke with on this topic 

agreed. 

Simple Example of Dividend Exemption 

Domestic parent corporation

Dividend income $80

Foreign subsidiary

Net income $100

Taxes paid $20

After-tax profit=$80 

Dividend $80

Income tax $20

Foreign government

20% corporate 

income tax

Source: GAO.

View GAO-09-934 or key components.

For more information, contact Jim White at 

(202) 512-9110 or whitej@gao.gov. 
Page i GAO-09-934 

Contents 

Letter 1

Background 4 

Study Countries Vary in the Types of Foreign-Source Income 

Exempted from Domestic Tax and in the Rules Governing Those 

Exemptions 9 

Study Countries Face Areas of Compliance Risk and Burden 

Known to Exist in the United States 18 

Conclusion 30 

Recommendation for Executive Action 31 

Agency Comments 31 

Appendix I Objectives, Scope, and Methodology 32 

Appendix II Transfer Pricing Documentation Requirements in the 

Study Countries 34 

Appendix III Example from Australia of the Process for Obtaining 

an Advanced Pricing Agreement 35 

Appendix IV Examples of Other Anti-avoidance Rules in the Study 

Countries and the United States 36 

Appendix V Description of Dividend Exemption Systems in Japan 

and the United Kingdom 37 

Appendix VI Comments from the Department of the Treasury 38 

Appendix VII GAO Contact and Staff Acknowledgments 39 

 International Taxation 
Related GAO Products 40 

 

Tables 

Table 1: Select Examples of Types of Income That Can Be 

Generated from Foreign Sources 6 

Table 2: General Domestic Tax Treatment of Different Types of 

Foreign-Source Income 11 

Table 3: Dividend Qualification Criteria—Required Domestic 

Ownership Type and Level of Foreign Subsidiary to 

Qualify for Tax Exemption of Foreign-Source Dividend 

Income 12 

Table 4: Dividend Qualification Criteria—Domestic Tax Treatment 

of Foreign-source Dividend Income Distributed from 

Active and Passive Income 13 

Table 5: General Overview of CFC and Other Anti-avoidance Rules 17 

Table 6: Overview of Rules Governing FTCs in the Study Countries 

and the United States 26 

Table 7: Examples of Additional Anti-avoidance Rules by Country 36 

Table 8: Required Domestic Ownership Type and Level of Foreign 

Subsidiary to Qualify for Tax Exemption of ForeignSource Dividend Income 37 

Figures 

Figure 1: Continuum of Tax Systems of Foreign-Source Corporate 

Income 7 

Figure 2: Simple Example of Deferral 8 

Figure 3: Simple Example of Dividend Exemption 9 

Figure 4: Simple Depiction of CFC Rules 15 

Page ii GAO-09-934 International Taxation
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Page iii GAO-09-934 International Taxation
Page 1 GAO-09-934 

 

United States Government Accountability Office

Washington, DC 20548 

 

September 15, 2009 

The Honorable Max Baucus 

Chairman 

The Honorable Charles E. Grassley 

Ranking Member 

Committee on Finance 

United States Senate 

One hallmark of the global economy is greater mobility of income and 

economic transactions. As technology advances and globalization 

continues to eliminate barriers to conducting business across countries, 

companies routinely earn income in several countries. For example, U.S. 

corporations reported $205 billion in foreign-source income for tax year 

2003, the latest year currently available.1

 This is about half of the $425 

billion of total worldwide income (foreign plus domestic) earned by U.S. 

corporations in that year.2

 Often income is not earned directly by a 

domestic corporation, but rather through wholly or partially owned 

subsidiaries incorporated in other countries. 

Foreign-source income, especially when earned by multinational 

corporations (MNC), presents challenges for income tax design and 

administration. These challenges include ensuring tax law compliance, 

minimizing tax induced distortions of businesses decisions about where to 

locate investment, avoiding the double taxation of income earned in one 

country by companies located in another country, and minimizing 

unnecessary taxpayer compliance burden, such as recordkeeping. 

There are two general approaches to taxing foreign-source corporate 

income. Under both approaches, a corporation pays any tax due in the 

foreign country where the income is earned. The approaches differ in how 

the corporation is taxed domestically, that is, in the corporation’s home 

country. One approach—called worldwide taxation—taxes all income 

earned by a corporation regardless of where the income is derived. Under 

this approach, double taxation is addressed through foreign tax credits 

1

These are U.S. corporations that claimed foreign tax credits on IRS tax forms. This may 

not include all U.S. corporations. 

2

Internal Revenue Service, Corporate Foreign Tax Credit, 2003, Statistics of Income 

Bulletin. Fall 2007. 

 International Taxation 
 

(FTC). The FTC is a credit, usually subject to limits, against domestic tax 

for foreign taxes paid. A corporation would pay domestic tax on foreignsource income only to the extent that the domestic tax on that income 

exceeds the foreign tax credit. 

The other approach—called territorial taxation—only taxes the 

corporation’s income derived within the taxing country’s borders, 

irrespective of the residence of the taxpayer. Thus, unlike worldwide 

taxation, foreign-source income earned by a domestic corporation is 

exempt from residence-country tax. The exemption generally eliminates 

the possibility of double taxation.3

In practice, large developed countries do not use a pure worldwide or pure 

territorial approach when taxing foreign-source corporate income. 

Instead, they use hybrid approaches. Most developed countries, especially 

after recent policy changes in Japan and the United Kingdom, now lean 

toward a territorial approach but are not purely territorial—in part, 

because they place significant limitations on what types of income are 

eligible for exempt treatment.4

 The United States and a few other 

countries, on the other hand, lean toward a more worldwide approach but 

are not purely worldwide—in part, because taxation can be deferred on 

certain qualifying income until it is actually paid to the domestic 

corporation by subsidiaries as dividends. Basic features of the U.S. tax 

system result in the ability of some MNCs to defer domestic taxation until 

it is actually paid to a domestic part of the MNC.5

 

 

3

Under a worldwide approach, domestic corporations generally face the same total income 

tax liability regardless of whether an investment is located at home or abroad (assuming 

the foreign tax rate is the same or lower than the domestic rate), so investment location 

decisions are not distorted by the tax. However domestic corporations may not necessarily 

pay the same tax on a foreign investment as a foreign competitor. Under a territorial 

approach, domestic corporations earning foreign income only pay foreign tax, ensuring 

that they do not face a greater tax liability on that income than foreign competitors in the 

same country. However, this means that a domestic corporation could face different tax 

liabilities for foreign and domestic investments. 

4

See appendix V for additional details on the tax treatment of foreign-source income in 

Japan and the United Kingdom. 

5

In general, the U.S. tax system does not tax income until it is actually earned. The U.S. also 

generally imposes its corporate income tax at the corporate entity level. Deferral is a result 

of these basic features: anti-avoidance rules generally create exceptions to these principles 

in specific circumstances. 

Page 2 GAO-09-934 International Taxation
 

In the United States, proposals have been developed to reform the 

taxation of foreign-source income.6

 The proposals differ, with some 

designed to move the United States toward more territoriality and others 

intended to maintain a more worldwide approach. An extensive body of 

literature debates the economic merits of these proposals, including the 

effects of taxes on competitiveness and the location decisions of firms. 

While some research shows that taxes change location incentives, the 

existing research does not reach definitive conclusions about important 

economic effects such as the impact of foreign investment by U.S. 

corporations on U.S. employment. 

Compared to the extensive examination of economic effects, little has 

been done to study whether there are important differences between 

worldwide and territorial systems in terms of tax administration and, more 

specifically, in terms of compliance by taxpayers and taxpayers’ 

compliance burden (recordkeeping, reporting, and other costs). In the 

context of foreign-source income, at least two broad compliance issues 

exist. One is ensuring that domestic corporations pay the tax due on 

foreign-source income. The other is ensuring corporations do not erode 

the domestic tax base by illegally shifting domestic income abroad. 

Because of the ongoing debate about the taxation of foreign-source 

income and because of the limited information available on administering 

a worldwide system versus a territorial system, you asked us to report on 

other countries’ experience administering territorial systems. Based on 

your request, our objectives are to (1) describe, for select case study 

countries that take a territorial approach, what types of foreign-source 

income the countries exempt and the rules governing those exemptions; 

and (2) describe, to the extent information is available, the compliance 

risks and taxpayer compliance burdens that the taxation of foreign-source 

corporate income presents for each of these countries. 

To address our objectives, we selected five countries—Australia, Canada, 

France, Germany, and the Netherlands—to study based on several criteria, 

including range of rules governing the taxation of foreign-source income, 

unique tax system features, and Organization of Economic Cooperation 

and Development (OECD) membership. To provide assurance that all of 

 

6

For examples see Department of the Treasury, Leveling the Playing Field: Curbing Tax 

Havens and Removing Tax Incentives for Shifting Jobs Overseas (TG-119) (May 4, 2009); 

and President’s Advisory Panel on Federal Tax Reform, Simple, Fair, and Pro-Growth: 

Proposals to Fix America’s Tax System (Washington, D.C, November 2005). 

Page 3 GAO-09-934 International Taxation
 

the information used in this report is sufficiently reliable, we used data 

from commonly used and cited sources of statistical data, such as the 

OECD, and other publicly available reports from international government 

agencies. Additionally, we performed an in-depth literature review on all 

of the study countries, including government documents, private sector 

studies, and academic publications. We collected and analyzed data on the 

countries and their systems for taxing foreign-source corporate income, 

including tax policies, administrative mechanisms, compliance activities, 

and taxpayer reporting and documentation requirements. We interviewed 

knowledgeable government officials from the study countries, including 

officials from the tax agencies. We also interviewed U.S. tax agency 

officials, international tax experts, including academic and private-sector 

experts, and members of a number of professional services organizations 

that represent and serve MNCs that have large numbers of foreign 

subsidiaries under their control. We provided the tax agencies of our study 

countries a copy of our report to verify data and specific factual and legal 

statements about the tax treatment of foreign-source income in those 

countries. We did not conduct a formal legal review of the tax laws and 

rules in other countries, but relied on the information supplied by tax 

agency officials in those countries. We made technical corrections to our 

report based on these reviews. A more detailed discussion of our 

methodology is in appendix I. 

