So, you’ve decided that your business is going to expand overseas?
Most business owners put a high priority on the commercial reasons for launching into new markets, but what about the tax and structural issues that come with offshore expansion? The structure you take into a new market can have a huge impact on how much tax is paid in Australia and overseas.
We’ve outlined some of the key tax and structural issues Australian business operators need to think about when expanding overseas:
Getting your structure right – branch vs subsidiary
The most common structures for managing offshore business activities are through either a branch of an existing Australian company or a new subsidiary established in the foreign country.
|Liability & risk exposure||A branch is treated as an extension of its Australian parent company. As it is not a separate legal entity in its own right, its parent company remains accountable and responsible for all the debts and liabilities of the branch. A branch structure would inevitably expose the Australian company directly to the regulatory environment of the foreign country.||A subsidiary company is a separate legal entity in its own right therefore, the risks and liabilities of the foreign subsidiary company do not generally extend to its Australian parent company.
As a general rule, limited liability protection is extremely important to all types of businesses.
|Tax systems & incentives (see Tax considerations below)||Some countries offer specific tax incentives to local companies. A branch is generally unable to access these concessions.||A subsidiary company may be able to take advantage of tax incentives available to maximise the overall returns to the ultimate Australian owners.|
|Compliance & accounting||A branch is generally required to submit the financial statements of the Australian parent company to the local authorities.||A subsidiary company is generally required to lodge its own financial accounts and tax return with the regulatory and revenue authorities in the foreign country.
For those Australian companies reluctant to disclose their sensitive and confidential financial information in other jurisdictions, a subsidiary may be a preferred option over a branch.
Although this does not always guarantee protection as increasingly, regulators are looking to ensure that the relationship between related entities is disclosed.
|Market presence||A branch may be a simple and cost effective option to ‘test the waters’ of offshore expansion.||Some customers, suppliers and financial institutions may prefer to deal with a local company rather than the branch of a foreign entity.|
This table is a broad overview of the issues involved in the two dominant structures. There are a lot more issues involved in selecting the right structure. The tax systems, legal and regulatory requirements of a foreign jurisdiction are important factors that all need to be taken into account. Some of the issues may not be clear or readily understood by business operators without local knowledge and input.
The tax considerations and consequences
The tax treatment of profits or gains made by an offshore business in both the foreign country and Australia can have a significant impact on the net returns to the owners. Unfortunately, many business owners leave the tax considerations until it is too late and end up paying far more tax than they really need to.
It is important to obtain advice as early as possible on how the foreign country’s taxation system operates and how it interacts with the Australian tax system to ensure that the operations are structured in a tax efficient manner. This includes reviewing any applicable double taxation agreements that Australia has entered into with foreign governments. Australia currently has income tax agreements with around 45 different countries.
Here are some of the key Australian tax issues that need to be considered if you establish a company structure offshore:
Repatriation of profits to Australia
Dividends received by an Australian resident shareholder from a foreign company would normally be taxed in Australia. The shareholder might then be able to claim a foreign income tax offset for any withholding tax deducted from the payment in the foreign country. However, no tax relief can generally be claimed in Australia for corporate tax that the company has paid in the foreign country.
There is a specific exemption that applies where an Australian company holds at least 10% of the shares in a foreign company. If certain conditions are met then the dividend paid by the foreign company is not subject to Australian tax in the hands of the Australian company which holds the shares. This effectively defers the Australian taxing point until the Australian company subsequently pays dividends to its shareholders. It is important to remember that the Australian company would not be generating any Australian franking credits in relation to the foreign profits, even if they have been taxed overseas.
CGT implications when you sell
Where Australian residents hold shares in a foreign company, the sale of shares in the company would be subject to capital gains tax (CGT). However, where shares in the foreign company are held by an Australian company, there is a special concession which can apply to reduce the capital gain (or loss) made by the Australian company if the foreign resident company holds assets that are used in active business activities. The main condition to access this concession is that the Australian company must have held at least a 10% voting interest in the foreign company for a continuous period of at least 12 months in the 2 years before the sale of the shares.
Foreign controlled company rules (CFC rules)
Broadly, the CFC provisions are designed to tax Australian residents on the income of foreign companies that are controlled by Australian residents in the year the profits are derived by the foreign company (i.e., even if no dividends have been paid to the shareholders).
The main exceptions to this are where the income of the foreign company is subject to a tax system that is similar to Australia’s or where the company is predominantly engaged in active business activities in the foreign company.
Transfer pricing rules
The purpose of the transfer pricing rules is to prevent companies avoiding or underpaying tax in Australia by inflating the fees and charges for goods and services between international related parties.
The transfer pricing rules basically apply when the prices charged between international related parties are not consistent with the prices that would be charged between parties that were not related. The main focus of the Australian Tax Office (ATO) when applying these rules is to ensure that profits are not being artificially shifted outside Australia, especially to lower taxed or “tax haven” countries.
Transfer pricing has been a focus of the ATO for many years and continues to be an audit target. Businesses with offshore related party transactions need to carefully assess their level of compliance with the transfer pricing rules and have adequate documentation in place to support their transfer pricing policies.
Thin capitalisation rules
In very broad terms, the thin capitalisation rules are designed to place a limit on the amount of interest deductions that can be claimed by an entity where its Australian operations or assets are heavily funded by debt rather than equity. This is to prevent debts being loaded into the Australian entity. The thin capitalisation rules do not apply where the entity and its associates have total interest deductions of $2 million or less for the relevant income year.
Goods and services tax (GST)
There are a range of specific GST rules that can apply to cross border business dealings. While GST is really only intended to apply to goods and services that are consumed in Australia, the rules can be complex and it is important to ensure that they are considered carefully as early in the process as possible.
When you’re taking your business offshore, you are often bombarded with information. Let us help you make the process a smooth one and ensure that your business is structured in a way that you can achieve the best possible outcome. Contact me on +61 2 9221 6666 or email at email@example.com.