An Australian resident taxpayer has started increasing its sales to international customers, mainly across Asia. Should the taxpayer set up a company offshore?
The Taxpayer carries on its operations through an Australian company. Assume the company is owned by Australian resident individual shareholders who are taxed at the top marginal rate (currently 49%).
With increased sales to customers in various Asian countries, the Taxpayer is considering setting up an entity in Asia. They are currently looking at either Singapore or Hong Kong. As Singapore has a company tax rate of 17% and Hong Kong has a company tax rate of 16.5%, the Taxpayer considers that either of these options would provide immediate tax savings (when compared to the Australian corporate tax rate of 30%).
The above scenario is not uncommon for growing Australian businesses. Generally the increased customer base outside Australia means the business may benefit by having some staff on the ground so that they can more readily liaise with their Asian-based customers. While tax is generally not the primary reason for looking to set up offshore, they see the lower tax rates as a bonus. However, Taxpayers sometimes fail to take into account the full tax picture.
Assume the net profit from sales into Asia is approximately A$100,000. Let’s also assume the Taxpayer chose Hong Kong as the location of its new office, and set up a HK company as a subsidiary of the Australian company.
The Taxpayer sees the outcome as follows:
For Australia’s Controlled Foreign Company (CFC) rules we have assumed the Hong Kong income is active income.
Note the above outcome assumes the profit is retained in Hong Kong.
What happens if the profits are repatriated back to Australia?
Where the Hong Kong company declares and pays a dividend to the Australian company, the amount received will be treated as ‘non-assessable, non-exempt’ (or NANE). Therefore, the profits can be repatriated back to the Australian company without any additional Australian company tax.
However, if the Australian company was to pay this profit out as a dividend, practically the $83,500 would be paid as an unfranked dividend. As no Australian company tax has been paid, there would be no franking credits attached and the full $83,500 would be subject to tax in the hands on the individual shareholders at their marginal rates. Assuming they are on the top marginal rate of 49% tax of A$40,915 would be payable, leaving the individual with $42,585 after tax. The effective tax rate to the individual is in the order of 57%.
When planning for expansion offshore, consideration of the overall picture is fundamental, as it can be expensive to change a structure after the foreign entity is already deriving profits. Ultimately, the right structure takes into account the commercial benefits as well as the tax implications and cashflows.