We conducted our work from June 2008 to September 2009 in accordance 

with all sections of GAO’s Quality Assurance Framework that are relevant 

to our objectives. The framework requires that we plan and perform the 

engagement to obtain sufficient and appropriate evidence to meet our 

stated objectives and to discuss any limitations in our work. We believe 

that the information and data obtained, and the analysis conducted, 

provide a reasonable basis for any findings and conclusions in this 

product. 

Background 

Multinational Corporations 

and Foreign-Source 

Income 

Corporate income tax is levied on business entities that organize and 

operate as corporations, as defined by each individual country’s tax rules 

and laws. Generally, corporations are individual business entities that 

issue shares and can make distributions to shareholders, such as dividend 

payments. 

Page 4 GAO-09-934 International Taxation
 

Corporations can be shareholders in other corporations, both domestic 

and foreign. The amount of control the corporate shareholder has over the 

other corporation can vary depending on the percentage of shares owned 

and other factors. At the low range of corporate ownership, portfolio 

shareholding allows a corporate shareholder to invest in a business but 

does not involve maintaining a controlling stake in the firm. At greater 

levels of ownership, corporations can own a sufficient percentage of 

shares to gain partial or total control of major business decisions, such as 

the level and timing of dividend distributions and investment and pricing 

strategies. For this report, we will call the controlling firm a parent 

corporation and the controlled firm a subsidiary.7

 Parent-subsidiary 

relationships can be complicated, involving a corporation owning multiple 

subsidiaries, subsidiaries being controlled by multiple parents, or tiered 

arrangements with subsidiaries owning subsidiaries of their own. When 

these relationships involve entities in more than one country, these 

corporations are referred to as multinational corporations (MNC). 

MNCs are groups of separate legal entities, which can include 

corporations, partnerships, trusts, and other legal entities, that operate 

and generate income in multiple countries, and different parts of an MNC 

may have different domestic jurisdictions. MNCs may also have 

branches—domestic, foreign, or both—as part of a corporation’s internal 

organizational structure.8

 In general, each corporate entity that is part of 

the MNC is taxed as an individual taxable entity by the relevant 

governments, unless the corporation is allowed to and chooses to file a 

consolidated return. 

Different Types of ForeignSource Income 

Corporations can earn a variety of different types of income from foreign 

sources. This income can be generated from transactions with either 

unrelated parties, such as retail customers located abroad, or related 

parties, such as foreign subsidiaries or other parts of the same MNC. 

Corporations can earn foreign-source income from active and passive 

activities with foreign parties. While countries vary somewhat in their 

 

7

There is no standard definition of a subsidiary. For the purposes of our report, we use the 

term subsidiary loosely to refer to a chain of ownership whereby a parent corporation 

exercises a degree of control of another corporation. The level of ownership which 

determines control differs by individual circumstances. We discuss these scenarios later in 

the report. 

8

In general, branches of U.S. corporations are not regarded as separate legal entities for tax 

purposes. 

Page 5 GAO-09-934 International Taxation
 

definitions of active and passive income, generally speaking, active income 

is considered to be the income generated through the primary business 

activities of the corporation. Passive income, in contrast, is income that is 

not earned through primary business activities. Interest earned, rental 

income, and royalty payments from foreign sources are generally 

considered passive income. However, for some companies, such as 

financial services companies, these types of income may constitute the 

primary business and be considered active income under the tax laws of 

some countries. Additionally, corporations can purchase shares of foreign 

companies and receive dividend distributions based on the earnings of 

those companies. Table 1 below lists some general examples of different 

types of income that can be generated from foreign-sources. 

Table 1: Select Examples of Types of Income That Can Be Generated from Foreign Sourcesa

Type of income General definition 

Example of foreign-source income in a 

parent-subsidiary relationship 

Capital gains The gain realized from the appreciated value between 

the purchase and sales price of an asset, such as 

shares in a corporation. Investments that have not yet 

been sold, but would yield a profit if they were sold 

have unrealized capital gains. 

A domestic parent sells shares it held in a foreign 

subsidiary for $50. The domestic parent had bought the 

shares for $20. The realized capital gain is the $30 

difference. 

Dividends A payment distributed by a company to its 

shareholders. Dividends are usually given out in the 

form of cash, but can also be given out as stock or 

other property. 

A domestic parent company owns 10,000 shares of a 

foreign subsidiary. The foreign subsidiary makes a 

dividend payment of $1 per share to all shareholders, 

including $10,000 to the parent. 

Interest Payments received as compensation for lending 

money. 

A domestic parent makes a 10-year, 5 percent loan for 

$1 million to a foreign subsidiary. The subsidiary makes 

semi-annual interest payments of $25,000 to the 

domestic parent. 

Rent Compensation for the use or occupation of property. A domestic parent owns a factory in a foreign country. A 

foreign subsidiary makes monthly payments to the 

domestic parent for occupation and use of the factory. 

Royalty Income generated from licensing the use of property, 

such as intellectual property. 

A foreign subsidiary pays a domestic parent firm for the 

right to use trademark logos on goods produced and 

sold. 

Source: GAO 

a

The definitions in this chart reflect how we use these terms for the purposes of this report. Other 

definitions exist for these terms but are outside the scope of this report. 

Most Countries Take a 

Hybrid Approach to Taxing 

Foreign-Source Income 

In practice, countries combine elements of worldwide and territorial 

approaches to taxing foreign-source income. One approach, generally 

referred to as deferral, deviates from the worldwide model and taxes the 

domestic corporation on all of its income, including income and dividends 

received from foreign subsidiaries, but defers taxation until the income is 

Page 6 GAO-09-934 International Taxation
 

repatriated. Another approach, generally referred to as dividend 

exemption, is closer to the territorial model and permits the tax-exempt 

repatriation of the dividends distributed by foreign subsidiaries, but may 

limit the extent to which some income is exempt. In either system, foreignsource income is taxed first in the source country; under a deferral system, 

a residual tax is then imposed only when the income is repatriated. Figure 

1 shows a continuum of tax treatments for foreign-source corporate 

income with hybrid systems ranging between the pure worldwide and 

territorial models. 

Figure 1: Continuum of Tax Systems of Foreign-Source Corporate Income 

All income, regardless of 

type, production source, 

or country source is

taxed currently. Foreign 

taxes offset by 

deduction or credit.

Foreign-source 

income is exempt. 

Domestic source 

income is taxed.

Pure

territorial

Pure

worldwide

Hybrid systems

Source: GAO.

The current tax system in the United States is an example of a worldwide 

system with deferral, which taxes domestic corporations on their 

worldwide income, regardless of where the income is earned and gives 

credits for foreign income taxes paid. Income unrelated to a U.S. trade or 

business earned by foreign corporations is not taxed domestically until it 

is distributed to a domestic shareholder, such as a domestic parent 

corporation, which allows deferral of taxation on income of foreign 

subsidiaries. Special rules may exist that tax certain shareholders, such as 

a parent corporation, currently on the income of certain subsidiaries in 

order to protect the domestic tax base. To reduce the double taxation of 

income, corporate taxpayers can offset, in whole or in part, the domestic 

tax owed on the foreign-source income through a FTC. In certain 

circumstances, a parent corporation may claim FTCs for foreign taxes 

paid by a subsidiary. Figure 2 shows how a dividend payment is generally 

taxed under a worldwide tax approach that permits deferral. 

Worldwide System with 

Deferral 

Page 7 GAO-09-934 International Taxation
 

Figure 2: Simple Example of Deferral 

Domestic parent

corporation

Dividend income $80

Reported foreign taxes paid $20

Taxable income=$100a

$35 tax liability

Foreign tax credit claimed $20

 After-tax income $65

Foreign subsidiary

Net income $100

Taxes paid $20

After-tax profit=$80 

3

1

2

Dividend $80

Reported foreign 

taxes paid $20

Income tax 

$20

Foreign

government

20% corporate 

income tax

Domestic

government

35% corporate 

income tax

Step 1 Foreign subsidiary 

earns $100 profit from active 

business activities in the foreign 

country.

Step 2 Foreign subsidiary is

subject to a 20% income tax in 

the foreign country. Foreign 

subsidiary pays $20 in taxes

leaving an after-tax profit of $80.

Step 3 At some point in time, 

foreign subsidiary distributes its

after-tax profits of $80 as a

dividend to its sole shareholder, 

domestic parent corporation.

Step 4 Domestic parent

corporation calculates taxable

income on the grossed-up 

amount of dividend received.

Step 5 Domestic parent

corporation is assessed a 35%

income tax by domestic country.

Domestic parent corporation 

pays the tax through a

combination of $15 in cash and 

$20 in imputed FTCs.

Step 6 Domestic parent

corporation’s after-tax net income 

is $65.

Source: GAO.

Foreign tax

credit $20

Income tax 

$15

4

5

6

a

Domestic tax liability is based on the grossed-up value of the dividend plus the amount of foreign 

income tax paid on the associated earnings. 

Many OECD countries exempt some types of foreign-source corporate 

income from domestic tax. Exemptions are commonly granted in these 

countries for dividends paid by a foreign subsidiary. As shown in figure 3, 

which is a simplified example of an exemption system, the domestic 

corporation does not incur a tax liability by receiving the dividend income 

from its foreign subsidiary. However, similar to the worldwide systems 

with deferral that were described earlier, exemption systems may disallow 

the tax advantages of foreign-source income under certain circumstances 

to protect the domestic tax base. 

Exemption Systems 

Page 8 GAO-09-934 International Taxation
 

Figure 3: Simple Example of Dividend Exemption 

Domestic parent

corporation

4 Dividend income

(tax exempt) $80

Foreign subsidiary

Net income $100

Taxes paid $20

After-tax profit=$80 

3 1

2 Dividend $80

Income tax

$20

Foreign

government

20% corporate 

income tax

Step 1 Foreign subsidiary 

earns $100 profit from active 

business activities in the foreign 

country.

Step 2 Foreign subsidiary is

subject to a 20% income tax in 

the foreign country. Foreign 

subsidiary pays $20 in taxes

leaving an after-tax profit of $80.

Step 3 Foreign subsidiary 

distributes its after-tax profits of 

$80 as a dividend to its sole 

shareholder, domestic parent 

corporation.

Step 4 Domestic parent 

corporation receives $80 

dividend from foreign subsidiary. 

The domestic country exempts

from taxation foreign-source 

dividends. Domestic parent’s net 

income is $80.

