Tax minimization and closely controlled corporations

Since 2013, international corporate taxation has undergone substantial tax reform changes driven by the Organization for Economic Co-operation and Development (OECD) and G20 nations. These changes aim to reduce tax losses estimated at over $400 million annually through profit shift across tax boundaries, especially to “low-tax” or “no-tax” jurisdictions [1].

These tax reform changes have primarily targeted large multinational enterprises (MNEs) — groups with revenues over €750 million annually — under the Base Erosion and Profit Shifting Project and the “Two-Pillar” Solution [2].   However, these reforms largely exclude MNE groups that have annual revenue of less than €750 million — especially enterprises that are “closely controlled corporations” (CCCs).

This article explores how CCCs may be used in tax minimization strategies and where further scrutiny may be required by tax administrations to recoup a large percentage of unquantifiable annual tax losses. It offers a possible way forward for tax administrations to scrutinize CCCs areas of tax risk.

Understanding closely controlled corporations

CCCs are typically privately held companies where a small group of shareholders — often family members or close associates — hold a significant portion of the company’s shares. These corporations are distinct from publicly traded companies due to their ownership structure and the level of control exercised by the shareholders. The concentrated ownership allows for more direct decision-making processes, including those related to tax planning and minimization.

A depiction of tax minimization practices

Tax minimization is a strategic approach corporations use to reduce their tax liabilities within the legal framework. However, some practices border on aggressive tax avoidance or evasion, which involves the tax authorities. Closely controlled corporations, often characterized by a small number of shareholders who have significant control over the company, frequently engage in tax minimization strategies to enhance their financial efficiency. The table below gives some insight into how CCCs compare with publicly traded corporations in reviewing possible approaches to tax minimization across several areas of tax risk.
 

Table: Tax risk factors: publicly traded corporations versus closely controlled corporations 

The table's analysis illustrates that CCCs benefit from significant adaptability in tax planning strategies, primarily due to reduced transparency obligations. This environment also subjects them to lesser regulatory oversight, grants them heightened leeway in transfer pricing by allowing lower disclosure thresholds for regulatory purposes, and offers ample chances for income splitting. By distributing earnings among family members or associated entities, these corporations can exploit lower tax rates. In terms of ownership, CCCs enjoy the advantage of operating with increased managerial autonomy and control, free from public scrutiny. The concentrated ownership structure not only facilitates streamlined decision-making processes but also enhances efficiency in tax planning and tax minimization efforts.

Leveraging Moody’s data and tax risk assessment toolkit

Utilizing Moody’s data and tax risk assessment toolkit presents a strategic approach for tax administrations to enhance their oversight of CCCs. This method provides comprehensive visibility into business operations across various tax jurisdictions. By employing Moody’s extensive database and analytic resources — which encompass detailed records of corporate ownership structures, direct and indirect ownership links, and in-depth financial data spanning several years — tax authorities can effectively identify CCCs and their associated entities.

By using Moody’s Tax Risk Catalyst tool, it becomes feasible to uncover practices such as income splitting and transfer pricing issues, which are frequently deployed to minimize tax liabilities [3]. Additionally, this tool aids in identifying exposure to tax havens, allowing for the examination of profit-shifting activities and the detection of corporate frameworks designed to facilitate aggressive tax planning strategies. This proactive approach significantly aids in upholding tax compliance and mitigating tax evasion risks.

Analysis provided by Moody’s Tax Risk Catalyst tool suggests there are several million CCCs globally, which provides a solid starting point for tax administrations to see how they are impacted and review the possible tax losses through such enterprises. The graph below shows CCC structures across high-tax and low-tax jurisdictions:

Graph: Tax Risk Catalyst model example of closely controlled corporation cross-jurisdictional structure with consolidated annual revenues of less than €750 million   

Conclusion

There are significant opportunities for CCCs to engage in tax minimization due to their flexible and less scrutinized regulatory requirements as well as close and direct involvement of individual owners and family members in running the businesses. The recent tax reforms engineered through the OECD and G20 nations have targeted the larger corporate entities, but there should be more scrutiny of the smaller corporate businesses that fly just beneath the radar of the OECD’s Pillar 2 €750 million revenue threshold. However, by leveraging Moody’s global data and tax risk tools, tax administrations are in a stronger position to identify and scrutinize these corporations to address potential tax losses and further enhance their work in closing their annual “tax gap” [4]. 

References
 

1. Moody’s, “Will changing international tax rules combat tax losses by countries?” June 2, 2022.
2. OECD/G20 Base Erosion and Profit Shifting Project, “Two-pillar solution to address the tax challenges arising from the digitalization of the economy,” October 2021.
3. Moody’s, “Tax risk management I Tax Risk Catalyst I explainer video,” February 10, 2023. 
4. OECD, “Tax Administration 2024: Comparative information on OECD and other advanced and emerging economies,” 2024.