Avoiding tax complexity for companies expanding offshore

By carefully managing the timing of a taxable presence, Australian
companies can expand offshore while keeping income tax obligations in
Australia – maximising franking credits and minimising tax complexity.

Many companies are looking offshore for new sales to foreign customers. The opportunity of being driven through the global recognition of Brand Australia for quality products in many industries.

When seeking global expansion, often the first step companies take is to establish a foreign subsidiary in each country. While this may be the long-term solution, it introduces a level of complexity in the early days when all efforts need to be focussed on generating sales.

The complexity arises as the foreign subsidiary is considered a taxable entity in its home country. The Australian company then must deal with not only the Australian Taxation Office but also the tax authorities in each country they establish a subsidiary. The risk arises of profits in one country and losses in another, the need for transfer pricing documentation, withholding taxes and loss of franking credits in Australia. Each of these issues can create tax leakage, less profits being available for distribution to shareholders and lower franking credits on dividends paid resulting in higher taxes at the shareholder level.

By careful planning, understanding how each country determines when a company needs to start paying tax in each foreign country and use of Australia’s double tax treaties, Australian companies can sell to overseas customers and only pay income tax in Australia. Foreign taxes can be limited to customs, GST and employee tax compliance.

When Australian companies expand offshore, a path to consider as they move from simply selling products to foreign customers is to commence operations in the foreign country by having the Australian company establish a presence overseas without establishing a taxable presence for as long as possible.

In considering this approach, planning for VAT/GST and customs is also necessary. This planning should take place irrespective of the model adopted for income tax.

Let’s break down the approach with each step explained in the context of taxation and international expansion:

1. Sale of Products to Foreign Customers:

• Initial Export: An Australian company starts by exporting goods or services to customers in a foreign country. At this stage, the company may not yet have any physical presence in the foreign country (no employees or inventory).
• Tax Consideration: From an Australian tax perspective, the company will likely be subject to Australian taxation on profits earned from the sale, but not in the foreign jurisdiction except for local VAT/GST or other indirect taxes.
• No Permanent Establishment (PE): At this point, the company does not create a "permanent establishment" (PE) in the foreign country. Under most tax treaties, the company does not have a taxable presence in the foreign country, meaning it would not be subject to local income taxes.

2. Stock of Goods in the Foreign Country:

• Establishing Inventory Abroad: The company may decide to store inventory in the foreign country, typically by using a third-party warehouse or a logistics provider. This could be in response to demand in the market or for more efficient distribution.
• Tax Consideration: If the company starts holding inventory in the foreign country, this may trigger the creation of a PE in that country, as many tax treaties consider a warehouse as a form of taxable presence.
• No Immediate Taxation: However, if the goods are simply stored (and not directly sold by employees), this stage might still allow the company to avoid paying tax in the foreign country. The company will likely continue to be subject to taxation only in Australia.

3. Hiring Employees Offshore:

• Establishing a Local Workforce: As demand in the foreign market grows, the company might hire employees locally (sales staff, management, or distribution personnel).
• Tax Consideration: Hiring employees in the foreign country may mean that the company has crossed the threshold for having a taxable presence. However, in many countries it will depend on the activities that the employees are undertaking. Where the employees are not concluding sales or signing contracts and those activities continue to be performed in Australia, it is likely that no taxable presence will exist at this stage.
• Permanent Establishment: Depending on the activities of the employees, where no taxable presence exists, income tax continues to be paid in Australia and not in the foreign country.
• It is at this stage that the company needs to know precisely what the triggers are in each country as it could create a PE in the foreign country. The local tax authorities may require the company to file taxes based on the activities conducted by the employees.

4. Determining When a Taxable Presence is Established:

• Tax Treaties and Permanent Establishment: The key question at this stage is whether a taxable presence has been established under the local tax laws and international tax treaties. Commonly, tax treaties define a PE based on the presence of a fixed place of business, personnel, or substantial business activities within the foreign country.
• Tax Deferral: Once a trigger applies in some cases, tax treaties allow companies to defer the creation of a taxable presence for some time (e.g., 12 months) or to limit what activities would trigger taxation. This means a company could continue selling products or holding stock without becoming taxable in the foreign country, depending on how it structures its operations and the treaty in place.

5. Maximising Franking Credits for Fully Franked Dividends:

• Franking Credits: When an Australian company pays dividends to its shareholders, it can pay these dividends "fully franked" (i.e., with a tax credit for the corporate taxes already paid in Australia). This allows shareholders to receive dividends without paying additional tax on those amounts, or with reduced tax depending on their tax status
• Minimising Double Taxation: To maximise the benefit of franking credits, Australian companies often look for ways to ensure that income is taxed primarily in Australia. By managing their foreign operations and structuring them in such a way that taxes are deferred or avoided in the foreign jurisdiction, companies can continue to pay fully franked dividends without triggering additional foreign tax obligations.

In Summary:

Australian companies expanding offshore often start by exporting products to foreign customers and gradually move toward establishing a more formal presence (warehouses, employees, etc.). They can manage the timing of creating a taxable presence carefully, using tax treaties to defer or limit foreign taxation. Compliance is streamlined by avoiding a foreign taxable presence for as long as possible and avoiding the complexities of transfer pricing and dealing with multiple tax authorities.

By adopting this approach, the company pays income tax in Australia only which maximises franking credits to ensure that dividends paid to Australian shareholders are fully franked and avoiding double taxation.

This approach can simplify tax compliance obligations and allow companies to focus their efforts on growth while knowing the triggers that will require foreign tax compliance in the future.