Source: GAO.

Our study countries—Australia, Canada, France, Germany, and the 

Netherlands—have hybrid tax systems that exempt some types of foreignsource income and tax others. All of the study countries tax domestic 

corporations on income earned through rental payments and royalties. 

Such payments may be made by unrelated parties or by subsidiaries and 

are generally expenses of the payee in the foreign country but are received 

as income by the domestic corporation. Subject to an extensive list of 

exceptions, the study countries generally exempt, but to varying extents, 

income of domestic corporations received as foreign-source dividends 

from foreign subsidiaries, sales by foreign branches, and the gains from 

the sale of shares in foreign subsidiaries. For example, all of the study 

countries permit domestic corporations to receive dividends that meet 

certain qualifications as tax-exempt income, but differ in the rules they use 

in determining which dividends are qualified. In addition, Canada does not 

allow domestic corporations to earn tax-exempt, foreign-source income 

through foreign branches and taxes up to half of the capital gains on the 

Study Countries Vary 

in the Types of 

Foreign-Source 

Income Exempted 

from Domestic Tax 

and in the Rules 

Governing Those 

Exemptions 

Page 9 GAO-09-934 International Taxation
 

sale of foreign subsidiary shares while the other study countries generally 

exempt income from these sources.9

In addition to the rules above covering income payments received by 

domestic corporations, all study countries also have rules that tax 

domestic corporations on some income at the time it is earned by foreign 

subsidiaries, regardless of when or if the foreign subsidiary distributes a 

dividend. These rules, generally referred to as anti-avoidance rules, 

attribute certain earnings of related foreign entities to domestic 

corporations in order to limit the tax benefits of holding certain types of 

income offshore. 

Table 2 presents a brief overview of the tax treatment for different types of 

foreign-source income in our study countries. All rows except the last 

show the tax treatment of income payments received by a domestic 

corporation. The last row shows the tax treatment of income at the time it 

is earned by a foreign subsidiary that is subject to certain anti-avoidance 

rules regardless of whether the income was distributed as a dividend. 

While data was not available for most of our study countries, in Canada, at 

least 76 percent of foreign-source dividends received by Canadian 

taxpayers from foreign affiliates from 2000 to 2005 were qualified foreignsource dividends and, therefore, were tax exempt.10

 

9

As shown in table 2, France and Germany effectively exempt 95 percent of capital gains 

from the sale of foreign subsidiary stock from domestic tax. 

10As measured by the Canadian dollar value of total dividends received from foreign 

affiliates. Advisory Panel on Canada’s System of International Taxation, Enhancing 

Canada’s International Tax Advantage (December 2008). 

Page 10 GAO-09-934 International Taxation
 

Table 2: General Domestic Tax Treatment of Different Types of Foreign-Source Income 

Australia Canada France Germany Netherlands 

Foreign 

subsidiaries 

Rent, royalty, Taxable Taxable Taxable Taxable Taxable 

and interest 

income paid by Unrelated 

third parties 

Taxable Taxable Taxable Taxable Taxable 

Nonqualifying foreign-source 

dividends 

Taxable Taxable Taxable Taxable Taxable 

Qualified foreign-source 

dividends 

Exempt Exempt Effectively 95%

exempta

Effectively 95%

exempta

Exempt 

Active foreign branch income Exempt Taxable with FTC Exempt Taxable with FTC 

under domestic 

law but generally 

exempt through 

tax treaty 

Generally exempt 

Capital gains from the sale of 

foreign subsidiary shares 

Generally exempt 50% to 100%

Exempt 

Effectively 95%

exempta

Effectively 95%

exempta

Exempt 

Attributable foreign earnings 

subject to anti-avoidance rules 

Taxable with FTC Taxable with FTC Taxable with FTC Taxable with FTC Taxable 

Source: GAO analysis of country information. 

Note: This table shows general treatments. It does not present all of the details, exceptions, or rules 

that govern the tax treatment of foreign-source income for our study countries. 

a

For France and Germany, the exempt amount of qualified foreign-source gross dividends and capital 

gains is effectively 95 percent due to rules that tax 5 percent of the income as nondeductible 

expenses. This is discussed in more detail later in this report. 

Study Countries Use 

Different Criteria to 

Qualify Foreign-Source 

Dividends for Domestic 

Tax Exemption 

Our study countries all have certain criteria that, when met, allow 

domestic corporations to receive tax-exempt income in the form of 

dividend payments, called qualified foreign-source dividends in table 2. In 

each of the countries, all of the criteria must be met for the domestic 

corporation to receive the foreign-source dividend tax-exempt. If any of 

the conditions are not met, then the dividend does not qualify for the tax 

exemption and is, therefore, taxable. Our study countries applied up to 

three criteria when determining which income is tax-exempt: domestic 

ownership type and level of foreign subsidiaries; the type of income 

(active versus passive) distributed as a dividend; and the presence of a tax 

treaty or similar agreement between the domestic and foreign government 

where the subsidiary is located and income is earned. 

All of our study countries except Germany require the domestic 

corporation to have a minimum ownership stake in a foreign subsidiary in 

order to qualify for the benefits of exemption. In general, these minimum 

ownership level stakes mean that income from portfolio or portfolio-like 

Page 11 GAO-09-934 International Taxation
 

investment is not exempt. Each country takes a different approach in 

determining the type of shares that qualify dividend income for exemption 

with distinctions made on the type of shares and the length of time the 

shares are held. For example, while Canada requires domestic 

corporations to own 10 percent or more of any class of shares in the 

foreign subsidiary, France requires its corporations to own at least 5 

percent of a foreign subsidiary’s shares.11 The requirements for each 

country are summarized in table 3. 

Table 3: Dividend Qualification Criteria—Required Domestic Ownership Type and Level of Foreign Subsidiary to Qualify for 

Tax Exemption of Foreign-Source Dividend Income 

Australia Canada France Germany Netherlands 

Domestic ownership 

of foreign company 

Direct shareholding 

of at least 10%

Direct ownership of 

1% and direct or 

indirect ownership of 

at least 10% 

At least 5%

ownership 

None In principle a 

shareholding of at 

least 5%

Foreign company 

share type 

Shares must have a 

voting interest 

Any type Ownership or 

participating shares 

Any type Any type 

Ownership duration None None 2 years None None 

Source: GAO analysis of country information. 

Note: This table shows general treatments. It does not present all of the details, exceptions, or rules 

that govern the tax treatment of foreign-source income for our study countries. 

In addition to the criteria above, Canada also makes a distinction between 

dividends distributed from active and passive income, while the other 

study countries do not, as shown in table 4. 

 

11To qualify for the tax exemption, the French corporation must hold or intend to hold the 

shares for 2 years. 

Page 12 GAO-09-934 International Taxation
 

Table 4: Dividend Qualification Criteria—Domestic Tax Treatment of Foreign-source Dividend Income Distributed from Active 

and Passive Income 

Australia Canada France Germany Netherlands 

Dividends 

distributed from 

active income 

Exempt Exempt Effectively 95%

exempta

Effectively 95%

exempta

Exempt 

Dividends 

distributed from 

passive income 

Exempt Taxable with FTC 

eligibilityb 

Effectively 95%

exempta

Effectively 95%

exempta

Exempt 

Source: GAO analysis of country information. 

Note: This table shows general treatments. It does not present all of the details, exceptions, or rules 

that govern the tax treatment of foreign-source income for our study countries. 

a

In France and Germany, the gross dividend amount exempt from domestic tax is effectively 95 

percent due to rules that tax 5 percent of the gross dividend amount as nondeductible expenses. This 

is discussed in more detail later in this report. 

b

Income that was previously taxed under anti-avoidance rules may be tax exempt upon repatriation. 

Of all our study countries, currently only Canada requires that the foreign 

subsidiary be located and earn active income in a designated treaty 

country in order to qualify for the dividend tax exemption that was shown 

in table 2. For Canada, a designated treaty country is a country with which 

Canada either has a tax treaty or a tax information exchange agreement 

(TIEA). As was noted earlier, at least 76 percent of dividends received by 

Canadian taxpayers from foreign affiliates between 2000 and 2005 were 

tax exempt. 

Study Countries Limit Tax 

Advantages of Earning 

Foreign-Source Income 

under Certain Conditions 

As was shown in the last row of table 2, all study countries have antiavoidance rules that limit the tax advantages of earning certain types of 

income abroad. In general, these rules are intended to protect the 

domestic tax base by preventing taxpayers from avoiding domestic tax on 

passive or other specific types of income by moving to or holding these 

types of income in a foreign country. When triggered, these rules require a 

domestic shareholder to be taxed currently on its pro rata share of certain 

types of income earned by certain foreign subsidiaries, regardless of when 

or if that income is distributed to the shareholder.12 Anti-avoidance rules 

exist in both worldwide and territorial tax systems, and are in effect in 

each of our study countries and the United States (commonly known as 

Subpart F in the United States). 

 

12Income taxed under anti-avoidance rules may, in some cases, be distributed to the 

domestic parent corporation as tax-exempt dividends. 

Page 13 GAO-09-934 International Taxation
 

A prominent anti-avoidance rule used by all study countries except the 

Netherlands applies to controlled foreign corporations (CFC).13 Each 

country’s CFC rules vary, but they generally tax domestic shareholders, 

including shareholding corporations, currently on certain types of income 

earned by foreign corporations that qualify as controlled by domestic 

shareholders. This is illustrated in figure 4. This means that the domestic 

corporation may be taxed on income that it has not received from the 

foreign corporation (called a deemed dividend in figure 4). This income is 

taxable when earned by the subsidiary, although CFC rules generally 

permit the domestic taxpayer to offset some or all of their domestic tax 

liability through credits on the foreign taxes paid on the income. 

 

13We use the term controlled foreign corporation (CFC) to describe foreign subsidiaries 

that are controlled by a domestic parent company as defined by each country. Some of our 

study countries use similar terms, such as controlled foreign company or controlled foreign 

affiliate, which we include in our use of the term controlled foreign corporation. Although 

this term has a specific technical meaning in several jurisdictions, including in the United 

States, we do not use this term in any of its technical senses, but as a generic description of 

these types of rules in various countries. 

