He wishes to exploit this ‘amazing’ technology overseas and asks you, his trusted accountant, what his options are. Whatever you propose must be the most tax-efficient structure in terms of cash flow and should give the best result for shareholders on future exit.
With the economy increasingly becoming global, many small to medium enterprises (SMEs) in Australia are looking to expand their operations overseas. Often taxpayers (and their tax advisers) that face such situations are unsure of how they can expand overseas and the consequences of doing so.
Structuring options
There are numerous ways in which Jimmy B Pty Ltd can exploit this technology overseas. Some of the key structuring options that can be considered are:
- manufacturing in Australia and exporting overseas directly
- manufacturing and selling overseas
- selling online
- setting up a foreign branch to sell overseas
- setting up a subsidiary overseas
- entering into a partnership with a third party and setting up a joint venture overseas
- licensing the technology to a subsidiary, joint-venture company or a third party.
What to consider
There are several key factors you need to consider when deciding which approach will suit you best.
1. Residency and source
An Australian resident will be taxed on income derived from all sources, including overseas. Therefore if an Australian resident entity sells offshore directly, the proceeds of sale will be taxed in Australia, regardless of where the purchaser of the goods or services is located. This will also be the case if goods are sold online.
Sometimes, where the customer is located in a jurisdiction that seeks to tax non-residents on income sourced in that jurisdiction, foreign sales may give rise to the potential for double taxation.
There are two main methods for relief from double taxation in this situation:
- a double tax agreement, or
- the availability of a foreign income tax offset (discussed below).
2. Know your double tax agreements
Double tax agreements (DTAs) are agreements between countries to determine which country has the source of income, the ultimate taxing rights and the applicable tax rates to that income.
It is important that taxpayers consider how DTAs can apply to them to determine how and where they are taxed. This ensures that taxpayers are not taxed twice.
The common forms of income that are usually covered under such agreements include:
- interest, dividend and royalty income
- income derived from real property
- business profits attributable to a permanent established of an Australian resident in the foreign country.
Generally speaking, DTAs can be used effectively to minimise withholding rates.
3. The availability of foreign income tax offsets
Foreign income tax offsets (FITOs) (which were previously referred to as foreign tax credits) may be available to an Australian resident for any foreign income tax paid on income, profits and gains (including gains of a capital nature).
Essentially, FITOs are:
- available in relation to all worldwide income
- only available to the extent that foreign income tax is paid
- non-refundable and cannot be carried forward for utilisation in income years following the year in which they arise
- applied to reduce Australian tax that would be payable on the foreign income that has been subjected to foreign income tax, and
- subject to a cap, which will require the taxpayer to undertake a calculation to the extent that the total foreign income tax paid in the income year is more than $1000.
4. Do you have a permanent establishment (PE)?
Where an Australian entity expands their offshore operations to more than merely selling their products overseas over the internet (for example, manufacturing products offshore, operating a foreign office or having staff employed offshore), this may result in the creation of a PE.
Whether a PE exists or not in a foreign country is a complex issue and depends on a number of factors. It is a question of fact and each case is considered separately.
If a foreign PE of the Australian entity does exist, the following tax outcomes will generally arise:
- in respect of foreign income and expenses attributable to the foreign PE, the Australian entity will be subject to tax in accordance with the domestic law of the foreign country
- subject to satisfying an active income test, income attributable to the foreign PE of an Australian company may be non-assessable and non-exempt in Australia (refer section 23AH of the ITAA 1936). Where the taxpayer is not a company, the income may be taxed in Australia and FITO is to be considered
- similarly, capital gains on active assets of the foreign PE of an Australian company may be able to be disregarded (refer subsection 23AH(3) of the ITAA 1936)
- withholding taxes may be levied by the foreign country on interest and royalties paid to Australia (if any), and
- no Australian tax deduction will be available for expenses incurred in deriving non-assessable income from the operations of the foreign PE.
5. Availability of franking credits
Corporate taxpayers should be mindful that no franking credits can arise in respect of any foreign tax paid. Consequently this increases the effective tax rate for any overseas profits distributed by Australian companies to their Australian shareholders. In some cases you may wish to factor in the tax leakage when deciding what to charge the overseas customer.
6. Be mindful of VAT/GST/customs duty
Aside from income tax, you also need to be mindful of indirect taxes and how they operate when you deal cross-border.
This may be further complicated where you source products or materials from different jurisdictions (ie outside Australia) and you sell elsewhere (eg the US).
7. Keep up-to-date with transfer pricing
Transfer pricing rules apply to ensure that international transactions between related parties are conducted on an arm’s length basis. The rules aim to prevent profit shifting from one jurisdiction to another.
For example, an offshore branch of an Australian parent which is located in a low-tax jurisdiction and which supplies goods or services to US customers may seek to recognise significant profits overseas rather than Australia and obtain significant tax benefits.
The transfer pricing rules ensure that where there are attempts to create non-arm’s length dealings, an arm’s length methodology is substituted to prevent profits shifting from Australia.
Therefore, it is important that taxpayers have up-to-date and accurate documentation that supports compliance with the arm’s length principle and provides evidence of the processes being undertaken to reach an arm’s length price on any international intra-group transactions.
8. Be smart – but not too smart
It is good to structure your tax affairs in a smart way so as to pay the minimum tax possible. However, remember that often there is a very thin line between tax minimisation and the application of the anti-avoidance rules here and overseas. So be smart about your tax affairs, but don’t get too smart.
9. Talk to the right people!
Moving your business offshore can be complicated and various factors need to be taken into consideration to make it a tax-effective move. We recommend taking professional tax advice in Australia and overseas before any decisions are made.
Disclaimer
The views in this article are those of the authors and do not represent the views of Deloitte Private or Deloitte Touche Tohmatsu or any of its related practice entities. This article is provided as general information only and does not consider anyone’s specific objectives, situation or needs. You should not rely on the information in this document.
