Expanding offshore - the tax conundrum

The downturn in the global economy is impacting businesses all around the world.  However, if nothing else, it has reminded us that there are plenty of opportunities even in recessionary times and robust business owners must be in a position to seize these opportunities when they arise. 

Globalisation is fast becoming a reality for many businesses. What then, should a business consider, when positioning itself to emerge from the credit crunch and seize the opportunities in front of them both locally and offshore? 

Certainly, tax implications are one of many factors which a business must consider when expanding offshore.  Understanding the volume of taxation legislation in Australia can be challenging.  In view of these complexities, we have highlighted below some common tax issues which a business would typically encounter in its offshore journey.

Setting up an optimal operating structure that will help you achieve your goals
Offshore operations can be undertaken using a range of vehicles – an offshore branch, joint venture or incorporation an offshore company – but the most appropriate structure to be adopted depends on the overall business objectives.  Businesses should keep in mind the size of their offshore operations, start up costs, laws and regulations of the foreign jurisdiction and the complexities of ongoing administration.

Australian tax regime for controlled foreign entities
Where an Australian company is considered to have control of a foreign subsidiary company, any profits derived by the foreign subsidiary may be assessable and taxed to the Australian parent despite these not actually being distributed to the Australian company.  Conversely, where the foreign subsidiary is considered to be deriving income from carrying on an active business and the profits are taxed in a comparably taxed jurisdiction no further taxes arise in Australia.  Branch operations are not subject to such taxes.

Returning profits back to Australia
Profitable foreign operations can return profits back to Australia by a number of mechanisms, including dividends, interest, royalties and management fees.  The most appropriate method of returning profit will depend on the individual business circumstances.  Businesses should consider ascertaining the most appropriate profit repatriation strategy to suit their circumstances.

Foreign tax credits
Where businesses have paid taxes in the foreign jurisdiction, a foreign tax credit is generally available to ensure there is no further taxation on the foreign sourced income in Australia.  Businesses need to maintain records of any taxes paid in foreign jurisdictions to support their entitlement to claim these tax credits.  Businesses should be aware that the application of the foreign tax credit rules has recently changed in Australia with regard to how the credits are applied and carried forward to future years. 
 
Global tax efficiency
Multinational businesses should be structured to ensure the taxes are legally minimised on a global scale.  This would require an analysis of after-tax income received and a comparison of tax rates in the respective jurisdictions.  This can be managed with effective transfer pricing planning (see below).  There are also incentives, concessions and grants offered by some jurisdictions depending on the nature of the operations and the business model.    

Transfer pricing
Transactions between an Australian entity and its foreign business operations must be conducted on pricing similar to transactions undertaken by unrelated parties. The Australian Taxation Office is currently performing rigorous reviews in respect of transfer prices charged between related parties and businesses need to ensure they have the appropriate documentation to show the arms length nature of their overseas transactions.

Thin capitalisation
Businesses expanding offshore also expose themselves to Australian thin capitalisation rules that put a cap on the amount of interest deductions available for multinational businesses.  Highly geared businesses should be cautious that interest deductions in Australia may be denied by the act of expanding offshore.  Businesses should maintain a thin capitalisation calculator in Australia (and possibly in other jurisdictions) and regularly monitor their debt levels to avoid breaching these rules.

Exit strategies
When planning to expand offshore, businesses should also consider exit strategies from the offshore market.  Depending on the exit strategy and structure adopted, differing tax outcomes arise.  There are Australian capital gains tax exemptions available for gains made on the sale of shares in a foreign company, where structured appropriately however, this exemption is not available for gain on the sale of foreign assets.

GST
While GST is intended to operate in relation to goods or services consumed in Australia it may still impact an entity that is providing goods and services to off-shore entities. The GST legislation lists certain categories of supplies of services which are treated as GST-free. However, a supply that falls into one of these categories may still be subject to GST if it has a connection with Australia and it would normally not be GST-free in Australia. There are further specific restrictions which may prevent the supply from losing its GST-free status. Determining whether these restrictions apply can be a complex task.

First time overseas investors must understand the importance of establishing the right structure initially in respect of their offshore operations.  Apart from the obvious risk of paying too much tax, undoing errors from the lack of tax planning can be far more costly after the fact, than during the initial set up phase.

Author: Ekanshu Khera, September 2009

Want advice or more information on this topic?
Click here to contact the author

Alternatively, phone Ekanshu directly
T +61 3 8663 6161