Page 14 GAO-09-934 International Taxation
 

Figure 4: Simple Depiction of CFC Rules 

Foreign subsidiary

$100 interest income

Taxes paid $5

(after tax profit $95)

3

1

2

$100 deemed 

dividend

$5 reported foreign 

taxes paid

Income

tax $5

Foreign

government

5% corporate

income tax rate

Domestic

government

35% corporate 

income tax rate

Step 1 Foreign subsidiary, a

wholly owned subsidiary of 

domestic parent corporation, 

earns $100 in interest income 

earned from a loan provided to 

another foreign corporation. 

Interest income is considered 

passive income in the domestic 

country.

Step 2 Foreign subsidiary is

subject to a 5% corporate income 

tax in the foreign country. 

Foreign subsidiary pays $5 in tax, 

leaving it with $95 in after-tax 

profit on passive income.

Step 3 Foreign subsidiary does

not make any profit or earnings

distribution to the domestic 

parent corporation. Domestic 

parent corporation must 

recognize $100 as a deemed 

dividend for passive income 

earned by the foreign subsidiary.

Step 4 Because foreign 

subsidiary is a controlled foreign 

corporation of domestic parent 

corporation, domestic parent 

corporation pays taxes on the 

$100 undistributed passive 

income of the foreign subsidiary. 

Domestic parent corporation 

receives $5 in foreign tax credits

to off-set taxes paid to foreign 

government on the deemed 

dividend and pays a net tax of 

$30 to domestic government.

Source: GAO.

Foreign tax

credit $5

Income

tax $30

Domestic parent 

corporation

$100 deemed dividend 

recognized by the domestic 

parent corporation

$35 tax liability

$5 foreign tax credit claimed

4

Generally, study countries establish criteria in three areas that, when met, 

define a domestic shareholder’s tax liability for certain types of income 

earned by a foreign corporation under the CFC rules. First, countries 

define when a foreign corporation is controlled by domestic shareholders. 

For example, Australia defines a controlled foreign corporation as any 

foreign corporation that meets either of the following definitions: (1) 

where five or fewer Australian residents effectively control the foreign 

corporation or own more than 50 percent of the foreign corporation; or (2) 

where one Australian entity has an individual ownership of 40 percent or 

more of the foreign corporation not controlled by another corporation. 

Page 15 GAO-09-934 International Taxation
 

Second, countries generally set a minimum level of ownership in the 

foreign corporation that domestic shareholders must meet before being 

taxed on the foreign corporation’s earnings. For example, under Canada’s 

CFC rules, a Canadian shareholder must own at least 10 percent of the 

foreign corporation to be taxed on certain types of income earned by the 

foreign corporation. Third, the controlled foreign corporation generally 

must earn certain types of income that are specified in each country’s CFC 

rules. For example, Germany requires that a CFC earn passive income that 

is taxed at an effective rate of 25 percent or less by the foreign country 

before a domestic corporation is required to pay tax on the CFC’s 

earnings. 

Once the criteria above are met, domestic shareholders are taxed 

currently on certain types of attributed income earned by the CFC. Some 

countries, like Canada, generally limit the taxable foreign earnings to the 

domestic corporation’s pro rata share of passive income.14 Other 

countries, like France, tax domestic corporations on their pro rata sh

all earnings by the foreign corporation. Table 5 presents a simplified 

overview of the CFC rules used by our study countries. Additional details 

on other types of anti-avoidance rules can be found in appe

are of 

ndix IV. 

 

14In Canada, this income taxed currently is known as foreign accrual property income 

(FAPI). FAPI income includes categories of income that may not meet all definitions of 

passive income. 

Page 16 GAO-09-934 International Taxation
 

Table 5: General Overview of CFC and Other Anti-avoidance Rules 

Australia Canada France Germany Netherlands 

Criteria a foreign entity 

must meet to be 

considered a CFC 

Either: 

(1) five or fewer 

Australian residents 

control or own more 

than 50% of the 

foreign entity; 

or 

(2) When one 

Australian resident 

owns 40% or more 

of the foreign entity 

Five or fewer 

Canadian residents, 

including parties 

that do not deal at 

arm’s length with 

them, own greater 

than 50% of the 

foreign entity 

(1) The foreign 

entity is located in a 

country with an 

effective tax rate 

that is 50% or less 

than that of France; 

(2) French residents 

own 50% or more; 

(3) Intragroup 

income is greater 

than 20%, or 

passive income and 

intra-group services 

income is greater 

than 50% 

(1) German 

residents own 50%

or more; 

(2) The foreign 

entity earns passive 

income; 

(3) Passive income 

is taxed at an 

effective rate less 

than 25% 

N/A 

Domestic shareholder 

ownership level 

necessary 

10% or greater 10% or greater Directly or indirectly 

hold 50% or greater

Any level of 

ownership 

N/A 

Foreign earnings 

subject to current 

taxation 

Pro-rata share of 

passive earnings in 

most countries 

Pro-rata share of 

passive earnings 

Pro-rata share of all 

earnings 

Pro-rata share of 

passive earnings 

N/A 

Additional features of 

CFC rules 

CFCs resident in 

“listed” countries—

those with similar 

tax systems to 

Australia— have 

fewer types of 

income that may be 

attributed to 

domestic 

corporations 

CFC rules do not 

apply if the foreign 

subsidiary is 

located in another 

EU country and 

does not exist 

solely to avoid 

French taxation 

CFC rules do not 

apply if the foreign 

subsidiary exists in 

another EU or 

European 

Economic Area 

country and 

conducts genuine 

economic activities 

Additional Antiavoidance Rules Foreign investment 

fund rules 

Offshore investment 

fund rules 

Abuse of law 

doctrine 

General antiavoidance rule Low-taxed passive 

shareholding rules 

Source: GAO analysis of country information. 

Note: This table shows general treatments. It does not present all of the details, exceptions, or rules 

that govern the tax treatment of foreign-source income for our study countries. 

a

The percentage ownership by the domestic shareholder corresponds to the type of shares that were 

presented in table 2. 

Page 17 GAO-09-934 International Taxation
 

Differences in tax rates across countries and differences in the taxation of 

different types of income may create incentives to avoid tax by shifting 

income from a high tax jurisdiction to a lower taxed jurisdiction or by 

converting income from a taxable type to tax-exempt type. Such efforts to 

reduce taxes may sometimes be legal tax avoidance, but may also be 

illegal noncompliance. 

Tax experts identified four areas as sources of compliance risk or 

taxpayer compliance burden in our study countries. None of our study 

countries were able to provide quantitative estimates of the extent of 

noncompliance with their tax laws governing foreign-source income or the 

amount of compliance burden placed on taxpayers. Furthermore, an 

exhaustive list of all sources of compliance risk and burden does not exist. 

However, four areas that tax experts, including tax agency officials, tax 

practitioners, and academics identified were: 

Study Countries Face 

Areas of Compliance 

Risk and Burden 

Known to Exist in the 

United States 

• transfer pricing, 

• anti-avoidance rules, 

• foreign tax credits, and 

• domestic expense deductions. 

These areas are also viewed by the Internal Revenue Service (IRS) or 

other tax experts as sources of compliance risk or compliance burden in 

the United States. 

While countries establish rules in these four areas to serve a variety of 

policy goals, including maintaining economic competitiveness and 

avoiding double taxation, one important consideration is protecting the 

domestic tax base. One unique tax administration challenge that MNCs 

present is that they can shift income and assets among related entities in 

different countries to convert taxable income, either foreign or domestic, 

to tax-exempt or lower-taxed foreign-source income. The laws and 

regulations in these four areas are intended, in part, to protect the 

domestic tax base by preventing MNCs from mispricing transactions, 

relocating domestic passive income, misusing foreign tax credits, or 

reallocating expenses in ways that inappropriately reduce domestic taxes. 

These laws also create compliance burden, often requiring taxpayers to 

maintain detailed records and conduct complex analyses of international 

transactions. 

Page 18 GAO-09-934 International Taxation
 

Many tax agency officials we met with stated that transfer pricing was the 

most significant compliance risk they face in the area of international 

taxation. Similarly, many business representatives said complying with 

transfer pricing rules was often the most burdensome aspect of 

international taxation. Transfer prices are the prices of goods and services 

transferred among related entities within an MNC. These prices create 

compliance risks because MNCs can sometimes deliberately manipulate 

them to shift income from one related entity to another in order to reduce 

tax liability. For example, a parent corporation that charges a foreign 

subsidiary a below-market price for a good or service lowers the parent 

corporation’s taxable income and raises the subsidiary’s taxable income. 

Depending on tax rates and rules governing exemption and deferral, 

shifting income in this way may reduce an MNC’s overall tax liability. An 

above-market price would shift taxable profits from the subsidiary to the 

parent. 

Transfer Pricing, 

Particularly for Intangible 

Property, Is a Major 

Compliance Risk and 

Source of Compliance 

Burden in all of the Study 

Countries 

Because transfer prices can shift taxable income from one country to 

another, all of our study countries have focused attention on transfer 

pricing with emphasis on stringent documentation requirements and 

audits. Generally, the study countries require taxpayers to provide 

evidence that transfer prices meet an arms-length standard, which means 

pricing transactions as if they occurred between unrelated parties. 

Establishing an arms-length price can be difficult when there is no 

comparable market price, such as for a unique good, service, or intangible 

property. 

Although comprehensive data were not available, several experts, 

including the OECD, have noted that a significant amount of trade occurs 

between related parties.15 Trade in services in the United States, while not 

a measure of overall U.S. trade, provides an example. According to the 

U.S. Bureau of Economic Analysis, trade in services between CFCs and 

related parties increased (in nominal dollars) from approximately $38.4 

billion in 1999 to approximately $178.7 billion in 2006.16 

The changing nature of international trade, particularly the growing trade 

in intangibles, is making international transactions more susceptible to 

 

15OECD Observer, Transfer Pricing: Keeping it at Arm’s Length, July 3, 2008. 

16U.S Bureau of Economic Analysis. U.S. International Services: Cross-Border Trade 

1986-2007, and Services Supplied Through Affiliates, 1986-2006.

