Tax Issues When Expanding Overseas

In this article we will look at some of the tax issues that an Australian business faces when expanding overseas. Some businesses may grow organically and the foreign countries involved may be determined by the location of their customers, whereas others may have some specific objectives and target a specific foreign country or countries. There are also a range of commercial issues, and these may impact on some of the tax issues.

It is not the intent of this article to provide an exhaustive list of all the different tax rules for all different tax structures. However, we will illustrate some of the tax issues using an example where we have assumed the Australian business is operating in a company (referred to here as ‘AusCo’). We will also focus on the tax issues from an Australian viewpoint. (Refer to this previous Assessment article which highlights some of the issues.)

Different Australian tax rules may apply depending on whether the activities in the destination foreign country are:

• a representative office of AusCo;
• a permanent establishment (PE), or branch, of AusCo;
• a foreign subsidiary of AusCo; or
• undertaken by an independent distributor appointed by AusCo.

Representative Office

A representative office (RO) usually refers to an office or business presence established by an entity (in our example, AusCo) in a foreign country to conduct activities (such as marketing and other non-transactional operations, liaison with distributors and/or customers, etc). The RO generally does not make sales or may be limited from generating revenue. However, they typically involve employees or contractors to assist with carrying out these activities.

An RO is not a separate entity, and therefore any tax issues will be the responsibility of AusCo. With limited activities in the foreign country, and if it does not (or cannot) derive revenue it is unlikely that the activities would comprise a PE (however, see further comments below). Assuming the RO is not a PE, the tax issues would essentially relate to how the costs are treated.

Whether the activities promote or generate sales made by AusCo (e.g., to foreign customers), AusCo would be entitled to claim income tax deductions for the costs of the RO.

Probably the main tax issue will relate to staff. If Australian based staff are employees, the normal PAYGW rules will apply. However, when those employees start spending time in the foreign country at the RO, AusCo would need to consider tax compliance in the foreign country. This would also be the case if the RO engages local staff in the foreign country. AusCo would then be legally responsible for any payroll-related tax compliance in the foreign country (e.g., payroll, PAYGW, etc.). Such activities would also likely require AusCo to establish a presence with the tax authority in the foreign country.

PE or Branch

A PE is a defined term (in s. 6(1) of the ITAA 1936) and means a place at or through which the person carries on any business, and has some specific inclusions (i.e., activities through an agent, installing substantial equipment/machinery, a construction project, etc.) and exclusions (i.e., engaging in business dealings through a bona fide commission agent, through an agent that does not have authority to conclude contracts, etc.).

PE is also a defined term in the Double Tax Agreements (DTAs) that Australia has with other countries, however that PE definition contains similar, but different, inclusions and exclusions.

A PE or branch is generally a business presence with activities that goes beyond a RO, and where those activities generate, or contribute to, revenue being derived. However, like an RO, those activities are still those of the same legal entity – AusCo.

If the activities do comprise a PE, from an Australian domestic tax viewpoint, s. 23AH (ITAA 1936) applies to treat the active foreign branch income of an Australian company as non-assessable, non-exempt (NANE) income. To determine this profit requires an allocation or apportionment of the income and deductions that relates to that PE/branch, and this profit allocation requires the application of Australia’s transfer pricing rules. Having applied these rules, that income and those deductions would not be subject to tax in Australia and would be excluded when AusCo calculates its taxable income.

The foreign country’s domestic rules will also usually seek to tax the profits in that country. However, if Australia has a DTA with the foreign country, this should be reviewed to determine if the foreign country has taxing rights. If the activities of AusCo are a PE under the DTA (and are not expressly excluded), then the foreign country will retain the right to tax the profits. As those profits are NANE in Australia, any tax paid in the foreign country would not be available as a foreign income tax offset (FITO) or foreign tax credit to AusCo.

