CFC rules

What it means

CFC rules stop profit from being parked in subsidiaries in low-tax countries and left untaxed. Where the conditions are met, that company’s profit is added to the Slovak parent’s tax base.

Control and the effective foreign tax rate decide. The target is not a real operation with its own people and assets but a shell holding licences or loans and doing nothing.

CFC rules are not the same as transfer pricing. Transfer pricing adjusts the price of individual transactions within a group so it matches the market. CFC rules look at the subsidiary’s whole profit: even when every price is right, profit left in a low-tax country without real activity behind it is added to the parent.

How it works in practice

In a group with a foreign arm, closing the year means checking not only the tax domicile but where the activity actually happens. Transfer pricing documentation and the subsidiary’s accounts are the evidence.

If the rules apply, the profit is taxed in Slovakia whether or not a dividend was paid. Foreign tax is credited, so this is a top-up rather than double taxation.

When a Slovak s. r. o. sets up a foreign subsidiary, for instance to hold a trademark and collect royalties for it, we go through the questions with the client before incorporation: who takes decisions there, where its people are, and what the actual tax will be. The answers show whether the structure saves money or just adds administration.

What to watch out for

Companies assume the rules are for large groups only. They are not: control and a low rate are what count, so a small subsidiary owned by a single Slovak director falls in scope too.

The second risk is assessing CFC only at incorporation. If tax in the subsidiary’s country falls in later years, or the subsidiary lets its staff go, the rules can start to bite without any formal change to the structure. The test is therefore repeated with every tax return of the parent.