Page 19 GAO-09-934 International Taxation
 

transfer pricing abuse.17 Tax experts repeatedly identified intangible 

property as a particular challenge when attempting to establish a transfer 

price that meets the arm’s length standard. The unique nature of many 

intangible assets, such as patents, trademarks, copyrights, and brand 

recognition, means that it is difficult or impossible to identify comparable 

transactions for transfer pricing purposes. The revenue risk posed by 

mispricing intangibles can be significant because it can result in a 

company converting taxable income into tax-exempt or lower taxed 

income. For example, a parent corporation can license a patented 

computer technology to a foreign subsidiary and charge a below-market 

royalty, which is taxed in the domestic country. The subsidiary, which is in 

a low-tax country, uses the technology to generate a profit. The subsidiary 

then pays a tax-exempt dividend to the parent corporation. The parent 

corporation’s country loses tax revenues because the tax-exempt dividend 

received is inflated and the taxable royalty is reduced. Conversely, the 

subsidiary’s country receives additional tax revenues because the 

subsidiary’s income is higher than it should be, as the smaller royalty 

payment is a deductible expense. In the aggregate, however, the MNC 

reduces its tax liability because the tax rate in the subsidiary’s country is 

lower than the tax rate in the parent corporation’s country. 

Because identifying comparable prices for intangibles is often difficult, tax 

agencies and taxpayers often rely on a profit-split approach. The goal is to 

determine the percentage of profit attributable to buyers and sellers in 

different countries. Company officials consistently reported that making 

these determinations often requires costly special studies done by outside 

technical experts. In Australia, for example, to help protect against 

penalties, it is recommended that companies document that they followed 

a four-step process including selecting and justifying a transfer pricing 

methodology and then conducting an analysis based on that methodology 

to determine an arm’s-length price. Appendix II provides details on the 

transfer pricing documentation and filing requirements for all of our study 

countries. One company official further said that even after making these 

investments, tax authorities may disagree with the results because of 

differences in opinion about the assumptions that had to be made. A 

 

17This is a significant issue for tax authorities because of the growing significance 

intangibles play in the global economy. Although there is currently no complete measure of 

the amount of income generated globally, or even in the United States, from investment in 

intangible assets, one indicator is the amount of income generated through royalty 

payments. According to Treasury tax files, royalties paid by the top 7500 CFCs of U.S. 

parent corporations increased 68 percent ($22.4 to $37.6 billion) from 1996 to 2002. 

Page 20 GAO-09-934 International Taxation
 

number complained about transfer pricing reviews turning into disputes 

between countries over the distribution of tax liabilities. This can occur 

because, in many transfer pricing disputes, there are at least three 

interested parties, the taxpayers and two tax agencies. When a taxpayer 

reaches an agreement with one government on a price it can result in a 

lower tax payment for the other government. 

On the other hand, tax agency officials repeatedly told us that they needed 

detailed information on the pricing methodologies used in order to verify 

that companies’ prices satisfy the arm’s-length standard. Tax agency 

officials said documentation of the data used and analysis conducted are 

critical to conducting independent determinations of the appropriateness 

of transfer prices. As one example of the importance tax agencies place on 

this documentation, the Australian Tax Office (ATO) has a system for 

rating the documentation quality. Under this system, poorly documented 

transfer pricing decisions are more systematically identified, allowing 

better targeting of audits. 

Transfer pricing abuse is also known to be a significant problem in the 

United States. For example, IRS lists transfer pricing abuse as a high-risk 

compliance area because of the large number of taxpayers and significant 

dollar risk. 

While there is agreement that transfer pricing is a major compliance risk in 

both our study countries and the United States, there is no consensus 

among the tax experts we met with about whether the compliance risks 

are greater in our study countries’ exemption systems or in the United 

States’ deferral system. Some argued that the tax benefits for an MNC 

from manipulating transfer prices are potentially larger under an 

exemption system than a deferral system. They argue that gains from 

transfer pricing abuse are larger if income can be made tax-exempt rather 

than tax-deferred. However, other experts pointed out that transfer pricing 

abuse is already a significant problem in the United States. Some of these 

experts noted that the incentives to avoid or evade tax under a deferral 

system can be quite large because tax can be deferred indefinitely. One of 

these experts also pointed out that there is no empirical evidence 

supporting the claim that countries with exemption systems face greater 

noncompliance with transfer pricing rules. 

According to tax agency officials and outside tax experts, all study 

countries are placing greater emphasis on transfer pricing when auditing 

MNCs. For example, a tax practitioner in France said that the 

overwhelming majority of the audit issues he faces are transfer-pricing 

Study Countries Have Placed 

Greater Emphasis on Enforcing 

Transfer Pricing Rules 

Page 21 GAO-09-934 International Taxation
 

related. Another tax practitioner made the same observation about 

Germany, saying that there is a general perception that the burden for 

complying with transfer pricing has increased in recent years. These and 

other company representatives we spoke with said that time spent 

determining and documenting transfer prices in accordance with country 

requirements is a primary source of burden. These findings are echoed in 

the research of others. For example, according to a survey of 850 MNCs, 

65 percent of respondents believe that transfer pricing documentation is 

more important now than it was 2 years ago.18 Similarly, two-thirds of 

those respondents said they increased their resources on transfer pricing 

experts and studies in the last 3 years. 

All of the study countries have developed advanced pricing agreement 

(APA) programs that allow taxpayers and tax agencies to resolve transfer 

pricing issues before tax returns are filed and without the need for time 

consuming and expensive audits. Tax experts’ opinions on APA 

participation varied, but often these experts did not consider them an 

efficient use of resources for addressing transfer pricing issues. Due to the 

time and resources required to obtain an APA, some taxpayers only pursue 

them for high-value transactions. Guidance provided by the Australian Tax 

Office illustrates the time and extensive documentation that can be 

required for an APA. The document, included in appendix III, lists 

requirements such as numerous meetings with agency officials, details of 

the transfer pricing methodology, and data supporting that methodology. 

The amount of time needed to complete an APA can be greater when it 

involves multiple countries. According to statistics from some of our study 

countries, APAs may take a year, or multiple years, to finalize. Between 

1992 and the end of 2007, Canada finalized 153 APAs. 

All Study Countries Use 

Advanced Pricing Agreements 

to Address Compliance Risks 

Some tax practitioners said that the decision to use APAs can also depend 

on the perceived risk that a transaction is likely to be subject to audit. 

Some taxpayers determine that APAs are less burdensome than going 

through an audit. 

 

18Ernst & Young, Global Transfer Pricing Survey 2007-2008. We did not validate the 

information reported in this study. 

Page 22 GAO-09-934 International Taxation
 

According to taxpayers and tax officials we spoke with from the study 

countries, rules limiting the tax advantages of earning certain types of 

income offshore can serve as a source of taxpayer compliance burden and 

can be subject to compliance risk. As shown earlier in table 5, all of our 

study countries with the exception of the Netherlands use CFC rules as a 

primary method to limit the exemption or tax-deferral of certain income 

held offshore.19 In addition, all of our study countries, including the 

Netherlands, have additional anti-avoidance rules that may apply and 

disallow tax advantages on specific types of income earned offshore. See 

appendix IV for details of other anti-avoidance rules in our study countries 

and in the United States. The study countries were not able to provide us 

with statistics on the number of subsidiaries subject to these antiavoidance rules, the amount of income earned by them, or the residual tax 

revenue they generated.20 Government officials we spoke with in several 

countries estimated the revenue generated from these rules to be low. 

However, some tax experts we spoke with stated that these rules played 

an important role in preventing MNCs from avoiding domestic taxes by 

earning income through CFCs. 

Complying with and 

Enforcing Anti-avoidance 

Rules, both CFC and Other 

Rules, Presents Challenges 

in All of Our Study 

Countries 

When CFC rules are triggered, it can result in an increase in the MNC’s tax 

liability. As a result, some of the tax practitioners we talked to said that 

structuring subsidiaries to avoid CFC rules requires careful planning and 

continuous monitoring. It is even possible that the actions of others could 

change a foreign subsidiary’s CFC status. For example, as shown in table 

5, one way a subsidiary of an Australian MNC can be a CFC is if five or 

fewer Australian investors own more than 50 percent of its shares. 

Consequently, a subsidiary that is not currently a CFC could become one if 

other Australian investors increase their ownership share. 

Some tax practitioners told us that the complexity of the requirements for 

determining whether CFC rules applied and the amount of information 

needed to support a determination created considerable burden. For 

example, a French tax professional said that France’s CFC rules are 

burdensome because they require the taxpayer to make a series of 

 

19As stated previously, we use the term CFC to generally describe foreign subsidiaries that 

are controlled by a domestic company as defined by each country. We do not use the term 

in any of its technical senses, but as a generic description of these types of rules in our 

study countries. 

20Some of this data is available for U.S. MNCs based on corporate tax returns. For example, 

for tax year 2004, IRS reported the existence of 74,676 CFCs that earned $362.2 billion 

before income taxes. These CFCs paid $69.3 billion in income taxes worldwide. 

Page 23 GAO-09-934 International Taxation
 

complex determinations (these were summarized in table 5)—such as 

whether the foreign tax liability of a subsidiary is greater or less than 50 

percent of what it would be had the income been earned in France—in 

order to decide whether the subsidiary is a CFC. Given differences in 

accounting and tax rules between France and a foreign subsidiary’s home 

country, these calculations can become complicated. German CFC rules 

require similar comparisons of actual taxes paid to theoretical taxes owed 

in determining whether the subsidiary will be taxed as a CFC. Australia 

takes a different approach, providing a list of countries where CFCs can be 

located and have fewer types of income that may be attributed to domestic 

corporations. It is not clear the extent to which this reduces burden in 

comparison to the other study countries. 

Tax experts in Canada also said that acquiring information for 

documentation requirements related to CFC rules is particularly 

burdensome. For example, a Canadian firm with a 10 percent holding in a 

foreign subsidiary is required to provide the Canada Revenue Agency 

(CRA) with detailed tax and operations information from the foreign 

subsidiary. With only a 10 percent ownership stake, the Canadian firm may 

find it challenging to obtain such information in a timely manner, or at all. 

Generally, CFC rules intend to limit an MNC’s ability to shift income, 

especially passive income, to foreign jurisdictions to avoid or postpone 

domestic tax. Enforcing these rules could be difficult if the tax agency is 

not present in the foreign jurisdictions. For example, some officials in 

France and Canada said they may not be able to obtain and validate 

information needed to enforce these rules. One French official stated that 

it is difficult to see if a foreign subsidiary located in a low-tax jurisdiction 

thousands of miles away was an active business or being used to shelter 

income. 