Subsidiary

Where a foreign subsidiary (SubCo) is established, the application of the Australian tax rules will depend on what type of entity owns SubCo. Sticking with our AusCo example, for illustrative purposes, we have assumed SubCo is 100% owned by AusCo.

Unlike a RO and a PE, SubCo is a separate legal entity to AusCo. Having incorporated SubCo in the foreign country, the starting assumption is that the foreign country will have the right to tax the income/profits of SubCo.

Looking at this from an Australian tax viewpoint, the first issue is the tax residency of SubCo. Just because SubCo is incorporated in the foreign country doesn’t automatically mean that it will not be a tax resident of Australia. If SubCo has its central management and control (CMAC) in Australia, it would be an Australian tax resident under the Australian tax rules. If there is an applicable DTA, this would need to be reviewed and any tiebreaker may determine the tax residency.

Assuming SubCo is a resident of the foreign country and not a resident of Australia, the net income of SubCo would generally not fall within the ambit of the Australian tax regime – a non-tax resident of Australia deriving foreign income. However, transactions between AusCo and SubCo will be subject to Australia’s transfer pricing rules (and the transfer pricing rules of the foreign country).

Next, Australia’s controlled foreign company (CFC) rules should be considered. Broadly, if SubCo is a company in one of the listed countries (France, Italy, Germany, New Zealand, United Kingdom, Japan, United States – considered to have similar and comparable tax regimes), or the income of SubCo is from an active business, then the CFC rules would not apply to attribute income of SubCo’s activities to AusCo. If this is the case, the profits of SubCo would be taxed in the foreign country and not taxed in Australia.

Assuming the above, the next thing to consider is when the profits of SubCo are repatriated to Australia. When SubCo declares and pays a dividend to AusCo, such income will generally be NANE (via Division 768-A, as AusCo owns more than 10% of SubCo). Being NANE, if any dividend withholding tax (WHT) applies when the dividend is paid, that WHT (and the company tax paid in the foreign country) would not be available as a FITO to AusCo.

Independent Distributor

One way AusCo could expand overseas would be via appointing an independent distributor in the foreign country. While an independent distributor can be appointed to sell goods or services, they are more typically appointed to sell and manage the distribution of goods.

Assuming an independent distributor is appointed (and AusCo does not have an RO, PE or SubCo in the foreign country), AusCo’s activities would generally just be taxed in Australia and not taxed in the foreign country. However, there may still be other tax issues, and non-tax issues, particularly if staff employed by AusCo spend time in the foreign country.

Other Comments

While not dealt with in this article, there remains a range of other tax (and commercial) issues to consider, such as:

• indirect taxes from both an Australian viewpoint and in the foreign country;
• any funding requirements, including whether thin capitalisation rules apply;
• withholding taxes;
• visas for AusCo staff working in the foreign country;
• different structures/entities (on the Australian side and the foreign side);
• regulatory issues (including licensing, corporate regulation/registrations;
• banking/bank accounts;
• websites and e-commerce;

Also, we have only touched on some of the tax issues that may arise in the foreign country. Ideally, advice should be obtained about how taxes apply fundamentally in the foreign country and the key tax compliance and reporting obligations. These are likely to impact on the potential structures to adopt in the foreign country.

Transfer pricing is also a major consideration. The rules are conceptually simple – international related party dealings should be done, and charged, reflecting arm’s length transactions – but this requires the push and pull of both jurisdictions seeking to retain its fair share of the profits. It also comes with compliance and documentation requirements.

Repatriation of profits, and the overall effective tax rate, should also be considered and not underestimated. It often comes as a surprise to the ultimate Australian individual owners when the effective tax rate of the profits derived from the foreign country exceeds Australian highest marginal tax rate. (Refer to this previous Assessment article which illustrates this.)

If you need assistance navigating these issues, Webb Martin Consulting is able to help. As a member of the PrimeGlobal association, we can also draw on other PrimeGlobal member firms for guidance on how the tax rules apply in foreign countries.

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