While the Netherlands does not have specific CFC rules, taxpayers and tax 

officials stated that the compliance burden associated with other antiavoidance rules can be significant. According to tax professionals we 

spoke with, the Netherlands has low-taxed passive shareholding rules, 

another type of anti-avoidance rule. Overall, the tax practitioners and 

experts we spoke with agreed that the compliance burden related to antiavoidance rules in the Netherlands could be significant. 

Page 24 GAO-09-934 International Taxation
 

The study countries all have FTC systems; however, according to both tax 

agency officials and tax practitioners FTCs play less of a role in these 

countries than in the United States because of the extent to which foreignsource income is exempt. For exempt income, taxpayers do not have to 

track and report foreign taxes paid. However, FTCs still exist as the study 

countries use them to avoid double taxation on foreign-source income that 

is not exempt, such as income subject to anti-avoidance rules. Most study 

countries were not able to supply data on the amount of FTCs that are 

claimed by domestic parent corporations in their countries. However, 

some tax experts said that the extent to which FTCs are generated varies 

by country, the type of industry in which the MNC conducts business, and 

the overall structure and location of the MNC’s subsidiaries. For example, 

according to one German tax practitioner we spoke with, FTCs in that 

country tend to be generated mainly by businesses in the financial and 

insurance industries or where CFCs are involved. 

Exemption of ForeignSource Income Reduces 

the Need for Foreign Tax 

Credits, but They Can Still 

Serve as a Compliance 

Risk 

As shown in table 6, the study countries vary in the rules they apply to 

FTCs. Many of these rules address the extent to which companies are 

allowed to accumulate FTCs and use them to offset other types of income. 

For example, Australia requires that all FTCs must be used in the taxable 

period in which they are recognized by the taxpayer on their tax filing. Any 

FTCs that a company has accumulated that are in excess of the amount of 

domestic tax actually paid on that income are lost. Canada, on the other 

hand, allows companies to carry excess FTCs back into the previous 3 

years or forward up to 10 years. The United States allows companies to 

apply accumulated FTCs across different types of foreign-source incomes, 

across multiple countries, and over multiple years. For example, FTCs 

accumulated for foreign taxes paid on royalty income can be combined 

with FTCs accumulated on dividend income. 

Page 25 GAO-09-934 International Taxation
 

Table 6: Overview of Rules Governing FTCs in the Study Countries and the United States 

FTC carryover 

Country 

FTC 

allowed Some limits on the use of FTCs Back Forward 

Australia Yes Domestic tax liability on the foreign-source income None None 

Canada Yes Domestic tax liability on the foreign-source income by country 3 years 10 years 

France YesaGenerally only allowed for withholding taxes paid to eligible tax treaty 

countries 

None None 

Germany Yes Domestic tax liability on the foreign-source income by country None None 

Netherlands Yes Domestic tax liability on the foreign-source income None None 

United States Yes Domestic tax liability on the foreign-source income by broad category of 

income (general or passive) 

1 year 10 years 

Source: GAO analysis of country information. 

Note: This table shows general treatments. It does not present all of the details, exceptions, or rules 

that govern the tax treatment of FTCs for our study countries. 

a

French domestic law, generally, does not allow FTCs; income subject to foreign tax and not exempt 

from French tax is taxable net of foreign tax paid. However, most French tax treaties provide for a tax 

credit that generally corresponds to withholding taxes on passive income. 

Some practitioners said there was some burden in tracking FTCs, but 

generally these rules were much less burdensome than complying with 

transfer pricing and anti-avoidance rules. One tax practitioner from 

Germany pointed out that in instances where MNCs have numerous 

subsidiaries subject to anti-avoidance rules it generally results in more 

instances where income is subject to tax in two countries, thus creating 

additional burden to identify and track FTCs. 

Tax agency officials, taxpayers, and tax experts agreed that Canada’s rules 

for tracking foreign-source income and determining whether the income 

qualifies for tax exemption are complex and challenging for taxpayers and 

tax officials. As discussed earlier in this report, Canada’s rules for 

determining whether or not dividend income received from foreign 

subsidiaries is exempt from domestic taxation include ownership 

requirements, location and business activities in a treaty country, and 

evaluating what type of earnings (e.g., capital gains, passive income, or 

active income) the subsidiary is distributing as a dividend. Canadian 

corporations receiving dividend income that does not qualify for 

exemption are taxed on that income, although FTCs may be applied to 

offset domestic tax. Canadian corporations are responsible for tracking all 

foreign earnings to ensure appropriate taxation once the income is 

received by the Canadian corporation. Taxpayers said these rules are 

burdensome, in part, because they require information only available from 

Canada’s Rules for Determining 

if Dividend Income Is Taxable, 

with FTCs Allowed, or Exempt 

Is a Compliance Challenge and 

Imposes Significant Taxpayer 

Burden 

Page 26 GAO-09-934 International Taxation
 

foreign subsidiaries, complex calculations and adjustments to income 

based on Canadian rules, and monitoring ownership changes for the 

foreign subsidiary. Tax agency officials said the rules are a compliance 

risk because of their complexity and difficulty of validating adherence. 

One area identified by tax officials as a source of compliance risk in 

Canada is the generation of abusive FTCs to offset overall tax liability. 

Often termed FTC generators, these activities, for example, allow 

taxpayers to take advantage of definitions of debt and equity in two 

countries by setting up a subsidiary for the purpose of holding assets and 

generating an income stream in such a way that the income stream is 

subject to foreign tax but also receives an offsetting deduction so that 

there is no net foreign tax. The taxpayer then tries to claim a domestic tax 

credit against this foreign tax paid while ignoring the offset. 

The Generation of 

Inappropriate Foreign Tax 

Credits Was Identified as a 

Compliance Risk in Canada but 

the Risk Was Uncertain for the 

Other Study Countries 

Tax agency officials in Canada told us that FTC generators are considered 

a significant compliance risk in their country. CRA officials said they were 

currently auditing a number of domestic corporations to determine the 

extent to which Canadian companies are participating in these types of 

schemes. Because there is often no economic purpose to such a 

transaction, one company generally pays the other a fee for participating 

in the transaction. CRA officials said, so far, they have identified a 

substantial amount in avoided Canadian tax from 2001 to 2005. 

Several experts we spoke to with knowledge of the other study countries 

said they did not think FTC generators were a significant issue in those 

countries. For example, a tax practitioner in Germany told us that since 

the majority of repatriated income to Germany is tax exempt FTCs are not 

produced in many instances. Similarly, Australian tax agency officials said 

that since Australian rules require FTCs to be used immediately in the year 

they are recognized, it reduces the ability to exploit the FTC generator 

scheme. However, some experts also pointed out that there is always a 

possibility that taxpayers could structure specific transactions to produce 

improper FTCs. 

FTC generators are also known to be a significant problem in the United 

States. For example, IRS lists them as a high-risk compliance area because 

of the large number of taxpayers and significant dollar risk that these 

types of schemes present. 

Page 27 GAO-09-934 International Taxation
 

Using sometimes indirect methods, all study countries limit the domestic 

deductibility of some expenses associated with earning foreign-source 

income. Tax experts said that methods resulted in fewer compliance risks 

and burdens as compared to more direct methods. The deductibility of 

expenses incurred to earn foreign-source income is an issue because of 

the effect on revenue. If domestic deductibility is allowed under an 

exemption system, then MNCs are able to deduct expenses even though 

the resulting income is not subject to domestic tax. 

Study Countries Differ in 

How They Limit Domestic 

Deductions for Expenses 

in Order to Prevent 

Erosion of the Domestic 

Tax Base 

France and Germany provide an example of an indirect approach to 

limiting expense deductions. As shown in table 2, they require 

corporations to add 5 percent of their gross tax-exempt dividends to their 

domestic taxable income (making dividends effectively 95 percent 

exempt) as an offset for deductible expenses incurred to earn the 

dividends. In our interviews with tax officials and members of the business 

community, this approach was cited as being less burdensome than 

tracing or allocating domestic expenses to tax-exempt income. Tracing 

would involve matching specific expenses to actual income generated. 

Some tax experts that we spoke to generally agreed that tracing would be 

ineffective. Many of the domestic expenses incurred by domestic 

corporations to invest or maintain an investment in a foreign subsidiary 

are general to the domestic corporation. These expenses include general 

management expenses, interest expense on borrowed money, and other 

administrative expenses. Because these expenses are general to the 

corporation, they are difficult to trace to the income items. 

One alternative to tracing, mentioned by several experts we talked to, is 

allocating overhead expenses to income sources according to formulas. 

Rather than tracing expenses to actual income items, this alternative 

would allocate expenses according to a rule. Although not used in our 

study countries, allocating overhead expenses in this way could be made 

less burdensome than tracing. However, some experts stated that this 

approach would create compliance risks and burdens that do not currently 

exist. Several experts pointed to the United States as an example of this. 

In general, the United States requires U.S. corporations to allocate their 

expenses to a class of gross income and then, if a statutory provision 

requires, apportion deductions between the statutory grouping and the 

residual grouping. IRS officials stated that these rules were a compliance 

risk because corporations sometimes do not apply them appropriately. 

Some tax experts said these rules were a significant compliance burden 

because they are complex, requiring considerable time to conduct detailed 

calculations. 

Page 28 GAO-09-934 International Taxation
 

Another approach taken by all of our study countries is to limit the amount 

of interest expense that domestic corporations may deduct. Without limits 

on interest rates and amounts, corporations could shift income offshore 

and artificially increase domestic interest expenses, eroding the domestic 

tax base. The rules vary by country and in many cases apply to all 

corporations, not just multinationals. For example, Germany and France 

require that interest rates be equivalent to arm’s-length terms; the amount 

of expense that exceeds those terms is generally nondeductible.21

Germany also has a rule disallowing interest expenses that exceed 30 

percent of the corporation’s adjusted earnings. Canada has a rule that 

targets interest paid to a foreign related-entity with a limit based on debtto-equity ratios. With a few exceptions, tax professionals generally stated 

that the general types of interest expense rules described above did not 

pose much of a compliance burden. 

 

The approaches taken by the study countries do not disallow all domestic 

deductions for expenses incurred with respect to foreign-source dividend 

income. However, some experts thought that the indirect approaches for 

limiting the deductibility of overhead expenses were more administrable 

and less burdensome than more targeted alternatives. 

Australia, France, and Germany exempt active foreign-source income 

earned through foreign branches, but generally disallow domestic 

deductions for direct expenses attributable to earning the tax-exempt 

income. Direct expenses, like the cost of inventory, can be traced more 

easily to the income generated than more general expenses, like interest or 

other overhead costs. 

Study Countries and the 

United States Do Not 

Regularly Report Basic 

Information about the 

Revenues Generated by 

Taxing Foreign-Source 

Corporate Income 

In addition to lacking data about compliance and compliance burden for 

their foreign tax rules, our study countries lack data on the amount of tax 

revenues generated from the foreign activities of domestic corporations. 

This is also the case for the United States. Several federal agencies 

consistently report on the business activities of U.S. MNCs, but tax 

revenues are not included in these reports. For example, the Bureau of 

Economic Analysis reports on the foreign direct investment activities of 

U.S. MNCs and IRS reports data on the amount of income U.S. MNCs earn 

through CFCs. 

21These requirements are related to transfer pricing rules in that they both aim to set the 

prices involved in certain related-party transactions at arm’s length. 

Page 29 GAO-09-934 International Taxation
 

U.S. international tax experts, including noted academics with multiple 

publications who we spoke to on this topic all agreed that regularly and 

consistently reporting U.S. tax revenue from foreign-source corporate 

income would be useful. They said that this information would help inform 

the debate about how to tax foreign-source income and potentially 

improve understanding of the role international tax rules play in the U.S. 

tax system. For example, one of these experts pointed out that it was not 

widely understood how little domestic revenue is actually raised from 

taxing foreign-source income and that the tax regime governing foreignsource income plays a role in protecting the domestic tax base. 

Treasury officials and the experts we talked to noted that producing 

regular revenue reports is feasible. A few academic papers and a recent 

release from the Secretary of the Treasury on international tax issues have 

reported estimates.22 However, the experts said that these reports from 

different sources are not as useful as they could be because they are 

irregular, incomplete, and lack transparency. The experts felt that 

consistent and transparent reporting by a reputable government source 

that clearly describes the methodology used to produce the numbers and 

any limitations would be superior to the current occasional reports that 

sometimes lack much explanation. IRS and Treasury officials said IRS 

already collects the necessary data through corporate income tax returns 

to make the necessary calculations. Therefore, the tax experts said there 

should not be significant additional cost to the government to provide this 

information. 

The United States, like our study countries, does not report the taxes 

collected by the United States on foreign-source income. Such basic 

information about the U.S. system would not be costly to provide and 

could contribute to the ongoing debate about the direction of U.S. policy. 

Such reporting would make explicit to policy makers, and perhaps to the 

general public as well, how little residual revenue is received by the United 

States from taxing foreign-source corporate income. Doing so could help 

Conclusion 

 

22Altshuler and Grubert reported U.S. corporations paid $12.7 billion in U.S. taxes on 

foreign-source corporate income reported in tax year 2000 in “Corporate Taxes in the 

World Economy: Reforming the Taxation of Cross-border Income” in Fundamental Tax 

Reform: Issues, Choices, and Implications, edited by John W. Diamond and George R. 

Zodrow (2008). The Department of the Treasury reported about $16 billion in revenue for 

tax year 2004 in Leveling the Playing Field: Curbing Tax Havens and Removing Tax 

Incentives for Shifting Jobs Overseas (TG-119) (May 4, 2009). 

Page 30 GAO-09-934 International Taxation
 

highlight the important role that international corporate tax rules play in 

protecting the domestic tax base. 

We recommend that the Secretary of the Treasury use currently collected 

information to report annually on the revenue to the United States 

Treasury from taxing foreign-source corporate income. To enhance 

usefulness, such reports should describe the methodology and important 

limitations. 

Recommendation for 

Executive Action 

We requested comments on a draft of this report from the Secretary of the 

Treasury. Treasury agreed with our recommendation. The Acting 

Assistant Secretary (Tax Policy)'s letter is reprinted in Appendix VI. 

Treasury and IRS staff also provided technical comments, which we have 

incorporated as appropriate. 

As agreed with your offices, unless you publicly announce its contents 

earlier, we plan no further distribution of this report until 30 days after its 

date. At that time, we will send copies to the Secretary of the Treasury, the 

Commissioner of Internal Revenue, and other interested parties. This 

report will also be available at no charge on GAO’s Web site at 

http://www.gao.gov. 

If you or your staff has any questions, please contact me at (202) 512-9110 

or whitej@gao.gov. Contact points for our Offices of Congressional 

Relations and Public Affairs may be found on the last page of this report. 

James R. White 

Key contributors to this report are listed in Appendix VII. 

Director, Tax Issues 

Team 

Agency Comments 

Strategic Issues 

Page 31 GAO-09-934 International Taxation
Appendix I: Objectives, Scope, and 

Methodology 

Page 32 GAO-09-934 

Appendix I: Objectives, Scope, and 

Methodology 

The objectives of this report were to (1) describe, for select case study 

countries that take a territorial approach, what types of foreign-source 

income the countries exempt and the rules governing those exemptions; 

and (2) describe, to the extent information is available, the compliance 

risks and taxpayer compliance burdens that the taxation of foreign-source 

corporate income presents for each of these countries. 

To address our objectives, we selected five countries—Australia, Canada, 

France, Germany, and the Netherlands—to study based on several criteria, 

including range of tax treatments for foreign-source corporate income, 

unique tax system features, and Organization for Economic Cooperation 

and Development (OECD) membership. To gather information related to 

our selection criteria, we interviewed a number of corporate income tax 

experts, including academics, corporate tax practitioners, corporate 

taxpayers, officials at the OECD, and government officials. We contacted 

those experts that we identified through our literature review, which is 

described immediately below, along with experts that were recommended 

by other experts. Our literature review consisted of academic articles and 

books, national government publications, OECD and other multinationalorganization publications on worldwide and territorial tax systems, and 

private sector research pertaining to various international aspects of 

corporate income tax systems and administration. 

To describe the corporate income tax systems of our study countries, we 

consulted with corporate taxpayers, business representatives, government 

tax officials, and academic experts. We performed an in-depth literature 

review on each country’s corporate income tax system, focusing on the 

rules governing international taxation. We also reviewed research-based 

publications produced by professional services organizations, academic 

experts, and international organizations. In general, we relied on 

information provided by tax officials from the study countries as well as 

published documents to summarize and characterize the corporate income 

tax systems for each country. We collected and analyzed data on the 

countries and their systems for taxing foreign-source corporate income, 

including tax policies, administrative mechanisms, compliance activities, 

and taxpayer reporting and documentation requirements. We did not 

conduct a formal legal review of the tax laws and rules in other countries, 

but relied on the information supplied by tax agency officials in those 

countries. We also provided the tax agency officials in our study countries 

a copy of our report to verify data and specific factual and legal statements 

about the tax laws in their country. 

 International Taxation 
Appendix I: Objectives, Scope, and 

Methodology 

To address our second objective, we searched for publicly available data 

that quantified taxpayer compliance risk and burden for each of our study 

countries. In addition, we interviewed tax practitioners, taxpayers, 

government tax officials, business representatives, and officials from the 

OECD. We analyzed the information gathered through interviews as well 

as published documents to identify and describe the common sources of 

taxpayer compliance risk and compliance burden across the study 

countries. When available, we used publicly available data obtained from 

governments, private sector research, and academics to support evidence 

provided in the interviews. In addition, we provided tax agency officials 

from each of the study countries with a statement of facts that were 

presented in the report for their review and comment. Technical 

corrections were made to this report based upon country responses. This 

report shows general tax treatments and does not present all of the details, 

exceptions, or rules that govern the tax treatment of foreign-source 

income in our study countries and the United States. 

We conducted our work from June 2008 to September 2009 in accordance 

with all sections of GAO’s Quality Assurance Framework that are relevant 

to our objectives. The framework requires that we plan and perform the 

engagement to obtain sufficient and appropriate evidence to meet our 

stated objectives and to discuss any limitations in our work. We believe 

that the information and data obtained, and the analysis conducted, 

provide a reasonable basis for any findings and conclusions in this 

product. 

Page 33 GAO-09-934 International Taxation
Appendix II: Transfer Pricing Documentation Appendix II: Transfer Pricing Documentation Requirements in the Study Countries 

Requirements in the Study Countries 

Country Documentation requirements 

Time at which 

documentation should be 

prepared 

Time to fulfill 

formal requests 

made during an 

audit 

Australia Documentation should evidence that the taxpayer has followed 

the following four-step process in setting and reviewing its 

transfer prices: 

Step 1: Accurately characterize the international dealings 

between the associated enterprises in the context of the 

taxpayer’s business and document that characterization; 

Step 2: Select the most appropriate transfer pricing methods 

and document the choice; 

Step 3: Apply the most appropriate method, determine the 

arm’s length outcome and document the process; and 

Step 4: Implement support processes. Install review process to 

ensure adjustment for material changes and document these 

processes. 

Contemporaneous. However, 

generally only required to be 

submitted to the revenue 

authority following a specific 

notification, such as through 

an audit 

28 days 

Canada Contemporaneous documentation required for cross border, 

related party transactions. Form T-106 required to be filed 

annually asks for reporting of non-arms-length transactions. 

Must exist at the time of tax 

filing 

3 months 

France Taxpayers are not required to keep any transfer pricing 

documentation but are expected to cooperate with the tax 

agency in transfer pricing audits. 

No formal contemporaneous 

documentation requirement. 

60 days, but could 

be extended an 

additional 30 days 

Germany Documentation that shows the type and content of business 

transaction to related parties, including general information 

about (1) the group and ownership structure, (2) business 

relations to related parties, (3) analysis of functions and risks, 

and (4) transfer pricing analysis. 

Contemporaneous for 

exceptional business 

transactions only 

60 days 

Netherlands Documentation must show the arm’s length nature of the 

transfer price that was applied. 

Generally expected to be 

available at the time when the 

transaction occurs 

4 weeks, but up to 3 

months for certain 

complex 

transactions 

Source: Organization for Economic Cooperation and Development and Ernst & Young. 

Page 34 GAO-09-934 International Taxation 
Appendix III: Example from Australia of the 

Process for Obtaining an Advanced Pricing Appendix III: Example from Australia of the Agreement 

Process for Obtaining an Advanced Pricing 

Agreement 

Step 1: Pre-lodgment meetings

The purpose of pre-lodgment meetings is to:

■ discuss the suitability of an APA

■ allow a business to provide a broad outline of the proposed transfer pricing methodology

■ discuss whether the APA will be unilateral or bilateral

■ discuss the required documentation and analysis

■ determine whether independent expert advice is required

■ discuss Tax Office audit activity (if an APA is to flow on from audit)

■ agree on a date for lodging a formal application

■ agree on the APA timetable, and

■ discuss the process for evaluating the application.

Pre-lodgment meetings do not bind either party to the APA program.

Step 2: Lodgment of formal application

If proceeding with the APA, a business will be required to lodge a formal application.

The APA application should include:

■ details of the proposed transfer pricing methodology, supported by relevant information

■ terms and conditions governing the application of the transfer pricing methodology

■ data showing that the transfer pricing methodology will produce arm’s length results

■ a discussion and analysis of the critical assumptions, and

■ a suggested period of time for which the APA will apply.

For bilateral APAs we normally advise the treaty partner’s tax authority once the application has been accepted.

Step 3: Analysis/evaluation

We evaluate the data submitted and other relevant information, and seek additional information where necessary. We normally have numerous

meetings with a business.

Step 4: Negotiation and agreement

For a bilateral APA, the relevant tax administrations exchange position papers outlining the acceptability of the proposed transfer pricing 

methodology. A written confirmation of the concluded agreement is provided to the business.

For a unilateral APA, we provide written confirmation of the agreement we reach with the business.

Step 5: Concluded APA

A concluded APA contains at least the following information:

■ the transactions, agreements or arrangements covered by the APA

■ the period and tax years covered by the APA

■ the agreed transfer pricing methodology and the critical assumptions on which it is based

■ the definition of key terms that form the basis of the methodology (for example, sales, operating profit)

■ if applicable, a range of arm’s length results, and

■ the business’s obligations as a result of the APA.

Source: Australian Tax Office.

Page 35 GAO-09-934 International Taxation
Appendix IV: Examples of Other Antiavoidance Rules in the Study Countries and Appendix IV: Examples of Other Anti- the United States 

avoidance Rules in the Study Countries and 

the United States 

Table 7 provides some examples of non-controlled-foreign-corporation 

(CFC) anti-avoidance rules. This is not a complete list of the antiavoidance rules in these countries. The consequences of falling under 

these rules are not necessarily the same as the CFC rules, but those 

consequences are beyond the scope of this table. 

Table 7: Examples of Additional Anti-avoidance Rules by Country 

Country Regime General definition of anti-avoidance rules 

Australia Foreign Investment Fund 

(FIF) rules 

Certain Australian shareholders are subject to annual taxation on a deemed return on 

their pro rata shares of foreign investment funds if: 

(a) the foreign company or trust is not controlled by Australian residents; and 

(b) the taxpayer’s shareholding is more than 10% of the total value of the 

taxpayer’s interest in foreign companies and trusts; and 

(c) the foreign company or trust engages in “blacklisted” activities, such as 

certain financial intermediary, insurance, and banking transactions; and 

(d) the taxpayer holds the interest at the end of the taxable year. 

CanadaaOffshore Investment Fund 

(OIF) 

Canadian shareholders of an OIF are taxed currently on an imputed return basis where 

the investment in the OIF is established to be motivated by tax avoidance 

France Abuse of Law doctrine General anti-avoidance law that permits the tax authorities to take action against legal 

arrangements or particular transactions when those arrangements and transactions 

were fictitious or undertaken for solely tax reasons. 

Germany General Anti-Avoidance Rule General anti-avoidance rule, re-written in 2007, that prevents taxpayers from 

establishing legal forms or structures for the sole purpose of obtaining a tax advantage. 

Tax authorities may disregard structures for tax purposes in these situations. 

Netherlands Low-Taxed Passive (LTP) 

Shareholding 

The Dutch shareholder that holds 25% or more, alone or together with an affiliate, of 

the shares in a (foreign) entity has to value its shareholding at market value in case the 

following conditions are met: 

(a) At least 90 percent of the assets of the subsidiary are, directly or indirectly, of 

a portfolio nature; 

(b) The foreign tax paid on profits is less than 10 percent of tax on profits if 

calculated under Dutch tax law; and 

(c) more than 50 percent of the carrying value of its property is not investment 

property. 

United States Passive Foreign Income 

Companies (PFIC) 

A foreign corporation is a PFIC if: 

(a) 75 percent of the corporation’s income is passive income; or

(b) 50 percent of the corporation’s assets (by value) are held for production of 

passive income. 

Unlike a CFC, a PFIC does not have any minimum stock ownership requirement. Each 

U.S. shareholder of a PFIC can choose to be taxed in one of two ways (or, in the case 

of marketable stock, one of three) ways. 

Source: GAO analysis of country information. 

a

A more comprehensive ‘foreign investment entity’ (FIE) regime is proposed but not yet enacted. 

Under these proposed rules, Canadian investors in a FIE would be taxed currently on an imputed 

return basis, except where qualifying investors elect for accrual or mark-to-market treatment instead. 

Page 36 GAO-09-934 International Taxation
Appendix V: Description of Dividend 

Exemption Systems in Japan and the United Appendix V: Description of Dividend Kingdom 

Exemption Systems in Japan and the United 

Kingdom 

Japan and the United Kingdom both adopted dividend exemption systems 

in 2009. These countries previously taxed dividends received from foreign 

subsidiaries but allowed for foreign tax credits (FTC) for foreign taxes 

paid. Like our study countries, Japan and the United Kingdom have 

specific rules used to determine whether a dividend qualifies for 

exemption. Table 8 describes these rules. 

Table 8: Required Domestic Ownership Type and Level of Foreign Subsidiary to 

Qualify for Tax Exemption of Foreign-Source Dividend Income 

Japan United Kingdom 

Domestic ownership of 

foreign company 

Direct shareholding of at 

least 25%a

Direct or indirect 

Foreign company share 

type 

Any type Most types 

Ownership duration 6 months None 

Source: GAO analysis of country information. 

Note: This table shows general treatments. It does not present all of the details, exceptions, or rules 

that govern the tax treatment of foreign-source income in these countries. 

a

If the foreign company is a resident in a country with which Japan has concluded a tax treaty that 

provides for the allowance of an indirect FTC on qualifying dividends for a shareholding percentage of 

less than 25 percent, then the exemption can be applied in those cases. 

Like the study countries, both Japan and the United Kingdom have antiavoidance rules, including controlled foreign corporation (CFC) rules, 

which limit the tax advantages of earning or holding certain types of 

income in relatively low-tax jurisdictions. Japan revised their rules at the 

same time the dividend exemption system was implemented. The United 

Kingdom plans to address reforms to their CFC rules in future years. 

However, the United Kingdom did introduce a worldwide debt cap rule 

that limits the extent to which debt expenses can be deducted by 

corporations in the United Kingdom. One goal of this rule is to prevent 

situations in which businesses in the United Kingdom borrow excessively 

in order to invest internationally to produce exempt dividends. This is 

similar to some of the interest expense limitation rules we identified in the 

other study countries. 

Page 37 GAO-09-934 International Taxation
Appendix VI: Comments from the Department Appendix VI: Comments from the of the Treasury 

Department of the Treasury 

Page 38 GAO-09-934 International Taxation
Appendix VII: GAO Contact and Staff Appendix VII: GAO Contact and Staff Acknowledgments 

Acknowledgments 

James R. White, (202) 512-9110 or whitej@gao.gov 

In addition to the contact named above, José Oyola, Assistant Director; 

Brian James; Ed Nannenhorn; Danielle Novak; Chhandasi Pandya; 

Matthew Reilly; A.J. Stephens; and Charles Veirs IV made significant 

contributions to this report. 

GAO Contact 

Staff 

Acknowledgments 

Page 39 GAO-09-934 International Taxation
Related GAO Products Related GAO Products 

Cayman Islands: Review of Cayman Islands and U.S. Laws Applicable 

to U.S. Persons’ Financial Activity in the Cayman Islands, an Esupplement to GAO-08-778, GAO-08-1028SP. Washington, D.C.: July 2008. 

U.S. Multinational Corporations: Effective Tax Rates Are Correlated 

with Where Income Is Reported. GAO-08-950. Washington, D.C.: August 12, 

2008. 

Tax Administration: Comparison of the Reported Tax Liabilities of 

Foreign- and U.S.-Controlled Corporations, 1998-2005. GAO-08-957. 

Washington, D.C.: July 24, 2008. 

Business Tax Reform: Simplification and Increased Uniformity of 

Taxation Would Yield Benefits. GAO-06-1113T. Washington, D.C.: Sept. 20, 

2006. 

Understanding the Tax Reform Debate: Background, Criteria, and 

Questions. GAO-05-1009SP. Washington, D.C.: September 2005. 

Tax Administration: Comparison of the Reported Tax Liabilities of 

Foreign- and U.S.-Controlled Corporations, 1996-2000. GAO-04-358. 

Washington, D.C.: Feb. 27, 2004. 

Tax Administration: IRS’ Advanced Pricing Agreement Program. 

GAO/GGD-00-168. Washington, D.C.: Aug. 14, 2000. 

Tax Administration: Foreign- and U.S.-Controlled Corporations That 

Did Not Pay U.S. Income Taxes, 1989-95. GAO/GGD-99-39. Washington, 

D.C.: Mar. 23, 1999. 

International Taxation: Transfer Pricing and Information on 

Nonpayment of Tax. GAO/GGD-95-101. Washington, D.C.: Apr. 13, 1995. 

International Taxation: IRS’ Administration of Tax-Customs Valuation 

Rules in Tax Code Section 1059A. GAO/GGD-94-61. Washington, D.C.: 

Feb. 4, 1994. 

International Taxation: Taxes of Foreign- and U.S.-Controlled 

Corporations. GAO/GGD-93-112FS. Washington, D.C.: June 11, 1993. 

International Taxation: Problems Persist in Determining Tax Effects of 

Intercompany Prices. GAO/GGD-92-89. Washington, D.C.: June 15, 1992. 

(450672) Page 40 GAO-09-934 International Taxation
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